The State Bank of Vietnam began taking immediate measures to tighten monetary policy at the beginning of 2008. However, there are still doubts about whether the central bank’s measures will help keep the inflation rate below the economic growth rate.

On January 16, Governor of the State Bank decided to raise the compulsory reserve ratio for deposits of different terms from 10% to 11%.

This was a slight increase in the required compulsory reserve ratio, which was easily accepted by commercial banks, though it certainly made banks’ capital mobilization cost higher.

However, 11% looks like it will not be the last compulsory reserve ratio increase. According to Huynh The Du, Lecturer at the Fulbright Economics Teaching Program, the decision by the central bank to withdraw VND20tril from circulation means that the central bank has indirectly raised the compulsory reserve ratio by another 3-4% to 15%.

“Because the central bank will force commercial banks to buy VND20tril of promissory notes, commercial banks will be forced into an even higher compulsory reserve ratio,” said Mr. Du.

He added that the only difference is that banks can receive interest from the promissory notes, while they cannot with the compulsory reserve.

Prior to that, in June 2007, the State Bank of Vietnam decided to double the compulsory reserve ratio, from 5% to 10%. The decision then faced strong opposition from commercial banks, since this made their capital mobilization cost increase by 0.25%.

The central bank, once again, has decided to act strongly towards curbing inflation. Analysts have warned that this will negatively impact the market, especially as banks are seriously lacking capital in VND.

Right after the central bank’s measures to tighten the monetary policy, some banks had to stop loan disbursements, as the inter-bank interest rate at one point hit 25% per annum.

“I don’t understand why the State Bank decided to take such a strong measure, an action that will surely shock the market. This is a very sensitive time, and the central bank needs to tread more lightly. We need to withdraw money from circulation to curb inflation; but I’m afraid the central bank will only cause monetary market troubles,” said Mr. Du.

According to Mr. Du, commercial banks’ efforts to limit lending reveal liquidity problems.

“Tightening the monetary policy may help curb inflation, but too strong of measures will not bring about the desired effects and could result in the collapse of the entire banking system,” he added.

“I think that the State Bank is determined to slow inflation, buts its inflexible policies are dangerous,” he continued.

In principle, in a stable economy with a strong monetary market, strong actions would bring about the desired results. However, Vietnam’s market possesses neither of the above traits, and needs careful decisions and a softer touch.

One banker, who asked not to be named, also expressed his concern that banks’ low liquidity will adversely affect client confidence.

According to Mr. Du, instead of tightening monetary policy to curb inflation, the Government should consider delaying the implementation of several State funded projects that demand huge injections of capital.

Mr. Du fears that the goal to keep inflation below the economic growth rate may be unrealized anyway due to weaknesses in monetary policy, bad weather in the north which has decimated agricultural production and because of material price fluctuations on the world market.

Source: Tien phong