1. A booming of high inflation

Although causing many difficulties to the majority of Vietnamese residents who had enjoined more than a decade of smoothly economic growth, under-controlled and low inflation, and increasing foreign investment, the inflation of 12.6 percent in 2007 did not confuse the leadership and policy-makers in Vietnam as the food price fever - with an increase up to 10.5 percent just in February 2008 – does. CPI in the February 2008 increased with a rate of 6%, comparing to that of December 2007, making up the highest CPI increase in the last 13 years. Inflation forecasts has turned from pessimistic numbers (8 – 8.5% of GDP) into 12 - 17%. Moreover, CPI in May 2008 did increase 16 percent, comparing to that of December 2007. It is said that CPI is hardly kept with an increase of 1% in the last seven month of 2008. According to a statement made by the Prime Minister Nguyen Tan Dung, two digit inflation is expected to continue in next year, and it may decrease to a certain level in late 2009, at best. High inflation affects the whole socio-economic life of the nation, therefore it is a decisive factor to the content of management policies, and measures provided by the Government.

2. Inflation is a disaster

Vietnam just got rid of galloping inflation for some time, impressions of inflation aftermaths are still clear in many people’s mind; thus, the return of high inflation has caused rather much concern to the society.

High inflation destroys achievements of economic development, people living standard improvements, and poverty gained over the last two decades..

As a country ranks in the top lowest income countries of the world, prices of foods and grain are of first interest of Vietnamese consumers. Since the country got rid of the high inflation in 1985-1990 and became the second rice exporting country of the world, grain price increases have happened sparsely and being ceased rapidly thanks to the usage of rice exporting valve. Urban people have given up the habit of storing rice in their house even though rice is the most important food to a majority of Vietnamese people. However, in May, people flocked into the market for rice and storing in their house, making rice prices increased unexpectedly, just because of some rumor about rice shortage. This shows a standing instability to the goods given the unbalance of demand and supply particularly, and the world shorting of foods generally that would unavoidably affect Vietnam. The Governmental decision of temporarily stop exporting rice until June may ease urban consumers on the one hand, but causing losses to rice producers on the other hand. The most suffering group of the decision is farmers. Hence, it is required to provide rice producers with some compensation for their losses caused by the State decision of stop exporting rice for macro regulation targets. Only by doing this, rice producers particularly and farmers generally are treated equally as other groups. In addition, the article allowing grant agricultural subsidy of 10 percent to some countries, including Vietnam, in WTO has not taped by Vietnam. At present, agricultural subsidy is just 2 percent in Vietnam.

While increases in petroleum and fertilizer prices are causing difficulties to farmers, expensive prices of foods, consumer goods and services, and contracting employments as aftermaths of inflation also make a part of urban people become the poor.

Increasing inflation resulted from shortcomings in monetary policy management

The first shortcoming is rapidly and continuously store-buying a large amount of US dollar with an effort to stop the appreciation of VND against this currency, thus creating a shortage of the currency in the market. Speaking at a section of the National Assembly meeting in 31^st May 2008, the Governor of State Bank announced that the bank had absorbed from market circulation 80 percent of the money issued to buy US dollar. There were no evident for the statement, while the market followed it own rule: more money injected into the market makes prices increase. The robust inflation increase since the beginning of 2008 rejected the argument that a large amount of money issued to buy US dollar in 2007 have been absorbed from circulation.

In addition to the store-bought of dollar, a range of administrative measures have also been applied in some early month of 2008, including the decision of limiting foreign currency sold to importing enterprises as a way to reduce trade deficit which reached US$ 14 billion in May 2008. However, the decision could not make the credit flow tell the difference between export and import on its own. As a result, both export and import enterprises faced difficulties in accessing foreign currency capital. The decision made enterprises have to buy USD at the rate of VND 18,200/ USD while the quoted rate announced by the State Bank was VND 16,200/ USD.

A high-tech zone management board, when buying foreign currencies at banks, also had to pay additional fees of VND1,600/US$1 and 10% of VAT on transaction fees, which meant it had to pay VND1,760/US$1 more than the quoted exchange rate.

It has been asked if Vietnam actually lacks foreign currencies. If the answer is ‘yes’, then how can businesses still buy foreign currencies if they agree to pay higher prices?

Fiscal activism

While receiving a large amount of external funds is the root cause of the current inflation, it is not the only cause. Fiscal activism is an additional internal factor which accelerates the economic boom created by the injection of external purchasing

power.

Supported by strong economic performance, the Vietnamese government has ambitious plans to upgrade the country's infrastructure. Sustaining high growth is a top priority and any sign of slowdown is met by renewed efforts to accelerate public investment projects and secure their inputs by any means.

According to GSO, the budget deficit amounted to 5% of GDP in 2006 and is increasing.

Pro-cyclical fiscal spending has also been observed elsewhere including Indonesia and a number of resource-rich Latin American countries such as Mexico and Brazil. As the economy grows strongly, public investment is also expanded to provide necessary infrastructure and diversify economic structure. However, risks associated with such policy should be well recognized. Aggressive spending may lead to huge indebtedness and economic crisis when the situation turns around.

Both commodity markets and investor psychology are known to fluctuate wildly over time. Countries with externally driven booms should install mechanisms to smooth these swings, including a public fund to save windfall revenues for rainy days.

In sum, current inflation in Vietnam should be understood as the consequence of three combined forces: (i) pressure from the large inflow of foreign funds (main cause); (ii) aggressive public investment; and (iii) exogenous and largely uncontrollable shocks from global commodity markets, animal diseases, and natural disasters.

Three complaints about interest rate policy

First, banks are trying to limit loaning because they cannot let their credit grow by more than 30% this year over last year. Banks have capital, but they dare not lend money.

Second, businesses complain that their credit limits have been lowered, while they still have high demands for loans for re-investment and business expansion.

Third, businesses even have to re-negotiate lending interest rates on contracts they signed with banks a long time ago and of which 20-30% of the money has been disbursed. In most cases, they have to accept higher interest rates.

“The 21% per annum interest rate proves to be unaffordable for us. And the more risky thing is that the lending interest rate is not stable, which makes us unable to set up our business plan,” said the director of a joint stock company.

Businesses weeping, banks too

The general director of a big bank said that he well understands the problems of businesses, but he also said that banks themselves now are unhappy.

“Businesses want stable interest rates. But the deposit interest rates fluctuate all the time due to the high inflation. How can we keep the lending interest rates stable?” he asked.

Pham Xuan Lap, General Director of state-owned Vietinbank, has called on businesses to check corporate governance in order to cut expenses. He has also called on businesses to reconsider sales methods and try to collect money early and use loans in the most effective ways.

Bankers say that they don’t want to lend at high interest rates, but they have no other choice. Vietinbank, for example, has the average capital mobilisation cost of 19.5% per annum, while it lends at around 21% – a modest margin.

If inflation goes down, interest rates will go down too

Deputy Governor of the State Bank of Vietnam Tran Minh Tuan has promised that commercial banks will provide businesses with enough capital, but according to the new interest rate base. As the capital mobilisation cost is 18% per annum for banks in HCM City, they cannot lend money at low interest rates.

Statistics show that by June 26, banks in HCM City had gained the growth rates of 7% in capital mobilisation and 20.9% in lending.

Experts say that when inflation goes down, interest rates will go down too. As the central bank is continuing its tightened monetary policies, commercial banks will focus on providing working capital to businesses, while limiting providing loans for investments.

Source: VNEP, June 2008.