“The State Bank of Vietnam will have to start explicitly tightening monetary policy as early as this year,” Johanna Chua, the Hong Kong-based head of Asian economic research for Citigroup, said in a note dated Wednesday. “Maintaining the current loose policies is unsustainable” as inflation may begin accelerating this month, she said.

The State Bank of Vietnam’s benchmark lending rate has held at 7 percent since February, after having been cut from 14 percent in October 2008. The central bank said last month it would hold the rate at its current level for now in an attempt to ensure that the country records economic growth of at least 5 percent this year.

The Vietnamese currency is forecast to depreciate and the current level of the benchmark rate is putting pressure on bank margins, Chua said. Recent monthly figures have suggested inflation is picking up, while “weakening pressure on the Vietnamese dong will persist,” she added.

Vietnam’s inflation eased to 2 percent in August, down from 28.3 percent a year earlier and was the slowest rate since 2002.

The currency’s so-called official exchange rate Thursday was about 17,834 per dollar, down from 17,483 at the end of 2008. Vietnam Holding Ltd. this week estimated the free-market exchange rate of the dong at about 18,300 per dollar.

Depreciation pressure

The Asian Development Bank said this month the dong faces depreciation pressure, while Vinacapital Investment Management Ltd. said accelerating inflation may create a currency risk next year.

“It is a good signal that foreign banks have started offering U.S. dollars again in the interbank market after months of staying on the buy side,” Ho Chi Minh City-based fund manager Dragon Capital said.

“The State Bank of Vietnam has done a reasonable job of anchoring depreciation expectations in the 18,000-19,000 per dollar range,” Dragon said in a weekly note to investors.

A “rigid” foreign-exchange peg, as well as the country’s trade deficit and “lackluster” capital flows are hurting Vietnam’s foreign reserves, which fell to $17.6 billion by the end of June from $23 billion at the end of 2008, said Chua.

“The State Bank of Vietnam’s tolerance for significant erosion of foreign reserves from here will likely diminish following the sharp drop,” she wrote. “With export recovery (ex-gold) lagging some of the region, we expect the State Bank of Vietnam to be willing to move the official dollar-dong weaker to prevent significant pressure on reserves.”

Source: Bloomberg