Since the beginning of the year, policy statements by the government, researchers and the media accompanied by various policy proposals, most recently Resolution 11, have created lively discussion about Vietnam’s economy in 2011.

To simply present those ideas, we need to look at three major problems for the government’s policy agenda this year:

* Problems of stabilising the exchange rate, interest rates and inflation in three to six months.

* Another “accompanied” problem is to reduce the budget deficit by cutting public investment, a key element to macro stabilisation for solving the short-term problems mentioned above, but in the long-term for changing the economic structure, seriously lacking efficiency (reflected by the very high ICOR), by reducing public investment and replacing it with more efficient private investment.

* The next problem, after solving the above two problems, is to help break the frozen stock and real estate markets, which are considered “non-productive” areas for credit allocation, although they are truly the two long-term capital mobilisation channels.

Stabilisation of exchange rates, interest rates and inflation

Within the framework of Resolution 11, the State Bank sought to stabilise the exchange rate through two major packages of measures:

* Stabilising the gold market and reducing the difference between the domestic gold and world prices by administrative measures (but there still is serious doubt about the sustainability and efficiency of these administrative measures), to reduce hoarding of dollar for smuggling gold.

* Reducing inflation expectations through the adoption of tight money and credit policies with specific measures announced in the last few weeks which all aim to reduce pressures on the exchange and interest rates. Quantitative limits on money supply M2 and on domestic credit for the whole banking system and each individual bank, increasing the major intervention interest rates of the State Bank twice to 12 per cent and recently to 13 per cent, imposing more difficult conditions to reduce foreign currency borrowing. This is the main source for strong credit growth in the first quarter of this year.

On April 9, the State Bank issued some additional logic measures such as increasing reserve requirements on short-term and long-term dollar deposits and lowering dollar deposit interest rate to 3 per cent. These took aim at two short-term goals for stabilising the money market:

* Increasing the attractiveness and value of the dong to stabilise the exchange rate in the short-term and encouraging residents and businesses to shift from dollar to dong holdings or local currency accounts.

* Efforts to reduce dollarisation in the long-term, together with stricter foreign exchange management.

The State Bank also increased the interbank exchange rate to the highest level of VND20,723 per dollar. Therefore, commercial banks can apply the exchange rate of VND20,930 with the current permitted band of 1 per cent, or quite close to the free market exchange rate.

This is probably a sign that the State Bank is ready to allow a more flexible exchange rate policy and also create the opportunity to end the parallel rates. Due to the difference between the official exchange rate of VND20,930 per dollar applied at banks and the free market rate of VND21,000-21,100 for small transactions and VND21,200-21,300 for large transactions, the State Bank may eventually allow banks to apply a larger band of 3 per cent on the interbank rate. The application of the band of 3 per cent will make the official exchange rate be up to VND21,344, such rate would make it equal to the black market rate. Residents and businesses will bring more foreign currency to commercial banks for exchange and in the next few months, the rate could be back to VND21,000 because of the abundant foreign currency supply. Thereby, this would help commercial banks to shift their activities from borrowing-lending dollars to buying-selling dollars. When the State Bank prepares its plan to manage the gold market, commercial banks may also participate in buying-selling gold pieces.

What is the outlook for local and foreign currency interest rates in the second quarter and the whole of 2011?

The answer is not as simple as a tightened money policy continuing at least into the second quarter and most people have shifted their “free” money flows (or rather the “smart” money) from VND to gold and dollars, so the dong interest rates will continue to be high in the second quarter due to the lack of liquidity. The existing deposit rate is sill about 17-18 per cent, beyond the legal ceiling rate of 14 per cent and the lending rate is about 20-23 per cent. However, due to the new above measures to reduce the attractiveness of lending and mobilisation of foreign currencies, it is possible to hope that VND rates will start to fall from the third quarter with more supply of the domestic currency, especially if the State Bank continues to adopt new measures such as:

(i) Reducing commercial banks’ foreign currency state from 30 to 20 per cent

(ii) Administrative measures to reduce the share of dollar lending in total credit.

One main reason why the State Bank has hesitated to reduce dollar interest rates for a long time is because it did not want to drastically reduce the amount of overseas Vietnamese’s remittances, about $8 billion annually. The hot money flows into Vietnam were designed to enjoy high dollar interest rates, which meant the money could exit Vietnam at any time. Reducing the dolalr rate to 1-2 per cent in the future could make this hot money exit Vietnam. As local residents are also expected to gradually shift their “free” money flows from dollar back into dong, the State Bank should also prepare gradually measures to neutralise the necessary amount of dong issued for buying dollar in the present context of tight money policy.

In summary, from the third quarter of 2011, local and foreign currency interest rates could fall if the government succeeds in reducing inflation from the third quarter.

The promise of reducing the budget deficit and public investment in reality?

This is the most watched policy issue. Will the government immediately shift to loosen policy for supporting the economic growth target when inflation begins to reduce or persist with a tightened monetary and fiscal policy?

It is indeed difficult to predict the moves of the government, due to the political pressures on the new government and National Assembly after May-June if there is a marked slow-down in national output as a result of tightening credit in the early months of the year.

In any event, it is now more than a month since the issuing of Resolution 11 on February 24, there have been no specific measures and clear quantitative targets on reducing the budget deficit.

An initial statement by the Ministry of Planning and Investment, which is to cut public investment by about VND3,400 billion ($160 million), is not really realistic. This is because it is too little compared with total such spending of some $15-16 billion, or with the aim of reducing the budget deficit below 5 per cent of GDP this year. In addition, and most importantly, if the recent statements by the National Assembly Budget Committee had not indicated the need to revise the revenues and expenditures of the 2011 budget, it is clear that the awaited adjustment in fiscal policy is not yet taken seriously.

Problem of solving the frozen state of the stock market and the real estate bubble

For a solution, domestic and foreign investors have to think about Vietnam’s economic outlook in the medium-term and the inevitable question is that can the current macro imbalances be overcome?

An optimistic prediction is that these imbalances will be gradually repaired in the short-term, about six months, through reducing inflation from the third quarter and the stability of the exchange rates as stated above. But to completely repair the macro imbalances, remedies will be needed for three years from 2011.

If the State Bank really reduces dollar interest rates as the above prediction for reducing dollarisation, the hot money in the form of the overseas inflows will decline, but the hot money into the stock market will probably increase due to the expected recovery of the stock market with the VN-Index perhaps bypassing the 500 point level.

But what about the real estate bubble? Will it explode?

Vietnam’s real estate market is complex and depends on land or houses along with an important factor in all markets, their location.

However, a segment of the real estate bubble is being gradually “deflated” as the prices of high-end condominiums are forecast to decline by 20-30 per cent this year and reduce further by about 10-20 per cent in 2012, but the bubble is probably hard to explode because most of the real estate assets in Vietnam are paid in cash instead of bank credit as in many other countries.

However, there will be liquidity difficulties for commercial banks with the large debt amount of some VND350,000 billion related to real estate. Bad debts will increase. If the policy on tightening credit continues to be applied by the State Bank, it is not excluded that some small banks might face bankruptcy and be merged with other banks.

It is difficult to find the certain answers for the above problems. The expected results will depend on the persistence of the government’s policies in the next three years to restore the macroeconomic balances which were lost during 2007-2010. In summary, there are perhaps only two scenarios as follows:

* An optimistic medium-term scenario: the government succeeds in firmly applying Resolution 11 along with the subsequent adequate measures; or

* A pessimistic scenario: these difficulties continue throughout the rest of the year, due to the lack of consistency of policies such as if fiscal policy does not support monetary policy, or if monetary policy is loosened in the third quarter causing high inflation to continue with more difficult financial imbalances from 2011’s third quarter to mid-2012.

Source: VIR