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    Southeast Asia
     Sep 22, 2009
Vietnam teeters towards a currency crisis
By Duy Hoang

The Vietnamese currency, the dong, could face a significant devaluation, given worsening macroeconomic conditions and deteriorating financial fundamentals. The country has traditionally run large fiscal and trade deficits financed by foreign inflows, but there are growing signs that the imbalances are no longer sustainable.

The roots of the present crisis date to late 2007 and early 2008, when Vietnamese authorities lost control of their money supply. Authorities mismanaged the influx of US dollars into the economy by printing excessively more dong, forgetting the technocratic rule about sterilizing currency inflows by soaking up excess liquidity.

Inflation predictably accelerated, roaring ahead at nearly 30% by

 
mid-2008, and Hanoi responded by increasing short-term interest rates, implementing price controls and announcing cutbacks in "inefficient" government spending. The country was saved from runaway inflation by the global financial meltdown in late 2008, which depressed global commodity prices and demand.

Almost overnight Vietnam went from an economy that was too hot to one that was too cold. Prime Minister Nguyen Tan Dung in response announced a large fiscal stimulus program - ironically reinstating large infrastructure projects that just months before were considered too wasteful and had to be chopped.

Most governments also ramped up spending to stimulate their domestic economies, but Vietnam faces technical and political constraints on its ability to efficiently pump-prime. Hanoi's fiscal deficit, estimated by Fitch Ratings at a large 9.3% of gross domestic product (GDP), must be financed somehow.

Apart from more foreign donor aid, the main traditional avenue is to issue more government debt. But the Vietnamese government has failed to sell any bonds in five consecutive public auctions between March and July this year. Local investors opted against purchasing notes at 9% interest rates, underscoring widespread pessimism about future inflation risks.

In the most recent bond auction, in late August, Vietnam's Treasury managed to raise just US$57 million out of a hoped for $150 million. Government debt plays a vital role in pricing corporate and consumer borrowings, and without an orderly government bond market, global experience shows that capital markets often grind to a halt.

Unable to raise capital through bond issuances, Hanoi will probably aim to unload its debt onto private and state-owned financial institutions, sowing the seeds for a future banking crisis. At the moment, Vietnam cannot access outside debt markets: earlier plans for an international bond issue were shelved indefinitely after rating agencies downgraded Vietnam's credit to junk status, on par with the likes of Serbia and Kenya.

Few will be surprised if Hanoi decides to ramp up the monetary printing presses to close its huge budget gap. The World Bank says it doesn't know exactly how much the Vietnamese government is spending because of a lack of official transparency, but that it is "too large compared with the financing resources available".

Lack of transparency
Vietnam's precarious fiscal position is compounded by a large and volatile trade deficit. According to a recent Standard Chartered Bank forecast, imports will outrun exports by some $7 billion this year, representing nearly 10% of GDP. This, too, has potentially grave implications for the future value of the Vietnamese dong.

The country's main sources of foreign exchange are exports, foreign direct investment, remittances from overseas Vietnamese and donor aid. With the global downturn, all of these income sources - with the notable exception of donor flows - have drastically fallen off. Local newspapers now report a widespread shortage of dollars for business transactions.

Because Hanoi treats information about its foreign reserve levels as a state secret, investors can only guess at how much is in the national coffers to defend the dong against speculative attack. Foreign reserves have probably fallen $17.6 billion by June 2009 from $23 billion at the end of 2008, according to Citibank.

All of these factors - unsustainable government deficit, reduced foreign inflows, and a lack of transparency - have led to a steady fall in the dong. The exchange rate is at around 18,300 dong per US dollar, which is at the upper end of the trading band set by the central bank. Many Vietnamese individuals and firms are known to be hoarding their dollars or dealing in the black market, where the rates are north of 19,000, higher than allowed by the government.

The official line is that there will be no devaluation of the dong. Indeed, the central bank has sold dollars to prop up the dong, but it's unclear how long it can sustain the interventions before its limited foreign currency reserves are exhausted. By maintaining the currency at an unrealistically strong exchange rate and ignoring the underlying financial imbalances, authorities are by the day increasing the likelihood of a currency collapse.

It is possible that the government is unsure about how to handle its exchange rate policy. Former central bank governor Le Duc Thuy, who advises the prime minister, was quoted in an interview on September 16 recommending a slight devaluation of the local unit. The following day, when asked whether the central bank planned to depreciate the currency, current governor Nguyen Van Giau insisted that the dong would be managed "with flexibility, as normal".

Exchange-rate management is at the best of times a vexing technical challenge, particularly for a country in transition from a command to market-based economy. With maneuvering for the next Communist Party Congress underway, it is unlikely there will be any bold economic decisions from Hanoi in the foreseeable future. But many analysts believe that simply muddling through could be a recipe for disaster.

To compound those suspicions, the government has effectively banned groups in Vietnam from publishing research on economic issues. A new decree from the prime minister came into effect on September 15 limiting scientific and technical research to 317 specifically approved topics; macroeconomics is glaringly one of the subjects omitted from the list.

The Institute of Development Studies (IDS), Vietnam's only private think-tank, decided to disband in protest the day before the decree took effect. IDS gathered some of the country's most eminent economists and had suggested solutions to tackle the financial mess. With public debate on economic matters now forbidden, it is hard to see how the government will pursue well-informed policies to stabilize an accelerating crisis situation.

Duy Hoang is a US-based leader of Viet Tan, a pro-democracy, unsanctioned political party active in Vietnam. He was formerly a principle financial officer at the International Finance Corporation responsible for local currency financing in Vietnam.

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