Pressure on monetary policy

The State Bank of Vietnam (SBV)’s efforts since April to regulate liquidity through the bond market have led to a sharp increase in interbank VND interest rates. While the interest rate gap between the VND and USD has narrowed somewhat, the exchange rate continues to rise steadily. Analysts suggest that given the substantial global inflationary pressures, domestic exchange rates are unlikely to stabilize in the near future.

Exchange rates

A wave of optimism briefly swept through global financial markets at the beginning of 2024, fueled by investor beliefs that the battle against inflation was nearing an end and that central banks would soon relax monetary policies. Such expectations, however, failed to materialize, replaced by unexpected shocks.

In Vietnam, exchange rates became a focal point as early as March. Experts attribute this to the prolonged VND - USD interest rate differential, which has persisted for nearly nine months since mid-2023, when the SBV began reducing interest rates to bolster economic growth.

Comprehensive data on the balance of payments indicates that Vietnam continued to benefit from positive FDI disbursements in 2023. However, there has been a notable increase in the outflow of investment capital from Vietnam since the second quarter of 2023, coinciding with the central bank’s successive reductions in policy interest rates. The significant interest rate differential between the VND and global benchmark rates resulted in estimated deficits in both the capital and financial accounts in 2023, reaching approximately 0.7 per cent of GDP.

In discussions with Vietnam Economic Times / VnEconomy, Mr. Nguyen Ba Hung, Chief Economist at the Asian Development Bank (ADB) in Vietnam, said that given the current USD - VND interest rate gap, the ongoing trend of withdrawing funds for markets with higher interest rates is expected to persist for a few more months, adding to the strain on the balance of payments.

The exchange rate experienced minimal pressure in 2023 due to a record-breaking trade surplus of $28 billion. However, it is essential to note that the surplus primarily resulted from a rapid decline in imports. Total exports in 2023 amounted to $355.5 billion, equivalent to 83 per cent of GDP and down 4.4 per cent compared to 2022. Meanwhile, imports fell to $327.5 billion, approximately 76 per cent of GDP, for a decline of 8.9 per cent, according to ADB data.

Heightened production activity has spurred increased demand for USD to facilitate the importation of raw materials. According to figures from the General Statistics Office, imports in the first quarter totaled approximately $85 billion, a 14 per cent increase year-on-year, while foreign currency revenues from export operations typically exhibit a lag.

Furthermore, the interest rate gap encourages speculative actions like stockpiling foreign currency to capitalize on the difference.

These market dynamics, both domestically and globally, have led to consecutive record-breaking exchange rates since the start of April.

Given this scenario, there has been speculation that the SBV may need to tap into its foreign exchange reserves to stabilize the exchange rate. However, Mr. Hung suggested that the current level of exchange rate fluctuation remains manageable for policymakers and does not warrant any selling to support the VND.

The research team at DSC Securities, meanwhile, pointed out that the leeway for exchange rate adjustments based on foreign reserves is becoming limited. Foreign reserves are under $100 billion, while import demands are expected to rise in the months to come.

Path to take

The SBV has activated the bond auction channel since March 11 to counter exchange rate speculation, by reducing the amount of VND in circulation and narrowing the interest rate gap between the VND and the USD in the interbank market.

In contrast to the situation at the end of 2023, this time around, policymakers are showing great resolve, immediately introducing 28-day term bonds (previously, only seven-day term bonds were auctioned during the initial phase). Interest rates have also surged sharply, from 1.4 per cent to 3.5 per cent per annum, which represents a significant increase from the 0.5-1.5 per cent per annum seen at the end of last year.

Influenced by the SBV’s net withdrawal of VND, interbank interest rates have also risen. As of April 17, the average overnight interbank VND interest rate stood at 4.92 per cent per annum; its highest since June 2023.

However, on the same day, the interbank USD/VND exchange rate rose to VND25,373 per USD; the highest level for 52 weeks. From the beginning of the year until now, the interbank exchange rate has increased 4.63 per cent and 8.02 per cent year-on-year.

Many analysts argue that the SBV lacks the necessary flexibility to pursue a multi-targeted monetary policy aimed at “controlling inflation, stabilizing the exchange rate, and fostering growth.”

Amid the backdrop of escalating political tensions, there is a possibility that the exchange rate could surpass the central bank’s predetermined threshold. In such a scenario, more assertive measures like increasing the benchmark interest rate may be under consideration by mid-year.

Additionally, to address the unpredictable fluctuations in the exchange rate, the SBV has proposed amendments to Circular No. 02/2021/TT-NHNN regarding the USD/VND forward exchange rate, with two significant revisions.

Firstly, the forward exchange rate between the VND and USD will be determined through negotiations between participating parties and will adhere to regulations set forth by the central bank for each specific period.

Secondly, there will no longer be specific criteria defining the three bases used to determine the forward exchange rate, as was previously the case. These bases typically included the spot exchange rate of USD/VND on the transaction date, the difference between current interest rates, including the rediscount rate announced by the SBV and the USD target rate of the US Fed, and the term of the transaction.

According to Mr. Trinh Viet Hoang Minh, an analyst with ACBS, the pressure on the USD/VND exchange rate is expected to persist until the US Fed officially reduces interest rates. Consequently, the SBV must employ flexible measures to effectively support the market, including managing VND liquidity to adjust the USD-VND interest rate gap and supplying foreign currency to meet market demands if a shortage of USD appears.

“In recent weeks, liquidity adjustments through bond channels have not effectively cooled the exchange rate,” Mr. Minh said. “Therefore, we anticipate that the SBV will soon need to utilize alternative tools, like forward foreign exchange sales to banks. The revisions to Circular No. 02 will provide flexibility for the central bank to proactively set forward USD selling prices, enhancing intervention in the foreign exchange market.”