VIETNAM CURRENCY: GOING GOING DONG? British Embassy, Hanoi

Transcription

1 VIETNAM CURRENCY: GOING GOING DONG? British Embassy, Hanoi March 2009

2 VIETNAM CURRENCY: GOING GOING DONG? SUMMARY 1. A devaluation of the Vietnamese Dong (VND) looks almost inevitable in The question is will it be orderly or disorderly, and will it matter? A gradual devaluation ( a crawling peg ) seems somewhat more likely. DETAIL 2. The world financial crisis has reminded us once again that, in the long run, markets have a habit of returning into balance (e.g. Iceland). In SE Asia the country with the most striking macroeconomic imbalances is Vietnam, with a current account deficit of 13.7% of GDP in Their imports hugely outweigh their exports. How has the situation developed? 3. Vietnam maintains a pegged exchange rate, and each Foreign Exchange transaction requires supporting documentation of a physical trade. In other words, the exchange rate is government-determined, not market-set. 4. To finance the huge current account deficit in 2008, Vietnam needed US$17.5 billion of foreign exchange. This came from: foreign direct investment (US$11.5 billion in 2008), remittances from overseas workers (US$8 billion), and overseas development assistance (est US$2 billion). This more than financed the current account deficit (as reflected in growing FX reserves in the chart below). But FDI and remittances are likely to fall in 2009 and FDI could plummet after the unusually high levels in 2007 and Recent pressures on the Dong 5. The government did allow the Dong to devalue in 2008: a 2% increase in the official rate (11 June); a 3% increase in the official rate (25 December).

3 They also widened the trading band: from 0.75% to 1% (10 March); from 1% to 2% (27 June); from 2% to 3% (7 November). 6. After each devaluation, and after each widening of the band, the Dong has traded at the top (i.e. the weakest rate allowed). The black market rate trades 2-3% weaker than the official rate. 7. But this fall is modest compared to other currencies such as Sterling and the Indonesian Rupiah (20% apiece) and really reflects the strength of the Dollar rather than a Dong depreciation. Source: Vietnam Monitor Issue 21 (HSBC, Jan 2009) 8. The Dong devaluation was driven by economic fundamentals (high inflation (averaging 22.4% in 2008), current account deficit (13.7% of GDP) and negative real interest rates (the central bank cut rates five times in Q4 2008). 9. There is a limit to how much investor sentiment can impact the value of the Dong (given that it cannot be freely traded by currency traders). But the IMF and World Bank in Vietnam are taking no chances and have avoided making any comments on the value of the currency. What will happen next? -Downward pressures will intensify 10. External financing is expected to decline sharply in 2009, for the following reasons:

4 Foreign investment is likely to fall as the global credit crunch continues to worsen. As FDI accounted for US$11.5 billion of Vietnam s $17.5 billion capital account in 2008, a dramatic fall in FDI in Vietnam would similarly have serious implications for the financing of the capital account. Export revenue will be the next thing to be hit. Vietnam s exports-gdp ratio is over 60% (compared to the UK s level of 26%). As an open trading nation, her exports will be disproportionately hit (although her imports will also drop as well, somewhat mitigating the impact). Equally important, with 30% of exports as crude oil, her export receipts will be hit by the recent drop in the oil price (72% since June 2008). Reduction in remittances from overseas workers in response to the economic slowdown (although this has not yet materialized according to most recent data). Vietnam s defences are low 11. Since early 2007, Vietnam ceased publishing FX reserves figures (which in itself can be taken as a cause for concern). Banks have managed to scavenge some data FX reserves were put at US$24 billion as of the end of Q3 2008, and the latest number from the Prime Minister s speeches is US$25 billion. To put this (unconfirmed) figure in perspective, Vietnam s FX Reserves are only equivalent to 3 months of import cover the minimum amount generally considered safe. If the capital account (FDI, remittances and ODA) dries up (as many expect), Vietnam will continue to use up its reserves to finance its purchases of imports. But there is a limit to how far this process could go. Which is why the authorities are likely to devalue the Dong 12. Local bankers are therefore forecasting devaluation in the range of 3-10% of GDP. This would make exports more competitive (especially given the devaluations of competitor nations) and encourage inward investment, essentially bringing the current account deficit to a more sustainable level. 13. The Minister of Finance, Vu Van Ninh, is on record as saying that Vietnam would not depreciate the currency to encourage exports. Independent experts increasingly however reckon on a gradual devaluation of the Dong, which would benefit the economy and relieve the intense pressure on the foreign exchange market.

5 One Temptation not to devalue 14. While overall government debt is sustainable (47% of GDP compared with the UK s 55%), Vietnam is running a high level of external debt at over 30% of GDP. A Dong depreciation would increase the value of this external debt. Besides, several key export sectors of Vietnam highly depend on imported materials for production. A devaluation could give another inflationary shock to the economy. Facing the rising demand for the US Dollar and the declining confidence in the local currency, the government have recently announced their decision to issue bonds in US Dollars, in an attempt to balance the market demand and cover the budget deficit. Comment 15. The government have reasons to resist substantial devaluation: a dent to prestige and a desire not to increase the (local) value of their foreign currency debts. They have tools to prevent devaluation (pegging the exchange rate and forbidding currency trading). But can they really buck the market? 16. They have low defences (FX reserves) and the pressures on the currency are likely to increase as FDI and remittances slow. If the reserves were becoming exhausted, a black-market exchange rate could emerge and undermine the official rate driving business into the grey economy. Examples of this have already emerged: in 2008, banks disintermediated the official US-Dong exchange rate by trading through Euros (the government quickly plugged that loophole), and anecdotally we have heard that police officers visited banks to check the official exchange rate was being used. The greater the gap between the free market value and the official exchange rate, the greater the profit incentive for individuals to shift to the grey-market economy. 17. The optimal outcome might be for the government to continue its crawling peg policy and follow the December 3% devaluation with further gradual moves throughout the year. Given that policymakers chose to devalue twice last year (and three times widen the trading band), we anticipate they may continue this policy of gradual devaluation. But if the authorities attempt to buck the market, the government could face the prospect of a more drastic devaluation (or accept a growing black-market exchange in market-priced Dong).

6 Relevance for the UK 18. The Vietnamese Government may be keen to explore ways to support their FX reserves/currency. The Chiang-Mai Initiative (ASEAN + Japan, Korea and Hong Kong) may well appeal this is an Asian attempt to multilaterlise bilateral swap arrangements to stabilise currencies, currently being worked on. Vietnam may also wish to approach IFIs should their reserves drop and they become unable to hold the currency peg. 19. UK businesses in Vietnam may wish to consider possible currency movements when making investment decisions. More information on this market is available from the Vietnamese market page or alternatively contact your regional trade team