The Land of Three Currencies

Vietnam is in danger of falling back into inflation.

In the annals of easy-money policies over the last decade, Vietnam deserves its own chapter.

Hanoi tried to use cheap credit to spur growth while neglecting fundamental reforms.

Now it is reaping the consequences.

Year-on-year consumer price inflation hit 11.75% last month, a 22-month high.

Erosion of the domestic value of  the currency has also helped weaken the Vietnamese dong externally.

All this is dissuading investors from holding dong assets, and capital is fleeing the country.

More could flee if Vietnamese firms have trouble making good on their debt.

The state-owned shipbuilder Vinashin defaulted on a $600 million international loan last month.

Moody’s and Standard & Poor’s downgraded the country’s debt rating in the past month; Fitch did so last July.

Four or five years ago, encouraged by cheap loans, such firms were enjoying the ride.

They ramped up investment, which, as the country’s Communist rulers intended, boosted GDP growth.

The State Bank of Vietnam, the central bank, allowed annual credit growth of around 50% in 2007.

The country was itching to follow China’s model of investment-led, credit-powered growth.

Now the credit expansion boom is leading to a bust.

Vietnam saw inflation at 28.3% in mid-2008—a 17-year high—a rate that makes today’s environment look benign in comparison.

Workers were striking at factories to demand higher wages, as they saw their purchasing power destroyed.

The aftermath of the global recession temporarily caused inflationary pressures to ease, but with the central bank cutting rates and encouraging lending, it wasn’t long before overheating reared its head again in late 2009.

In response, Hanoi enacted a law, in effect from last October, that gives the state the power to impose price controls.

Foreign businesses complained that the law unfairly targets their imports.

As with China, some of the price increases (particularly for food) have been caused by temporary shortages due to poor harvests.

Some of it could also be attributed to productivity increases and a secular rise in household purchasing power, typical in a growing economy.

But headline inflation wouldn’t be increasing at the rate it is without loose monetary policy.

Nor would households be saving and transacting in gold and U.S. dollars if they weren’t afraid of an increasingly debased dong.

Vietnam is again becoming a land of three currencies, as it was in  the 1980s when inflation at one point hit nearly 500%.

The economic solution is straightforward: the State Bank of Vietnam should be tightening.

The central bank did hike its primary policy rate by one percentage point in early November, but judging by the sheer buildup in inflation expectations, the bank is far behind the curve.

The problem is that the State Bank—which isn’t independent of government—remains politically focused on growth.

So last month, despite the threat of inflation, it capped the interest rates banks charge for loans, to ensure firms don’t run into too much trouble accessing credit.

The Communist Party of Vietnam, with its iron grip on power, wants to follow the Chinese model of growth.

As Beijing is finding out, an investment-led economy is a liability in a sluggish global economy.

Vietnam is in an even more precarious position as it has failed to free up its private sector and encourage productivity growth.

If it continues to promote credit growth without such reforms, continuously accelerating inflation will result.

Source: AWSJ



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