News Room - Business/Economics

Posted on 25 Mar 2008

Vietnam's overheating economy

The communist government in Vietnam, showered with praise for posting a booming 8.5% growth rate last year, is now facing a tough challenge—how to keep its economy from overheating. Over the past few months, both ordinary residents and international financial experts have been wondering how Vietnam plans to tackle its spiralling inflation rate, which topped 15% in February year-on-year. 

The rise in consumer prices is a result of Vietnam's economic success: steady direct foreign investment (about US$20 billion promised for 2008), improved quality of life and huge state investments, which have sparked a credit crunch.

Experts, including analysts at the International Monetary Fund (IMF), have cautioned the Southeast Asian country about the dangers of high inflation and a widening trade deficit, estimated at US$12.4 billion in 2007.

Vietnam is now also more vulnerable to global economic shocks since it joined the World Trade Organisation one-year ago, they say.

"We think the fundamental story that makes Vietnam such an attractive destination remains true," Benedict Bingham, IMF senior resident representative, told AFP.

"Vietnam has a bright future if it continues to keep the pace of economic reforms, but maintaining macroeconomic stability is fundamental."

Faced with mounting public anger over high prices, especially from the poor who do not see immediate benefits of the country's success and are finding it increasingly difficult to make ends meet, the government took action.

The central bank raised benchmark interest rates for the first time since December 2005, and Vietnam ordered banks to increase their dong and foreign currency reserves, the proportion of funds they must hold relative to loans.

Authorities also ordered local lenders to buy up government bonds to drain dong from the financial system, thereby putting a cap on spending.

Vietnam has also allowed the dong to marginally gain against the dollar, meaning cheaper imports from abroad.

"My impression is that the government is in a process of sorting out its economic priorities. It's a new situation for them," Bingham said.

But faced with opposition, mostly from exporters who want their products to remain cheap on world markets, the government has hesitated to go further.

"There's a camp in the government that believes competitiveness is at risk. So they allow the dong to appreciate step by step," Ayumi Konishi, country director at the Asian Development Bank, told AFP.

Though the United States is the most important market for Vietnamese exports, taking more than 20% of the total, "the fact is that the dong is still depreciating against many other currencies," said Konishi.

If the government wants to tackle inflation effectively, it needs to ensure coordination of its fiscal, monetary and pricing policies, experts say.

"It doesn't make sense if on one hand the state bank shows its determination to tighten monetary policy and if at the same time the government increases oil prices," Konishi said.

"This coordination is a big challenge and so far, regrettably I have to say they haven't done too great."

The IMF would prefer that Vietnam focus on a controlled rise in interest rates rather than squeezing liquidity, which can send rates soaring, Bingham said, noting that an economic slowdown in the short-term could be the solution.

"They need to control short-term interest rates and increase them sufficiently so that they become positive in real terms and maintain them at that level until inflation starts going down," he said.

"But to do so, they need a consensus on the fact that some short-term slowdown in growth is acceptable in order to bring inflation down."