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Vietnam’s loose monetary policy a stability threat

US dollar and Vietnam dong banknotes at a branch of VPBank in Hanoi, November 2017.
US dollar and Vietnam dong banknotes at a branch of VPBank in Hanoi, November 2017.

Vietnam’s overly loose monetary policy poses a downside risk to macroeconomic stability, according to a new analysis by Fitch Solutions.
A new report by Fitch Solutions Macro Research, a unit of Fitch Group, forecasts that the State Bank of Vietnam (SBV) will opt to keep its benchmark refinancing rate at 6.25 percent this year, to balance.

This level will be kept steady to balance growth and inflation objectives, the report said.

Fitch Solutions also expects policy makers to adopt selective tightening measures, such as tightening lending or implementing macroprudential policies.

It noted that although the SBV is gradually modernizing its monetary policy framework – moving towards inflation as the nominal anchor and allowing more exchange rate flexibility, it still uses credit growth targets as the main monetary tool.

Overall, Fitch Solutions believes the central bank’s monetary policy stance and banking liquidity remain too loose. At present, this has not yet impacted on macroeconomic stability but there are downside risks.

In fact, the SBV has moved towards a tighter monetary stance since the beginning of the year, as seen by a slightly lower credit growth target (17 percent as opposed to 18 percent in 2017).

Credit growth in the first eight months was lower year-on-year at 8.2 percent, compared to 10.8 percent last year. At the same time, the central bank has kept the benchmark refinancing rate at 6.25 percent for 15 consecutive months.

The central bank also announced tighter lending regulations in August. In October, the SBV instructed commercial banks to maintain control over new loans in high risk industries like real estate, consumer credit and securities investment.

Despite these measures, Fitch Solutions considers Vietnam’s monetary policy to be too loose. Interbank rates were still significantly lower than refinancing and discount rates, limiting the effectiveness of the SBV’s monetary transmission mechanism, it said.

As of October 7, the overnight interbank rate stood at only 3.14 percent, with the one-month interbank rate at 4.11 percent, while refinancing and discount rates were 6.25 percent and 4.25 percent respectively.

This is partly due to the SBV’s efforts to build foreign reserves without full sterilization, the report noted.

Although inflation remains relatively low (4 percent in the past two months), the liquidity surplus is likely to increase inflation, as well as result in more non-performing loans as interest rates may be distorted.

At the same time, credit growth at 17-18 percent per annum is still much higher than nominal GDP growth (11-12 percent). This is a concern, as the credit-to-GDP ratio of the private sector has risen to 130.7 percent in 2017, according to the World Bank, up from 96.8 percent in 2013.

This indicates the economy’s reliance on credit for growth, which is unsustainable, the report said.

The amount of leverage in Vietnam’s economy is also significantly higher than those of other countries in the region, such as the Philippines (47.8 percent), Indonesia (38.7 percent), Cambodia (86.7 percent) and Malaysia (124 percent).

Fitch Solutions concluded that if distortions in the economy continue to grow, it will increase the risk of a subsequent unwinding of the credit binge, due to domestic and exogenous shocks (such as the collapse of the real estate market 2010 – 2012) being more painful. The economy would grow less and over longer periods than the previous banking crisis, it warned.

Several Vietnamese experts have found Fitch Solutions’ analysis valid, based on two factors: credit size and the K-ratio (the consistency of an equity’s return over time).

Can Van Luc, chief economist of state-owned lender BIDV commented: “Not only Fitch, but other international organisations such as the IMF have also made similar observations, that Vietnam needs to control the size and quality of credit to ensure a healthier system”.

He explained that Vietnam’s credit-to-GDP ratio was 130 percent in 2017 and is projected to grow to 137-138 percent of GDP this year.

In addition, the equity consistency ratio is currently quite low, given that credit has grown by 15-16 percent but bank equity has only increased by 8-9 percent. A low K-ratio means that it will be difficult for Vietnam to meet Basel II’s banking regulations in the upcoming period.

Pham The Anh, a lecturer at Hanoi-based National Economics University, said that an increase in the money supply would result in higher prices, which is not good for the economy.

He believed that if GDP growth this year could reach or exceed the target of 6.7 percent, monetary policy should be tightened to avoid a spike in inflation.

“There is no need to try to achieve even higher growth rates, which is very risky for the economy. If we have overcome the downturn and transitioned into a period of stable growth, we should be relying less on currency and credit stimulus,” The Anh said.

The professor also noted that if inflation rises, one of the ways to counteract it is to raise interest rates but this comes at an expensive ‘price’.

“Increasing interest rates will reduce long-term growth, affecting the financial well being of businesses. Preventing inflation is always easier than trying to remedy it,” he added.