Neighbours uneasy with cheaper dong

But measures seen as only temporary relief

28/11/2009

Vietnam's decision to devalue its currency by 5% this week is likely to have a major impact on neighbouring countries, an expert on the country said.

"It is very attractive destination for investments and now it has just made itself more attractive," noted Wittaya Supatanakul, a retired general manager of Bangkok Bank's Vietnam office and now adviser to the Board of Investment's CLMV (Cambodia, Laos, Myanmar, Vietnam) projects.

Vietnam, one of the main competitors of Thailand, on Wednesday announced that it was devaluing its currency and raising interest rates.

Vietnam's central bank said the devaluation and the increase in the policy interest rate by 100 basis points to 8% was necessary to relieve the pressure on the dong and protect foreign reserves.

The State Bank of Vietnam devalued the dong by 5.4%, effective on Thursday, resetting the US dollar reference rate to 17,961 dong from its current level of 17,034 dong.

"This is not good news for Thailand, as there are various sectors in which Thailand is a direct competitor to Vietnam; namely, the garment, textile and footwear industries," Mr Wittaya said.

Other sectors such as agriculture and food processing could be hurt as well because Thailand and Vietnam compete in the global market for exports.

Santi Vilassakdanont, chairman of the Federation of Thai Industries (FTI), said Thailand's exports could be hurt, especially rice, in which Vietnam is running neck-and-neck with Thailand to become the world's largest exporter.

He said that foreign investors may also turn to Vietnam instead of Thailand since costs would be cheaper, he said.

Finance Minister Korn Chatikavanij, however, disagreed, saying that the dong devaluation would not lead to Thailand changing its monetary policy as the impacts were going to be very limited.

He explained that Thai goods were of higher quality and are therefore less susceptible to potential impacts. Citing a similar move by the Vietnamese authorities in 2008, Mr Korn said Thai exports were barely affected.

Mr Wittaya said the impacts on rice and marine products would be very limited as rice prices are now determined by global demand and the marine products Vietnam is exporting serve the lower end of the market, although some of the Thai exports compete in this segment.

Despite the devaluation news, latest reports suggest that the dong was trading at between 19,600 and 19,800 to the US dollar.

The central bank also narrowed the trading band of the dollar against the dong to 3% from 5%. The move is Vietnam's third devaluation in two years.

Apart from this, the central bank will lift its benchmark interest rate to 8% from 7% from Dec 1.

"This move to raise the rates is going to have an impact on Vietnam but not too much as businesses there are already enjoying a 4% interest-rate subsidy from the government. This simply means the subsidy falls to 3%, and therefore the overall impact is minimal," Mr Wittaya said.

He added that the 4% subsidy was set to be halved to 2% next year.

Hanoi is offering the subsidy as part of the stimulus package to keep the economic growth going during the recent global financial crisis.

Yet economists pointed out that the new measures are likely to be only a temporary relief for the country.

"The SBV's (State Bank of Vietnam) moves may work temporarily, but as we have noted previously, inflation and the trade deficit are on the rise again, and the fiscal deficit and lack of institutional capacity are serious concerns," Matt Hildebrandt, an economist for JP Morgan said in a note to clients.

"Thus, even if these moves bring the official and unofficial dong rates closer together temporarily over the medium term, they will likely diverge again unless the government can effectively address the deterioration in the macroeconomic environment."

This move reflects the central bank's continued attempt to balance several economic objectives at once amid a weak policy framework and deteriorating economic fundamentals. The devaluation is aimed at making exports cheaper to support growth, reduce the trade deficit, and slow the pace of foreign exchange reserve losses, now reportedly down to US$16 billion from around $23 billion at the beginning of the year, he said.

The rise in the policy rate is aimed at restraining inflation, which just rose to 4.4% year-on-year in November, and slowing credit growth, which was already up 33% year-to-date in October compared to the full-year target of 30% in 2009.

The SBV seems to believe that by weakening the dong to a level closer to the unofficial rate, a more market-determined rate of around 20,000, tightening the band to 3% from 5% to show commitment to this new midpoint, and increasing domestic rates to support the currency at its new level, pressure on the dong to depreciate will diminish.

The interest-rate increase was its first move since lowering the base rate to 7% (from 8.5%) in January, and it makes the SBV the first central bank in emerging market Asia to lift interest rates.

"We expect inflation to rise further to around 10% year-on-year by mid-year, which will likely provoke further monetary tightening by the SBV in the first half of next year," Mr Hildebrandt said.