Why is Vietnam’s interest rate still high?
admin 19-09-2020, 07:49

Although the State Bank of Vietnam (SBV) has twice cut its policy rate this year, in March and May, to 4.5% (Figure 1, with data from Tradingeconomics), overall interest rates Vietnam’s economy remains high in the region, even compared to the same ranking economies as the Philippines, Indonesia or India.

Many individuals and organizations have recommended the SBV to lower policy rates further in the context of still high domestic interest rates and many countries are continuing to loosen monetary policy and even quantitative easing ( central banks directly buy government bonds) since the beginning of this year.

Why is Vietnam’s interest rate still high?

In fact, it is not possible to simply look at the interest rate differential with other economies to call for lowering interest rates in Vietnam. Because interest rates can be reduced or not and how much depends first on the inflation rate of Vietnam compared to the region and the world.

As Figure 2 shows, while the general trend when a pandemic breaks out is that inflation tends to drop sharply, even to below zero, but in some countries like Vietnam and India, inflation is still at a significant level, over 3% / year in recent months.

It is noteworthy in Figure 2 that there is a clear relationship between inflation and interest rates. Countries with lower and even negative inflation such as Singapore, Malaysia and Thailand, their interest rates also fall to very low levels.

Indonesia is one of the exceptions. Although their inflation has been relatively low in recent months, interest rates have not been cut accordingly – slowed down at 4% since the last adjustment in July this year. This is because the country’s central bank fears further cuts in policy rates will further undermine its currency, which has dropped 1% in value against the US dollar, becoming a fruitful currency worst rate in the region in August so they decided to keep interest rates unchanged after 2 policy meetings this month.

Thus, it can be seen that exchange rate is also one of the other important parameters to decide whether to cut interest rates or not. Regarding Vietnam, it is hard to deny that moderately reduced interest rates are a factor, besides direct intervention in the exchange rate (buying into USD by the SBV), helping to maintain the stability of the USD / VND exchange rate during the past time.

Exchange rate stability may be a priority policy of the State Bank in recent years. This stability can be seen as a successful indicator of the SBV’s monetary and exchange rate policy management. In the context that the US accuses Vietnam of manipulating the currency, the SBV has more reasons to not loosen monetary policy too much (further cut interest rates) to weaken the exchange rate, because doing so will help confirm the legitimacy of the US accusation.

In the coming months, should the SBV be able to, or should, cut more interest rates to support the economy? The answer must firstly depend on the evolution of inflation in Vietnam in the coming time. If inflation continues to soften, it is clear that the SBV will have more room to cut interest rates further.

While this rate cut could affect exchange rate stability and cause the dong to slightly depreciate its nominal value against the USD, this is not, should not be, considered a risk factor for US trade retaliation. Because, as I have argued before, accusations of currency manipulation of the US or any other country are not allowed to rely on domestic policy actions such as loosening monetary policy (to export promotion and economic growth), which is only allowed based on clear evidence that the host country intervenes directly in the exchange rate (buy USD, sell the currency).

It should be further noted that given that the inflation gap between the US and Vietnam remains relatively significant this year (and the coming years), the real exchange rate of the VND to USD has been and will continue to increase, photo negatively affects the competitiveness of Vietnamese goods and services. Therefore, maintaining a stable nominal dong versus USD exchange rate will not be enough to limit this real appreciation of the dong. Instead, it is necessary to let the nominal dong-to-USD exchange rate weaken according to the inflation gap between the two countries, as well as the inflation in Vietnam itself against the set inflation target.

The adjustment of the weaker nominal exchange rate, if any, should be done mainly through adjusting the policy interest rates instead of direct intervention by buying USD as in the past.

Source: ndh.vn – Translated by fintel.vn