Vietnam's Economy Struggles to Keep up with Success

Despite Vietnam's economic success to date and certainly Vietnam's recent progress has been quite stunning, the Vietnamese government in January 2008 said the annual inflation rate had hit 14.1% - its highest since 1995. Shortly after, on January 30th, the central bank raised its various official interest rates by up to 1.5 percentage points to try to prevent an inflationary spiral, reported the Economist magazine in a recent article.  Vietnam along with many other countries in the region and worldwide is suffering from the worldwide surge in the cost of fuels and food prices which are up by a raise 22% year-on-year.

Resource: Department of Statistics
Graph by: Runckel & Associates

Vietnam's economy grew by around 8.5% in 2007, one of Asia's most impressive rates, having grown by an average of 7.5% annually in the previous decade. At the same item, bank lending is expanding fast (by 37% last year) and there is huge demand for building materials and equipment, exacerbating the risk of overheating.

Nevertheless, the government, keen to keep the good times rolling, does not want to cool the economy down. In January the prime minister, Nguyen Tan Dzung, reiterated his “determination” to ramp up this year's growth to 9%. But Nguyen Van Giau, the governor of the State Bank of Vietnam, the central bank, admitted that curbing price rises was “very urgent”. As well he might: the rising cost of living has caused a rash of strikes and the papers daily report concerns and complaints from local persons on the rise in prices on all commodities and goods.  The next day the prime minister gave another speech, calling for a “well-managed monetary policy” and urging improvements in the central bank's forecasting and supervision—which sounded rather like a public dressing-down to the governor.

Vietnam's inflation target is not very exacting: the aim is only that it should fall below the rate of economic growth. But even this proved too hard last year, when inflation was around four percentage points higher than growth. After the Prime Minister's , the central bank tightened banks' reserve requirements, to rein in their lending. (China, also worried by rising food prices, announced similar measures the same day.) However, the Vietnamese central bank this week loosened some restrictions on lending for share purchasing, imposed last year to discourage investors from borrowing to bet heavily on the then soaring stockmarket. The measures were, it seems, too successful: the main VN share index ended the year 21% below its March peak.

China and Thailand have responded to public discontent at rising food costs with further price controls on some staple items. So far, Vietnam, which is intent on liberalising its economy after joining the World Trade Organisation last year, has not followed suit. Indeed the government talks only of further relaxing its grip on prices: it plans soon to start letting the market set the prices of fuels, though it has not named a date. It is also busy privatising, thereby freeing from official control prices set at present by state firms. However, it does still own enough of the food-distribution chain to be able to promise plentiful supplies of cheap produce for Tet.
Some of the things Vietnam wants and needs to do to make the economy more competitive in the long term are pushing up prices in the short term. This is true, for instance, of a big infrastructure drive to build roads, power stations and so on. The IMF, worried that public spending is intensifying inflationary pressures, is urging the government to save any windfall from its recent tax reforms, rather than use it to boost spending on infrastructure even more. The World Bank, by contrast, is urging it to spend even more on such projects, worried that the country's continued growth will otherwise be at risk. The state electricity firm has been giving warnings of blackouts as it struggles to meet big increases in demand.

The reform of public-sector pay is also fuelling inflation. Minimum wages for public servants were increased by 20% in January. In the long run, decent wages for the police and other officials should help cut corruption, which itself increases costs. Businessmen, for instance, grumble about the bribes their lorry-drivers have to pay to highwaymen in uniform. But such increases in spending power will also add to inflationary pressure. Privatisation is another example. Over time, liberated state firms should become more efficient and thus cut their prices. But in the short term they may take advantage of their freedom to raise them.

The dong with voluminous flows

Rising inflows of foreign direct investment and speculative money have put Vietnam's currency, the dong, under strong upward pressure. Early last year the central bank responded by selling dong for dollars, building up foreign-exchange reserves and thus bolstering defences against speculative attack—but also stuffing the banks with excess liquidity and prompting the lending splurge.

In December the central bank switched tactics and increased the flexibility of its currency regime. The dong can now fluctuate within 0.75% of a central rate reset each day, supposedly in response to market pressures. However, the bank still seems to be managing the central rate, which has not moved far. Pham Hong Hai of HSBC, a bank, in Ho Chi Minh City, says a stronger dong would do much to curb inflation. Officials, farmers and some manufacturers are worried that it might also hurt exports. Mr Hai suggests that the central bank could point out that exporters are suffering from rising costs of imported fuels and raw materials—so they would get at least some benefit from a currency rise. Several big privatisations are on the way, which will greatly increase foreign inflows, making it harder still to resist the pressure to let the currency rise. Higher interest rates should also help, says Dominic Scriven of Dragon Capital, an investment firm in Ho Chi Minh City. Until this week's rise they were barely above zero in real terms.

The global economic storm-clouds now gathering could have a silver lining for Vietnam, provided the tempest is not too harsh or prolonged. The country earns a lot from exports, especially of farm produce. But much of its growth is driven by domestic demand. So a modest weakening in external demand might be just enough to stop the economy overheating and curb inflation, allowing Vietnam's remarkable run of growth to continue at a more sustainable rate.

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