DBS says the country’s inflation will likely register a high 18.6% this year.
Growth has been fairly strong at 7% in the last five years, however, with it came high inflation.
Here’s more from DBS:
The last few years have been challenging times for Vietnam economy. While economic growth has been fairly strong, high inflation, huge external deficits and falling foreign reserves have continued to hog the limelight. While the economy now appears to be on the path towards stability, there are some structural challenges that need to be overcome in order to sustain longer term growth. These would include the needs to revitalise private sector contribution, diversify export markets, moving up the value chain as well as to rein in inflation.
Recent economic performance and cyclical challenges
Inflation threatened twice within a short four year period. It averaged 23% in 2008 and will likely register a high 18.6% this year.
Apart from inflation persistent trade and current account deficits and internal capital flight with residents opting to hold gold and USD to hedge against inflation are also key concerns. These have led to the decline in its foreign reserves and strong depreciative pressure on the Dong. At one stage, foreign reserves were down to about 8 weeks of import cover. The State Bank of Vietnam had to devalue the local currency by 5 times in 2 years in order to curb the decline in reserves and the widening of the external deficits.
Moreover, devaluation can be self-reinforcing as it encourages expectation of more downward pressure on the currency. It’s a vicious cycle. Furthermore, devaluation is ineffective against a ballooning trade deficit and it exacerbates imported inflation unless growth is allowed to slow..
That explains why the SBV had to apply the emergency brake on monetary policy twice, in 2008 and earlier this year. The central bank hiked the policy rate by a total of 575bps in 1H08 and raised 3 key rates, which are the discount rate, refinance rate and OMO rate, by about 500-600bps in the first 5 months of this year.
Growth was deflated in 2008 and will likely take a hit again this time as a result of the drastic monetary tightening. Headline growth moderated to 6.3% in 2008, down from 8.5% and will most likely fall short of the earlier official target of 7.0-7.5% and register 6.5% instead this year.
The root of the problem came from its “growth oriented” strategy. When faced with external shocks, the authorities preferred to protect its rapid growth rate by introducing highly accommodative monetary and fiscal stimulus at the expense when economic cycle turned positive.
In fact, the recent bout of high inflation stems from the late withdrawal of expansionary monetary and fiscal policies pursued in the aftermath of the global financial crisis. This is further juxtaposed with the spikes in global commodity and food prices as well as simultaneous hikes in domestic fuel prices and electricity tariffs. To counter these, drastic tightenings were taken, as was the case in 2008, which created unnecessary strain and volatility on the economy.
Vietnam needs to maintain the delicate balance between growth aspiration and economic stability. Fortunately, there has been improvement after the conclusion of the 11th Party Congress in Jan11 and the subsequent introduction of the measures under Resolution 11.
The economy appears to be on its path towards economic stability for now, albeit a bumpy one. There are indications that foreign reserves position has been improving, depreciative pressure in the currency has eased while FDIs are also returning. Inflation likewise, will ease in the second half of the year based on our estimation.
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