This is the first reduction in the refinancing rate since May 2013 and is small by Vietnamese standards. However, any monetary easing at this point is borderline risky, given that inflation is expected to reaccelerate during the second half of the year.
IHS perspective | |
Significance | The State Bank of Vietnam (SBV) announced a 50-basis-point (bp) reduction in the refinancing, repurchase, and discount rates, putting them at 6.5%, 5.0%, and 4.5%, respectively. |
Implications | This is the first policy interest rate cut since May 2013. Previously, the SBV had lowered the refinancing rate by a total of 800 bp between February 2012 and May 2013. |
Outlook | Although inflation fell below 5.0% in February, it is expected to reaccelerate during the second half of 2014, so IHS does not anticipate further monetary easing. If further rate cuts do occur, they would pose serious risks of yet another inflationary spike of the sort seen in 2008 and 2011. |
Slower inflation facilitates modest monetary easing
Vietnam's current monetary easing cycle began in February 2012, when the State Bank of Vietnam (SBV) lowered the refinancing rate by 100 basis points (bp) to 14%. The interest rate had previously been raised to such high levels in a belated and desperate effort to bring inflation under control and stem capital outflows that threatened an outright sovereign debt crisis. Consumer price inflation had peaked at 23.0% year on year (y/y) in August 2011, whereas foreign exchange reserves (excluding gold) bottomed at USD11.5 billion in February of the same year. A combination of monetary tightening, administrative import controls, and rising exports eventually allowed macroeconomic stability to be restored. Consumer price inflation eased from an average of 18.7% in 2011 to 9.1% in 2012, and 6.6% in 2013. In February 2014, it stood at 4.6% y/y. Meanwhile, the reserve position has also improved, with foreign exchange reserves (excluding gold) exceeding USD26.0 billion in May 2013.
Against the more favourable financial backdrop, the SBV has been moving to offer more support for the economy, which has been a constant request from the government. In addition to lowering the policy rate, the central bank announced yesterday (17 March), that the interest rate cap for dông deposits with maturities of less than six months will be cut from 7% to 6%, while the cap on dollar deposits will be lowered from 1.25% to 1%. These measures lower the cost of capital and should encourage lending and economic growth. The stock market responded positively to the rate cut announcement, adding to its already impressive gains in 2014; Vietnam's benchmark (VN Index) is up 19% since the start of the year.
However, whether the broader economy truly requires added support is not clear. It is true that growth remains below levels typically recorded prior to the global financial crisis, but conditions have been improving. The economy grew 5.4% in 2013, and IHS forecasts a 5.7% expansion in 2014. Meanwhile, there are favourable trends at play in the country's manufacturing sector. The rapid growth of new, higher-value industries has been analysed in a recent special report (see Vietnam: 5 March 2014: Vietnam's evolving manufacturing landscape: Successfully moving up the value chain) and is indicative of positive economic momentum, which suggests growth should continue to improve in the coming quarters.
Has SBV learned from past mistakes?
Although the economy is improving and inflation has stabilised, Vietnam's recent economic history has been one of severe boom-bust cycles. Since 2007, there have been two such major cycles of overheated growth followed by policy tightening, and then sharp deceleration. The key question now is whether the central bank has learned from its past mistakes and whether it will take a more proactive stance in guiding the economy rather than allowing things to get out of control before acting. It is in this light that the latest rate cut reduction is concerning as it resembles past episodes when modest inflation (which proved to be only temporary) had lured the SBV into excessively accommodative monetary stance, triggering an eventual inflationary flare-up.
Outlook and implications
In the SBV's defense, inflation has now been lower for longer than is typically the case, and the subdued external environment means global commodity prices look set to trade largely sideways over the next few months. This means that risks of imported inflation are limited, unlike in 2008 and 2011. The currency also appears sufficiently supported by a combination of favourable trade balance and strong inflows of both portfolio and direct investment inflows. This means another potential source of inflation is not problematic at the moment. In this respect, the decision to lower the interest rate slightly is defendable, as long as the central bank will not hesitate to retrace this step as inflation begins creeping higher, which we expect to happen during the second half of the year.