Default Viet Nam's Rate, Dong Moves May Prevent `More Disruptive Crisis'

Viet Nam''s decision to raise interest rates and allow its dong to weaken may help it avoid a ``more disruptive crisis,'''' analysts say, predicting further moves by the central bank to cool inflation.

The State Bank of Vietnam said yesterday it would increase its base rate to 14% from 12%, and lower the dong''s reference rate by 2% from today to prevent currency speculation. The currency declined 1.9% today, the most since 1998.

``The measures announced should help Vietnam avoid being forced into a more disruptive crisis with a significant one-off devaluation in currency value in the near future,'''' said Helen Qiao, an economist at Goldman Sachs Group Inc. in Hong Kong, in a note late yesterday. ``Further monetary tightening will likely be needed to bring growth and inflation under control.''''

Inflation in Viet Nam is running at the fastest since at least 1992, increasing concern the economy is overheating. Standard & Poor''s, Moody''s Investors Service and Fitch Ratings have all lowered their outlook on Viet Nam''s credit rating to negative since the beginning of May.

The rating agencies along with the International Monetary Fund and other donors have encouraged the Vietnamese government to tighten monetary policy to rein in inflation. Consumer prices surged 25.2% from a year earlier in May, and the key interest rate at 14% is the highest in the region.

The Southeast Asian nation also increased the refinancing rate to 15 percent from 13 percent and the discount rate to 13% from 11% today.

Key Message

``The key message is that the central bank is getting serious about controlling inflation,'''' said Prakriti Sofat, an economist at HSBC Holdings Plc in Singapore. ``We look for the central bank to hike the base rate further.''''

Viet Nam''s inflation may ``peak'''' in the third quarter at around 30% and the central bank may raise its base rate by another 1 percentage point, Sofat said.

``The interest rate hike should entice more residents to hold dong-denominated deposits, as well as slow credit and GDP growth, import demand, and inflation,'''' Matthew Hildebrandt, an economist at JPMorgan Chase Bank in Singapore, wrote in a research note.

Still, the central bank''s decision to weaken the currency band sent a ``negative signal'''' that the country may be facing a balance-of-payment crisis and a larger devaluation of the dong, he said.

Dong Uncertainty

``It doesn''t help anything at all and it raises uncertainty about the government''s commitment to the peg,'''' Hildebrandt said in a telephone interview today. ``A 2% one-off devaluation won''t greatly affect inflation or boost exports. It does raise uncertainty on the dong.''''

Today''s devaluation by the central bank may be the last move for the year, he said.

The one-off devaluation needs to be reinforced by central bank intervention to support the trading band and regain ``credibility of the foreign exchange regime,'''' HSBC said in a note. Without this, the dong will trade outside the band ``as continued uncertainty and depreciation pressure'''' persists.

The currency devaluation helps remove some uncertainty on the dong, said Goldman''s Qiao. Still, she expects the dong to fall 10 percent against the dollar in the next year as faster inflation puts the currency at risk of ``becoming excessively overvalued.''''

The bank lowered its forecasts on the dong, and expects it to reach 18,000 in 12 months from 16,400 previously.

``It is laudable that the Vietnamese monetary authority has reacted preemptively against the dong''s overvaluation in real terms,'''' she wrote. ``This will likely mark the beginning of more managed dong devaluations against the dollar.''''
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