World Crisis Online

Vietnam increased interbank lending rates by 2 percentage points late on Thursday as it battles to keep a lid on soaring prices following last week’s sizeable devaluation of its currency, the dong.

The south-east Asian nation has achieved impressive growth rates over recent years but at a cost, with stubbornly high inflation, large trade and budget deficits, and investment skewed towards inefficient state-owned enterprises.

Annual inflation hit 12.2 per cent in January and, with the dong devaluation expected to drive prices even higher, economists reiterated that the communist government had to abandon its obsession with credit-fuelled growth in favour of macroeconomic stability.

The State Bank of Vietnam, the central bank, increased its refinancing interest rate, a key interbank borrowing rate, from 9 per cent to 11 per cent with immediate effect on Thursday afternoon. It also increased two other interbank borrowing rates.

“This is a signal that banks should be more careful about lending in order to help the government’s fight against inflation,” said one banker at a state-owned bank. While the base and discount rates remained unchanged at 9 per cent and 7 per cent respectively on Thursday night, bankers said that the central bank would have to increase these rates as well if it wanted to demonstrate its determination to fight inflation.

“Vietnam needs to tighten rates decisively and feel some short-term pain in order to knock out inflationary expectations,” said Paul Gruenwald, chief economist for Asia at ANZ in Singapore.

Last Friday the state bank devalued the dong by 9 per cent against the US dollar to reduce the trade deficit and close the large gap between the official and black market rates. Some analysts said that, taken alongside the rate increase, there were tentative signs that the government might be starting to focus on stability rather than growth.

But having seen inflation hit 28 per cent in 2008 and the dong fall by more 25 per cent since then, many Vietnamese remain reluctant to hold on to the currency, preferring dollars and gold as a store of value.

On Thursday, the dong hit a new low of 22,000 against the dollar in the black market, more than 6 per cent below the official exchange rate. Economists believe that the government will have to continue tightening monetary policy if it is to bring back confidence.

Mr Gruenwald said the central bank would need to increase rates by another 2 percentage points if it was bring inflation into single-digits. That would mean Vietnam’s gross domestic product growing at 5-6 per cent this year, well below the government’s 7-7.5 per cent target, he said.

“But the reward is that they’ll get expectations back to where they want and then they can have a good 2012.”