Exchange Rate Stabilization: AN ENDLESS STORY

The sudden fever of US dollar recently has rung a warning bell for the government’s policy on exchange rate control.

A gold and US dollar fever observed in the local market in recent days has caused many negative impacts. While there has been strong depreciation of the US dollar against most other currencies, the dollar has appreciated again in the Vietnamese market. In the free market, prices rose to above VND21,000 per dollar in early November 2010, while the official exchange rate has remained at VND19,500 for over a month. So, what are the causes and how can this be remedied?
The annual circle
At the peak of the US dollar escalation, there was a tendency to hoard US dollars. This occurs more when people believe in “upcoming” official exchange rate depreciation from the authority, as it has occurred in the past year.  That emotion has caused a psychological addiction to US dollars that has distorted the US dollar value in Vietnam.
Official statistics also shows that there has been a substantial fall in US dollar reserves in most commercial banks. In August 2010, the US dollar reserve rate in banks was lowered to three percent; in recent days, this has dropped to more than one percent; presently, this figure has fallen to almost zero percent. Meanwhile, according to the National Financial Supervisory (NFS) Committee, during October, credit activities in US dollars have risen by 52 percent since the beginning of the year while those in Vietnamese dong have only risen 14.6 percent.

Also signaling the extent of US dollar speculation is the strong increase in foreign currency deposits. At the end of September, total foreign currency deposits were VND40 trillion lower than total foreign currency loans; during only the first 15 days of October, this difference was lowered to VND20 trillion. So, within just a half month, total foreign currency deposits have increased by VND20 trillion (converted). “There has been a big increase in the demand for US dollars which has led to the increase of foreign currency prices. In addition, people are losing confidence on the possibility of stabilization by administrative bodies,” said Mr. Le Duc Thuy, Chairman of the National Financial Supervisory Committee.
The lack of effective control
At a press conference on November 4, 2010, Mr. Thuy said that the story originated from the low level of loan interest rates in US dollar against that of the Vietnamese dong. Businesses gave indications of intense foreign currency borrowing at the start of 2010, as borrowing principally in US dollars: their borrowing even exceeded demand.  This excess was resold to the market, causing an artificial supply and sometimes lowering the value of the US dollar even further than the price offered by banks. However, this situation is short-lived: in the long-term, all debtors must again buy dollars to repay loans as the artificial supply dries up.
In recent years, these fluctuations in the exchange rates have continuously repeated as the end of the year arrives. This cycle has caused many people to the question when this situation will end. There are currently regulations to control exchange rates, however, few seem to be effective. For instance, Circular No. 03/2010/TT-NHNN of the State Bank of Vietnam (SBV) stipulates that the interest rate ceiling for deposits in US dollars of enterprises should be one percent. This regulation aims to restrict the potential of currency speculation. However, commercial banks are allowed to decide their own deposit US dollar interest rates for individuals, with rates reaching up to five percent per annum. Making use of this flaw, many institutions are still hoarding US dollars by personal accounts to benefit from the high deposit interest rates. In this case, Circular No. 3 fails.
Compounding the problems with the US dollar, Vietnam is one of the few countries to retain sovereignty over its own currency, with few controls over foreign currency exchange in its population. “Article 8 of the Ordinance on Foreign Exchange mentions that people are allowed to keep foreign currency. Thus, the law cannot prohibit profit-seeking behavior of someone holding foreign currencies, even if this deforms or destabilizes the market,” explains Nguyen Van Giau, Governor of SBV.
In need of transparency
There has been a repetitive cycle in Vietnam’s exchange rate for the past few years: starting from the US dollar fever on the free market, along with the scarcity of US dollar in commercial banks, to the concession of SBV to depreciate VND by several percentage points. As a result, when the black market boils, enterprises and individuals tend to hoard US dollars more because they believe that the exchange rate will surely be adjusted. On one hand, this behavior results in the pressure on SBV; but on the other hand, this results from the unclear policies of this agency.
The situation seems much better in other countries. Indonesia is a good example, said a financial expert. As explained by her, Indonesia incurred a similar situation two years ago, wherein there was a similar hoarding of US dollars. However, the Indonesian government took adequate measures during period of 2009-2010 to balance monetary and fiscal policies to reduce high inflation and to expedite economic growth. As a result, its currency has made stable increases against the US dollar. Indonesia made successful issuances of government bonds and there was an increase in foreign capital that entered the economy. Indonesia applied the credit default swap (CDS) measures very flexibly and enhanced transparency. Every month, the Minister of Finance and State Governor held press conferences to disseminate data regarding national debt, government expenditure, foreign currency reserves, inflation, and growth rates, which helped investor confidence and understanding, and hence empowered them to make informed decisions. 
A high level of transparency results in increased confidence and aids market stabilization. Yet, confidence should also come from people themselves. Mr. Le Xuan Nghia, the NFS Committee Vice Chairman raised the question: if people rush to buy US dollars, and they know the US dollar has devalued in most other countries, should they stop?
A right solution: short-term and long-term
There is a common solution to solve the US dollar fever, which is to increase the exchange rate. However, a representative from the National Financial Supervisory Committee said that the government thinks the time is not right to adjust exchange rates. “Leaders of the Asian Development Bank have also confirmed that the Vietnamese dong has not become overly weak due to the current devaluation of US dollar in most parts of the world,” Mr. Thuy shared.
Hence, the Government has been advised to further intervene to stabilize the market and to help meet foreign currency demand as people and businesses buy imported fuel, fertilizer, and equipment for production. Imports of luxury products should not be encouraged, while demand for commodities should be satisfied immediately.
According to Mr. Thuy, although there has been a sharp decline in foreign currency reserves of US$23 billion, the remainder kept by SBV is still much higher than levels in 2008. “The current reserve level is enough to stabilize the market. SBV is strong enough to make suitable interventions to stabilize the market if necessary,” said Mr. Thuy.
“On another hand, the Government plans to rationalize the interest rates in Vietnamese dong in a more flexible manner. SBV will utilize open-market transactions, other tools, and open-market interest rates to adjust interest rates in Vietnamese dong,” added Mr. Thuy. This, however, is a short-term policy. In the long-term, ordinance on foreign exchange should be reviewed and amended, aiming at reducing US dollar reserves, as advised by Mrs. Duong Thi Thu Huong, the former SBV Governor.

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