Inflation tests Vietnam’s growth

 http://www.atimes.com/atimes/Southeast_Asia/JC18Ae02.html

Vietnam’s transition from a centrally planned to market oriented economy faces a new host of challenges posed by galloping inflation. Depending on how deftly economic and financial policymakers respond, it could make or break the country’s until now successful economic reform program.

The country’s main consumer inflation benchmark was up 15.7% year on year in February, the biggest jump in over a dozen years and currently the highest rate in industrializing East Asia. Inflation has jumped by double digits for each of the past five months, threatening to undermine the macroeconomic and social stability that has underpinned fast GDP growth, which over the past five years has averaged over 8%.

In particular, discontent over increased inflation is on the rise in the industrial sector, the backbone of Vietnam’s export-driven economy. That’s been witnessed in the growing number of industrial disputes and strikes over wages and work conditions, which to date have disproportionately hit foreign-invested firms.

In mid-February, more than 5,000 workers went on strike demanding pay rises, more allowances, and a reduction in working hours at the Japanese-owned Yazaky Eds Viet Nam Ltd, which produces automobile parts for export from the northern industrial city of Haiphong City. Local newspapers reported that the workers said that their average monthly wages of between 1.1 milion dong – 1.2 million dong (US$68.75 to US$75), which are above minimum wage rates, were not enough to cover even their daily living expenses.

In the first two weeks of this year, 50 strikes took place across the fast industrializing country, according to the Ministry of Labor. In early March, some 10,000 workers walked off the job at the South Korea-owned Tae Kwang Vina factory, which makes shoes for US apparel company Nike on the outskirts of Ho Chi Minh City. Those factory workers similarly demanded higher pay to keep pace with rising prices.

From 1995 to the end of January 2006, more than 1,000 strikes took place in Vietnam, with some 387 of those worker walk-outs occurring last year and coinciding with rising local costs, according to government statistics. Of those, 300 strikes targeted foreign-invested firms. To the chagrin of foreign investors, the government last year increased the minimum wage for industrial workers by around 25%. But as consumer prices surge, labor unrest is nonetheless on the rise.

Vietnam is not alone in Asia in facing inflationary pressures, but its headline rates are nearly double those of its main regional competitors, with China’s rate hovering around 7.1% and Indonesia 7.4%. Hanoi’s emerging inflation problem can only partially be blamed on global market forces, including fast rising food and petroleum prices.

The state-run General Statistical Office said upon its announcement of February’s 15.7% year-on-year spike in consumer prices that the increase was driven mainly by a 25.2% increase in the cost of foodstuffs and a 16.4% rise in housing and building materials, reflecting the country’s breakneck construction boom.

The overheating economy is also unsettling the balance of payments, with a huge trade deficit opening up as imports rise. For the first two months of 2008, the deficit was US$4.2 billion, compared to $12.4 billion for the whole of 2007. That statistic represented a sharp rise on the $4.8 billion for 2006.

But those pressures are being compounded in Vietnam’s particular case by a host of domestic factors, including the rapid inflow of foreign capital, consequent fast growth in the local money supply and, apparently, the government’s relative inexperience in managing such technocratic challenges.

The government has in recent years sought to modernize the State Bank of Vietnam (SBV) into a capable steward of monetary and exchange rate policies, as part of its World Bank endorsed financial sector reform program. It was precisely those types of market-friendly reforms that had in recent years made Vietnam a regional darling for international investors and manufacturing businesses.

Now with macroeconomic stability at risk, that love affair has hit choppy waters. Those concerns were underlined when the government abruptly postponed a major EuroMoney investment conference scheduled for earlier this month which last year drew over 1,500 delegates from more than 30 different countries, resulting in scores of new multi-million dollar investments and joint venture deals.

Then there was only praise for Vietnam’s economic dynamism and the government’s pro-market and pro-investment policies; now the government appears to be crawling at least partially back into its isolationist communist era shell as it avoids a possible platform for criticism of its new, more restrictive policy settings. The conference organizers have said the event will be held in September instead.

But it’s not clear that by then macroeconomic stability will have been restored. Inflation and other pricing distortions brought on by what some analysts refer to as Vietnam’s “overheating” economy clearly represents the government’s and central bank’s first big technocratic test since opening widely the economy to foreign capital inflows.

The SBV has in recent months put a brake on money supply growth, in a blunt attempt to mop up the liquidity flowing into the financial system through foreign direct investments and portfolio flows. The SBV has long maintained an effectively fixed exchange rate at an artificially low rate to promote exports. Now that rate, as of March 13 officially at 15,865 dong per US dollar, is coming under increasing speculative pressure for an upward revaluation.

Foreign businesses in the export sector have been most adversely affected by the SBV’s recent interventions. That includes the central bank’s efforts to tighten the local money supply, which have made it increasingly difficult for firms to exchange foreign currency, primarily US dollars, for the local currency, the dong.

At the same time, the government has ordered the central bank and other ministries to put more restrictions in place. That includes stricter rules for lending, raising interest rates, increasing compulsory bank reserves and expanding bond issues to absorb local currency. Credit growth through the banking system is also through government order to be limited to 30% in 2008, capped lower than the 40% growth seen in 2007.

The government has also tentatively allowed the exchange rate to appreciate above its current above-under trading band of 0.75% to 2%, an official rate set and managed by the SBV. A strong dong, policymaker hopes, will help reduce inflation by making imports relatively cheaper, but also raises concerns that an appreciating currency will also make exports less competitive vis-à-vis China, which has also recently allowed its fixed exchange rate to rise only marginally.

Hanoi’s new tighter monetary policy settings are also straining local businesses, particularly those with significant foreign currency receipts and which draw on foreign funds in order to make local payments. There are a growing number of reports about foreign-invested firms encountering dong shortages at local banks, with some as a result lacking the resources to pay staff and rents. With banks under strict orders to preserve their dong holdings, many businesses are now operating outside of the official banking system for their local currency needs.

Vietnam’s nascent stock market, which has lost much of its luster over the past 12 months, is also being hit by inflation and the government’s restrictive response. For instance there has been widespread selling on the Ho Chi Minh Exchange among the local retail investors who dominate the US$20 billion market. In an attempt to calm investor jitters, the government’s investment arm is reportedly purchasing more shares to shore up prices.

The bigger risk is that tighter monetary conditions afflict the banking sector, which some argue was already wobbly before inflationary pressures entered the financial equation. Analysts predict that cracks could appear first at the so-called joint stock banks, as competition for deposits increasingly favors larger state-owned banks because of their inherent (or at least hoped for) sovereign guarantee. The US credit rating agency Standard & Poor’s (S&P) warned in a February report that “a prolonged liquidity squeeze will exacerbate the inherent structural weakness in Vietnam’s banking system”.

Meanwhile US investment bank JPMorgan Chase expects headline inflation to average 16.1% this year, nearly double the 8.5% clip experienced in 2007. However views about how dangerous the inflationary situation is to the country’s overall economic health vary. S&P says it does not expect high inflation to result in a sovereign credit rating downgrade in the next one or two years, unless inflation accelerates much faster.

That’s cold comfort to the country’s huge poor population, which with the rising price of basic staples is finding it increasingly difficult to make ends meet. Jonathan Pincus, the United Nations Development Program’s (UNDP) senior economist in Hanoi, recently told the media that the government needs to target inflation below 10% so that businesses can confidentially map out production and investment plans, exports remain competitive, and the poor are not disproportionately hurt.

The economist noted that Vietnam’s inflation rate is now twice as high as other countries in the region, including China. “It is a big blow if the inflation is above 10%,” Pincus said. “Vietnam has to recognize that there are global problems, but there are also problems that are very specific to Vietnam and need to be solved in Vietnam.” For now, the verdict is still out on whether Vietnam’s until now untested technocrats are up to that task.

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