[Vnbiz] Cost-of-living increases of concern in Vietnam

[Tai Phan]

Last updated February 5, 2008 9:58 a.m. PT
Cost-of-living increases of concern in Vietnam

THE ECONOMIST

Worries about the soaring cost of living are being felt across Asia, but in
few places is there more concern than in Vietnam, where the government last
week said the annual inflation rate had hit 14.1 percent, its highest since
1995.

On Jan. 30 the central bank raised its various official interest rates by up
to 1.5 percentage points to try to prevent an inflationary spiral.

The country is suffering from the worldwide surge in the cost of fuels and
foodstuffs -- food prices are up by a whopping 22 percent year-on-year. But
the inflationary spike is also partly the consequence of a prolonged boom:
Vietnam's economy grew by around 8.5 percent last year, one of Asia's most
impressive rates, having grown by an average of 7.5 percent annually in the
previous decade.

As the country develops at breakneck speed, bank lending is expanding fast
(by 37 percent last year) and there is massive demand for building materials
and equipment, exacerbating the risk of overheating.

Nevertheless, the government, keen to keep the good times rolling, does not
want to cool the economy down. In January the prime minister, Nguyen Tan
Dzung, reiterated his "determination" to ramp up this year's growth to 9
percent.

But Nguyen Van Giau, the governor of the State Bank of Vietnam, the central
bank, admitted that curbing price rises was "very urgent." As well he might:
the rising cost of living has caused a rash of strikes and worries that food
might be scarce over the Tet lunar new year holiday.

The next day the prime minister gave another speech, calling for a
"well-managed monetary policy" and urging improvements in the central bank's
forecasting and supervision, which sounded rather like a public
dressing-down to the governor.

Vietnam's inflation target is not very exacting: the aim is only that it
should fall below the rate of economic growth. But even this proved too hard
last year, when inflation was around four percentage points higher than
growth.

After the prime minister's ticking-off, the central bank tightened banks'
reserve requirements, to rein in their lending. (China, also worried by
rising food prices, announced similar measures the same day.)

However, the Vietnamese central bank last week loosened some restrictions on
lending for share purchasing, imposed last year to discourage investors from
borrowing to bet heavily on the then soaring stock market. The measures
were, it seems, too successful: the main VN share index ended the year 21
percent below its March peak.

China and Thailand have responded to public discontent at rising food costs
with further price controls on some staple items. So far, Vietnam, which is
intent on liberalizing its economy after joining the World Trade
Organization last year, has not followed suit.

Indeed the government talks only of further relaxing its grip on prices: it
plans soon to start letting the market set the prices of fuels, though it
has not named a date. It is also busy privatizing, thereby freeing from
official control prices set at present by state firms. However, it does
still own enough of the food- distribution chain to be able to promise
plentiful supplies of cheap produce for Tet.

Some of the things Vietnam wants and needs to do to make the economy more
competitive in the long term are pushing up prices in the short term. This
is true, for instance, of a big infrastructure drive to build roads, power
stations and so on.

The IMF, worried that public spending is intensifying inflationary
pressures, is urging the government to save any windfall from its recent tax
reforms, rather than use it to boost spending on infrastructure even more.

The World Bank, by contrast, is urging it to spend even more on such
projects, worried that the country's continued growth will otherwise be at
risk. The state electricity firm has been giving warnings of blackouts as it
struggles to meet big increases in demand.

The reform of public-sector pay is also fueling inflation. Minimum wages for
public servants were increased by 20 percent in January. In the long run,
decent wages for the police and other officials should help cut corruption,
which itself increases costs. Businessmen, for instance, grumble about the
bribes their truck drivers have to pay to highwaymen in uniform.

But such increases in spending power will also add to inflationary pressure.
Privatization is another example. Over time, liberated state firms should
become more efficient and thus cut their prices. But in the short term they
may take advantage of their freedom to raise them.

Rising inflows of foreign direct investment and speculative money have put
Vietnam's currency, the dong, under strong upward pressure.

Early last year the central bank responded by selling dong for dollars,
building up foreign-exchange reserves and thus bolstering defenses against
speculative attack but also stuffing the banks with excess liquidity and
prompting the lending splurge.

In December the central bank switched tactics and increased the flexibility
of its currency regime. The dong can now fluctuate within 0.75 percent of a
central rate reset each day, supposedly in response to market pressures.
However, the bank still seems to be managing the central rate, which has not
moved far.

Pham Hong Hai of HSBC, a bank, in Ho Chi Minh City, says a stronger dong
would do much to curb inflation. Officials, farmers and some manufacturers
are worried that it might also hurt exports.

Hai suggests that the central bank could point out that exporters are
suffering from rising costs of imported fuels and raw materials -- so they
would get at least some benefit from a currency rise. Several big
privatizations are on the way, which will greatly increase foreign inflows,
making it harder still to resist the pressure to let the currency rise.

Higher interest rates should also help, says Dominic Scriven of Dragon
Capital, an investment firm in Ho Chi Minh City. Until last week's rise they
were barely above zero in real terms.

The global economic storm clouds now gathering could have a silver lining
for Vietnam, provided the tempest is not too harsh or prolonged. The country
earns a lot from exports, especially of farm produce.

But much of its growth is driven by domestic demand. So a modest weakening
in external demand might be just enough to stop the economy overheating and
curb inflation, allowing Vietnam's remarkable run of growth to continue at a
more sustainable rate.
*c.2008 Economist Newspaper Ltd. Distributed by The New York Times
Syndicate.*
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