[Vnbiz] Inflation Control

Sun Feb 24 15:07:25 PST 2008

Dear CACC,

  I have read through your nice analyzes. Unfortunately I am not very convinced, hence let me put my two cents in as follows.    

  First, Vietnam's export depend on largely on import for inputs therefore the export elasticity to exchange rate is very tiny and sometimes negative. It means that a significant change in exchange rate has a negligible effects on export. Vietnam's think-tanks all know that fact. Hence, It hardly believes that policy makers in Vietnam suggesting to "pump more Vietnam dong into the market to slow down the appreciation of the Dong against (the depreciation) of the US dollar to help export" at a time of high inflation. 

  Second, even USD keep depreciating these days it puts modest pressure on Vietnam's export as long as her main competitors in the world market remain peg their currency against USD. So far, the Vietnam's main competitors are China and ASEAN countries and they remain peg their currency against USD. So there is no point to depreciate VND in inflationary period.

  Third, Hao has mentioned before, high interest rate does help reduce inflation except in super-inflation time. The process is simple. When interest rate is high, people will reduce consumption today to save more for tomorrow's consumption. The inflation will be declined when demand reduced. Hence, in my opinion raising interest rate now is a prudent response to control inflation at the moment.

  Four, high interest rate induces banks cut down their risky investments hence the banking sector is expected to be healthier. The "saving switch" phenomenon these day is normal and a good adjustment. It is a normal behavior in a competitive market. A better bank can offer higher interest rate then consolidate their position, worse banks may lose their depositors hence has to restructure their loans and deposits. It results in a better banking sectors.

  Fifth, high rise of prices of stocks alone rarely cause inflation. If it happens in primary market, the money gained would be invested in productive projects and then increase supplies. Price level is expected to slow down. If it (high rise of stocks' prices) happens in secondary market, it essentially redistributes wealth between investors. In aggregation, it does not affect price level!

  What are causes of inflation in Vietnam. I have not worked thoroughly on this issue, hence I can not have a firm answer. Nevertheless, let me presume to list some reasons for discussion.

  1. A fact that state investment in total investment from 2002 to 2007 is always more than 50% (Vietnam economy in 2006, by CIEM). Put it differently government spend to much bring about a big increase in aggregate demand, then inflation.
  2. Boom in FDI. This  phenomenon is similar "Dutch disease" in economist. When there is a huge influx of foreign exchange into the economy, money supply increases then inflation does. Further more, influx of foreign exchange cause a rise in demand for two type of goods: non-tradable goods (services, goods that not easily imported such as foods) and tradable goods. For the former, a rise in demand can not be met by import then push price up. Result in inflation.
  3. State bank has to undertake too many targets. On the one hand they have to curb inflation, on the other hand they have to stimulate economic growth. Theoretically, It is impossible to fulfill both targets at the same time. 

  Just my two cents,

  With warmest regards

  Tu Anh

Tran Dinh Hoanh <tdhoanh at gmail.com> wrote:
  [ Vietnam Business Forum ]

  Dear CACC,

  Thank you, anh Roger, for posting The Straits Times article.  It brings life into the discussion. Even though the numbers can give me a very good sense of what is going on, my heart still hurts when I read your article.  Please continue to send more articles into this forum.  As you see, we cover every thing related to Vietnam.  Our fundamental philosophy is that every thing is interrelated and we want our all brothers and sisters to always have a clear comprehensive picture of Vietnam.

  In search of the causes for our current high rate of inflation, I ran into this article by  anh Pham Do Chi and Nguyen Hoai Bao, published on Thanh Nien a month ago (please see the article below).  I know anh Chi as a a nice gentleman at the International Monetary Fund (IMF) in Washignton DC (Hello, anh Chi!) and the Thanh Nien article is very good, and it seems the government has implemented several suggestions by anh Chi and anh Bao.  But  the article does not exactly pinpoint the causes of the problem.  

  And I have problem with one possible cause of inflation mentioned in the article:  That is the high rate of foreign investment.  "Last year, the record level of foreign investment, direct and otherwise, pouring into the country increased both demand for the dong and the amount circulating in the market, thus fueling inflation."  Well, I am not sure about this.  When you have FDI (foreign direct investment) you have a bunch of money coming in (intiailly USD, immediately exchanged into Dong for spending) and you have products and services in response to that money, then everything will be fine.  Inflation may occur a little when the money is out for spending but the first batch of products and services are not in the market yet.  But this kind of inflation is very short, no one even sees it (maybe in a couple of weeks only).  

  FDI may also create inflation when invesment money comes in, but a big chunk of that money has no services or products in return.  This usually happens when that big chunk of money goes into the private pockets of a couple of corrupt guys in power.  TBut this doesn't happen in Vietnam.  Corruption is rampant, but mostly at lower level, involving many in the rank and file, and mostly in the form of tien boi duong of some kind, which is more or less like a kind of additional wages, which are generally used for regular spending, which stimulates production for the economy.  I feel that the inflatinary effect of FDI in Vietnam would be very minor.  (Therefore, the Thanh Nien's article's proposal to slow down the country's GDP growth as a solution to the inflation problem is not in my book at this time). 

  Another cause that the Thanh Nien article mentions is the rise in oil prices and food prices.  Vietnam is an oil and rice exporter, so I don't think these two things wouold push Vietnam inflation up higher than its neighbors.  The Thanh Nien article recognizes this point.

  So what are the causes of inflation other than the two causes I mentioned previously: The State Bank's pumping more Dong into the market and the trade deficit?  

  The trade deficit has been there for more than a year, so its effect has been there all along.  Thus, by itself, it doesn't explain the recent jump in inflation rate.  The State Bank's Dong pumping is relatively new, but it  was done after the inflation was known to be high.  So it may be an additional actor, but not the original culprit.

  So what other causes that we are looking for?

  There is this cause that I have been thinking more than a year.  Since more than a year ago, I have been waiting for its affect to show up.  It seems it is showing up now, but since no economist anywhere in the world mentions it, I haven't said anything either.  However, now that I search more seriously for inflation causes, I am really convinced that it is a major cause for the recent unexplained jump in inflation:  That is the STOCK MARKET.

  For the last two years, especially the last one year, the stock market grew disproportionately fast and put a lot of inflationary pressure on the economy.  However,  riding on the excitement of the stock market, economists and policy planners miss this all together, and it seems everyone still misses it now.

  We all know that many companies have put their stock on the stock exchange and their stock have grown in value tremendously immediately, sometime growing tenfold within a very short time.  Obviously that kind of growth is not real.  No company can grow that fast.  The stock price rose just because of the stock fad at the time.

  But such an atomic-bomb boom in the stock market attracted a lot of money into the market, both from foreign and domestic clients.  Foreign clients paid by USD which was immediately changed to VND to pump into the market.  Domestic clients were more interesting.  Of course, many small investors used their hard-earned dong.  But many people who had secretly hoarded unaccounted-for wealth in the form of USD or gold, now had the golden chance to "wash their money" by investing in the stock market (and the government would not investigate the source of money going into the stock market because it wanted the stockmarket to keep growing and growing.  Crazy investigation ruins the party!).   These people simply sold their gold and USD in the open market for the VND and usde the dong to buy stocks.  If my memory is correct, the gold and USD prices in 2007 in Vietnam were lower than their prices in December 2006.  That was because of all the selling of these secret holdings.  

  All these stock purchases brought a lot of Dong into the market, without ANY services and products in return.  Can anyone tell me any of these companies that sold stock to the public last year invested seriously in anything in their operation?  Most of the new wealth is in the hands of a small group of stockholders in paperwork form; the bulk of the Dong simply floats in the market without any products and services produced.  That generates tremendous inflationary pressure on the economy.  If my memory is correct, the stock market was valued at 10 percent of GNP as of December 2007.  That, by itself, would probably add 10 percent inflation rate into the economy.

  This surprised stock money may account very well for the surprised jump in inflation in 2008.  I said "surprised" because no one has paid attention to it at all.  But it has been there for a couple of years, most prominently last year.

  Thus I temporarily conclude that there are 3 major causes for inflation at this point:  The trade deficit, the stock money and the government's pumping of the Dong into the economy.  I said "major causes" because many other things in the economy may have some inflationary effect.  That is very normal all the time.  We are now just focus on the major causes so that we can focus on solutions.

  I will temporarily stop here, to wait for comments from you brothers and sisters (Please chip in), and to take a rest to clear my head.  In the next message we will explore the solutions.

  Have a great day!  

  Hoanh

  ____________ 

    Bitter pill may alleviate Vietnam inflation woes

  http://www.thanhniennews.com/features/?catid=10&newsid=35250

          Last Updated: Wednesday, January 23, 2008 14:40:05 Vietnam (GMT+07)                        E-mail to a friend   Print version      Bitter pill may alleviate Vietnam inflation woes
                   Customers check out the prices of sauce at a Ho Chi Minh City supermarket. Vietnam's 2007 inflation reached a ten-year high of 12.6 percent so it is time for the government to take action to subdue rising costs  To rein in soaring inflation, the government needs to take tough action, possibly even lowering its ambitious growth target for the gross domestic product (GDP.       Inflation reached a ten-year high of 12.6 percent last year.
  Commonly known as a "monetary phenomenon," inflation occurs when there is too much money in circulation relative to the volume of goods and services.
  In Vietnam, in order to support the steadily growing production of goods and services in recent years, the government has constantly increased the money supply.
  This is suspected of causing inflation.
  Yet, it isn't just expanding supply and shrinking demand that is pushing down the purchasing power of money - or pushing up price levels.
  For the past few years, factors such as bird flu and bad harvests caused by floods have also reduced the supply of food and consequently pushed up prices.
  China's increasing demand for input materials to fuel its phenomenally growing industry has also added upward pressure on input prices worldwide, especially oil and gasoline prices.
  But at the end of 2007, when all the offenders lined up for investigation, the Vietnamese government's monetary policies, or lack thereof, had to take most of the blame.
  Neighboring countries have also had to cope with increasing food and fuel prices but none of these countries suffered an inflation rate as high as Vietnam's.
  Last year, the record level of foreign investment, direct and otherwise, pouring into the country increased both demand for the dong and the amount circulating in the market, thus fueling inflation.
  The State Bank of Vietnam (SBV) had two options.
  It could have either relaxed its control on the exchange rates so that the dong would gain in value relative to foreign currencies.
  A revalued dong would make Vietnamese exports more expensive to international consumers and thus reduce exports.
  Or it could have bought a large amount of foreign currencies to increase its foreign exchange reserves and keep the value of the dong down to benefit exports and growth.
  SBV chose the second option - without using other methods, such as issuing high-interest bonds, to help absorb the excess money in circulation in the market.
  The end result was an upward-spiraling demand for money to conduct transactions the rate of production couldn't keep pace with.
  Solutions?
  In the face of high inflation, Vietnam still has many options.
  One of them is to lower its GDP growth target until inflation reaches a healthier level of five percent to six percent.
  This is often seen as the most effective and direct way to curb inflation since high targeted growth pushes up demand for goods and services while supply lags.
  However, at present the Vietnamese government is following policies that are only fueling demand.
  For instance, it is encouraging high levels of investment to boost economic growth.
  Yet, the current Incremental Capital Output Ratio (ICOR) index for Vietnam, measured by annual investment divided by annual increase in GDP, is quite high.
  It suggests the Vietnamese economy isn't using investment efficiently.
  Though the quantity of investment is unquestionably important, it is the type and quality of investment that ultimately matters.
  For instance, investment in highly-productive sectors that aren't labor intensive is considered much more conducive to sustainable economic growth.
  The government is thus strongly encouraged to screen all investment inflows for possible upward pressure on inflation.
  As for the State Bank, it can also pitch in the efforts to curb demand by tightening up its credit and monetary policies.
  For instance, it can reduce or discourage loans for activities that don't directly fuel production by increasing interest rates and requiring a higher level of bank reserves.
  In addition, the State Bank should give exchange rates more latitude to operate according to market forces.
  It has been making a start in this direction with the recent 50 percent increase in the interbank exchange rate margin.
  This move allows banks to offer exchange rates at a wider margin from the rate announced daily by the State Bank.
  And last but not least, the central bank can issue high-interest bonds to attract money currently in circulation.
  By Pham Do Chi - Nguyen Hoai Bao * (TBKTSG)
  (*) Pham Do Chi is a former senior expert at IMF with a Ph.D. in economics from the University of Pennsylvania in the US and Nguyen Hoai Bao is a macroeconomics lecturer at Ho Chi Minh City Economics University

  On Sat, Feb 23, 2008 at 9:33 PM, Roger Mitton <rogermitton at hotmail.com> wrote:
  [ Vietnam Business Forum ]

  How all this affects plain folks in Vietnam:

          THE STRAITS TIMES, Feb 24, 2008

      DISPATCHES
  Inflation in East Asia hits Vietnam hardest
      By Roger Mitton 

      HANOI - A GOOD way to sense how Vietnam's economic boom is affecting ordinary people is to visit wet markets in the city suburbs and the rural villages. 

  Bundled up against the unseasonal cold, the shoppers look pinched and sullen as they poke about for affordable groceries. 

  They are the great silent majority of Vietnam's 85 million people: the salaried factory hands, the drivers and builders and labourers, the working wives and retirees, the masses of lowly state minions and municipal functionaries. And they are not happy, despite the bounty of foods on offer. 

  The gravy train that is Vietnam's economic boom appears to have passed them by. 

  They are people like Ms Nguyen Thi Hoa, 28, a typical hardworking young mother, who toils for six days a week at a Hanoi textile company for US$70 (S$99) a month. Her husband does the same at a TV assembly plant and makes US$80. Out of that, they pay US$60 for a babysitter and for food and milk for their six-year-old daughter. 

  Then, after paying the electricity bill and getting fuel for their motorcycle and other essentials, they are left with US$30 for themselves each month. A dollar a day for two working adults. 

  Said Ms Hoa: 'Nowadays, I can buy some meat only for my daughter, not for my husband. Sometimes I break into tears because I love my husband, but I can't give him a decent meal.' 

  Their situation is not a rare sob story. It is increasingly the lot of ordinary working class Vietnamese who are being devastated by rampaging inflation. 

  Vietnam now has the highest annual inflation rate in East Asia. At 14.1 per cent, it is almost twice as high as that of its nearest rival, Indonesia, 7.4 per cent. 

  And there is no end in sight. Vietnam's inflation increased again last month by 2.4 per cent over the previous month and it is on track to increase again this month. 

  It is not only labourers and factory workers who are hurting, but even young professionals bristle that their college education does not count for much when it comes to earning a decent living. 

  Hanoi schoolteacher Nguyen Thu Phuong, 35, who earns about US$150 a month, said: 'A year ago, I could afford to prepare a wholesome meal of four dishes for my family. Now it's hard for me just to make two dishes.'' 

  Even the respected former deputy prime minister Vu Khoan commented in a local newspaper that his standard of living was falling. He said: 'My wife complains about rising prices every time she goes to the market. I notice it myself and we have to economise.'' 

  Down in the nation's booming southern business centre of Ho Chi Minh City, food prices have leapt by 24 per cent compared to January last year. 

  And the cost of other essentials like electricity, water and petrol has soared by around 17 per cent over the past year. 

  Mr Nguyen The Hai, 25, a worker at a Japanese industrial plant near Ho Chi Minh City, is single and shares a rented room with several friends in order to make ends meet. 

  He said: 'When I started here, I got 900,000 dong (S$81) a month. Now, after three years, I make 1.1 million. But while my wage has increased a bit, my rent and food and fuel bills have shot up more than 50 per cent.' 

  Property prices have skyrocketed, as landlords exploit a lack of supply and a soaring demand caused by rural workers flocking to the cities to seek a better wage. Tenants are often abruptly told that their rent is to be doubled or even tripled, take it or leave it. And the lease contract invariably proves not worth the paper it is written on. 

  Said Mr Hai: 'I hoped that with all the economic good times that you read about in the papers, I'd be able to make enough to send some money back to my old parents. But now I can't even make enough for my own daily needs.'' 

  Officially, it is all happening because of a confluence of troublesome factors. They include soaring oil prices, excess foreign currency, high wage demands, a flood of expensive imports, a growing trade imbalance - Vietnam imports far more than it exports - poor harvests due to bad weather and natural disasters, and lingering bird flu and pig disease. 

  Government spin doctors throw in other reasons as well, but they still don't seem to appease the despairing lowincome workers. 

  After all, other countries like Indonesia, Thailand and the Philippines have the same problems and their inflation rates are less than half that of Vietnam. 

  Ah, but they are more developed economies - is the usual retort. 

  Yet Cambodia, Laos and even China are similarly developing and prices in those countries are rising less than half as fast as in Vietnam. China's inflation rate was only 6.5 per cent last year. 

  Even the state-owned media has found its patience wearing thin. A recent article in the best-selling Thanh Nien newspaper reported that 'the government's moves to control the galloping prices have proved deficient, passive and fragmented in the emerging market economy''. 

  That said, the Cabinet has taken steps to curb the money supply, cap fuel and food prices, and impose a temporary ban on rice exports to boost domestic supply and try to keep prices down. 

  But it will need to do a lot more if it is to stem the growing public discontent. 

  On Jan 1, the minimum monthly wage for state employees was upped from US$28 to US$34, and for those in foreign-owned companies, from US$34 to US$44. 

  However, it appears to have been too little too late and a rash of wildcat strikes soon followed. 

  Said Ms Nguyen Thanh Mai, 27, a schoolteacher in north-western Dien Bien Phu: 'The small wage increase I got last month didn't match the rise in prices, so I get a bit more, but end up worse off.'' 

  Due to similar sentiment, truculent workers walked out of factories across the nation last month, demanding more pay and better conditions to combat price hikes and soaring rentals. 

  Most of the strikes were settled after modest increases were paid, but that is viewed as a stop-gap measure as inflation continues unabated and ordinary folk continue to bemoan their falling living standards. 

  Said Ms Phuong: 'Nowadays, my husband does not have enough money to take us out to dinner like he used to do. When the kids suggest it, he says we have to save or we'll starve. Life is just more miserable these days.'' 

          Roger Mitton, 
  Hanoi Bureau Chief,
  The Straits Times (Singapore), 
  21, Phan Boi Chau St,
  Hoan Kiem District,
  Hanoi,
  Vietnam. 
  Office Phone:               (84...       . 
  Mobile:               (84) ...       .
  Fax: (84-4) 942-8964.
  Email: rogermitton at hotmail.com or mitton at sph.com.sg  

---------------------------------
  Date: Sat, 23 Feb 2008 14:48:15 -0500
From: tdhoanh at gmail.com
To: vnbiz at vietlinks.net
Subject: Re: [Vnbiz] Inflation Control

Dear brothers Hao & Tuan and CACC,

  Thanks for the quick responses, bros.  Let me capture the situation so far, incorporating brother Hao's and brother Tuan's input into the large picture.

  The Central Bank of Vietnam has pumped more Dong into the market (probably by buying the UDS) to keep the USD dollar artificially high against the Dong, hoping that it would help Vietnam export.

  The additional Dong in circulation, in turn, has generated inflation (or at least helped inflation).

  To reduce the Dong circulation (to reduce the inflation pressure), the Central Bank ordered commercial banks to buy treasury notes.  This forced purchase of treasury notes has dried up the banks' liquidity (i.e. Dong).  

  The Central Bank has also increase interest rates on the Dong (in January of this year) probably to "reduce the Dong circulation and therefore reduce inflation pressure".  (Please read in Vietnamese http://vnexpress.net/Vietnam/Kinh-doanh/2008/01/3B9FEEC3/ ).

  Banks, having no money for lending, have reduced real estate loans.  This may soon lead to a drought in the real estate market and the construction industry.  (Please read in Vietnamese http://vnexpress.net/Vietnam/Kinh-doanh/2008/02/3B9FF6D5/ )

  Because of the shortage of the Dong and because the Central Banks has increased interest rate on the Dong, banks have also increased interest rates, which lead to many withdrawals by saving account holders to switch banks, shopping for higher interest rate on their savings.  (Please read in Vietnamese at http://vnexpress.net/Vietnam/Kinh-doanh/2008/02/3B9FF85C/ ).  OF course, higher inerest rate also hurts the real estate market and the construction industry.

  That is the situation so far.  The order of appearance I have up there is roughly, but not strictly, the chronological order of all the events.  But I think this point is not crucial, since all the events affect each other like in a circle, regardless of what happens first.

  So, what do we have now?

  1.  We have higher interest rate, which may increase inflation ( and not reduce inflation).  High interest rates usually bring higher prices because (1) producers of products and services have to pay higher interests on their operating loans and (2) psychologically, in the Vietnam I know, every time people hear about "higher interest" they panic and increase prices.  (So the theory that "higher interest rate may reduce the money circulation and thefore reduce inflation" may not work at all in Vietnam).

  2.  We have the Dong circulation dried up because of the forced purchase of treasury notes.  This may dry up the real estate market and the construction industry, which may precede a recession.  But the recession may increase inflation (instead of reducing inflation as recession usually does), because the volume of services and products (in real estate and construction industry and related "beneficiary industries") will go down with more people without jobs, while the money circulation is still the same.

  3.  We have the Dong circulation essential the same (I am not sure the same or a bit different), because the Dong pumped in by the Central Bank have been absorbed by commercial banks when they were forced to buy treasury notes.  So, the Dong value compared with the USD is essential the same.  Whatever the Dong's appreciation the Central Bank has achieved will disappear immediately because the money exchange rate is extremely sensitive to the supply and demand of the market.  You cannot fool the exchange market at all. 

  4.  In the meantime, the inflation that was caused by the Central Bank's pumping money into the market has occured and won't go away soon, because inflation is less sensitive to the market and more sensitive to psychology.  Once inflation has already happened, it may take a while to disappear even if we do all the right things.  Once sellers have increased their price because of inflaion, they are very reluctant to go down.  

  5.  In addition, the "interest crisis" at the banks and lending institutions may feed more into the inlfation psychology.  Actually if inflation continues to rise, saving customers will withdraw their savings, not to switch banks, but to buy gold to be safe.  Which wil make inflation much worse.

  Am I on the right track so far?

  Hoanh
  ____________

-- 
Tran Dinh Hoanh, Esq., LLB, JD
Washington DC _______________________________________________
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