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CENTRAL INSTITUTE FOR ECONOMIC MANAGEMENT
CENTER FOR INFORMATION AND DOCUMENTATION
WORKING-PAPER
MONETARY AND FISCAL
POLICIES CONTROL UNDER
HIGH INFLATION IN VIETNAM
Hanoi, April 2008
CENTRAL INSTITUTE FOR ECONOMIC MANAGEMENT
CENTER FOR INFORMATION AND DOCUMENTATION
WORKING-PAPER
MONETARY AND FISCAL
POLICIES CONTROL UNDER
HIGH INFLATION IN VIETNAM
CENTER FOR INFORMATION AND DOCUMENTATION
Tel – Fax: 084-4-7338930
E-mail: [email protected]
TABLE OF CONTENT
I.
SOME CONCEPTION ON INFLATION
1. What is inflation
2. How to measure inflation
3. Negative effects of inflation
4. How to employ monetary and fiscal policies to deal with inflation
II.
CURRENT STATUS OF INFLATION IN THE WORLD AND
VIETNAM
1. Inflation in the world
2. Inflation in Vietnam
3. To dissecting causes of inflation in Vietnam
3.1.
Trade and payment balance deficit
3.2.
Management of foreign capital inflows
3.3.
Management of public investment
3.4.
Monetary supply growth
III.
THE IMPLEMENTATION OF MONETARY AND FISCAL
POLICIES UNDER HIGH INFLATION IN VIETNAM
1. The execution of monetary policy during the last time
2. The execution of fiscal policy during the last time
3. Some comments, remarks, and recommendations
High inflation has returned after many years and becoming an enormous
concern to policy-makers in almost all countries in 2008. Two-digit inflation
in developing countries has been an existing constraint to macroeconomic
stability, potentially slowing down economic growth and eroding
achievements gained over the last years of poverty elimination work.
Inflation has also extraordinarily increased in Vietnam during recent months,
after a long time kept under control. In the first six months of 2008,
consumer price index (CPI) increased with a year-on-year rate of 26.8
percent which is a terrified number and among the top highest of the world
at current time. Since Vietnam’s transition to a market-oriented economy,
inflation has never attracted as much attention of national and international
analysts as it does now. The government has also taken many actions with a
view to curbing inflation. However, the story of inflation is continuing and
will certainly leave long-term impacts.
The paper focuses on inflationary issues of Vietnam under current situation
with three main parts. The first chapter reviews theoretic framework of
inflation, in which concentrating on monetary nature of inflation.
Inflationary situation of the world and Vietnam will be discussed in chapter
2 as an effort to figuring out rationales of inflation in the world generally
and Vietnam particularly. Chapter 3 focuses on monetary policy
management with at inflation curbing measures taken in Vietnam currently,
while providing relevant remarks and policy recommendations for the future
time.
I. Theories on inflation and money supply
1.1.
What is inflation
A definition which is most widely accepted assumes that inflation is
continuous price increase in the whole economy. To define whether there is
inflation, attention is often paid to general price increasing trend rather than
any sudden elasticity of common prices. Thus, short-term price increases of
some certain goods in the market do not mean inflation occurring.
Economic theories dedicated that general price increases as aggregate supply
decreases or aggregate demand increase. Aggregate supply decrease may be
resulted from an adverse technology sock, labour supply decrease, or
increase in production factor prices. Aggregate demand increase may be
resulted from increases on governmental expenditure, tax cut, or increases in
monetary supply.
Inflation is often divided into three kinds: demand pull – inflation; cost push
– inflation; and monetary inflation.
Viewing from longer-term point, however, all kinds of inflation are
generally of monetary nature. Decrease in aggregate supply can derive from
adverse socks, such as labour supply decrease, and increases in production
factors. But aggregate supply decreases do not lead to continuous price
increase unless they are backed by the Central Bank through continuous
monetary increase. Familiarly, Aggregate demand increase may be due to
governmental expenditure increase, tax cut, or monetary supply increase.
Government’s expenditure increase and tax cut are limited; therefore they
are unable to cause continuous price increase unless the state budget deficit
is financed by continuous money issuance. In this case, only one factor that
is unlimited is monetary supply increase leading to continuous increase of
general price. Thus, although there are may factors leading to price
increases, economists usually figure out monetary supply as a major cause of
long-term inflation. No matter where and when inflation happens, its cause
is always monetary one.
1.2.
How to measure inflation
Inflation is often measured by economists through two common indicators,
namely: CPI (Consumer Price Index), and GDP Deflator – or GDP
adjustment, in another word. The former bases on a basket of consumption
goods and their prices at two different point of time. The latter is on a
foundation of total annual finished goods and services and their prices at two
different points of time, they are generally on a basis of fixed and current
price statistics. There are no significant differences among these two
measures. The approach of GDP Deflator will calculate inflation more
accurately given the definition of inflation. However, CPI has its own
advantage that is it allows calculating inflation at any time, basing on the
basket of commodities while GDP deflator just allows calculating the annual
inflation after the year report on GDP is provided.
%M+%V=%P+%Y
Or
%P=%M-%Y-%V
Inflation is also classified basing on its levels: low or moderate inflation is
inflation with annual price increase rate of less than 10 percent. High
inflation (galloping inflation) is inflation with two- digit annual price
increase rate. Super inflation is inflation with three-digit annual price
increase or even higher. In contrary, the phenomenon of decreasing of price
or as price increase rate is negative is called deflation.
CPI is used by Vietnam to calculate inflation rate. The General Statistic
Office publishes inflation data after calculating consumption price index
(CPI) of a basket covering 494 primary commodities divided into 10
categories of goods and services. The shares, or the contribution ratio in
GDP (which is so called weighted numbers) captured by respective price
increases of goods and services categories are as follows: restaurants and
relevant services accounts for 42.85 percent (of which, grains – 9,86 percent,
and food – 25 percent); housing, electricity, water, fuels, and construction
materials: 9.99 percent; transportation and tele-communication: 9.04
percent; household appliances: 8.62 percent; garments, hats, and food wares:
7.21 percent. Contribution to GDP of each category is equivalent to the
change of that category’s price (compared to the base time, e.g. the previous
year or month) multiplied with respective weighted number. CPI is an
aggregating value of such components.
1.3. Negative effects of inflation
Economists have vey different viewpoints regarding the scale of inflation’
adverse impacts. Some even suppose that losses caused by inflation are
moderate, and this is true as long as inflation rate is kept at a stable and
reasonable level. However, once inflation is at a considerable rate, its social
effects on the property redistribution among individual are definitely
significant, thus governments of all countries have to do their utmost to
prevent this kind of inflation.
If inflation is predictable, entities of the economy are able to response
proactively, though there are still certain losses to the society. Inflation is
similar to a tax imposed in money keepers, and the nominated interest rate is
a sum of actual interest rate and inflation rate, therefore, inflation makes
people less willing to keep money and the monetary demand decreases. This
leads to more regular bank withdraws. Economists have provided the term of
“shoe leather cost” to mention losses aroused due to more inconveniences
and time consumption that people have to suffer comparing to those in noninflation period. In addition, inflation will certainly result to price increases,
causing an additional expenditure of changing and reprinting product price
lists to enterprises. This phenomenon is so called “menu cost”.
Inflation makes relative prices change unexpectedly. For example, as long as
inflation occurs, some enterprises increase their product prices (and of
course menu cost aroused), while other enterprises want to keep the same
prices to avoid menu cost; therefore prices of the latter group will relatively
cheaper than those of the former group. Given the fact that a market
economy distributes resources on a basis of relative prices, thus inflation
lead to infectivity in microeconomic terms.
Inflation can deviate
II. Current situation of inflation in Vietnam
and the world
2.1.Inflation in the world
The world entered 2008 with a gloomy economic prospect. Some big
economies like United States and EU have been dealing with increasing
inflation and unemployment, and stanstill economic growth. Inflation in EU
member economies was 4% in June 2008, breaking the inflationary record of
3.7% in May 2008, and twice as high as the inflation curbing target of ECB
that keeping inflation in the euro zone of EU below 2 percent. United States
has also been facing with inflation rate of more than 3 percent during this
year; also two folded the number of previous years. Almost all developing
countries and newly emerged economies have been suddenly fell in high
inflation and faced with the risk of slowed down growth after a long time of
rapid grow. Inflation in China is 8.5%, the highest level in recent 12 years;
the number in Russia has jumped from 8 percent of the last year to 14%, etc.
Some analyses reports that the above statistics are not efficiently calculated,
and real inflation is expected even much higher. It means that two out of
three parts of the world population are struggling with two-digit inflation.
Major reasons of high inflation are increasing food and energy prices. Many
analyses have showed that rapid inflation in developing countries derived
from socks. However, a deeper reason lies in loosen monetary policies
applied over recent years with a view to gaining desirable growth rate, which
is the reason of all reasons.
However, it is impossible to ignore a fact that triggered high and rapid
inflation is the instability of financial sectors in developed countries, of
which the largest economy of America is responsible for. It is clear that
economic regression of American economy, which accounts for 25% of
global GDP and 15% of total the world imports, has caused adverse impacts
to the world economies.
In addition, loosen monetary policies with continuous interest rate cuts and
the US’ policy of maintaining weak dollar have even caused more
difficulties to monetary policy management in newly emerged economies
and developing countries. All analysis has clearly showed the reason of
inflation
Food prices are rising quickly. The rice price reached to the level of
US$1200 per ton, doubled that of last year. Worries of food crisis has raised
during the beginning of 2008 when some countries like India, The
Philippines and others Africa countries were in the brink of serious food
shortage. If there were no prompt support actions from Governments and
international organizations, food crisis has been swollen and hurted those
economies.
Sadly, food prices are still on its high-sky trend. In China, for example, food
price jumped by 22% last year while others slightly increased by 1.8%. It is
demonstrated that food stuff accounts for 30% to 40% proportion of goods’
basket in developing countries, meanwhile this rate is only 15% in G7
countries. This shows that higher food prices have a much bigger impact on
the overall rate of inflation than in richer economies, where food accounts
for a smaller proportion of the goods’ basket.
The question is why inflation was soaring in surprising way and in so short
of time to various countries in the world? In fact, there are many analysis
demonstrated that soaring inflation in developing countries was rooted from
supplying shock. According to The Economist, from 2002 till now, emerging
countries themselves with their big demand counted for 90% ( for oil and
metal) and for 80% for food stuff has shot up the world demand on those
commondities. It is also proved that developing countries has consumes a
large amount of cereal for biology fuel. The short supply surely lead to
continuous bumper price.
The surface reason for food and fuel price shocks are lied on supply.
However the underwater part of the iceberg showed that it is prolong loosen
fiscal policies for dramatically development kicked the shocks. This lead to
overheating development occurred for a long time in series of countries. The
loosen fiscal policy, especially in emerging economies lead to an significant
increase of monetary supply. Also reported in The Economist, the monetary
supply in emerging economies has an average of whopping increase by 20%
same period of last year and was triplicated the developed countries.
Monetary supply increased will in turn push up the domestic demands that
fosters food prices in high level.
In a nut shell, the reason of all reasons lies on fiscal managing policy.
Central banks in emerging countries had inadequate independence as well as
flexation when maintaining loosen fiscal policy that uses low interest rate for
political target to fast grow and employment. Given a tight fiscal policy,
food prices could have been decreased that also well controls the inflation.
In developing countries and emerging economies where apply inappropriate
monetary policies, the increase of inflation is a prominent response to
soaring prices of key products. It firstly came under the shape of surging
food and fuel prices and gradually expands to increase price of other
commondities. Due to fear of continuously rampant prices, there are upward
pressures to level up salary. This in turn has impact to swell the price and
contributes to a bigger inflation spiral.
We could not unacknowledged the real detector of inflation that lies on the
instability of rich economies, in which biggest responsibility is counted for
America.
The world biggest economy, America, for instance, conceded that they were
sunk in economic depression. Economic depression was rooted from
collateral crisis since end of 2007 that took away payment capacity of many
banks, pushed banks into the brink of bankruptcy. Bear Stearns, for example,
would have announced of bankruptcy if the America did not give a hand to
support. This crisis were dragging along dozens of banks inside and outside
America that burdened billions of USD loss. The crisis also spread to others
business field such as Insurance and manufacture sector. Until now, the
America has not recovered from this serious crisis. So far in the beginning of
July, the America has once again shaken violently when 2 biggest banks,
Fannie Mae and Freddi Mac had stuck with huge loans of 5000 trillion USD
(which accounts for ½ of all market). It was second times in a month the
Government and FED urged for urgent meeting to find the solution. The
estimated bulk jumped to 1000 trillion USD.
It is obviously the America might suffer from a vicious economic crisis.
There were argument that this has been the 80 year worse crisis since the
depression in 1929-1933. The America Government has applied various
whole package solution to saves it economy since end of 2007. Despite high
risk of inflation, America Government is maintaining perversely a loosen
fiscal policy. The Federal Reserve has reduced interest rate several times
since the beginning of 2008, at 2% currently comparing to 5-6% last year.
The president Bush tried to persuade the Congress approve to reimburse 150
trillion USD of tax in an aim to pump money into circulation that in turn
would encourage consumption and economic growth. This move however
seems don’t have much positive effect to America economy. The stock
market had month-on-month stumble, the dollar depreciated to those key
money notes, inflation and unemployment reached to highest points in recent
years. It is expected that the growth of America can gain only 1%, lowest in
years. The recovery will only come end of 2009.
Further analysis on land crisis in America also should be done. The reason
of the crisis is from the move of “speculation” which were furnished by
derivation fiscal tools of America banks themselves. The main reason lies
above. Quick housing price increase phenomena during a year is rarely
happened in America. Neglecting the fact that soaring price over real cost
within a year would create bubble, lots of citizens could not believe that the
price would crack down. Many parties were involved, including monetary
trader. Bankers overstated housing price for one reason, the higher price
was, the higher demand for house and the higher the service fee reached.
Furthermore, American law was changed under which allowed multi fields
financial trading, banks were allowed to do debit business (debit stock). The
bank will issue a stock per housing loan and sell to investors. This considers
a risk extract policy. Once the house price increase, it will immediately
boost the stock value, encouraging collateral housing loans. Consequently,
when the bubble was busted, investors failed to pay loans and being
squeezed by banks as a result. Banks in turn also being threatened to serious
losses by inability to pay loans, land price reduce, loosing stock value. Once
banking system is broken, the economic crisis will be inevitable. A similar
story could be told of Vietnams stock market and land market in which
commercial banks play roles in boosting demand and pushing assets prices.
Further studies to other commodities showed beside the above narrowed
supply, there is increasing participation of derivation tools in asset
speculation. Such tools as stockilized, future transaction, options transaction
becomes strong tools in hands of investors to rare commodities. And its
results are oil price reached its highest point ever recorded, gold and other
farm products and raw material also surprisingly increased. According to
Lehman Brothers, total entrusted assets amount in commodities index
markets from 75 billions USD in 2006 to 235 billion USD in mid-April
2008, triplicate that in 2006. The Financier George Soros in his speech to
policy makers in June 2006 affirmed that the current price bubble due to
speculation were “supper bubble”. The result when that supper bubble
busted, prices would be fallen to The “Y axis” causing unexpected serious
impacts to world economy.
It therefore proved that derivation fiscal tools put the international financial
market into a insecure and fragile situation. America, even though is
considered to create firm law framework for the stable development of
financial market, got such big matters. Never occurred a depreciation which
caused by out of control financial market under economy rules built up after
the crisis in 1930. Previously, the inflation mainly caused by over money
printing serving war expenditure, or soaring oil price without any actions of
monetary policies, or the overheating development. At present, new fiscal
tools that were made to increase banks and financial parties’ interest but
without controlling tools are provoking the world economy.
Obviously, the depreciation of America has negative effect to world
economy. The America economy which accounts for 25% of global GDP
and over 15% total import value in the world has strong impact to the world,
dragging various economies’ depreciation. Several OECD countries
announced to lower their growth criteria this year. American depreciation
also has domino effect to Euro area and other big economies such as China,
India, Brazil, etc,…
Nevertheless, the policies which unrest cut down interest rate and maintain
a weak dollar added troubles to developing and emerging economies. These
economies are suffering from huge off shore capital inflows, especially the
dollar, to enjoy the interest discrepancies. Since 1970 the capital inflows
have been loosen and facilitated a lot. In order to cope with numerous
monetary inflows, state banks in developing countries are facing a
dilemmas. The escalading capital inflows will put strong pressure to
appreciate the domestic money. However instead of appreciating the
domestic money, state banks prefer to bump more money (by printing more
money) in order to neutralize the capital and maintain the exchange rate,
stimulating their exports competitiveness. This action of state banks in one
side curbs domestic money appreciation but the other side boosts the
inflation spiral. Mean times, the policy of increasing interest rate encourages
more capital inflows. It therefore makes this policy be useless. Dramatically,
the appreciation of domestic money will attract turbulent investments and
thus increase inflation. This issue are provoking China.
2.2 Inflation in Vietnam
Vietnam has witnessed two- digit inflation with highest level since 1992,
which is also the highest rate in the region and falling into the top high of
inflation in the world at current time.
High inflation has become an enormous fear to the government and the
people. Vietnam’s growth rate will certainly slow down in 2008. Real
income of the people decrease, particularly that of farmers and paid workers.
Inflation also threatens undermining achievements of poverty elimination
that Vietnam gained over the past years.
There are arising and unsolved questions concerning why inflation in
Vietnam is much higher than almost all countries in the world. So far,
inflationary risks have been reviewed and granted the top priorities in
Vietnam. In the meeting in late March, the Government agreed on the
central tasks given the current conditions, including: curbing inflation,
stabilizing macro economy, ensuring social security and sustainable growth,
of which inflation curbing is the first priority.
Reasons of inflation have also discussed. In addition to objective ones, such
as high inflation in the world due to increased oil, food, and input material
prices, other significant contributors to high inflation in Vietnam are
weaknesses in the government’s management, particularly monetary
management.
In general, difficulties of the economies are resulted from: impacts of
investment capital boom in 2007, the unbalance between foreign currency
and domestic currency capital, ineffective money flow controls and
management, trade deficit, adverse effects caused by state economic
corporation. Of which, the most remarkable reasons are trade and payment
balance deficit; inflow foreign capital management; public investment
management; and money supply management.
Inflation in Vietnam has dizzily increased since 2008. The inflation in the
first 6 months of 2008 is 18.44%, increased by 26.8% comparing to same
period last year. The speed of inflation, though is now reducing in June, it is
predicted to be at 27.25% for all year of 2008 after three policies of growth
and inflation innovated recently by Vietnam General Department of
Figure 1. Inflation in Việt Nam
30
27.25
20
10
7.8
5.8 4.84.2
6.8
0
4
-0.4
7.8
7.3
4.3
7.1
6.9
8.4
8.2
8.4
12.68.5
7
6.6
-1.6
-10
1998
1999
2000
2001
2002
2003
2004
2005
2006
Inflation
7.8
4.2
-1.6
-0.4
4
4.3
7.8
8.4
6.6
12.6
27.25
Growth
5.8
4.8
6.8
6.9
7.1
7.3
7.8
8.4
8.2
8.5
7
Source: General Statistic Office, data for 2008 is estimated
2007 2008f
Statistic.
The two digit inflation rate of Vietnam is evaluated highest since 1992 (refer
to Picture 1), highest rate in the region and also amid of highest countries in
the world.
Surging inflation is now becoming serious concern to the economy. It
threatens each individual life as well as economic activities. It has been such
a long time since the three digit inflation in 1986-1987, the ghost of
hyperinflation comes back and put heavy burden to Vietnamese. Vietnam
puzzled with some rumors that told the old story of a crisis Vietnam with
collapse Dong and of that the Government would carry out money changing
as before.
In fact, inflation is not a ghost but a real worry of Vietnam economy.
Obviously, the growth will slow down this year. The net income of citizens
will reduce, especially farmers and workers. Inflation, in additional, are
threatening to remove achievements of Vietnam in poor elimination resulted
from dozens of years afforts.
If we turn back the hand of time to the end of 2007, at moment the inflation
started in Vietnam. The official number announced by The General
Department of Statistic was 12.6% in 2007, surprisingly high since 1992
disregarded the controversial new method of statistic. There were plentiful
of warnings on surging inflation stated on news papers as well as be
discussed in international and domestic workshops. However, the awareness
about inflation were not fully understood. For example, there were irrational
attitudes that put growth first but together with illogical statement “ must
keep the inflation rate lower than growth rate”.
The increase of inflation were shortly assigned to external reasons such as
surging fuel price and foodstuff price in all over the world. Reasons for
inflation in Vietnam were announced that the cost inflation were boosted due
to increase import value, or “import inflation”. There were also several
objective reasons such as disease in cattle, fowls and prolong damaging cold
causing farming losses. Some very firstly solutions of the Government
aimed at boosting supply such as cutting tax, subsidies. These solutions in
contrast, caused budget deficit. Recently, the Government has to increase the
fuel price by 30% and conceded by the Financial Ministry that the National
Budget can not afford the subsidies of 60-70 trillion USD from now on end
of the year.
Not until the unrest surging inflation early 2008 and lots of hanging question
of why inflation in Vietnam is significantly higher than those of other
countries in the world. In the meantime, all policies aiming at supply do not
work, were inflation risk and reasons once again put into the discuss round
table and curbing inflation put priority. In regular meeting end of March
2008, Government got the consensus: curbing inflation, stable the marco
economy, ensuring living stands, stable growth, in which curbing inflation
were put first priority. On 30th March 2008, The president Nguyen Tan Dung
gave his important speech on 7 solutions to curb the inflation that evaluated
as feasible solution.
Inflation roots were deeply analysised. Besides the increase of fuel price,
food price, and material price, the weakness of managing competence of
Government, especially financial management, were frankly conceded. On
the regular meeting early 2008, the president Nguyen Tan Dung frankly took
responsibility on weakness of management that is still subjective and in
fiercer.
Paradoxically, Vietnam is an agriculture country that obtains significant
achievements: 2nd biggest rice exporter in the world, 1st exporter of various
farming products such as shrimp, coffee, rubbery, etc, …. In other words,
there is no concerns about food security in Vietnam. In the mean time,
foodstuff accounts for big proportion of CPI of commodities basket (food
accounts for 43% of total basket). Vietnam, according to rational idea,
should have stronger capacity in curbing inflation than others food and fuel
dependent countries. Why this contradiction happened?
3. Deeply analy inflation roots in Vietnam
Inflation in Vietnam has deep root lies on instable of the economy.
According to Mr. Alan Greenspan, formal president of FED, there are
several reasons leading to economic difficulties: impact of bursting
investment since 2007, unbalance between domestic currency and foreign
currency, ineffectiveness in capital flows management, import surplus and
negative impact from state own economy. Details are as follows:
3.1. Trade deficit and payment balance deficit.
Let have an overview on commercial deficit. According to the report of
World Bank, the deficit of temporary account in 2007 was estimated to 15%
GDP, which worried by World bank (Picture 2). It were announced by GDS
on 1st July 2008, import surplus in 6 first months was estimated 14.8 billion
USD, accounts for 49.8% the export turnover, much higher than overall of
2007.
Import surplus is a chronic disease of Vietnam years on years. Import
surplus advocates agued that Vietnam is on process of modernization and
industrilization so it need a big import amount of machine. Furthermore,
export enterprises also need input material. In the contrast, recently, the
portion of import should be take into consideration which significant
Figure 2. Trade and Payment balances of Viet Nam in 2000-2008
increase of consumption goods, especially luxury goods. Importing car
separately touched the point of 1.306 billion USD in the first five months of
2008, jumped by 392,4% the same time of last year, the gold import of
enterprises ( not state bank) went up to 4 billion USD, making Vietnam the
world biggest gold importer, higher than China and India did. In the
meantime, import of other commodities also set up new peaks such as steel
and fertilizer were double last year. The paradox is that despite prices are on
high-sky trend, those imported commodities will be re-exported out of the
border, not to be used in manufacture.
It is common knowledge that too big and prolong import surplus (
comparing with export and GDP) will seriously sterilize balance of
payments. Although balance in Vietnam is still evaluated surplus thanks to
foreign currency storage, foreign Investments (both direct and indirect
investments), offshore remittance. However, if import inflation is considered
as one of reasons causing high inflation in Vietnam, over surplus import is
threatening the marco economy.
3.2. Offshore capital inflows management
Foreign investment has played a crucial role in to the economic growth in
Vietnam. These foreign currencies do not only contribute to the economic
growth but also compensate for the commercial deficit and enhance the
national reserve.
The underlying reason of commercial deficit in Vietnam lied on exchange
policy management. For years, the dollar seriously depreciated versa almost
key currencies in the world. The year on year peg of the dong versa the
dollar resulted to appreciation of the dong versa the dollar, contributing to
curb export and to encourage import which in turn caused the continuous
deficit on temporary accounts, fluctuating from 1.7% to 4.9% GDP in 3
years. According to Vu Quang Viet, statistic expert of United Nations
predicted that the dong appreciated 13% versa the dollars.
Consequently, the president of Vietnam has command to parties to curb
import surplus as an important solution to stable the macro economy and
constrain the inflation.
High inflation has become an enormous fear to the government and the
people. Vietnam’s growth rate will certainly slow down in 2008. Real
income of the people decrease, particularly that of farmers and paid workers.
Inflation also threatens undermining achievements of poverty elimination
that Vietnam gained over the past years.
There are arising and unsolved questions concerning why inflation in
Vietnam is much higher than almost all countries in the world. So far,
inflationary risks have been reviewed and granted the top priorities in
Vietnam. In the meeting in late March, the Government agreed on the
central tasks given the current conditions, including: curbing inflation,
stabilizing macro economy, ensuring social security and sustainable growth,
of which inflation curbing is the first priority.
Reasons of inflation have also discussed. In addition to objective ones, such
as high inflation in the world due to increased oil, food, and input material
prices, other significant contributors to high inflation in Vietnam are
weaknesses in the government’s management, particularly monetary
management.
In general, difficulties of the economies are resulted from: impacts of
investment capital boom in 2007, the unbalance between foreign currency
and domestic currency capital, ineffective money flow controls and
management, trade deficit, adverse effects caused by state economic
corporation. Of which, the most remarkable reasons are trade and payment
balance deficit; inflow foreign capital management; public investment
management; and money supply management.
3.3.Management of public investment
In term of theory, this is also a way of selling ineffective enterprises to
collect money for the State, transforming from owning tangible assets to
owning value. Then, the collected money will be invested into more
profitable areas, thus, its value will not be lost but transformed into another
form.
For joint-stock enterprises in which the State holds shares accounting for
less than 50 percent of charter capital. Actually, the rest of material assets
has been sold to individuals and they have ownership to the share that they
bought, but it is impossible to find any cases in which factories or
mechinaries are disassembled of taken to pieces to distribute to these
individuals. However, there are still a phenomenon of buying shares in bulk
taken in some places, but people have failed to discover such muster in a
group of shareholders. In fact, these enterprises are operating very well
under the management of a new board of directors, even shareholders
representing the State in these enterprises are also put under control of such
board of directors.
In accordance to a research, so far, none of equitized enterprises have been
privatized; up to 90 percent of existing joint-stock enterprises have recorded
good business performance, increased their state revenue contribution,
labourers income, social capital mobilization, and job creation, and stopped
lost indemnification from the state budget. The rest 10 percent of poor
performing enterprises are due to a fact that they were already of poor
performance when they were SOEs, furthermore, they failed to define proper
business strategies, and to settle shortcomings neither. In addition, there
have beeb also some scandals in these enterprises, such as: inner disunity,
fighting over power, some even suffered from undue interference of local
authorities right from the stage of equitization project approval to sending
representative personnel of state capital to the new board of managers, etc.
Since the beginning of 2005, the adoption of public bidding for shares, for
large enterprises (sold out shares are of more than 10 VND billion) it is
required to be taken on bouse, has further facilitated the transformation to
joint-stock companies with publicized orientation.
Even in his analysis on the classic capitalism-oriented society, Anghen did
state: “Capitalism-oriented production is because joint-stock business
companies are no longer of private production”, so how equitization of
SOEs can be make privatization under current mechanism in Vietnam
3.4.Monetary supply growth
Inflation is basically a monetary phenomenon. Persistent inflation occurs by
an injection of purchasing power into the economy beyond its absorptive
capacity. It is empirically well known
that excess liquidity usually stimulates both output (temporarily) and prices.
But it is important to
distinguish the case in which this liquidity injection occurs internally and the
case in which it comes from external sources. The classical balance-ofpayments crisis of the 1960s-80s, in which IMF played a crucial role, starts
with an irresponsible government which over-spends its revenue. The
resulting fiscal deficit is financed by printing money. This increases
domestic credit and money supply, and creates inflation. On the balance of
payments, the current account worsens and the capital account also
deteriorates as the country sinks deeply into debt until no one lends money
to this country. The monetary authority runs out of international reserves to
pay for imports and debt repayments.
The country has no option but to go to IMF and ask for an emergency loan
in exchange for the monitored execution of belt-tightening macroeconomic
measures.
However, as an increasingly large number of developing countries open up
to capital inflows, another type of macroeconomic problem emerged in the
1990s. As a country liberalizes its capital account, foreign investors are
aroused and begin to invest aggressively in that country. They often follow
herd behavior under the condition that information is imperfect and domestic
financial markets are primitive and not properly regulated.
Foreign funds may come in the forms of bank loans, stocks, bonds, real
estate purchases, and so on. FDI, remittances, and even ODA may also be
attracted to a country which is rumored to be a rising star. As these funds are
received, there will be broad repercussions in the macroeconomy through the
usual Keynesian multiplier effect. This generates consumption and
construction booms as well as land and stock market speculation. Goods
markets and asset markets reinforce each other to sustain the overheating.
This is the situation that Vietnam and China are experiencing at present.
The macroeconomic symptoms of irrational exuberance include strong
growth, accelerating inflation, rising international reserves, and gradual
overvaluation (the loss of international price competitiveness). This mix is
troublesome enough, but the real risk is the possibility of serious crisis if this
situation proceeds too far. A severe reversal may occur as asset markets
collapse, foreign investors leave the country, the currency plummets, bad
debt mounts, and credit crunch emerges. This type of crisis, caused by an
excessive inflow of foreign funds and their subsequent withdrawal, is called
the capital-account crisis, as opposed to the traditional current-account crisis
generated by loose fiscal policy. The Asian financial crisis of 1997-98 was a
typical capital-account crisis, but Vietnam was not directly hit by it because
its capital account was closed at that time2. To be not too alarmist, however,
it should be stressed that such a disaster is not inevitable. Even with
continued capital inflows, serious crisis may not develop and the economy
may suffer only from mild inflation and mini asset bubbles. Outcome
depends on the size and nature of capital inflow as well as the
appropriateness of policy response.
IV.
THE IMPLEMENTATION OF MONETARY AND FISCAL
POLICIES UNDER HIGH INFLATION IN VIETNAM
1. The execution of monetary policy during the last time
In 2008, domestic commercial banks need to utilize their advantages and at
the same time expand their markets to foreign countries. Global competition
requires them to improve their financial capacity and technological standard
as well as the management capability and the quality of products and
services so that they can maintain and increase their market share. In 2008
the equitization (partial privatization) of State-owned commercial banks will
continue at a higher speed. This is one of the most important measures to
accelerate the international integration process of the domestic banking
sector. It will create favorable conditions for commercial banks to improve
their financial capacity and enhance their competitiveness, helping them
operate in accordance with market principles.
Domestic commercial banks can seek the financial support and learn the
management experience of foreign banks in order to develop new kinds of
products and services. The participation of foreign banks in the Vietnamese
banking sector will also help domestic commercial banks develop agent
relations and expand cooperation with foreign partners in the fields of
international payment and technological exchange.
However, due to their limited financial capacity and low competitiveness,
and due to growing global competition, domestic commercial banks will
possibly have to merge. Those banks that are inefficient may have to close.
The establishment of new banks will make the shortage of manpower,
especially highly qualified human resources, even more serious. This is a
pressing problem of the entire domestic banking sector.
In such a situation, to ensure the safety of the banking system, the State
Bank of Vietnam (SBV) must focus on improving legal documents,
especially the regulations related to licensing, safety supervision,
bankruptcy, and deposit insurance. Improving the capability of bank
inspectors and supervisors is a need.
The Government-set target for GDP (gross domestic product) growth in
2008 is nine percent. Another target is to curb the inflation rate below the
GDP growth rate. Curbing the inflation rate in 2008 is not easy because
prices of fuels, materials and food in the world market are rising and the
amount of foreign currency flowing into Vietnam is increasing.
To contribute to the realization of the above two targets, and to ensure the
safety of payment activities within the entire banking system, SBV will be
more active and flexible in managing the monetary market based on market
principles. SBV will apply appropriate monetary policies to control and
regulate the amount of money in circulation as well as to adjust the market
interest rate in accordance with the orientation of the State.
SBV has worked out a number of measures. Specifically, it will improve the
capability for short and medium-term forecasts about the macroeconomic
situation, the monetary market, and the inflow of indirect foreign
investment. In addition, SBV will perform the open-market business more
flexibly to withdraw money from circulation and regulate the amount of
usable capital at credit institutions. SBV will also be more flexible in
managing interest rates. At the same time, SBV will continue to improve its
legal documents, focusing on the draft State Bank Law and draft
amendments to the Law on Credit Institutions, which will be submitted to
the National Assembly for approval. Appropriate measures will be taken to
accelerate the reorganization of domestic credit institutions and the
modernization of the banking sector as well as to expand the use of non-cash
means of payment in the economy.
Tthe REER index is computed from the monthly price and exchange rate
data of Vietnam and its 21 largest trading partners.
Vietnam's REER was on a rising (appreciating) trend until 1997-98 when the
Asian financial crisis broke out. During this crisis, Vietnam's REER was
pushed up temporarily as the currencies of most neighboring countries fell
relative to VND.
Subsequently, the REER of VND declined (depreciated) moderately until
2003 then rose (appreciated) modestly until 2007. The IMF Staff Report
stated in 2006 that "[t]he CPI-based real effective exchange rate fluctuated
significantly over the last few years without exhibiting any noticeable longterm trend." (IMF, 2006a, p.30) If Vietnam is going through an economic
boom caused by external capital inflows, why is overvaluation not detected?
The answer is the real depreciation of the US dollar. From the peak of March
2002 to end 2007, the REER index of USD declined about 20%. The
overvaluation of VND, which is closely tied to USD, should be measured
against this declining trend of USD. As the counterfactual calculation in Fig.
3 shows, Vietnam's REER index should have continued to fall if Vietnam
had maintained the inflation rate of 3.1%, which was the actual average rate
during 1996-2003, after 2004. Relative to this trend, VND was already
overvalued 22% in September 2007. The apparent lack of overvaluation is
therefore spurious. The Vietnamese dong is already overvalued, but this fact
is camouflaged by the falling US dollar.
Should VND be floated or at least made more flexible? It is reported that the
State Bank of Vietnam is pursuing a roadmap toward a more flexible
exchange rate regime, and IMF strongly supports it. However, it is not clear
what this policy implies for the movement of VND. First of all, the
Vietnamese foreign exchange market is too shallow and primitive relative to
the size of global capital markets. The authorities should have the ability to
curb speculation and volatility when Vietnam liberalizes currency trade
("fear of floating"). Second, after floating, whether VND should appreciate
or depreciate is not clear as both would produce negative effects (further loss
of competitiveness versus further booms and inflation).
To say that everything should be left to the market, including any volatility
or misalignment that comes with it, does not sound like good advice to a
transition economy. After all, it is difficult to find a satisfactory solution as
long as the root cause of the unwanted boom and inflation, namely large
capital inflows, is not directly addressed.
Finally, the most useful lesson from the recent currency crises appears to be
that capital flows should be properly monitored, and regulated if necessary,
in the process of capital-account liberalization. This is a double-edged
sword, because too much control would scare foreign investors and result in
lost opportunity in mobilizing foreign savings. Vietnam should begin to
study concrete policy options to stabilize capital inflows and manage capitalaccount crisis risks without sacrificing its development potential.
2. The execution of fiscal policy during the last time
While receiving a large amount of external funds is the root cause of the
current inflation, it is not the only cause. Fiscal activism is an additional
internal factor which accelerates the economic boom created by the injection
of external purchasing power. Supported by strong economic performance,
the Vietnamese government has ambitious plans to upgrade the country's
infrastructure. Sustaining high growth is a top priority and any sign of
slowdown is met by renewed efforts to accelerate public investment projects
and secure their inputs by any means. According to GSO, the budget deficit
amounted to 5% of GDP in 2006 and is increasing. Pro-cyclical fiscal
spending has also been observed elsewhere including Indonesia and a
number of resource-rich Latin American countries such as Mexico and
Brazil. As the economy grows strongly, public investment is also expanded
to provide necessary infrastructure and diversify economic structure.
However, risks associated with such policy should be well recognized.
Aggressive spending may lead to huge indebtedness and economic crisis
when the situation turns around. Both commodity markets and investor
psychology are known to fluctuate wildly over time. Countries with
externally driven booms should install mechanisms to smooth these swings,
including a public fund to save windfall revenues for rainy days. In sum,
current inflation in Vietnam should be understood as the consequence of
three combined forces: (i) pressure from the large inflow of foreign funds
(main cause); (ii) aggressive public investment; and (iii) exogenous and
largely uncontrollable shocks from global commodity markets, animal
diseases, and natural disasters.
One puzzle concerning Vietnamese inflation is the apparent lack of
overvaluation. Exchange rate overvaluation is usually measured by the real
effective exchange rate (REER), an exchange rate against multiple trading
partners adjusted for their inflation relative to the home country's. In
essence, REER is an overall index of international price competitiveness
with weights reflecting the importance of each trading partner.
As an increasing number of countries face the syndrome of excessive capital
inflows, some lessons should be recalled from the painful experience of
capital-account crises in the 1990s and the early 2000s. The most important
thing is that the macroeconomic situation must be diagnosed correctly as
being caused by capital inflows, not as a purely domestic malaise or a
current-account crisis. This is necessary to avoid wrong measures that would
aggravate the situation.
Fiscal and monetary policy should be managed to lean against the privatesector wind rather than toward it. That means that moderately tight
macroeconomic policy stance is appropriate while capital flows in. If,
unfortunately, a big reversal occurs and domestic demand begins to shrink,
policy stance should be revised quickly to be more expansionary. In this
regard, Vietnam's current fiscal spending is overgenerous given the already
strong private-sector demand and the soaring land market. The IMF's advice
to tighten fiscal and monetary policies is appropriate (IMF 2007). Asset
markets such as land and stocks should be monitored carefully and
restrictive measures should be introduced if there is evidence of speculative
bubbles. Between the land and stock market, the former moves more slowly
while the latter, driven by short-term market psychology, exhibits more
volatility. For this reason, the monetary authority may consider accepting
moderate corrections and mini-crashes in the stock market rather than trying
to prop up the prices when they wants to fall. This is necessary to avoid
making a small bubble into a gigantic one, for which soft landing is very
difficult.
3. Some comments on monetary policies with high inflation
situation in Vietnam
Unless inflation is prevented, there will be further unrests to social and
economic life of Vietnamese people. Thus, inflation fighting is the first
concern of policy makers.
Inflation showed some signs of increase in the last years, and reached
remarkably high levels in late 2007 and 2008, which is resulted from the
pursue of widen monetary policies aiming at desirable growth targets. This
leads to too high and rapid money supply increases, and eventually inflation.
The situation is even more serious given international inflation conditions
and Vietnam’s deeper international integration.
The perception and the consideration of inflation remained subjective until
the end of 2007, therefore failing to provide proper and timely measures to
cope with the situation. Some administrative measures of monetary policies
during this time even made the situation more serious.
Just in March 2008, proper and effective policies were provided, although
there is still some certain time latency.
Although it is rather late, the option of tightening monetary policies and
interest rate increase as tools of inflation fighting is seen effective and
suitable. This has resulted to the slowdown of inflation rate in June.
Recent interventions of the State Bank, including direct and indirect
measures, with a view to effectuating tightening monetary policies, are
provided basically in the right manner, however, there remains some lack of
rationality in terms of time, dosage, and implementation schedule,
particularly during the end of 2007 and the beginning of 2008. This
demonstrates a fact that the State Bank of Vietnam has not been serious
enough in their analyses, assessments, and forecasts, especially with the
supervision of the whole system, as a major monetary policy management
authority.
So far, monetary tightening policies adopted by the State Bank, including
basic interest rate increase, and foreign exchange rate loosening, have been
effective. This means the adoption of market-oriented mechanism to
monetary policy management is definitely appropriate. Have the State
handled market signs in more sensitive and better ways, thereby making
prompter policy responses, the results would have been much more
impressive.
It is necessary to make policies further transparent in the time to come
because this will create considerable contribution to people and enterprises’
confidence enhancement.
Inflation fighting has been set as first priority with “whole package”
measures. This means monetary alone can not fully prevent inflation.
Moreover, inflation derived from fiscal policies too. Therefore, synchronous
implementation and close connection of fiscal (public spending) and
monetary policies aiming at common goals are crucial factors. In other
words, tightening monetary policies will not lead to results as wishes unless
public spending and investment are tightened, particularly to ineffective
investment projects.
As a matter of fact, although domestic inflation may be curbed by the end of
this year it is still likely to suffer from adverse impacts of the world price
increase, which could be a significant constraint to inflation fighting policies
in Vietnam, and thus should be paid efficient attention to. Such conditions
require more precise, cautious, and flexible solution to prevent the economy
from falling to a worse situation.
There are some concerns that following inflation it could be regression
which is even more terrified than inflation. Such concerns are rather
reasonable given too high capital costs, with annual lending interest rate of
more than 20 percent, burdened by enterprises. Almost all businesses find
themselves hardly make profits with such interest rates. Furthermore, many
enterprises made notable investments into securities and real estate markets
while they are currently frozen. This fact will lead to bankruptcy of many
businesses by the end of 2008, and then difficulties faced by the banking
system due to bad debt increase. It is reckoned that this should be seen as an
opportunity to restructure business system, including banks also, towards
market-oriented regime.
The battle against inflation is always a touch and suffering one, requiring
painful commutation. However, these are expenses to restore
macroeconomic stability – a foundation factor for sustainable development.