Vietnam: Kicking off policy rate hiking cycle
- Further policy rate increases are on the cards
- Policymakers will be keen to curb weaker FX pressures, while keeping inflation below its 4% target
- Ultra-easy monetary policy is no longer needed given robust domestic growth recovery
- Refinancing rate normalisation to pre-pandemic level of 6.00% is in sight by 4Q22
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Vietnam’s central bank joined ASEAN’s hawkish bandwagon in a surprise announcement yesterday. The State Bank of Vietnam (SBV) said that it will raise its key policy interest rates by 100bps starting from September 23. The refinancing rate will be hiked to 5% from 4%, while the discount rate will be lifted to 3.5% from 2.5%. This marked the first increase since late-2011. We had been expecting a 50bps increase by 3Q22, vs analyst consensus estimates for a modest 25bps hike in 4Q22. In our view, further SBV hikes are on the cards. Key factors that will drive additional policy rate increases include curbing downside currency pressures in the context of rising inflation, and less need for very aggressive and loose monetary policy stance given the robust post-pandemic recovery. A normalisation in the refinancing rate to pre-pandemic level of 6.00% is in sight by 4Q22, and the rate would potentially reach 6.50% by 1Q23.
Yesterday’s interest rate announcement followed quickly from the earlier news in the day, where Vietnamese Prime Minister Pham Minh Chinh urged the SBV to consider raising its policy rates after the US Fed hiked by 75bps during its September meeting. In our view, the policy rate hike trigger was likely the Vietnamese dong’s weakness vs the US dollar, coupled with expectations of further USD upside pressures following the upward shift in the Fed’s expected terminal interest rate. The VND’s depreciation to an all-time low does not provide comfort to policymakers in a rising inflation environment. The currency has, however, outperformed many regional currencies so far in 2022 (down 3.7% vs Asia dollar index of 9.4% drop).
Keeping inflation at bay below 4% target
Vietnam’s biggest economic challenge at present is to keep inflation under control, according to the SBV. This, in our view, suggests that further interest rate hikes are likely, to be consistent with its price stability mandate. Vietnam’s headline and core inflation has trended higher since the February 2022 bottom to a high of 3.4% YoY in June, driven by a combination of higher energy and food prices, as well as an ongoing economic recovery.
Headline inflation eased slightly in July and August from June’s high of 3.4% YoY due to softening fuel prices, but food price increases remained on an uptrend. The moderation in headline inflation over the past two months appears set to reverse higher going into end-2022 towards SBV’s 4% target, partly due to base effects. The external cost environment also remains highly uncertain and a rapidly weakening currency could negate the correction in global commodity prices.
Core inflation has picked up quickly to 3.1% YoY in August, reflecting signs of demand-pull pressures, as economic growth gained significant traction amid the shift to endemicity. August’s core figure has exceeded headline inflation for the first time since February 2021. Further upside pressures would still be present due to ongoing domestic strength, even as the external demand landscape becomes more challenging. Policymakers would be keen to curb such upside pressures, especially to avoid high inflation seen in previous episodes.
Ultra-loose policy unwarranted given robust growth recovery
Vietnam’s key refinancing rate was lowered by 200bps to 4% during the height of the pandemic to cushion the impact of the unprecedented health crisis, which we think was appropriate. After two over years of pandemic, the Vietnamese economy has managed to recover rather strongly, following the effective deployment of vaccines and economic reopening domestically and internationally. In our view, the significantly easy monetary policy suitable for extraordinary conditions is therefore no longer warranted. A careful monetary policy normalisation to rebuild some buffers would instead place Vietnam in a better position to deal with an increasingly difficult global external environment. Recessionary risks in the US (Vietnam’s largest goods exports destination) would rise in 2023 amid restrictive interest rates and tightening financial conditions to tackle multi-decade high inflation.
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