Vietnam's economic crisis is simply a matter of course

What has happened in Vietnam?

The Vietnamese economy has been growing rapidly over the last decade, but high growth has its price. Inflation increased from an average of 3.5 per cent from 2003-04 to 8.4 per cent from 2005-07. This year, it has risen rapidly to 26.8 per cent, forcing the State Bank of Vietnam to raise its policy interest rate three times over the last six months to 14 per cent.

On the surface, this seems to be a normal macroeconomic prob-lem resulting from years of high growth. Vietnam also has a strong and decisive government. Once they decide to get serious about inflation, the situation will be under control. But unfortunately, other problems remain under-neath.

First, the dong has been under intense speculative pressure, forc-ing the central bank to widen the trading band of its currency to plus or minus 2 per cent on June 26. On the following day, the cur-rency fell to about 16,840 to the US dollar. Earlier this year, it was at 15,820 to the dollar.

Second, asset prices have been severely deflated in Vietnam. Since its peak in March 2007, share prices have dropped more than 60 per cent, hurting many local investors in the process. Real-estate prices have fallen drastically, with many sellers but no buyers.

Third, with credit growth exceeding 30 per cent for many years, financial vulnerability has risen markedly. The International Monetary Fund (IMF) reported the Vietnamese banking system had also "played an important role through both direct investment in shares and lending for stock purchases ... with a large amount of bank lending collateralised with shares".

Fourth, public debt is already at 43 per cent of gross domestic product. This will limit the govern-ment's ability to absorb losses from the financial sector's rescue and stimulate the economy once the crisis occurs.

What will hap-pen? Since the widening of its currency band, the Vietnamese government has been aggressively intervening in the foreign-exchange market to keep the dong steady at 16,840 to the dollar and trying to narrow the gap between the official and the black-market rates.

Thus far, the currency seems to be holding its ground at the top of the band. But how long will the Vietnamese government be able to support its currency, given its limited international reserves, esti-mated at $21 billion (Bt701 bil-lion)? Worse, the country's trade deficit tripled to $14.8 billion in the first half of the year.

Thus, the main question is not whether the crisis will occur, but how deep it will become and how long it will last. Vietnam is going to face a full-blown crisis down the road, with a currency crisis occur-ring alongside an intermediary financial crisis similar to ours in 1997.

Here is how it will play out: Given its determination to fight currency speculation like Thailand did 11 years ago, the Vietnamese govern-ment will lose much of its interna-tional reserves and consequently have fewer and fewer options. Eventually, it will be forced to float the dong - which will then lose a substantial portion of its value - in order to balance its trade and cur-rent accounts. The IMF will be brought in, Vietnam's economy will face a year-long recession and the health of the country's banking sector will sharply deteriorate with a high level of non-performing loans. Then, drastic economic reform will be necessary, which will allow the country to rebuild its economy later on.

The severity of the crisis will depend very much on the government's choice of action during the next three to six months, but it is important to remember the old saying: "When you find yourself in a hole, the first thing to do is stop digging."

Kobsak Pootrakool is an economist.