Diving dong reflects VN push to tackle trade deficit

Vietnam is now grappling with the dong crisis stemming from macroeconomic imbalances. Yesterday the Vietnamese currency continued to dive for the second day after the authorities had decided on a 3.25 per cent currency devaluation to bring the exchange rate to 18,544 per dollar. The devaluation has been aimed at tackling the trade deficit and also the widening gap in the black market rates. The dong fell as much as 2 per cent yesterday to 19,100 per dollar, the upper limit in which it is allowed to trade. At one point, it was down 0.9 per cent at 18,900 per dollar. It dropped 2.3 per cent for the week, the biggest loss since the period ended November 27, when the central bank last devalued the currency.

The situation is accentuated by inflationary pressure. Inflation accelerated for a fifth month in January to 7.62 per cent from a year earlier, the fastest pace since April. Vietnam has posted a trade deficit every month since the first quarter of 2009, with the shortfall at $1.3 billion last month. Imports dropped 16 per cent to $6.2 billion and exports fell 10 per cent to $4.9 billion in January.

The financial markets believe that the devaluation decision would not be the last. With its pro-growth strategy, it would come as no surprise that Vietnam would devalue its currency to boost the export competitiveness. But there is a danger of overdose. Insofar as Vietnam fails to tackle its trade deficit and inflationary pressure, it will have a difficult time encouraging investors or business operators to hold on to the dong. Now they are hoarding the dollar for fears of further weakening of the dong. This can reinforce further devaluation.

Based on latest official data, Vietnam's foreign reserves stood at US$20.6 billion in June 2009. This level is below totally external debt of $21.8bn as of December 2008, or 24per cent of GDP). Earlier this month, a state-run Vietnam newspaper indicated that total external debt might have risen to more than 30 per cent. The macroeconomic data of Vietnam remain vague. An IMF report last December indicated that Vietnam's foreign reserves excluding gold had dropped to $18.8 billion in August 2009. DBS Research, in its report on February 11, 2010, said it expects t the dong will reach 19,640 per dollar by the end of this year. "Effectively, the devaluation is less than the full-year depreciation we have factored in our last quarterly report. In short, more is probably coming over the course of the year," it said.

 Going forward, Vietnam is not out of the woods yet. The country might not face significant dollar shortage in terms of external flows, but the protracted period of dollar illiquidity in the market has created persistent erosion in dong confidence, leading to USD hoarding by residents. Citi AP Economic Research, in its February 11, 2010, report also said the challenge for the authorities is to manage "expectations" since repeated devaluation begets further devaluation expectations.

"This is tricky in a country whose foreign exchange reserves are declining, current account/trade deficit is wide, inflation has been rising, and yet, the foreign exchange policy remains rigid. We think Vietnam will have to tighten its policy more and/or eventually reform its foreign exchange regime. Otherwise, we think decline in official foreign exchange reserves will not abate without sizeable external funding support," it said.