Further interest rate cuts may disrupt Vietnam’s foreign exchange: IMF

The State Bank of Vietnam adopted easing monetary policy with interest rate cuts in early 2023 to stay ahead of challenges, but further interest cuts may disrupt the country’s foreign exchange dynamics, the International Monetary Fund (IMF) said.

In its September edition of the 2023 Article IV Consultation review for Vietnam, the IMF commented that the strategy proved effective, resulting in a decline in inflation by early 2023 and a return to the target range, and contributing to enhanced financial stability. This relaxation could help alleviate the burden on small and micro firms.

Besides, this relaxation of monetary policy is complemented by fiscal stimulus and sectoral policies within the context of the national economic policy mix to mitigate the risks of an economic slowdown.

During the first half of 2023, policy rate cuts were the first line of response to the slowdown, as headline inflation fell well below target, the negative output gap widened, and the Vietnamese dong remained stable, partially thanks to a large trade surplus in the first half of the year, the IMF highlighted.

However, further cuts can bring policy rates to historically (pre-Covid) low levels and could reignite disruptive FX dynamics. Global rates are likely to stay high for longer and the large trade surplus of the first half of the year is likely to unwind as the economy strengthens, heightening the risk of exchange rate depreciation passing through to inflation, it noted.

In addition, with banks facing increasing non-performing loans and high loan-to-deposit ratios, incentivizing credit growth would be risky and likely ineffective.

Instead, fiscal policy could take the lead in sustaining demand given the highly leveraged corporates and weak external demand. If inflationary pressures re-emerge, policy rates may need to be increased once again. Conversely, if more generalized financial distress materializes or the economic slowdown proves deeper, further support measures could be needed, which reinforces the need for keeping monetary policy’s powder dry for now.

Starting June 19, the State Bank of Vietnam (SBV) cut its refinance and discount rates by 50 basis points to spur the country’s growth amid prolonged global economic headwinds. The refinance is cut to 4.5%, the discount rate to 3%, and the overnight electronic interbank rate to 5%. It is the central bank’s fourth policy rate adjustment so far this year.

ADB newly-appointed country director Shantanu Chakraborty said the SBV's moves and the accomodative monetary policy had been productive. Going against the global trend of increasing interest rates, the central bank's interest rate cuts have been acting as the key to the country's economic resilience. Elaborating on the issue, ADB principal country economist Nguyen Ba Hung said economies need to set interest rates in line with inflation. "Thanks to Vietnam's low inflation, the country has been able to reduce rates," he added.

Meanwhile, the central bank may consider further interest rate cuts, the Singapore-based UOB bank said in a report.