VietFinanceNews.com – Curbing the decline of the dong has been a pressing policy concern. The analysis below offers some insights into policymaking that may prove useful for efforts to restore the stature of the dong.
Like it or not, the dong is closely tied with, if not pegged to, the greenback. This relationship is unavoidable since the U.S. dollar is often a currency of choice for Vietnam’s international transactions and a basis for quoting domestic prices. Notably, there is a constant effort to strike a balance between stability and flexibility in the value of the greenback and the dong. However, forex rate adjustments usually trail behind market forces and must conform to the Government’s subjective stance.
This would not be a daunting challenge if Vietnam’s domestic transactions were denominated strictly in the dong and the greenback did not see its value slipping drastically. Unfortunately, internal shortcomings have fueled excessive intervention and led to mounting pressure. The volatile greenback has only worsened matters.
The most intimidating test came on November 3, 2010. After keeping interest rates at 0-0.25% for two years (starting from December 2008) and injecting a stimulus package worth some U$1.7 trillion, the U.S. Federal Reserve decided to pump an additional stimulus package of US$600 billion through open market operations. This move, euphemistically called quantitative easing and expected to last until June 2011, helped to drastically drag down the greenback against many currencies. The dong, however, proves to be exception and has been under piling devaluation pressure for several reasons.
To begin with, the dong is nailed to the U.S. dollar, so when the latter plunges, the former is likely to follow suit. In addition, U.S. goods are much cheaper, too, feeding demand for the greenback. In Vietnam, the U.S. dollar is an enticing speculation supply whose demand far outstrips supply. Vietnamese’s thirst for the greenback has therefore been aggravated, making this currency increasingly expensive in the free market from late 2010 to early 2011.
Meanwhile, the Vietnamese Government’s reluctance to revise the official exchange rate at the end of 2010 prompted commercial banks to capitalize on carry trade. The inevitable happened on February 11, when the State Bank of Vietnam (SBV) pulled down the value of the dong by 9.3%, with the exchange rate climbing from VND18,932/US$ to 20,693/US$. Even then, concerns about the decline of the dong remained.
It should be added that the role of the dong in domestic transactions is far less dominant than it should be. The instability associated with the dong has, in turn, accelerated dollarization. In fact, the dollar has received legal recognition as a possible currency for capital contribution and stake acquisition.
Together with the greenback, many major currencies and gold have exerted tremendous influence on domestic transactions. These substitutes have further weakened the dong, which pales in comparison with foreign currencies and gold as a store of value.
Payments in foreign currencies and gold expand the total means of payment and make it difficult to control money supply (for example, it is hard to tell whether the public holds US$10 billion or US$100 billion worth of foreign currencies). This can trigger inflation and impede monetary policies, especially from a regulatory perspective. Tightening the dong supply may not pull down inflation if economic agents turn to gold and foreign currencies as means of payment. After all, if a problem is ascribable to myriad factors, it will be woefully inadequate to tackle only one cause. Such are the cases in 2008 and 2011, both marked by a liquidity crunch. Restricting dong supply has been ineffective in harnessing inflation because, for several reasons, dollars and gold are still popular.
Thus seen, the challenge has extended beyond the ownership and trading of foreign currencies and gold to verge on the realm of payment discipline. Ownership and trading relate to asset rights while payment discipline is a matter of national sovereignty. This article focuses on the latter issue.
Once established, payment discipline not only facilitates monetary policy, inflation control and forex management, but also reflects national sovereignty. If the dong is king within Vietnam’s border, demand for the domestic currency will soar and devaluation will no longer be a problem.