Over the last two year’s the US Federal Reserve (USFR) has raised its key rate 17 times and currently maintains it at 5.25% a year. Similarly, the European Central Bank boosted its interest rate. Japan has also stopped its policy of maintaining the interest rate at 0%.
Many countries have been tightening their monetary policies to curb inflation as the price of many commodities from petroleum to agricultural products and seafood has continuously increased. Following suit, the State Bank of Vietnam has in the last two recent years twice upped the discount and refinancing interest rates and continuously issued instructions about closely watching lending quality. Lately, the central bank has successively issued two decisions, namely limiting securities loans of commercial banks at less than 3% of total outstanding loans and doubling the compulsory reserve rate for dong deposits.
Many economists are worried that tightening credit would adversely impact on development investment and increasing the possibility of higher interest rates that are now already high. However, the central bank confirmed that tightening monetary policy would not adversely influence medium and long-term development in the economy, but would help to rein in inflation, which is tentatively rising. At the end of May, the consumer price index (CPI) had risen to 4.23% compared to 3.6% in the same period last year.
The SBV estimated that by the end of March, foreign indirect investment (FII) into Vietnam was some US$1.9 billion, together with the actualised amount of foreign direct investment (FDI) and overseas remittances has pushed up the money supply in the economy. This was demonstrated via a deposit growth rate of nearly 40% in credit organisations. Almost all banks have been seen a prolonged surplus of disposable income.
A bigger supply of money in the economy, in economics terms, will make inflation grow. Tightening monetary policy will cut the amount of money in circulation and partly curb inflation.
According to an official from the central bank, monetary policy does not impact on productivity or in other words, the economic growth in the medium term. The recent tightened monetary policy of the central bank has resulted in surplus amounts of money in commercial banks but this has not impacted on the efficiency of investments.
Raising the compulsory reserve rate will lower the disposable income of commercial banks. It is estimated that some 40 to 50 trillion dong would be reserved, making it impossible for banks to speed up credit growth easily to deal with their surplus of disposable income. Meanwhile, banks have no choice but to ensure credit quality, meaning that efficient projects are still able to access capital from banks while inefficient projects will be refused. Clearly, tightening monetary policy will not impact on long-term growth.
One of the SBV’s recently issued statutes includes the limiting of securities loans at below 3%. Warning documents on lending to securities investment and statements from the central bank’s officials pointed out that lending for securities investment contains many risks and is not encouraged. In a decision on adjusting the safety levels for loans of credit organisations, the central bank has also raised the risk in securities loans to 150%, far higher than other kinds of loans.
A report released by the SBV at the end of the first quarter said that the total securities loans of banks and finance companies stayed at 2.6% of total outstanding loans to the economy, or 20 trillion dong. Although the SBV’s officials said that the 2.6% rate remains within safe levels, the central bank does not encourage any further expansion.
Thus, limiting securities loans at less than 3% of total outstanding loans at each bank is the last solution after a previous series of warnings issued were not taken seriously.
Reports from commercial banks about securities loans that have been submitted to the central bank showed that 10 banks, mostly being joint stock banks, have already surpassed the cap of 3%.
Naturally, these banks must cut their securities loans to less than the ceiling level. However, the central bank’s instruction does not set sanctions in case banks fail to lower their securities loans to less than the ceiling level.
According to financial experts, cutting securities loans to less than 3% cannot be carried out right now by commercial banks which have already surpassed the ceiling rate because lending contracts all have specific terms and the banks cannot unilaterally collect such pre-matured loans from clients. However, those banks would not be able to sign new securities lending contracts.