In the first months of 2009, the State Bank of Vietnam (SBV) gradually loosened the monetary policy in order to promote business and production and curb impact of the financial crisis and preventing the economic recession. However, with the recovery of the domestic as well as the world's economy, movements of the financial-monetary market became more complicated and inflation pressures became increasingly clearer.
With the aim of maintaining the macro economic stability and a sustainable economic growth in 2010, the central bank decided to raise the basic interest rate from 7 percent a year to 8 percent a year under Decision 2665/QD-NHNN, increasing the refinancing interest rate from 7 percent a year to 8 percent a year, the discounting interest rate from 5 percent a year to 6 percent a year under Decision 2664/QD-NHNN applicable from 01 December 2009.
Additionally, upon targeting to regulate the forex rate in relation with interest rates and consumer price index (CPI), the central bank applied the inter-bank average forex rate at 17,961 dong a US dollar on 26 November 2009 and the new forex trading band at +/-3 percent from 26 November 2009. The central bank also pledged to strongly assist foreign currency sales to commercial banks accompanied with various support measures in order to stabilise the forex market, ensuring that the banking system supplies sufficient foreign currency to export and import businesses.
However, the above movements caused concerns for some domestic investors. They believed that is a sign of the monetary tightening policy to be applied in 2010, which may restrict the economic recovery. Nevertheless, based on realistic movements in the market, the change of the basic interest rate and the forex rate at the end of November 2009 accompanied with other measures on stabilising the forex rate and interest rates is a necessary but cautious measure, which came from the six reasons as follows:
Firstly, the government's monetary loosening policy and economic stimulus programme highly promoted the economic growth, which reached 33.29 percent by the end of October 2009, and 36.86 percent by the end of November 2009 compared the end of 2008. Thus, raising the basic interest rate and adjusting the forex rate are necessary in order to impact the credit growth, closely control scale and quality of credit in line with the government's macro economic targets and facilitate commercial banks to raise capital from the economic and prevent possible high inflation right from the start when the economy recovers.
Secondly, with the subsidised dong lending interest rate of 4 percent under the government's economic stimulus programme, the realistic dong lending interest rates to businesses and residents fell to 5 percent - 6 percent. This encouraged businesses that had demand for foreign currency to import goods and services to borrow dong loans to purchase foreign currency from commercial banks instead of borrowing foreign currency loans. Even, many businesses who owed banks foreign currency loans also managed to borrow dong loans to purchase foreign currency to make payment for foreign currency loans prematurely. This caused high pressure on banks regarding foreign currency as well as boosts the forex rate in the free market, causing big difference between the forex rate in banks and the forex rate in the free market.
Thirdly, in the first 11 months of 2009, the credit growth was always higher than the deposit growth, pressurising interest rates in the market. By the end of November 2009, the credit growth was reported at 36.86 percent while deposits grew by only 26.45 percent compared with the end of 2008. Thus, the central bank's raising the basic interest rate created stability, brought the market interest rates in line with the supply and demand rule.
Fourthly, the reality showed that Vietnam's inflation in three years, 2007, 2008 and 2009, climbed to over 40 percent while the US's inflation was only 20 percent in the same period. However, the official US dollar/dong exchange rate seemed to have changed insignificantly during that period, making dong be highly appreciated against the US dollar.
Thus, the central bank's increasing the basic interest rate and the forex rate in line with the market interest rate and narrowing the forex trading band to plus or minus 3 percent from plus or minus 5 percent was absolutely logical.
Thirdly, by the end of November 2009, Vietnam reported trade deficit of over $10 billion. Together with the government's business assistance policies, this figure was relatively high amidst the current post-recession period. Therefore, increasing the basic interest rate and the forex rate would push costs of import, which would reduce import, stimulate export in order to restrict high trade deficit and stimulate domestic production and consumption of domestic goods.
Sixthly, in addition to the above reasons, psychology of residents and businesses significantly impacted the change of the interest rates and the forex rate. Namely, with the forecasts that Vietnam's economy would continue facing various difficulties, challenges of the global economic crisis in 2010, both businesses and residents are worried over strong depreciation of dong, which led to speculation on US dollars. This made imbalance of foreign currency demand and supply more serious.
The government's decision in changing the interest rates together with the forex rate resulted in positive responds of the market. Namely, after the new basic interest rate became effective, commercial banks simultaneously increased deposit interest rates to 10.5 percent. Lending interest rates of all terms rose to the ceiling rate of 12 percent. So, both deposit and lending interest rates came to realistic interest rates in the market. The credit growth in December 2009 was estimated to increase by 0.87 percent compared with the increase of 3.57 percent in November and 2.04 percent in October. Furthermore, the forex rate adjustment also immediately became effective to the US dollar price in the free market. Right on 25 November 2009 when the central bank announced the adjustment of the forex rate, the US dollar price in the free market got reduced to 19,500 – 19,700 dong a US dollar from 19,750-19,800. On 26 November 2009, the free forex rate continued falling to 19,300-19,500 dong a US dollar.
The central bank's adjustments as well as effectiveness of those decisions were highly appreciated by the international community.
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