High interest rates could choke growth

Published: 19/06/2011 05:00

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With the aim of controlling inflation, the State Bank of Viet Nam has tightened the money supply.

With the aim of controlling inflation, the State Bank of Viet Nam has tightened the money supply.

Market interest rates are averaging 19.86 per cent for short-term borrowing, according to the May review issued yesterday by the company Viet Nam Asset Management (VAM).

If fees are included (which banks apply to get around the lending rate cap), borrowing costs increased to 23 per cent.

On the other hand, the US dollar cost of borrowing (approximately 3 per cent) and the rate paid by State-owned enterprises (SoEs) were actually negative in real terms, due to a two-tier lending rate.

Rates at these prohibitive levels in the private sector threatened to choke off any growth for the year; despite this, another 100 bps (basis points) interest-rate hike for the year was still a possibility, said the review.

Following April’s introduction of the US dollar denominated deposit cap of 3 per cent for individuals, domestic residents attracted by the large gap between dollar and dong deposit rates opted to keep fewer dollar deposits, thereby contributing to 2.89 per cent MoM decline in dollar-denominated deposits. Dong-denominated deposits increased by 1.27 per cent.

The nationwide CPI rose 2.21 per cent MoM (2.1 per cent when seasonally adjusted) in the first five months of 2011, reaching 12.07 per cent.

Inflation in May continued to accelerate, approaching levels not seen since 2008, with no signs of easing.

Monetary authorities have used both fiscal and monetary tools, tightening aggressively, yet little impact is visible.

Seasonally adjusted food prices were up 3 per cent MoM in May, following a 3.8 per cent increase in April.

It is likely that further monetary tightening is to be expected.

Meanwhile, the stability in the dong/US dollar exchange rate continued into the month of May.

Towards the end of May, the central bank announced that it had purchased US$1.2billion with the aim of increasing international reserves.

In this quest, the SBV outbid the market by VND40-50, to VND20,600 per dollar, indicating it was exercising caution while adding to reserves by striving to avoid more inflation through increased liquidity.

Domestic indicators such as growth in exports and imports both continued to show increases for the month, but growth came at a slower pace than it did in April.

Exports and imports increased at 5.7 and 2.7 per cent, respectively, for May.

While May’s trade deficit came to $1.7billion, the highest in 18 months, the drop in commodity export growth rates was a contributing factor.

Domestic consumption remains strong with industrial production expanding by 14.4 per cent year-on-year and retail sales growing by 23.7 per cent year-on-year.

FDI, overseas remittances and aid money remain important sources of exchange for Viet Nam to offset its trade deficit.

FDI figures for the first five months of the year totaled $4.7billion, or about 23.5 per cent of the year’s target.

Starting the month after a long holiday weekend, the VN Index opened at 483.3 points and ended the month at 421.37, representing a 12.23 per cent loss month-on-month.

The VN Index even plummeted to 386.36 points on May 23, its lowest level since 2009.

May also saw a dramatic downward trend in trading volume and a squeeze on liquidity on both bourses. Trading values for both bourses fell for yet another month, dropping to $27 million in May, down from $62 million and $42 million in March and April, respectively.

The massive sell-off from retail and even institutional investors resulted from investors’ low confidence which, in turn, was caused by the upward revision of inflation forecast and “a persistently high interest rate”.

Moreover, news about the bank’s deadline to reduce real-estate and non-production loans to below 20 per cent of total loans also ignited fears of margin calls and forced selling to recover bad debts on the bank’s part.

This led to 10 consecutive bear sessions on the market in spite of a strong rebound after hitting a record two-year low.

Further contributing to downward pressure was the fact that many investors needed to meet margin calls by liquidating holdings at limit down prices in a period of low liquidity.

Rounding out the month, the market saw an upturn with several large caps closing limit up. Many investors are abstaining from the market, choosing instead bank fixed-term deposits as high bank interest rates provide a profitable, safe alternative.

To better reflect the true sentiment in the market, a senior official has called for the introduction of new indices.

While the composition of the indices is yet to be determined, suggestions range from top 30 or top 50 large-market cap companies or dividing the market into business sectors.

The poor equity market performance shows macroeconomic factors continue to impede recovery and the outlook remains bearish.

“We believe the market will continue to fluctuate within the wider range of the trading band in the short-term as investors key concerns, namely double-digit inflation and trade deficit, are still prevalent,” said the review..

“Economic recovery seems a distant prospect, and investors prefer the high fixed deposit rate to equity at this time. However, in terms of valuations, we think Vietnamese equities are currently priced more cheaply than those of other regional market.”

In response to poor market sentiment, the Ministry of Finance recently announced their support to recover the equity market by allowing investors to use more than one broker to buy and sell the same securities within a trading day, provided that investors’ securities for sales are available in their depository accounts, effective August 1.

This news is considered a good catalyst to regain capital inflow into the system despite the current market instability.

For investors with a medium – to long-term outlook, the current poor market is a great opportunity to increase their equity holdings at cheap valuations.

Source: VNS

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