Asian FX and Economics: VND

Asian FX and Economics: VND

The State Bank of Vietnam has devalued the VND by 1% and widened the USD-VND trading band to +/-3%...
 … in an attempt to maintain competitiveness in an environment of a weaker RMB
 We raise our USD-VND forecasts higher and expect the exchange rate to end the year at 22,800 

The repercussions of China’s CNY fixing reforms are being felt across Asian currencies. But the Vietnamese dong, in particular, is facing mounting pressures. Since China eformed the CNY fix on 11 August, the State Bank of Vietnam (SBV) has widened the trading band twice, from +/-1% to +/-3%, and also raised the mid-rate of USD-VND by 1%. The VND has responded accordingly, falling nearly 3% against the USD over the last week (see chart 1). We believe the SBV may have to depreciate the VND by an additional 2% by the end of the year, as a weaker RMB provides an increasingly challenging environment for Vietnamese exports. We raise our 2015 and 2016 year-end targets for USD-VND to 22,800 and 23,300, from 21,830 and 22,300, respectively.

What has happened?

Today, the SBV announced it increased the mid-rate of USD-VND by 1%, the third time it has devalued the dong this year. In addition, the SBV also decided to widen the band to +/-3%. This is the second time in less than a week that the central bank has widened the trading band – the SBV widened the band to +/-2% from +/-1% on 12 August. The changes mean that, effective from today, the new USD-VND mid-rate is 21,890 with the upper ceiling at 22,547 and the exchange rate floor at 21,233 VND/USD.

Why has the SBV devalued the VND?

The move by the SBV to devalue the VND highlights the acute challenges the currency is facing at the moment. It also marks a notable shift in FX policy from a central bank which at the beginning of the year said it did not want the VND to weaken more than 2% against the USD in 2015.

The recent reforms in the CNY’s fixing mechanism and the subsequent depreciation of the RMB are
probably the most important reasons behind the SBV’s decision to let the currency weaken. After all,
China is an important trade partner for Vietnam, accounting for 21% of total trade. A weaker RMB would exasperate fears of declining exports to China, which in turn could push Vietnam’s trade balance further into deficit. Of even more concern is that China is a significant export competitor of Vietnam (see chart 4) especially on manufacturing goods. The SBV highlighted in its statement that the depreciation of the VND was a necessary step to ensure Vietnam exporters remain competitive in international markets.

Fears that the exchange rate is hurting Vietnam’s export competitiveness are well grounded. The central bank’s decision to ensure stability in the currency has actually meant the VND had been one of the strongest performing Asian currencies in 2015, prior to the recent devaluation and band widening (see chart 5). This has meant that on both a NEER and REER basis, the VND has appreciated substantially (see chart 6). In fact, we estimate the VND has appreciated by 9% y-o-y on a nominal effective exchange rate basis, the fastest rate of appreciation since 2000.



It was also indicated by the SBV that the decision to devalue the VND was a pre-emptive move to reduce pressure on the currency prior to the possibility of the Fed embarking on its tightening cycle before the end of this year.

Unlike a few years ago, the State Bank of Vietnam also has more room to accommodate depreciation in the VND. Inflation is at historical lows, thanks partly to the fall in global oil prices, so there are fewer concerns that weakness in the exchange rate will feed through into soaring prices. Furthermore, higher real interest rates also reduce the risks from domestic outflows (see chart 7).

What’s next for the dong?

The sharp depreciation in the VND over the last week reflects the external headwinds which have been working against the currency. Most important is the recent weakness in the RMB. As we have written previously, we expect the RMB to depreciate further as the PBoC allows the exchange rate to become more market determined while also pursuing its policy of monetary easing (see Asian FX Special: More volatility - a permanent fixture, 12 August 2015 ). In our view, this will also mean the SBV will have to accommodate further weakness in the VND if it wants to ensure its exporters remain competitive with China. Furthermore, if the Fed begins to lift rates this year, the VND could face additional outflow pressures.

The SBV obviously has its FX reserves which it can use to maintain some currency stability. But the
comments from Ministry of Finance Vice Minister, Vu Thi Mai, in April that the Vietnamese government could borrow money from the central banks’ reserves (source: Chichphu.vn) has dented investor confidence in the VND further and could lead to a loss of credibility in the SBV (see Vietnam: dipping into reserves?, 21 May 2015). Although the SBV has improved its FX cover, its reserve adequacy is already low by most conventional measures (see Chart 8). If the SBV’s foreign exchange reserves are used for financing government projects, this would leave the central bank with less ammunition to help it stick to its commitment.

Nevertheless, we do not think the VND will weaken aggressively from here. The Vietnamese economy has actually been one of the bright spots in Asia. Domestic demand has been picking up, and more balanced BoP flows, coupled with low inflation and higher real rates, should allow the FX policy to become more flexible in its ability to manage periods of USD demand. Furthermore, Vietnam’s high external debt limits the room for the central bank to let the currency weaken too fast.
As such, we have decided to revise our forecast and now expect the VND to depreciate against the USD by an additional 2% in 2015e, and then a further 2% in 2016e. Our year-end forecast for USD-VND is 22,800 for end 2015 and 23,300 for end 2016.


Economics implications

Vietnam has stood out recently as being one of the only Asian economies to boast strong export data. On a 3-month rolling y-o-y basis, it is the only country with positive growth by a wide margin (see Chart 9), even though the global trade pie is not growing. Vietnam has been able to take advantage of its labourintensive competitive advantage in manufacturing to gain market share and has pro-actively pursued freetrade agreements. As we show in Chart 10, manufacturing and manufacturing parts have been the main contributors to overall exports, particularly in recent years. Moreover, Vietnam stands out sharply from its ASEAN neighbours that have been hard hit by the commodity cycle.

That said, we believe policymakers are sensitive to competitive pressure from China and are wary of any loss of thrust from this important engine of growth. Vietnam is running an overall trade deficit in 2015 yt-d (although it was positive in 2014) as it imports a large degree of capital goods needed for investment, Chart 9. Vietnam has seen Asia’s best export performance Chart 10. Manufacturing has contributed most of Vietnam’s export growth however, the bilateral deficit with China is particularly large (Chart 11). China accounts for roughly 10% of Vietnamese exports but 30% of imports, a proportion that has increasingly grown in China’s favour. In the first seven months of 2015, the bilateral trade deficit grew 30.2%, reaching USD19.4 billion, according to Vietnam customs data, a record high. Although a part of this reflects imports of electronics and industrial components that are necessary for supply chain integration and capital investment in Vietnam, a sizeable share is in garments and footwear – where Vietnamese goods compete with Chinese equivalents. Moreover, Vietnamese goods are increasingly competing with China in international markets, and there is a fair degree of competition with China in nascent industries that Vietnam is trying to develop –notably automobile production and shipbuilding. From an economic fundamental point of view, the economy can handle the devaluation – the third round this year. Vietnam’s perennial headache – inflation – has moderated to record-lows in recent months (Chart 12), dragged down by lower transportation costs (a function of 5 cuts this year to RON 92 petrol prices). The pass-through of the weaker VND to headline inflation should be manageable, especially as energy prices stay low. Moreover, the Ministry of Finance recently released a document instructing regional finance departments to improve the management of transport fees, in order to prevent increases and ensure that further oil price reductions are passed onto consumers. This should help keep inflation pressures contained.

As our FX colleagues point out above, the devaluation and band-widening is not only for exports. It is partly to accommodate future volatility alongside Fed’s lift-off as early as September (although HSBC’s Chief US Economist Kevin Logan forecasts a move in December). The recent devaluation, together with a further 2% devaluation this year as forecasted by HSBC’s FX strategists, is unlikely to put much pressure on the domestic financial system seeing that short-term external debt levels are small and manageable (Vietnam has the third-lowest short-term debt coverage ratio in Asia, although the total stock of external debt has risen at a fast clip in recent years). Instead, it should ensure that Vietnam’s exports do not lose competitiveness versus regional peers. That said, Vietnam is unlikely to independently devalue its currency to help exports as it boasts a fundamental trade advantage based on low labour costs, infrastructure development and a pro-active expansion of free trade agreements by the government (Korea FTA, TPP, AEC, etc.). Accordingly, any further devaluation of the dong this year will likely be a reflection of exogenous factors.

Davi Nguyen
Source: HSBC
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