Q+A-What next for the Vietnamese dong?

HANOI Fri Nov 5, 2010 4:07am EDT

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HANOI Nov 5 (Reuters) - Vietnam raised interest rates on Friday, a day after the government ruled out a devaluation of the dong VND=VN from now until early February and a senior economic official said the central bank will instead tap foreign exchange reserves to keep the beleaguered currency stable.

Below are some questions and answers related to this latest approach to the currency's chronic weakness.

WHY HAVE THE AUTHORITIES CHOSEN THIS TACK?

The Vietnamese government has tried numerous measures to stop the dong from falling. It has devalued or widened the trading band to allow the currency to weaken nine times since March 2008. It has tightened gold trading rules. Authorities have also cracked down on black market activity, while attempting to limit inflation and cut imports. All to minimal avail.

Le Duc Thuy, chairman of the National Financial Supervisory Commission, said on Thursday the government had opted against a devaluation for two main reasons: First, a devaluation could stoke inflation, which tends to rise in the run-up to Tet, or the Lunar New Year. Thuy explicitly ruled out a devaluation before Tet. Second, economic growth was strong enough to hit the year's target of 6.5 percent so the focus of policy could shift.

One of the toughest factors to control in all of this is public wariness of the dong, and it is likely that part of the calculus in ruling out a devaluation was to try to break the cycle of devaluations fed by expectations of devaluations.

Politics are also a likely factor, analysts say. Politicians looking toward a leadership reshuffle at a Communist Party congress in January will be inclined toward policy decisions that make as few waves as possible. Devaluations look bad.

DO THEY HAVE ENOUGH FOREIGN EXCHANGE RESERVES?

Not for sustained defence of the dong, but that is not what they are likely to try to do.

Thuy said reserves were now equivalent to six or seven weeks of imports and told Reuters the central bank would use "hundreds of millions of dollars" each month to defend the currency.

In 2009, when the government tapped foreign exchange reserves to try to shore up the currency reserves sunk by about 40 percent last year from $23 billion at the start of the year. Low reserves were cited as a factor in Fitch's late July ratings downgrade.

The International Monetary Fund estimated that reserves, including gold, would reach $15.4 billion by end-2010 and $19.2 billion next year, from $14.1 billion at the end of 2009.

Reserves are low by the rule of thumb that central banks should keep the equivalent of three months' of imports on hand.

Economists agree there is no way for the State Bank of Vietnam to defend the currency alone. Thus, they say, it is likely to deploy its dollars somewhat sparingly in a way that keeps the banking system liquid but is not aimed at propping up the currency. The monetary policy tightening should help, too.

WILL THIS COMPLETELY SOLVE THE PROBLEM? No. But the authorities hope to cool a market and in the words of one currency trader at a bank in Vietnam "buy time" ahead of the 11th Party Congress where the reshuffle will take place.

The pace with which the dong had been losing value was increasing and the authorities had to take action to stop that.

Thuy said there would not be a devaluation before Tet, the Lunar New Year, which falls in early February 2011. What happens after that is anybody's guess, though, and many of the structural economic problems that have contributed to dong weakness remain.

The International Monetary Fund's resident representative in Vietnam, Benedict Bingham, said the rate hike was a good first step but more adjustments to policy rates might be needed.

Economists say the dong is not likely to strengthen for good until the the fiscal and trade deficits shrink, inflation comes under control and sentiment returns.

WHAT ELSE CAN THE AUTHORITIES DO?

In the past the government has asked major state-owned exporters, like Petrovietnam, to sell dollars, and policymakers at some point may decide to put administrative measures like that back on the table.

The IMF's Bingham, however, believes a dollar shortage was not the key issue because the trade deficit was more than financed by inflows from remittances, foreign direct investment and official development aid.

Rather, there was a perception that the authorities were not dealing decisively enough with high inflation and the pressure on the dong. Investors also needed to be reassured that the government was "fully committed to fiscal consolidation".

Vietnam loosened monetary and fiscal policy to cope with the global recession.

In September, the IMF said it expected the overall deficit to be about 6 percent of gross domestic product in 2010 after hitting 8.9 percent last year. The official government target for next year is 5.5 percent of GDP. (Editing by Kazunori Takada)

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