* Dong devalued 8.5 percent based on new midpoint
* Band narrowed to +/- 1 pct from +/- 3 pct
* Weak limit for interbank trading falls about 7 pct
* Move seen as latest step to deal with economic ills
(Adds comment from central bank forex chief, dollar)
By John Ruwitch and Ngo Thi Ngoc Chau
HANOI, Feb 11 (Reuters) - Vietnam devalued its beleaguered currency on Friday for the third time in a year, as authorities started to try to address festering economic problems that critics say have been brushed aside in the pursuit of growth.
The State Bank of Vietnam dropped the dong's reference rate VND=SBVN to 20,693 dong per dollar from 18,932, an 8.5 percent devaluation, and narrowed the currency's trading band to 1 percent from 3 percent on either side of that mid-point rate.
The reference rate adjustment gave the dollar a 9.3 percent boost against the dong.
The combined effect of the lower mid-point and the wider band pulled the weak limit of the band down about 7 percent to 20,900 from 19,500, and brought official and black market exchange rates closer to alignment.
The International Monetary Fund welcomed the changes, but said authorities needed a "broader set of policies" to restore macroeconomic stability.
The dong, unlike nearly all other Asian currencies, has been weakening against the U.S. dollar. Confidence in the local currency is low in Vietnam, where dollars and gold are widely used for major purchases and as a hedge against inflation.
Friday's devaluation was the sixth -- and by far the biggest -- in nearly three years. One year ago, the dong was devalued by 3.2 percent, and in August there was a 2.0 percent devaluation.
The currency's slide has come during a turbulent period in which authorities have grappled with volatile inflation, wide trade and fiscal deficits, rising global gold prices along with sinking confidence in the dong. For a timeline click [ID:nSGE70R05].
Economists applauded the move but said it would not be a panacea and the central bank now needed to target double-digit inflation, which the devaluation could exacerbate.
"This is a bold and decisive step by the central bank," said economist and former government advisor Le Dang Doanh. "But the devaluation should be just part of a package of measures that the government should take."
Many economists and international organisations, including the IMF, had said authorities were overly focused last year on attaining high gross domestic product growth before a January meeting, held once every five years, of the Communist leadership. Inflation soared to near two-year highs.
Fitch, Moody's and Standard & Poor's all downgraded Vietnam's sovereign ratings last year, citing macroeconomic imbalances.
After the devaluation traders said the dong was being quoted about 40-60 dong beyond the band on the interbank market.
Going forward, the central bank would monitor the midpoint rate proactively and flexibly and keep it "relatively closely linked to the situation in the market", Nguyen Quang Huy, head of the foreign exchange department, said on the bank's website.
Since June 2008 the dong reference rate has been devalued by more than 20 percent and foreign exchange reserves have fallen sharply, making it increasingly difficult for the government to break a cycle of devaluation expectations. Most other currencies in the region gained ground against the weak dollar.
Minister of Planning and Investment Vo Hong Phuc was quoted in state media earlier this week as saying foreign exchange reserves were "more than $10 billion" at the end of 2010. Reserves were nearly $24 billion at the end of 2008. In December 2009, the central bank estimated reserves at $16 billion.
Doanh said the low reserves had left the central bank little choice but take a big enough step to realign exchange rates.
Economists at Standard Chartered said the devaluation should ease downward pressure on reserves and help exports, but inflation would remain a problem.
"The latest devaluation could also lead to higher imported inflation in the months ahead, especially when combined with rising global commodity prices. While the central bank remains comfortable with the current level of interest rates, we see a need for higher rates in order to pre-empt economic overheating risks," the bank wrote on Friday.
Australia and New Zealand Banking Group (ANZ) also said the devaluation underscored the need for rate hikes.
The consumer price index rose to a near two-year high of more than 12 percent in January.
The central bank raised the base rate in early November by 100 basis points to 9 percent. Between then and January, while the base rate has stayed flat, it hiked the reverse repo rate on 7-day open market operations by 400 basis points to 11 percent in a tightening move.
Still, businesses in Vietnam have been complaining that lending rates are too high at up to 20 percent, and officials say they hope to eventually bring rates down.
The dong has languished outside its band for more than four months on unofficial markets VNDUNOFF=VN, hovering in recent weeks about 6-7 percent beyond the weak limit.
On Friday morning the dong was quoted at 21,300/21,400 per dollar on the unofficial market in Hanoi, according to two major gold shops that double as a foreign exchange dealers.
Stocks dipped slightly after the news, but recovered with the benchmark Vietnam Index .VNI closing down just 0.05 percent and the Hanoi Index .HNXI gaining 0.13 percent.
"For the short term (the devaluation) is bad, but after a week I expect more foreigners will come into the stock market to trade, so it'll be good for the market," said Quach Manh Hao, Deputy Director of Thang Long Securities.
"This is a message to the market that the government will focus on stabilising foreign exchange for the whole year."
Currency traders and economists had widely expected the SBV to make a move around this time after a senior official in early November ruled out a devaluation before Tet, the lunar new year festival, saying that authorities would instead tap foreign exchange reserves to try to meet dollar demand.
The Tet holiday ended on Monday and market activity resumed on Tuesday.
Reporting by John Ruwitch and Ngo Thi Ngoc Chau; Editing by Andrew Marshall, Richard Borsuk and Toby Chopra