VINACHEM

HSBC Bank has predicted the State Bank of Vietnam (SBV) will pare back intervention and allow the domestic currency to depreciate further in the coming months as the central bank’s foreign exchange reserves are getting increasingly thin.

In its macroeconomic report released on January 6, HSBC said the widening trade deficit is piling pressure on the Vietnam dong and foreign exchange reserves.

The Vietnam dong-U.S. dollar exchange rate has been at the upper side of the central bank’s band since early 2015. The pressure on the domestic currency has intensified due to the heightened yuan weakness.

In the last quarter of 2015, the SBV kept its promise to refrain from devaluing the dong further out of a desire to maintain a stable currency. However, since the central bank’s foreign exchange reserves are increasingly thin as import cover had fallen to 2.1 months as of the third quarter of 2015, the agency is likely to pare back intervention and allow the currency to weaken further in the months ahead.

Early this week, the central bank launched a new fixing mechanism that allows for a more market-based setting of the reference rate for the currencies.

Besides, with growth having firmly shifted gears to the 6-7% range, HSBC predicted inflation to rebound emphatically in the second half of this year, though the uncertainty around this outlook is quite high, given the difficulty of forecasting the path of oil prices.

“What we do know, however, is that some administered prices, such as school fees, will be increased this year. Together with base effects from stabilizing oil prices and a likely pick-up in food inflation, we forecast headline inflation to pick up to 3% year-on-year by the end of the first half and hit 5.1% year-on-year by the end of the second half, breaching the central bank’s target,” the bank said in the report.

The central bank has sounded more relaxed about the price outlook. In a recent interview with local media, SBV governor Nguyen Van Binh explained that the central bank intended to keep policy rates stable at current levels if inflation is contained in the 3-5% range.

He also said the central bank would target annual credit growth of 18% year-on-year though this could be raised as high as 20%, HSBC commented.

Even if credit growth is managed at the lower end of the target and core inflation stays contained due to further commodity price disinflation, it would be prudent to commence gradual tightening in the second half of the year to mitigate the risks of another overheating of the economy. In the past, a tilt towards an overly pro-growth policy has resulted in credit booms and overheating, which ultimately led to currency instability and required sharp policy tightening to reverse.

As such, HSBC expected the central bank to switch to a tightening mode this year. However, the aforementioned comments by the central bank governor, as well as the recent shift in the government’s policy stance towards a more pro-growth orientation, raise the risks that tightening will be delayed.

“Given that, we are less than half way through financial sector reforms and bank balance sheets remain fragile, we would be worried if credit growth begins to consistently top 20%,” it added.

In the report, HSBC maintained its 2016 gross domestic product (GDP) forecast of 6.7% year-on-year for Vietnam, which is in line with the government’s growth target. The bank raised the 2017 forecast by 0.1 percentage point to 6.8% year-on-year.