VND: Keeping A Stable Outlook, But Risks Remain
The Vietnamese dong has depreciated by 1.2% since the beginning of August to trade at VND20,827/US$ as of September 8, fuelling concerns that the State Bank of Vietnam (SBV) could be struggling under renewed pressure to defend its fixed exchange rate regime. However, with a narrowing trade deficit and moderating inflation, we believe that concerns over a potential devaluation in the currency are unwarranted, at least for now. Thus, we are happy to maintain our forecast for the exchange rate to remain relatively stable at around VND20,650/US$ over the coming months.
Back in February, we reiterated our concerns that failure by the SBV to address mounting inflationary pressures and a persistent trade deficit would risk further devaluations down the road (see 'Dong Devaluation Call Plays Out, Further Weakness Possible', February 11). However, we are seeing encouraging evidence that inflationary pressures are starting to moderate and a soft landing for the economy is becoming increasingly likely - headline consumer price inflation (CPI) slowed from 1.2% month-on-month (m-o-m) in July to 0.9% in August. The spectacular bull run in commodity prices since early 2010 is running out of steam, as concerns over global economic growth have resurfaced in recent months. This further supports our view that inflationary pressures should continue to wane, easing fears that the Vietnamese dong will come under further selling pressure.
As the accompanying chart shows, the 8.5% currency devaluation in February has helped to boost demand for exports, resulting in a narrowing trade deficit. The trade deficit has shrank to US$3.1 in Q211, compared with US$3.7bn US$3.4bn in Q410 and Q111 respectively. We believe that this has played a key role in supporting the SBV's efforts to reinstall confidence in the Vietnamese dong. We continue to believe that speculative selling pressures on the Vietnamese dong should remain muted in the short-to-medium term, and we are maintaining our end-2011 target for the Vietnamese dong to remain stable at around VND20,600/US$, followed by a mild appreciation towards VND20,100/US$ by end-2012.
The government has undertaken serious efforts to de-dollarise the economy in an attempt to reinstall confidence in the Vietnamese dong, and we believe that these structural reforms should provide stability to the SBV's fixed exchange rate regime over the longer term. The US dollar has traditionally been recognised as a substitute for the Vietnamese dong and has been widely used for transactions among businesses and individuals (according to the Asian Development Bank, the US dollar currently makes up around 20% of total money supply). Meanwhile, gold is also recognised as a substitute for the Vietnamese dong, mainly as a hedge against inflation and protection against a depreciating currency. The ease of switching between these alternative currencies has contributed to an extent, increased selling pressure on the Vietnamese dong during periods of high inflation and economic uncertainty. We believe that this phenomenon has been exacerbated by a spectacular surge in gold prices in recent years, which has boosted the metal's attractiveness among Vietnamese investors. Being fully aware that a dollarised economy could undermine the effectiveness of monetary policy, the SBV has taken aggressive measures to discourage the use of the US dollar. Furthermore, the authorities have also clamped down on black markets for trading currencies and gold. We remain optimistic that these measures to curb currency speculation and de-dollarise the economy should help limit selling pressures on the Vietnamese dong.
Risk To Outlook
Given that we are seeing evidence of moderating inflation, we remain optimistic that the central bank could start to ease monetary policy next year. Thus, we are penciling in 300 basis points worth of rate cuts next year. However, we note that Vietnam remains heavily exposed to a slowdown in external demand. The financial market remains unconvinced that recent measures by the SBV will be sufficient to address the currency's decline. The one-month non-deliverable forward (NDF outright) on the Vietnamese dong continued to trade below the spot exchange rate, effectively pricing in a depreciation of 1.0% over a one month period. This is not surprising given that the outlook on exports remains cloudy in the medium term. Should we fail to see a sustained improvement in the trade balance, we could see the dong come under further selling pressure over the coming months.