Trading band widened for VND 05 January 2007 Authors: Dr. Alex Joiner Economist, International +61 3 9273 6123 joinera@anz.com Truong Vu Minh Head of Markets Vietnam +84 4 9289105 vut3@anz.com ANZ Vietnam 14 Le Thai To Street Hanoi Vietnam www.anz.com/vietnam The State Bank of Vietnam (SBV) widened the USD/VND trading band from ±0.25% to ±0.5%. on Jan 2 2007 The band was widened due to strong inflows of foreign currency that has caused an appreciation of the VND in recent weeks The widening of the band will introduce more flexibility and more volatility in to the exchange rate going forward It is still expected that the SBV will maintain a depreciating exchange rate in the short-medium term to support local exporters The State Bank of Vietnam (SBV) has begun 2007 on the front foot widening the band in which the dong is traded from ±0.25% to ±0.5%. This is in effect a band of around ±80 VND either side of the official rate announced by the SBV each day, compared to ±40 VND previously. This step has been in response to the recent sustained appreciation of the VND due to the local currency market being flooded with US dollars in the latter months of 2006. The move reflects the recent requests from the interbank market to sell more USD against VND to the SBV as a last resort when the market is flooded with USD. Commercial banks are only allowed to hold certain sums of foreign currency and if these sums are exceeded, the bank must sell the excess to other banks. However, it has been the case recently that there has not been enough VND to buy this excess foreign currency and the SBV, fearing excess liquidity will fuel inflation, had not purchased enough local currency to keep the VND from appreciating. Consequently, the influx of foreign currency has put pressure on the VND to appreciate in recent weeks. This is against the marginal depreciating trend of the exchange rate that has been managed by the SBV in recent years. The SBV historically had purchased all excess foreign exchange flows coming into Vietnam to keep the local currency from rising and to build foreign currency reserves. The appreciation of the VND in recent months may indicate this policy is becoming increasing untenable due to the increased volumes of foreign currency investment inflows Vietnam now attracts. Given the recent appreciating trend, the immediate implication of the SBV s move is to effectively allow for the dong to revalue by around 0.25%. On Jan 2, the SBV set the rate at USD/VND16,101. While the new band implied that the dong had the potential to reach a new floor at around USD/VND16,020, this did not eventuate with the rate closing at USD/VND16,068. It has since been reported in the media that on Jan 2 and 3 the SBV bought foreign currency amounting to US$140 mn in an effort to reduce the surplus of foreign currency. This resulted in a depreciation to USD/VND16,068, however that has now retraced, with an appreciating pressure appearing to still be prevalent in the market. USD/VND 15,600 15,650 15,700 15,750 15,800 15,850 15,900 15,950 16,000 Movements of the VND in recent years 2004 VND depreciation of 0.91% 2005 VND depreciation of 0.84% 2006 appreciation of 0.3% since mid Nov Interbank trading band widened from ± 0.1% to ± 0.25% mid-2002 and to ± 0.5% in 2007. In 2004, the depreciation rate was 0.9%p.a, this slowed to 0.84% in 2005. For 2006, the dong depreciated by 0.79% in the calendar year. 16,050 2006 depreciation of 1.1% to mid Nov 16,100 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Bloomberg It would seem, at this early stage, that the SBV will continue setting its daily rates along a depreciating trend with the wider bands allowing for greater daily ranges. This increased
flexibility will allow excess foreign currency held by commercial banks to be cleared without the SBV having to increase its purchases to soak up the excess foreign currency. This should limit any increased inflationary impact that having to intervene in the market may have otherwise had. Historically, the widening of the band has resulted in increased volatility of the USD/VND, as was the case the last time the band was widened in 2002. This time should be no different, with volatility in the VND now expected to rise marginally in the coming year. Historical volatility of the VND in recent years USD/VND Volatility (%) 3,500 Trading 3 band widened 4,000 from 0.01% to 0.25 in 4,500 2002 Trading band 5,000 widened to 2 0.5% 5,500 6,000 6,500 Average Volatility 1 7,000 7,500 8,000 0 Jan-00 Dec-00 Jan-02 Jan-03 Feb-04 Feb-05 Jan-06 Jan-07 Source: Bloomberg, With this flexibility allowing the market to clear excess foreign currency build-ups more easily, pressure on the VND to appreciate in the short-term should also be alleviated. This is because the policy of widening the band should, for now, address the disequilibrium of supply and demand for local currency allowing for greater movements of the VND when it is required by the market. Going forward, this will allow the market to cope with periods in which the amount of foreign currency flowing into Vietnam is in excess of what the market can cope with. Particularly given that there are no significant outflows of capital, and both the current and capital accounts now are in surplus. However, it is still expected that capital inflows will exert an appreciating pressure on the VND going forward as it has in 2006 that may make it increasingly difficult for the SBV to sustain the gradual depreciation of the currency. In 2006, the sources of these inflows have been: Unprecedented inflows from investment; FDI reached a record US$10.2 billion in 2006 up 49% on 2005. Significant increases in official remittances from overseas that are expected to approach US$5 bn in 2006, exceeding the US$4.3 bn in 2005. Inflows generally peak in the latter months of the year due to Tet, the Lunar New Year holiday. It is reported that during this time hundreds of millions of dollars are being sent to Vietnam daily. A strong trade performance, with exports expanding by 22% to reach a record US$39 bn in 2006. Capital inflows into the increasingly liberalised and rapidly developing stock and bond markets. This increased access to capital is driven by investors who are keen to gain exposure to East Asia s second fastest growing economy after China. The Vietnamese economy is estimated to have expanded by 8.2% in 2006. Going Forward It may have been that the SBV foreshadowed the widening of the band. When speaking of the recent appreciation of the dong an SBV official reportedly (in the Vietnam Investment Review) stated late last year that The central bank will soon work out measures to prevent the Vietnam dong s further appreciation against the US dollar. The official went on to say that the appreciation of the USD/VND remained under control and that Commercial banks should set a suitable rate to sell out surpluses. The central bank will assist technically if needed to maintain the Vietnam dong s gradual depreciation against the US dollar. The widening of the band is now expected to give commercial banks the means to be able to sell this excess foreign currency. Page 2
These statements also seem to reinforce the government s commitment to the policy of gradual depreciation of the dong, at least into 2007. At this stage, we do not expect to see the underlying depreciating trend of the VND change significantly with the government still wanting to encourage the growth of exports. At this point, it is still expected that the currency will continue to be managed by the SBV to depreciate at a rate of around 1% per annum in an effort to support the domestic trade sector. However, it remains to be seen how the SBV will maintain this policy with the expectation that strong capital inflows will continue to exert appreciating pressure on the currency for some time. Yet this move by the SBV does send a clear signal that, like China, Vietnam is seeking to slowly liberalise its exchange rate regime on its own terms and supporting its own interests. The SBV has also demonstrated a willingness to respond to developments in the domestic foreign exchange market that may not have been seen 5 years ago. Therefore, if the managed depreciation of the VND does become too much of burden for the SBV to maintain, we would expect them to act relatively quickly to introduce further flexibility into the exchange rate regime. A brief history of the VND Pre-1980 Before the 1980 s, the exchange rate was essentially set by Government decree. A consequence of this system was the emergence of a black market for the currency. Rates of conversion to the US$ in this market often differed significantly from the official rate set by the government. 1980 s The Đổi mới economic reforms of the 1980 s prompted a raft of devaluations with the aim of unifying the official, traded, non-traded and internal dong rates. Toward the end of the decade, Vietnam adopted a heavily managed exchange rate regime against the US$ that was administered by the State Bank of Vietnam (SBV). In principle, the official rate was adjustable based on variables such as interest rates and inflation. However in practice, the official rate was set by the SBV with commercial banks able to set the rate for their own transactions within a ±5% band around this official rate. 1990 s to current In the early 1990 s, official exchange rates were set using auction based rates in foreign exchange markets. However, the SBV was the dominant market maker. By late-1991, commercial banks were setting their own rates within a ±0.5% band of this official rate. By the mid-1990 s the SBV set official rates based on interbank rates. This arrangement kept the dong relatively stable at around USD/VND 11,000 in the years preceding the Asian crisis. Due to a deteriorating trade balance in late 1996, the SBV began several orchestrated depreciations of the currency against the US$ by widening the trading band around the official rate. This facilitated a 4% depreciation of the dong over 18 months. Nonetheless, the currency became significantly overvalued relative to other currencies in the region that had depreciated significantly. This relative overvaluation again began to impact negatively on Vietnam s trade competitiveness. In addition, a significant fall in capital inflows during the crisis put increased pressure on financing the current account deficit. Subsequently, the dong was again devalued via the exchange rate band being widened from ±1% to ±5% in early 1997, then to ±10% in late 1997 and finally a one-sided band of +7% in August 1998. These policies allowed the dong to depreciate considerably from around USD/VND11,000 in 1997 to USD/VND14,000 by early 1999. In 1999, the SBV reintroduced a narrow band mechanism to contain exchange rate market volatility and eliminate rapid exchange rate movements. Within this framework, the official VND rate is set by the SBV through a process in which the official rate can move with the interbank market rate, but the interbank rate cannot deviate beyond a band set around the official rate. In practice, the SBV will quote the average exchange rate in the interbank market during the previous business day as the official rate. Banks can then trade at an exchange rate within a trading band on either side of this rate. However, a significant black market operates if the official rate seems over/undervalued. The gap between the black market rate and the official rates is usually around USD/VND20-30. This black market operates successfully, in part, due to the relatively high levels of dollarisation in the Vietnamese economy (estimated to be around 24% by the SBV). Between early-1999 and mid-2002 this band stood at ± 0.1% and was widened to ± 0.25% until the end of 2006. The band was widened again, to ±0.5% in early 2007 Page 3
ANZ Saul Eslake Fiona Allen Chief Economist Business Manager +61 3 9273 6251 +61 3 9273 6224 eslakes@anz.com allenf@anz.com Tony Pearson Julie Toth Mark Rodrigues Riki Polygenis Amber Rabinov Head of n Economics Industry Economist, Economist, +61 3 9273 5083 +61 3 9273 6252 +61 3 9273 6286 +61 3 9273 4060 +61 3 9273 4853 pearsont@anz.com tothj@anz.com rodrigum@anz.com polygenr@anz.com rabinova@anz.com Amy Auster Katie Dean Jasmine Robinson Dr. Alex Joiner Head of International Economist, Economics International International International +61 3 9273 5417 +61 3 9273 5466 +61 3 9273 6289 +61 3 9273 6123 austera@anz.com deank1@anz.com robinsj7@anz.com joinera@anz.com Paul Braddick Ange Montalti Head of Financial System Analysis Financial System Analysis +61 3 9273 5987 +61 3 9273 6288 braddicp@anz.com montalta@anz.com Warren Hogan Cherelle Murphy Head of Markets Economist, Markets +61 2 9227 1562 +61 3 9273 1995 hoganw1@anz.com murphc10@anz.com ANZ Investment Bank Warren Hogan Sally Auld Tony Morriss David Croy Cherelle Murphy Patricia Gacis Head of Markets Senior Interest Rate Senior Currency Strategist Economist, Markets Fixed Income Analyst Strategist Strategist +61 2 9227 1562 +61 2 9227 1809 +61 2 9226 6757 +44 20 7378 2070 +61 3 9273 1995 +61 2 9227 1272 hoganw1@anz.com aulds@anz.com morria15@anz.com croyd@anz.com murphc10@anz.com gacisp@anz.com Sarah Percy-Dove John Manning Bradley Bugg Head of Credit Senior Credit Analyst Senior Credit Analyst +61 2 9227 1142 +61 2 9227 1493 +61 2 9227 1693 percydos@anz.com manninj1@anz.com buggb@anz.com & Information Services Mary Yaxley Marilla Chant Manesha Jayasuriya Head of & Senior Information Information Officer Information Services Officer +61 3 9273 6265 +61 3 9273 6263 +61 3 9273 4121 yaxleym@anz.com chantm@anz.com jayasurm@anz.com ANZ New Zealand Cameron Bagrie Khoon Goh Philip Borkin Chief Economist Senior Economist Economist +64 4 802 2212 +64 4 802 2357 +64 4 802 2199 bagriec@anz.com gohk@anz.com borkinp@anz.com Sean Comber Steve Edwards Kevin Wilson Economist Economist Rural Economist +64 4 802 2286 +64 4 802 2217 +64 4 802 2361 combers@anz.com edwards1@anz.com Kevin.Wilson@nbnz. co.nz Page 4
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