VietNamNet Bridge – The Government looks at the possibility of tapping the country’s foreign reserves as a source of funding for development investment but HSBC Bank has cast doubt about this, saying the central bank needs the already limited reserves to defend the domestic currency.

The Government told the central bank to work with the ministries of finance and planning-investment to propose a mechanism that legalizes borrowing from the foreign reserves to fund state projects without affecting the safety of the financial system.

HSBC quoted sources as saying that at the cabinet meeting last month the Ministry of Finance proposed the Government use the foreign reserves as an alternative source of funding to cope with the low demand for government bonds. Seven bond auctions attracted little or no investor interest in May alone.

The ministry has described domestic bond issuance as a tough job this year. Of the VND250-trillion financing needs in 2015, it has successfully issued VND66 trillion debt papers year-to-date, HSBC said in a report released last week.

HSBC pointed the finger at Resolution 78, saying it limits the State Treasury to issuing bonds with tenors of five years or longer only. This has caused a significant change in the profile of Vietnam’s bond issuance.

A further reason for the weak appetite could be other legal documents, such as Circular 36 that restricts banks from using short-term capital for G-bond purchases.

However, the proposal may not be passed as the State Bank of Vietnam (SBV) needs to defend its exchange rate. Financing state projects with foreign reserves would leave the local currency in a precarious position.

Besides, foreign reserves cover only 2.5 months of imports, much less than the minimum guidance of three months, HSBC said. Thus, the SBV appeared to lack room to act, HSBC explained.

The bank said any decision on the part of the Government to borrow from forex reserves would risk impacting the stability of the dong. The SBV’s policy of maintaining a narrow daily trading band for the U.S. dollar - Vietnam dong exchange rate at 1% on either side means reserves are an essential tool to ensure exchange rate stability.

Unfortunately for the SBV, its reserve adequacy is already low by most conventional measures, even compared with other economies like Bangladesh and Sri Lanka that have similarly managed forex regimes. The latest numbers show the SBV held nearly US$35 billion in foreign reserves at the end of the last year while import cover is well below the traditional benchmark of three months.

To make matters worse, the trade balance has flipped from positive territory in November last year to a deficit of US$3.3 billion year to date, a level unseen since 2011. This will put further strain on forex reserves and the currency.

The negative sentiment surrounding the developments has already caused the dong-U.S. dollar exchange rate to test the upper end of the band despite the recent devaluation.

“Ultimately we expect there will be some alternative solution. Possible options include issuing in the international market. We therefore still expect the SBV not to devalue the dong again this year and maintain our year-end forecast of VND21,750 per dollar,” the bank said.