A 1 per cent cut in the deposit interest rate is unlikely to reverse the downward trend in Viet Nam's inflation, according to a Hong Kong and Shanghai Banking Corporation research report.
Based on its analysis of Viet Nam's monetary policy, the cut comes as no surprise, the report says. Core inflation has eased since its peak at 15.2 per cent y-o-y in August 2011 to 12.7 per cent in February.

The slowdown of both headline and core inflation plus the stability of the dong provided scope for the State Bank of Viet Nam to cut rates.

Despite today's cut, inflation should continue to decelerate to single-digits by year-end for three reasons: sluggish domestic demand, slow credit growth and a favourable base effect, the report said.

It said persistently high inflation in 2011 taught consumers to be cautious, which will affect their spending this year. Meanwhile, optically, inflation's rapid rise last year means that the base effect is enough to allow y-o-y inflation to fall.

"We also do not expect the rising oil price to significantly have an impact on inflation in 2012, assuming that oil prices do not rise above US$140 per barrel."

It said as far as the Vietnamese currency was concerned, "many of the factors that have concerned us are still there – double-digit inflation, negative real interest rates and a sizable trade deficit – but we are seeing improvements.

"For now, the risks are still skewed slightly to further dong weakness, and we forecast the exchange rate between the US dollar and dong at 21,500 by year-end. However, if these indicators continue to improve, then the dong may start to look more attractive again."

As a nation that exports crude oil, Viet Nam still had to import US$9.7billion worth of petroleum in 2011. This means that when the oil price increases, as it has recently, the country benefits through the export channel but suffers on the import side.

"In our view, the rise in oil prices will not significantly change the direction of headline inflation, which has been trending down. Transportation costs, which we use as a proxy for oil, account for 8.9 per cent of the total CPI basket. A 10 per cent increase in the oil price would therefore have only a muted direct impact on headline CPI."

Moreover, food prices, which make up almost 40 per cent of the total basket, have decelerated sharply and would offset the effect of a higher oil price. While secondary effects of higher oil prices will feed through in a couple months, the impact will be likely be offset by low demand.

More fundamentally, slower demand for loans as a result of earlier tightening will also reduce inflationary pressure, the report said.

Strong base effect

In the next six months a strong base effect, which reflects the strong 2 per cent m-o-m (seasonally adjusted (sa) increase in March-May 2011, will likely bring inflation down. The inflection point for inflation is not until November 2012, when we expect the y-o-y inflation rate to begin to pick up," the report said.

It noted that if loan demand was to able without significant supply shocks, headline inflation could even decelerate beyond November.

The report said credit growth in Viet Nam was a more important measure of liquidity conditions.

Credit grew 10.9 per cent in 2011, compared with 27.7 per cent in 2010. The Government capped credit growth at 20 per cent in 2011, suggesting that demand was low in 2011 because actual growth was lower than the cap. For this year, the cap is 17, 15, 8 and 0 per cent for different banks. The growth for loans for investment and trading in stocks and real estate as well as consumer loans is capped at 16 per cent. Given the lacklustre demand in the market, the cap is unlikely to be reached.

The easing of interest rates then would only meaningfully affect the domestic economy if it ultimately increases demand. The open market operations (OMO) rate was lowered to 13 from 14 per cent and the refinance rate to 14 from 15 per cent. The Government also decreased the deposit cap on interest rates to 13 from 14 per cent.

Both policy moves are part of the central bank's response to complaints from consumers about high interest rates. With the overnight interest rate being significantly lower than the OMO rate and expected to remain so for the rest of the year, the move is unlikely to significantly change domestic demand.

VNS