US embassy cable - 05HANOI2237

UNCLAS SECTION 01 OF 03 HANOI 002237 
 
SIPDIS 
 
STATE PASS USTR FOR EBRYAN 
STATE ALSO PASS USAID ANE 
TREASURY FOR OASIA 
USDOC FOR 4431/MAC/IFP/OKSA/HPPHO 
BANGKOK FOR USAID 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, VM, SOE, FINREF 
SUBJECT: MONETARY POLICY IN VIETNAM 
 
This cable contains sensitive information and should not be 
posted on the internet. 
 
1. (SBU) Summary: Responsibility for monetary policy-making 
rests with the State Bank of Vietnam (SBV), which functions 
as a central bank as well as the owner and supervisor of the 
State-owned commercial banks (SOCB).  For 2005, the SBV 
decided to focus on controlling the monetary aggregate, 
restraining credit growth from its 42 percent level in 2004 
and stabilizing the exchange rate.  The SBV has begun to act 
more indirectly to manipulate the money market.  While the 
Government blames recent inflation on supply-side and 
external shocks like rising global rice and oil prices, 
avian influenza, a persistent drought and loose monetary 
policies may also contribute.  Continued policy lending 
between State-owned enterprises (SOE) and State-owned 
commercial banks has fueled rapid credit expansion and may 
pose future risks.  End Summary. 
 
MONETARY POLICY MAKING 
---------------------- 
 
2. (SBU) The State Bank of Vietnam (SBV) is the central bank 
as well as the owner and supervisor of the State-owned 
commercial banks (SOCBs) which still dominate Vietnam's 
financial sector.  For many years, monetary policy in 
Vietnam was simple: the SBV made sure there was adequate 
liquidity for SOCBs to fund state-owned enterprises (SOEs). 
Tight government controls on access to foreign exchange, as 
well as a fixed exchange rate, insulated the economy from 
external shocks and minimized the need for sophisticated 
monetary policy making.  Relative to its neighbors, the 
country was largely untouched by the 1997 Asian financial 
crisis, not because of policy prowess, but because of its 
limited integration with the regional economies most 
affected by the crisis.  As Vietnam's economy has gradually 
become more open, it has faced greater exposure to external 
shocks, exchange rate fluctuation and the need to develop a 
monetary policy.  In recent years, the IMF has sponsored 
technical assistance programs to give SBV officials a better 
understanding of market-based monetary control techniques. 
At the same time, the SBV's increasing reliance on indirect 
instruments such as open market operations, which were first 
introduced in 2000 and still in their nascent stages, have 
given the SBV somewhat more influence in the domestic money 
market. 
 
3. (SBU) Vietnam's constitution assigns the SBV 
responsibility for creating an annual set of monetary policy 
objectives.  Following approval by the Government and the 
National Assembly, the SBV sets the specific policies to 
meet these objectives.  SBV's Monetary Policy Office's 
Deputy General Director Nguyen Ngoc Bao said that policy 
makers had agreed on 2005 growth rate targets of 8.5 percent 
for GDP and 6.5 percent for the Consumer Price Index (CPI). 
Based on those targets, SBV has determined its own secondary 
objectives for 2005, namely controlling the monetary 
aggregate, restraining credit growth and stabilizing the 
exchange rate.  Bao noted that interest rates have recently 
been liberalized and are now largely controlled by market 
forces.  The SBV only manipulates the discount rate to 
control bank credit, which is the main source of capital for 
the Vietnamese economy. 
 
4. (SBU) The SBV faced its first recent inflationary 
challenge in 2004 when CPI reached ten percent.  Vietnam's 
annual inflation rate had been consistently below four 
percent since 1998, and had not been in the double-digits 
since 1995.  Bao attributed the rapid inflation rate to 
higher prices for imported raw materials, the return of 
avian influenza, price increases for rice on the global 
market and distribution problems, particularly for 
pharmaceutical products.  1Bao downplayed the impact of 
loose monetary policy as a factor contributing to inflation. 
In order to manage last year's inflation, he explained that 
the SBV had adjusted its benchmark discount rate, raised the 
required reserve ratio and restrained the money supply.  The 
SBV has been maintaining a cautious monetary policy stance 
throughout 2005, Bao added.  Since the SBV introduced open- 
market operations five years ago, the response from the 
market has been encouraging, with electronic trading 
sessions now taking place three to five times each week.  An 
SBV committee is responsible for managing open-market 
operations, which Bao said has been very effective in 
manipulating the money market.  The SBV plans to use open- 
market operations increasingly as a policy instrument. 
5. (SBU) According to Nguyen Thi Vu, the SBV's inflation 
expert and manager of the Economic Analysis and Forecast 
Division, the SBV is continuing to reevaluate the CPI basket 
in order to represent core inflation values more accurately. 
Food and foodstuff prices constitute about 48 percent of 
Vietnam's CPI, which was originally calculated based on a 
survey of household expenditures in 2000.  SBV officials 
acknowledge that a rising standard of living, especially in 
urban areas, has already altered consumer spending habits, 
probably reducing the share of income spent on food items. 
While the General Statistics Office (GSO) plans to complete 
a survey on household expenditures by 2005, the SBV's 
inflation expert said preliminary data from the survey shows 
that food still represents more than 40 percent of the CPI's 
weighted prices. 
 
6. (SBU) According to International Monetary Fund Country 
Representative Susan Adams, the GVN's efforts to combat 
inflation have been somewhat misdirected.  In recent years, 
the GVN has been reluctant to tighten monetary policy 
because of a largely political commitment to sustain growth 
numbers before the five-year plan terminates at the end of 
2005.  Besides that, the SBV attributes the rising prices to 
temporary supply shocks resulting from continued drought, 
avian influenza and inflationary trends on the international 
market.  Adams said the IMF has encouraged the SBV to 
implement tighter monetary policies.  The IMF is also 
encouraging the SBV to more frequently use indirect monetary 
instruments, like open-market operations. 
 
7. (SBU) One of the SBV's primary objectives is to ensure an 
adequate supply of capital for continued growth.  Credit 
growth was 41.6 percent last year - a rate Bao considered 
reasonable in order to sustain the economy's 7.7 percent GDP 
growth rate for 2004.  The SBV is less concerned about 
credit growth because of the high level of investment for 
borrowed capital, he added.  The SBV's major challenge is to 
expand lending while improving loan quality.  Efforts to 
this end are reflected in commercial bank restructuring, 
which include implementing risk management regulations.  Bao 
also mentioned poor-quality bank loans and a high level of 
dollarization as added challenges for the SBV. 
 
8. (SBU) Borrowing and lending remain unrestrained, 
especially for the state-owned sector, according to Adams. 
This credit expansion reflects persistent structural 
problems, as state-owned banks continue to extend 
politically motivated loans to faltering state-owned firms. 
Joint stock and private domestic enterprises also represent 
a growing proportion of bank lending.  The SBV's 
contractionary monetary policies in 2004 did very little to 
affect credit growth.  Nevertheless, Adams believes rapid 
credit expansion is not directly correlated with inflation, 
but could be a contributing factor in the future if monetary 
policy remains loose.  To a limited extent, credit expansion 
is also an encouraging sign of positive intermediation in 
the economy, as well as growing public confidence in 
financial institutions. 
 
FOREIGN EXCHANGE RESERVES 
------------------------- 
 
9. (SBU) The SBV's Foreign Exchange Management Department 
Deputy Division Chief Nguyen Chi Thanh estimates foreign 
exchange reserves for Vietnam at 10-12 import weeks.   While 
the SBV officially refers to the exchange rate policy as a 
"regulated market policy," the policy functions like a 
"crawling peg" exchange regime.  The GVN has taken a heavy- 
handed approach to foreign exchange rates, according to 
Adams.  Vietnam's crawling-peg policy has further weakened 
its already weak foreign exchange position, making it even 
more vulnerable to external supply shocks.  Vietnam's 
dollarized economy has also become a cause of concern for 
the SBV.  At least in urban areas, a number of businesses 
accept U.S. dollars as well as Vietnam dong and change in 
dollars. 
 
10. (SBU) Comment: Even though SBV officials are still 
honing their monetary policy making skills, Vietnam's 
monetary policy has been prudent over the last year with a 
few exceptions.  In its capacity as a central bank, however, 
the SBV would do well to limit its politically motivated 
decisions.  Specifically, the SBV's initial reluctance to 
tighten monetary policy in the face of rapid inflation may 
have been politically motivated.  In any case, the IMF 
considers that the impact of interest rate changes is 
unclear.  The exchange rate position might benefit from 
looser controls.  Better risk management and less policy 
lending will be needed to control inflation as well as 
credit growth to SOEs in the future.  End Comment. 
 
MARINE 
 
_______________________________ 
1Sam: I could not read your comment on this. I added what I 
could make out.