Fiscal And Monetary Policies Not In Sync
By Hong Phuc
Monetary policy adopted by the State Bank of Vietnam, and fiscal policy by the Ministry of Finance do not always move in tandem. This inconsistency has affected macroeconomic governance to some extent.
At a recent seminar on the relationship between fiscal and monetary policies, which took place in Hanoi, Dr. Nguyen Thi Kim Thanh, director of the Banking Strategy Institute under the State Bank of Vietnam (SBV), says that the Ministry of Finance and the central bank should coordinate when fleshing out fiscal and monetary policies. Otherwise, State-run banks will tend to pour too much money in the Government’s valuable papers whose maturities exceed the terms of deposits, sparking a dearth of working capital.
A structural shortage of working capital may affect its distribution in the interbank market and influence the interest rate there. Overnight interest rates may vary drastically when the imbalance is severe. In that case, SBV will be forced to adopt several tools to inject capital into commercial banks to reduce interest rate fluctuations in the interbank market and, in so doing, stoke inflationary pressure. Moreover, depending on the circumstance, SBV may also offset the budget deficit by purchasing government bonds. This approach will serve as a monetary tool and reduce the Government’s issuance costs.
According to a paper presented by Nguyen Thi Hien from the Banking Strategy Institute, most of the budget deficit incurred since 2000 has been backed by over 70% of the domestic loans, which chiefly come under the form of government bond and treasury bill issuance. Government bonds are important in helping SBV conduct monetary policies in line with market forces and effectively adopt indirect monetary tools such as open market operations and discounts. However, if the Government does not set a yield that reflects market conditions (in other words, there is no standard yield curve, as is currently the case), the issuance of government bonds may crowd out private investment.
If the Government sets coupons above the interest rates in the banking sector and the dividends from stock investments, capital flows will be altered. Liabilities, assets and the banking system’s ability to mobilize capital will be affected, too. Banks will offer fewer loans and pour money into bonds, which are safe and still profitable. The role of banks as financial intermediaries will diminish and their operations will be more unstable and less efficacious.
On the other hand, if the yield on government bonds falls short of market expectation as it does now, bond issuance will flop. The market will possibly be confronted with equally disastrous impacts such as dismal liquidity.
At present, SBV determines the money supply annually and presents its findings to the Government for approval. The monetary policy will be adjusted to finance budget deficits. Meanwhile, the Ministry of Finance has imposed a ceiling on the coupon of government bonds. To mobilize sufficient capital for government projects, sometimes bonds and treasury bills offer more returns than the lowest deposit rate offered by commercial banks.
Consequently, monetary policies have been harder to conduct. The public and enterprises will invest more in bonds and have fewer financial resources to channel into the private sector. Commercial banks yearning to meet their targets for deposits must therefore increase the deposit rates. Unhealthy competition will probably arise, breeding systematic risks. Commercial banks may even need to raise the deposit rates above the yield on government bonds to lure long-term capital. In the long run, the budget deficit will balloon as social investment becomes less efficient.
Experts at the seminar contended that the lack of timely, effective coordination between SBV and the Ministry of Finance has hampered monetary policies. For instance, SBV may deem it appropriate to issue bonds now, but the Ministry of Finance is not prepared or able to do so due to external reasons. On the other hand, the information flow between SBV and the Ministry of Finance still leaves much to be desired, and there has not been adequate mutual support. For instance, it is challenging to formulate monetary policies given outdated, incomplete statistics and reports on public finances, as well as inconsistent statistical formats used by SBV and the Ministry of Finance.