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Policy space for forex control

By Thuy Le

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With pressure on the local currency still lingering, while resources and vehicles required to stabilize the forex rate are being exhausted, a big question arises over whether the monetary regulator still wields any policy space for forex control in the coming time

Increasing pressure

Since October 21, the U.S. dollar has been quoted by commercial banks at the upper limit (5% higher than the reference rate) allowed by the State Bank of Vietnam (SBV). The dollar was traded some VND200-300 lower than the upper limit last month and VND700-800 lower early this year, so the fact that the greenback touches the upper limit now indicates a severe dollar shortage among banks and high strains on the forex market.

It is noted that after the SBV widened the trading band on October 17, from 3% to 5% on either side of the reference rate, the dollar price quickly shot up. Only four days later, banks lifted the dollar price to the upper limit, proving pressure had accumulated on the forex market and how it was released, with banks shrugging off all the burden they had borne for a long time.

In October alone, the dollar price quoted at banks jumped by VND880-900, or twice the rate recorded in September, sending the greenback up by nearly VND2,000 this year, or a multiple-year high of over 8.6%. The SBV itself also raised the dollar selling price by VND490 to VND24,870, on par with the spot rate at commercial banks.

Meanwhile, the dollar price has also set new records on the free market, breaching the mark of VND25,000 on October 20 and staying high ever since. In the first half of October, the SBV prompted banks to raise the dollar spot rate, thus narrowing down the gap between the formal forex rate and the informal rate. However, in the latter half of the month, the greenback was rising faster on the informal market than at banks, thus widening the gap again.

Specifically, in October, the informal-market dollar strengthened by VND1,085, largely owing to a sharp rise of VND950 in the second half of the month. The official rate quoted by banks is currently some VND300 lower than the free-market rate. This gap may, at length, draw the dollar from banks onto the informal market, as seen in the past.

Though the monetary regulator has taken intervention measures, the pressure on the forex market remains high.

Vehicles employed by the SBV for forex control included increasing dollar supply, having sold nearly US$21 billion from foreign reserves this year, and raising the reference rate (the SBV has raised the central foreign exchange rate six times with a combined increase of VND1,820, with September and October alone seeing the rate revised up four times with a combined amount of VND1,470).

Further, the SBV has widened the forex trading band to absorb market forces, but this move has made it possible for the greenback to strengthen further in the second half of October. In addition, the central bank has twice raised key interest rates within a month by one percentage point each time, allowing the rates to soar at the fastest pace in over 10 years.

Policy space for forex control?

As Vietnam dong weakened by up to 4% in October, equal to the depreciation in the preceding nine months, it is assumed that the fast change of the forex rate within a short span of time may stimulate dollar holding among investors. The securities broker VDSC has recently commented that given the tight liquidity coupled with external pressure, a sharp depreciation of the local currency by 10-15% this year cannot be ruled out.

The forex pressure in the past month was largely due to internal factors. The dollar on the global market has not changed markedly, with the dollar index rising little. Incidents related to Van Thinh Phat Group have negatively impacted the banking industry’s liquidity, giving way to momentary worries and stimulating forex holding.

With pressure on the local currency still lingering, while resources and vehicles required to stabilize the forex rate are being exhausted, a big question arises over whether the monetary regulator still has any maneuvering room for forex control in the coming time. Take, for example, the policy to sell dollars for intervention. Since early October, the SBV has sold less than US$1 billion, which means this forex cushion has thinned out.

If the forex rate swings wildly beyond the target range in the coming time, the central bank still wields other policy vehicles for forex control if needed.

First, the SBV can lower the dollar reserve ratios to 7% for deposits shorter than 12 months and 5% for longer tenures. The respective foreign reserve requirements for other credit organizations are 8% and 6%. These ratios have stayed put for 11 years since August 2011. Credit organizations will have a sizeable amount of foreign currency to supply the market if the reserve requirements are lowered.

Another vehicle ready for use is to review the required forex position at credit organizations and foreign bank branches, which is regulated at 20% pursuant to Circular 07/2012/TT-NHNN issued ten years ago. Such a forex position was required when equities at banks remained modest. Now, after several years, many banks have spurred their charter capital, and coupled with retained earnings and proceeds from bond issues, these banks have seen their tier-2 capital increasing sharply, and as such, the forex amount at banks under such a position has swollen.

Furthermore, the SBV can order more entities to sell their forex earnings at certain points in time when the forex demand is dire; and tighten control over foreign exchange agents to block the foreign currency flow from banks into the informal market. Control over forex borrowing, and the mechanism and interest rate for forex mobilization also need to be strengthened.

The SBV can also further raise the dong interest rate as a measure to check the local currency’s depreciation. Recently, Governor of the SBV Nguyen Thi Hong noted that the lending rate in the year to September rose barely 0.3-0.4 percentage point against the end of 2021. The Governor also said the SBV had to raise the interest rate to control the forex rate, as a stable interest rate would not help in stabilizing the forex market. A stable forex market is pivotal in shoring up foreign investors’ confidence in Vietnam. Therefore, it is probable that the interest rate policy will still be resorted to.

Finally, as the U.S. Federal Reserve is winding up its rate hike roadmap, some observers say the dollar is peaking and may fall in 2023. If this projection proves right, the dollar trajectory would help ease the forex pressure in the coming time.

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