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The efficiency of the policy rate cuts

By Thuy Le

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The recent moves by the State Bank of Vietnam (SBV) to cut policy interest rates are expected to give a much-needed boost to the economy and enterprises. However, some are of the view that these moves have limited impact under the current circumstances.

Drastic interest rate cuts

Less than two weeks after the SBV governor said the policy interest rates would be further lowered, the central bank has lived up to the promise, issuing a decision to cut key interest rates on May 23. This time, the SBV singled out key rates that have widespread effects on the economy. Accordingly, the ceiling rate for deposits shorter than six months is lowered by 0.5 percentage point to 5% a year, while the refinancing rate and the interest rate of overnight lending in inter-bank electronic payment and lending to offset the capital shortage in the clearing of the SBV for credit institutions are also reduced by 50 basis points to 5% and 5.5%, respectively.

This is the third consecutive time the SBV has cut its policy rates over the past two months. In mid-March, the SBV trimmed by one point the rediscount rate and the interest rate of overnight lending in inter-bank electronic payment and lending to offset the capital shortage in the clearing of the SBV for credit institutions, and cut the lending rate cap for short-term loans for priority sectors by 50 basis points. Later that month, the SBV cut the refinancing rate, the ceiling rate for deposits shorter than six months, and the lending rate cap for short-term loans to priority sectors, all by 50 basis points.

In fact, there are good grounds for the SBV to further lower its policy rates. These include the lower inflationary pressure, ample forex supply that helps stabilize the forex rate and allows the central bank to inject more funds in Vietnam dong into the economy, the economic slowdown, lower credit growth, and the risk of bad debt rising, all incentivizing the SBV to act quicker.

Following the latest policy rate cut by the central bank, most commercial banks have revised down their borrowing rates, not only for deposits shorter than six months, but also for longer tenures to maintain a reasonable interest rate gap between short- and long-term deposits. The highest deposit rate has now been reduced to 8.5% for 12-month deposits, a high level seen at some banks only.

Policy effectiveness

The recent moves by the State Bank of Vietnam (SBV) to cut policy interest rates are expected to give a much-needed boost to the economy and enterprises. However, some are of the view that these moves have limited impact under the current circumstances.

First, it is due to the hardship induced by the lack of export orders faced by many enterprises in recent months as the global supply chain has shrunk. The consumer demand in many markets being major trade partners of Vietnam has tumbled due to economic slowdown or the risk of recession aggravated by higher inflationary pressure and higher interest rates. Therefore, Vietnam’s economic expansion in general and the growth of local traders in particular will to a large extent be contingent on the economic recovery and monetary policies of these countries.

Second, domestic production and business have slowed down lately due to the weaker purchasing power in the context of massive layoffs and high interest rates. Many enterprises have shied themselves away from business expansion in the absence of a positive economic outlook, while others are ineligible for new credits. Therefore, the demand for capital in the economy now is very low across the board, from production to commerce and consumption.

Third, although the monetary policy has become more accommodative lately via rate cuts, the credit growth and money supply are still put under stringent control. While credit growth is objectively impacted by the low capital demand in the economy, money supply is a subjective matter on the part of the monetary regulator, given concerns about inflation.

As a developing economy with high exposure, the domestic currency in particular and the forex market in general are susceptible to international trade and investment trends as well as monetary policies in major economies. Moreover, there are constant worries about high inflation. These explain why the central bank is always sensitive to variables that are determinants of inflation and tries to stick to an inflation target, thus its control over money supply. However, such a cautious approach has some time resulted in a liquidity crunch for the economy, disruption of the cash flow and wastefulness of financial resources.

Supplementary solutions

Given such situations, the Government and the SBV can resort to other vehicles or policies to underpin economic growth alongside the repeated reduction of policy rates as seen since March.

Regarding the impacts from trade partners, the Prime Minister has issued Telegram 470/CD-TTg dated May 26, 2023, urging the Ministry of Industry and Trade to work with the Foreign Ministry and other relevant ministries and bodies to make the most of existing free trade agreements (FTAs) and step up negotiations over new FTAs or other trade agreements, including an FTA with Israel and other partners like the UAE and MERCOSUR to diversify markets and supply chains to boost consumption of Vietnamese-made goods. In this Telegram, the Prime Minister also asked the SBV to instruct commercial banks to lower interest rates, and make lending conditions easier in disbursing a VND40-trillion package on interest subsidy for economic recovery, and a VND120-trillion package to support social housing developers and buyers. The SBV governor, meanwhile, has recently issued Directive 02 on restructuring and rescheduling debt payments to help clients overcome difficulties in line with Circular 02 dated April 23, 2023.

These solutions are expected to help cash-strapped enterprises to access new credits to resume business or production. Once enterprises resume business, the labor market will expand again, and alongside lower interest rates, consumption will thrive. Higher consumption will have positive impacts on the economy in general and business performance in particular.

Regarding the issue of money supply, as the inflationary pressure has eased, the central bank can feel rest-assured and confident to loosen its stringent control. With an aim to replenish the country’s foreign reserves by tapping the apple forex supply and a stable forex rate, the SBV can opt for boosting money supply via the forex market. Of course, this is not the single option for the monetary regulator.

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