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Friday, December 2, 2022

The situation is now different

By Dr. Vo Dinh Tri

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The State Bank of Vietnam’s (SBV) recent decisions to hike key interest rates, widen the trading band of the Vietnamese dong, and actively engage in open market operations have significantly contributed to ensuring macroeconomic stability and easing inflationary pressure

The effectiveness of monetary policy has its limits, as there is a trade-off for stabilizing inflation. While many economies have been struggling with rising inflation, Vietnam is trying to keep inflation at around 4% this year.

Challenges for inflation targeting

Since 2016, inflation below 4% has been one of the key targets in Vietnam’s annual socioeconomic development plan. Many central banks worldwide have adopted inflation targeting as this monetary policy helps anchor inflation expectations at a specific figure. For instance, some economies have targeted a 2% inflation rate. Once inflation is controlled, the central bank’s credibility will be enhanced and stable interest rates will pave the way for economic growth.

But supply chain disruptions and geopolitical uncertainties have pushed up prices globally. Rising inflation in the U.S. has prompted the Federal Reserve (Fed) to repeatedly hike interest rates, making the U.S. dollar stronger and fueling inflation in many other economies.

Given runaway global inflation, sticking to the inflation-targeting policy would create hurdles to implementing other economic policies.

For example, some central banks, worried about inflation far surpassing their targets, have tightened monetary policy by increasing interest rates. This is probably happening in Vietnam as capital flows in the local economy have become slower and some sectors, such as securities and real estate, have seen a drop in liquidity. In countries with modest inflation forecast ability, the risk of sticking to the inflation targeting strategy would be higher.

By contrast, due to its goal to tame inflation, a central bank may put on ice its supporting policy via interest rate adjustments when its economy slows down. If inflation targeting is treated as less important, the central bank will maintain soft monetary policy such as those currently adopted by Japan, China and Turkey.

More room needed for inflation

According to a Government report presented at a National Assembly session on October 20, Vietnam projected its inflation for 2023 at some 4.5%, which was revised compared to the 4% target reported by international institutions. But with the existing capability of Vietnam, room for inflation could be extended to ease pressure on other policies.

Interest rate hikes at present could place pressure on corporate borrowers amid limited funding sources and prompt them to stay more cautious after many corporate bond scandals occurred and the local stock market steeply declined.

Although Vietnam can easily intervene in the foreign exchange market, given its current foreign exchange reserves, trade surplus, foreign direct investment inflows and incoming remittances, the easing of inflation pressures would make foreign exchange adjustments more natural and controllable.

For many central banks, inflation targeting is not a fixed figure and there is no need to achieve it at all times. Instead, it is considered a medium-term goal and can be adjusted up or down flexibly in different periods.

The Fed set a 2% inflation target but later realized it was unfeasible, so it adopted a new policy called Flexible Average Inflation Targeting, thanks to which the Fed became increasingly flexible in making its monetary policy.

Most people and enterprises worldwide are voicing concern over an imminent recession and the economy slipping into stagflation. However, unemployment facing many countries has yet to reach an alert level and inflation, as freshly updated in research, has peaked and is going to decline.

Of the scenarios for the global and U.S. economies in the years to come, there is one forecasting that inflation would remain high and drop slowly, but economic growth would continue and remain high after 2023, mostly buoyed by fiscal policies. In this scenario, inflation and interest rates would remain high at present or a bit lower but would be stable.

Monetary policies made amid global uncertainties should be flexibly adopted, and their effectiveness greatly depends on the trust of people, enterprises and investors. To do so, the existing capabilities and response measures of the Vietnamese Government and the SBV have to be announced quickly and clearly, so that concerns over economic issues would be reduced and economic stability would return.

Therefore, macroeconomic stabilization and inflation control need to be taken into account more flexibly. Obtaining stability amid many global uncertainties will differ from that in a normal setting. Also, inflation control does not mean closely sticking to a specific figure. Inflation control should be treated and added to an overall picture in which the economy maintains its growth, consumption remains stable, and the economy is resilient to shocks.

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