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Friday, February 3, 2023

What are implications of a weakening dollar?

By Thuy Le

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The U.S. dollar has steadily dropped against the Vietnamese dong currency. This is good news given that the foreign exchange market normally comes under pressure from the huge year-end demand of importers for foreign currency.

Are supply and demand equated?

The State Bank of Vietnam (SBV), on November 25, decreased the dollar-dong exchange rate by VND10, marking the third straight downward adjustment in November. Earlier, the bank revised down the exchange rate by VND10 on November 11 and 18 to VND24,850 per dollar. Still, the current rate is higher than earlier this year by 7.3% or VND1,700.

Meanwhile, the SBV has continuously adjusted the central dollar-dong exchange rate. On November 28, the exchange rate was quoted at VND23,667 per dollar, down by VND28 over the start of the month.

The move to appreciate the dong follows two prior devaluations of one percentage point each on September 23 and October 25. According to analysts, the appreciation of the dong has led to a shift from holding foreign currency to the local currency which would enjoy a far higher interest rate if deposited at a bank.

In the meantime, the informal market has seen the dong rising against the dollar more strongly. Since early November, the dollar has fallen by VND260 (buy) and VND300 (sell) against the dong. The difference between the buy and sell prices has narrowed down to a mere VND60, indicating that supply and demand are moving towards equilibrium after they had come under pressure in the third and early fourth quarters.

The greenback had soared to VND25,500 per dollar in mid-October before it fell below VND25,000 on both buy and sell sides on the informal market. The informal market selling price of the dollar is only VND130 higher than the upper limit set by the SBV, way below the VND500 recorded in early October.

The dollar fall on the global market has allowed the SBV to stabilize Vietnam’s forex market, with the U.S. Dollar Index dropping by 6.6% to 105.5 points from its peak at 113 points in early November, the sharpest plunge in 12 years. According to minutes recently released by the U.S. Federal Reserve (Fed), most Federal Open Market Committee members agreed that the Fed might start cutting interest rates in the coming months as inflationary pressure eases. If that is the case, the dollar, which has grown strongly this year on the Fed’s hawkish interest rate hikes, would drop. Meanwhile, experts said that the currency had reached its peak recently.

What is the signal the SBV has sent out?

The U.S. dollar has steadily dropped against the Vietnamese dong currency. This is good news given that the foreign exchange market normally comes under pressure from the huge year-end demand of importers for foreign currency. With efforts to stabilize the exchange rate since early this month, this may be the SBV’s signal to prioritize combating imported inflation.

Earlier, the exchange rate turned highly volatile due to inflation pressures. Still, the country has gained some export advantages brought by the Vietnam dong depreciation, helping Vietnamese products become more competitive as the currencies of other economies in the region and Vietnam’s trade partners plunged against the greenback.

However, a lack of new orders is seen across the nation’s major export-reliant industries, namely textile and footwear, due to the geopolitical repercussions of the Russia-Ukraine military conflict and tight monetary policy driven by soaring inflation. As a result, interest rates have skyrocketed in the U.S. and European countries, which are Vietnam’s major trade partners.

Besides, some experts credited Vietnam’s trade surplus to foreign-invested enterprises, as domestic companies still depend heavily on goods and raw materials imported abroad. Hence, businesses with foreign investment benefited from the dong decline against the dollar but a weaker dong increased the pressure of imported inflation.

Still, Vietnam is projected to keep inflation in check and meet its inflation target in 2022, marking eight consecutive years of getting inflation below 4%. Such positive results were thanks to an ample food supply, stable global fuel prices, and a stable currency exchange rate.

However, because of a response lag, Vietnam would feel the inflation impact next year, especially when authorities plan to raise the prices of goods and services regulated by the Government, such as electricity, education, health and salaries, forcing the country to lift its 2023 inflation target to 4.5%.

Apart from cost-push inflation, the nation may be affected by imported inflation, as mentioned above, particularly for petroleum products. Another factor influencing inflation expectations is high interest rates. Thus, to curb imported inflation, mitigating currency risk may become an important goal at present and in the coming time.

Besides, it will harm the economy if the domestic currency slides too fast, putting a strain on interest rates. Given the recent two consecutive interest rate hikes, the SBV should stay cautious of increasing interest rates in the coming time. Otherwise, businesses’ operations would be severely affected, thus dragging the economy into recession, which developed economies are being scared of.

It should also be flexible in revising the dong-dollar exchange to avoid being accused of currency manipulation. On November 10, the U.S. Treasury Department removed Vietnam from the currency monitoring list.

However, if the dong continues to rise against the dollar, the SBV may buy the greenback, thus infecting liquidity into the banking system in the rest of the year.

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