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Sunday, September 25, 2022

Will ample supply ease exchange rate tension?

By Tue Nhien

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What came as a surprise is that after two stressful weeks, the foreign exchange rate on August 29 showed signs of stabilizing though the U.S. dollar climbed further on global markets

The greenback is back to 20-year high

A week ago, the selling price of the U.S. dollar on the domestic informal market shot up to its record high of VND24,160 per dollar, as the dollar inched up at banks and on global markets. The U.S. Dollar Index during that week picked up 2.4% to 108.17 points, the highest in more than a month. A basket of currencies used by U.S. trade partners to measure the value of the dollar has all declined against the dollar.

Specifically, the U.S. currency gained 2.59%, 2.55%, 2.16%, 3.73%, 1.63% and 1.83% against the Japanese yen, the British pound sterling, the euro, the Swedish crown, the Canadian dollar and the Swiss franc, respectively.

The strong rise of the greenback emerged amid expectations that the U.S. Federal Reserve (Fed) would continue to sharply increase interest rates in the coming time.

On July 28, according to the CME FedWatch Tool, which analyzes and forecasts the Fed’s interest rates, the probability of the U.S. central bank raising interest rates by 0.5 of a percentage point during its September meeting was 74%, whereas the chance of a 0.75 percentage point increase was 26%. Three weeks later, on August 19, the respective percentages shifted to 53% and 47%. After Fed Chairman Jerome Powell gave remarks at the Jackson Hole Symposium that wrapped up on August 26, the forecast of FedWatch once again drastically altered, with a probability of a 0.5 percentage point hike, dropping to only 39% and that of a 0.75 percentage point increment shooting up to 61%. As per the latest updates on August 29, the respective figures continued to change to 27.5% and 72.5%.

As stated by the Fed chairman, the Fed will take stronger action to rein in runaway inflation, which is still hovering near its 40-year high. Even after four consecutive adjustments with a total of 2.25 percentage points added, it is not yet time to stop raising interest rates although the benchmark rates are probably around the neutral range already, i.e. they do not stimulate growth or inhibit it, said Powell.

Therefore, the U.S. Dollar Index on the final days of August further soared to 109.48 points, its 20-year high. Compared to the beginning of the year, the index has risen more than 14%, marking its strongest gaining streak in decades, as the Fed is also witnessing the fastest and sharpest interest rate hike since the 1980s.

Domestic supply suddenly improves

However, what came as a surprise is that after two stressful weeks, the foreign exchange rate showed signs of stabilizing on August 29, though the U.S. dollar further rose on global markets. Such an opposite movement is probably thanks to positive news about trade activity and foreign direct investment that recently came in, reflecting how the domestic foreign currency supply has suddenly become abundant.

In August, the country enjoyed a trade surplus of around US$2.42 billion, taking the January-August total to US$3.96 billion, versus a trade deficit of US$3.52 billion in the same period last year, as per the latest data published on August 29 by the General Statistics Office. Such a result is quite unexpected, since data from the General Department of Vietnam Customs earlier indicated that in the first half of August, the nation ran a trade deficit of more than US$100 million.

Total foreign investment approvals in Vietnam (including newly registered and adjusted, plus capital contributions and purchases of shares by foreign investors) were nearly US$16.78 billion as of August 20, down 12.3% year-on-year. However, foreign direct investment (FDI) capital disbursements, the main contributor to the domestic foreign currency supply, amounted to US$12.8 billion in the first eight months of 2022, a surge of 10.5% against the same period last year. This is also the greatest amount of FDI disbursement in the January-August period in the past five years.

Higher foreign currency supply will ease the State Bank of Vietnam’s pressure to sell foreign currency to intervene in the market.

Vietnam’s foreign exchange reserves by the end of May 2022 had declined by US$4.5 billion compared to late 2021, at US$102.89 billion, according to the International Monetary Fund.

However, estimates by domestic organizations put the volume of foreign currency sold by the State Bank of Vietnam in the year to date has reached US$13 billion, equivalent to more than 11% of the foreign exchange reserves at its peak in late January this year, thus helping stabilize the dong against the dollar.

To accept greater depreciation?

Compared to the beginning of this year, the U.S. dollar inched up less than 0.3% against the dong, whereas it added 2.8% at commercial banks and 2% on the informal market. The dollar continued its strong uptrend against other foreign currencies, so the dong further appreciated against the currencies of the country’s major trading partners.

To be specific, based on the cross rates of the dong against some foreign currencies on the website of the SBV, the Vietnam dong currency has advanced 16% against the yen, 12% against the euro and the pound sterling, 9% against the New Zealand dollar and 4% against the Australian dollar and the Swiss franc. For the currencies in Asia, the dong has picked up 11% against the South Korean won, 8% against the New Taiwan dollar, 7% against the Thai baht and the Chinese yuan, 6% against the Malaysian ringgit and the Indian rupee, 4% against the Indonesian rupiah, and 3% against the Singapore dollar.

This could significantly affect the competitive advantages of Vietnamese exports, while encouraging imports from the aforesaid trading partners.

The first eight months of this year witnessed a trade surplus. But the fact that the country exercised social distancing in the second and third quarters of last year, and that economic activity has remarkably recovered this year, makes the year-on-year growth of 17.3% in merchandise exports in the past eight months quite modest.

As international trade has been badly hit by the military conflict between Russia and Ukraine, coupled with lockdowns and isolation policies adopted in the major cities and manufacturing hubs of China to combat the Covid-19 pandemic, Vietnam should have benefited more when it came to exports, with possibly much higher growth in turnover. Still, as the currencies of other countries have significantly fallen against the dong, it is apparent that there have been certain effects on export growth since the beginning of the year.

From the perspective of the SBV, keeping the exchange rate stable is a must in order to limit imported inflation, which will push up input costs of businesses. Even so, since inflation has shown signs of easing, with CPI in August only up 0.005% from the preceding month, 3.6% against December 2021 and 2.89% year-on-year, perhaps it is time for the central bank to consider letting the dong depreciate to a certain extent in the rest of the year, to provide commercial activities with greater support.

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