Currency trend a key risk in Vietnam

VINH PHUC, Vietnam Thu May 27, 2010 11:56am IST

An employee stacks bundles of Vietnamese dong banknotes at a bank in Hanoi April 21, 2010.  REUTERS/Nguyen Huy Kham

An employee stacks bundles of Vietnamese dong banknotes at a bank in Hanoi April 21, 2010.

Credit: Reuters/Nguyen Huy Kham

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VINH PHUC, Vietnam (Reuters) - Costantino Sambuy, local head of scooter maker Piaggio, opened a plant in Vietnam last June and faced two risks that beset most foreign investors -- a dollar shortage in the banking system and the ever-present threat of devaluation of the local currency.

The first, he says he's skirted by paying in euros whenever possible for imported parts that go into Piaggio's stylish, upmarket motorbikes. "We are trying to eliminate the dollar from our process, and it's working," he said.

The second, the government appears to have solved, removing a major risk for foreign investors and local traders alike -- at least for now.

A two-year struggle by Vietnamese authorities -- which included four devaluations -- has taken pressure off the dong and brought the foreign exchange market under control.

Central Bank Governor Nguyen Van Giau declared in mid-April foreign exchange supply and demand in balance. On May 13, the State Bank vowed to keep the forex rate stable.

The dong has strengthened around 4 percent since peaking near 20,000 per dollar on the unofficial market and it now trades mostly within the central bank-mandated band of 3 percent on either side of a daily reference rate.

But some economists say challenges remain in the wider economy, and those may have knock-on effects on the longer-term strength of the dong.

For a graphic on the dong click here

"The challenges now are not short term, but they are the medium-term challenges about inflation and the trade deficit and the level of reserves that they have. Those fundamentals haven't changed," said Jonathan Pincus, dean of Ho Chi Minh City's Fulbright Economic Teaching Program.

Relecting the unease, Vietnam's five-year credit default swaps , which reflect the cost of insurance against default, are at about 245 basis points, or about 80 basis points more than regional peers the Philippines and Indonesia.

The exact level of Vietnam's gross reserves is a state secret, but the World Bank has estimated reserves will rise to $17.5 billion by year-end after a fall of nearly 34 percent in 2009.

Annual inflation was 9.23 percent in April, easing a tad from March, but could hit double digits in coming months, which officials have said would be a problem. The trade deficit hit $4.65 billion in the first four months of the year.

CONFIDENCE

Where the dong heads will reflect overall confidence in the economy, economists say.

Last year's economic stimulus measures pushed Vietnam's fiscal deficit to among the highest in the region. Officially it was 6.9 percent of gross domestic product, but the International Monetary Fund, which uses a different standard, says it was closer to 9 percent.

Non-deliverable forwards reflect expectations that a dollar will be able to buy 19,725 dong in six months' time and 20,725 in a year, implying a slide of 3.7 percent and 8.4 percent respectively from current values around 19,000.

Still, the dollar crunch that hurt importers for most of 2009 has ended. The gap has almost disappeared between official dollar-dong rates and unofficial, or black market, rates , which widened to more than 10 percent last year.

The currency has also benefited from the end of a cap on dong lending rates, which has lifted the cost of dong loans while dollar lending and deposit rates have been tethered at much lower levels. Dollar loans at the end of April were up 17.5 percent from the end of 2009, while dong loans were up 2.3 percent, state media reported.

But that, said a senior currency trader at a major foreign bank in Vietnam, could be sowing the seeds of trouble down the line. Most of the loans were on three-month terms, he said.

"They will need to be re-paid," he said, adding that would increase demand for dollars and potentially push down the dong.

Fitch, the ratings agency, warned in March it may downgrade Vietnam's BB-minus local and foreign currency ratings due to low confidence and lack of transparency for key economic data.

Matt Hildebrandt, an economist at JP Morgan in Singapore, said there was plenty to be concerned about. "When I look across Asia right now, of all the countries out there the most likely for a downgrade for the external debt is Vietnam," he said, adding however he did not expect a default.

Down on Hanoi's Ha Trung Street, the heart of the city's currency black market, business is slow but the money changers aren't closing shop and changing jobs.

"It will go down again," said one foreign exchange dealer who declined to be named because transactions in the dong outside the official trading band are illegal.

"And everyone thinks by the end of the year it may be at 20,000, or possibly 21,000 if things are bad."

(Editing by Raju Gopalakrishnan)

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