After months of disparity between the official Vietnam dong/US dollar exchange rate and the rate commanded by the black market, the State Bank of Vietnam has weakened the local currency to a range surrounding 20693. This is the fourth decrease in 15 months, the sixth in two years. The move by the central bank came expectedly as there had been great pressure to devalue in the months leading up to Tet with a promise from the government not to do so before Tet.

This won't be the last devaluation for 2011.

For one, the new rate is still below the 21000+ the black market had been demanding before the change. Previously, the dollar would fetch up to 21300 VND at jewelry shops.

Secondly, the pressure on the dong due to rising inflation and the trade deficit remains -- and foreign currency reserves are still low, limiting how much the central bank can artificially support the currency. Inflation remains in the double-digit range after a lull from the global economic crisis and crash in oil prices. Gasoline prices will either continue to increase, contributing to imported inflation, or the government will continue to deplete its reserves to subsidize gas. The trade deficit, still high although there are signs of it lowering, is also dependent on now officially higher import prices as most manufactured exports rely heavily on imported materials. However, high prices will also discourage imports. High inflation will force rises in wages, making manufacturing in Vietnam less competitive, and adding to pressure to weaken the dong to make exports cheaper especially in a stalling glocal economic growth situation.

Economic consultant Bui Kien Thanh predicts a CPI increase of 0.15% for every 1% drop in the value of the dong, or a 1.4% increase in the CPI due to just the latest dong drop.

Third, Vietnamese people still lack confidence in their local currency and no plan has been announced to address any of these issues or for delaying further devaluations for any time. After a period of dollar scarcity it's now possible again to buy dollars from banks. Concerned about rising inflation and expecting continued high inflation, Vietnamese will continue to rely on assets they view as inflation hedges such as gold, real estate, and the dollar. These large one-off devaluations do nothing to increase people's confidence in the dong and the focus appears to be on rapid economic growth rather than macroeconomic stability. The central bank has stated they will adjust the official rate more frequently and flexibly, which should increase confidence in the local currency.

As a fourth factor, 12-month non-deliverable forwards for the currency had been in the 21000-22000 range for the previous 12 months but have shot up to the 23700s as of February 11th when the new rate was announced. One interpretation is that the dong will remain steady for the next 12 months, but as this latest devaluation isn't baked into past future predictions another interpretation is for the dong to drop another 11% in value by this time next year. The 12-month non-deliverable forwards have not always accurately predicted when devaluations would occur and the size of that market is small, allowing a small number of traders to have a large impact on the price, but they have been an indicator.

So what steps should Vietnam take? I think primarily we need to stabilize inflation with the important side effect of increasing confidence in the dong even at the expense of faster short term growth. Part of inflation is based on worldwide oil prices out of Vietnam's control, but we can try to be less dependent on oil and shift some responsibility to the Vietnamese free market by reducing subsidies for transportation fuel and we should be developing public transportation. Luxury imports could be discouraged. As a nation highly susceptible to prices on imported goods we should encourage export industries that are less dependent on imports and particularly encourage lending to these sectors while otherwise raising interest rates relatively to cool down other parts of the economy. We should consider the increase in food prices such as rice, which we are actively exporting to other countries, and we should be cognizant of the renewed housing boom which is making housing more expensive for everyone.

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