MONETARY POLICY PITS INFLATION HAWKS AGAINST EXPORTERS

UNCLAS SECTION 01 OF 03 HO CHI MINH CITY 000359 SIPDIS SENSITIVE SIPDIS STATE FOR EAP/MLS AND EEB/IFD/OMA USAID/ANE/EAA FOR FRANK DONOVAN COMMERCE FOR A/S SPOONER AND SSU USDOC FOR 4431/MAC/AP/OPB/VLC/HPPHO SINGAPORE FOR TREASURY STATE PASS USTR FOR BISBEE TREASURY FOR SCHUN E.O. 12958: N/A TAGS: ECON EFIN ETRD EINV VM SUBJECT: MONETARY POLICY PITS INFLATION HAWKS AGAINST EXPORTERS REF: A) HANOI 394, B) HANOI 377, C) 07 HANOI 1729 HO CHI MIN 00000359 001.2 OF 003 ¶1. (SBU) Vietnam's leadership remains intent on fighting inflation despite the increasingly apparent toll on economic growth; the Government of Vietnam (GVN) recently proposed revised growth estimates for 2008 down from 8.5 percent to 6.5-7.5 percent. Nevertheless, exporters now complain loudly and publicly that global commodities inflation, rising local costs and tight credit "threaten the very existence" of small and medium-sized (SME) exporting companies. Since the apparel industry alone employs two million largely unskilled workers, the GVN will be seriously tempted to consider industry proposals that could undermine the fight against inflation. End summary. GVN Seized with Inflation -------------- ¶2. (SBU) Vietnam's year-on-year consumer price index approached 20 percent in March. With newspapers carrying reports of dramatic increases in the cost of basic food items like rice (36 percent over last March) or beef noodle soup (up 50 percent in some venues),the GVN must be concerned about possible impacts on social stability. Industry is being hit hard by rising cost as well, especially for imported raw materials and local inputs like labor costs and fuel. Nguyen Thai Hoc, Vice Chair of the Vietnam Cashew Association, said at a meeting between the Ministry of Industry and Trade and domestic exporters in HCMC on March 14, "Against the same period of last year, input costs for processing one ton of agricultural products has risen 40 percent, fuel costs 30 percent, labor costs 30 percent and bank interest rates 50 percent." ¶3. (SBU) In an effort to restrain inflation and control prices, the GVN announced a series of monetary policy moves earlier this year. The State Bank of Vietnam (SBV) issued the compulsory 364-day treasury bills worth VND 20,300 billion (U.S. $1.3 billion) on March 17 and required 41 commercial banks and credit institutions to purchase the bills at an annual interest rate of 7.8 percent. To meet the State Bank of Vietnam's (SBV) mandate, commercial banks struggled to raise the required cash by March ¶17. The GVN also increased the reserve ratio at commercial banks from 10 to 11 percent. Together, these moves pushed up monthly interest rates for commercial operation loans in VND from 1.1 to 1.6 percent per month (13 to 19 percent annually). (Comment: Despite exporter complaints, these are negative real interest rates based upon current inflation rates. End comment.) Higher Interest Rates Hit Business in the Pocket Book -------------- -------------- ¶4. (SBU) Market analysts like HSBC expect a six to nine month lag before the effect these moves is felt on inflation, but the tightening monetary policy has immediate consequences for Vietnamese companies. Industrial associations like the Vietnam Textile and Apparel Association (VITAS) and the Vietnam Association of Seafood Exporters and Producers (VASEP) complain that small and medium-sized enterprises (SME) in particular need to borrow in VND to cover operating costs and USD to cover trading costs. The cost of borrowing has risen rapidly, cutting so deeply into returns that VITAS predicts many SMEs may go under if current conditions persist. ¶5. (SBU) According to the Director of Vinamit fruit processing company, the sharp jump in interest rates has forced the company to scale back investment plans. Chairman of the Young Entrepreneurs' Association of HCMC said the "current monetary policy is driving exporting companies to cede the playing field to foreign investors because the current exorbitant interest rates of bank loans mean expansion projects are no longer feasible." Waiting for the Other Shoe to Drop -- FOREX -------------- ¶6. (SBU) By pushing up VND interest rates, the SBV is also creating pressure on the VND to appreciate, making Vietnam's exports (especially contracts in USD) less attractive. From the end of 2007 to mid-March, the VND experienced nominal appreciation of nearly five percent against the USD. (Note: Because Vietnam's surging inflation has eroded the purchasing value of the VND, the real rate of appreciation of the VND had been much greater. End Note.) Pham Xuan Hong, General Director of Saigon Garment No. 3 Company, estimated that each month his company exports about 800,000 units valued at US$1 million. Due HO CHI MIN 00000359 002.2 OF 003 to the USD depreciation, the company lost U.S. $12,500 each month. Buu Huy, Director of An Giang Seafood Import Export Company, blamed the sharp fall in the U.S. dollar for exporters' financial loses. In January, his company signed a U.S. $1 million export contract at an exchange rate of VND 16,000 to the dollar. After the contract was paid, the foreign exchange rate dropped to VND15,550/USD, costing the company VND450 million (U.S. $28,000) each delivery because of the 60-day interval between contract signing and payment. Adding Insult to Injury -------------- ¶6. In the meantime, exporters find it extremely hard to sell dollars to commercial banks for dongs. While export revenue falls and the VND appreciated against the USD, banks added to exporter woes through their reluctance to exchange VND for dollars. With a surplus of U.S. dollars, banks were afraid to accumulate dollars that they expected would fall further in value. "We set a limit of the USD we buy each day because we must balance our capacity to buy and sell," said Vietcombank Treasury Director Nguyen Thanh Ha. Eximbank Deputy General Director Dao Hong Chau told us, "The USD value on free market is much lower than the officially listed price so banks must consider both its volume and price each day." (Comment: Another factor limiting VND/USD trade is that the SBV threatens legal/criminal action against banks caught trading outside the official band. End comment.) To make the situation even worse, banks typically charge a fee of two percent on currency exchange. Who Goes Where From Here? -------------- ¶7. (SBU) Exporter organizations like VITAS, HAWA and VASEP are pressing the GVN to stabilize the foreign currency exchange rate, stabilize interest rates for loans in VND and ensure industry access to bank loans. Some have argued directly to the Prime Minister that State-owned commercial banks should provide lower interest rates specifically for export-oriented companies. They also suggest easing lending restrictions to in order to make trade financing available on "more reasonable" terms. (Comment: In the past week they may have seen some success as the VND fell sharply against the dollar. Part of this was due to less overall pressure on the dollar, but some of it may have been due to market participants concern about Vietnam's widening current account deficit. End comment.) A Silver Lining, at Least for U.S. Exports -------------- ¶8. (SBU) The weak dollar presents a good chance for U.S. exports to make inroads into Vietnam's market, especially hardwood. According to HAWA Vice Chairman Manh relatively cheap U.S. hardwood has the added benefits of stable supply and guaranteed quality. Malaysia and Indonesia, key wood suppliers to Vietnam, limit their wood exports thereby driving up the price of their wood exports to Vietnam. Moreover, Vietnam furniture manufacturers are increasingly familiar with U.S. hardwood and trust its quality. He suggested to ConGen that U.S. wood exporters should set up a distribution system in Vietnam now to capitalize on the current market opportunity. Comments: -------------- ¶9. (SBU) There is a legitimate choice between whether to fight inflation with interest rates alone, or whether to also fight it with currency appreciation. Considering that the VND has gone down with the dollar, Vietnam has actually gained competitiveness vis-a-vis most of the rest of Asia. Vietnam could strike a different balance if they chose to let the currency appreciate to take some of the pressure off rather than just rely on interest rates and administrative controls. However, fighting it with neither, as the export associations want is not a viable alternative, since inflation will continue to eat away at their costs, eventually making them uncompetitive, but with a very high cost on the poor. ¶10. (SBU) Despite all their complaints, exporting industries as a whole are faced with the prospect of slimming profit margins and slowing growth, not decline. The exchange rate losses exporters are suffering are as much a reflection of the lack of sophistication of the overall financial system (where there is a paucity of products available to help exporters mitigate HO CHI MIN 00000359 003.2 OF 003 exchange rate exposure) as they are of long-term structural weaknesses in the major exporting industries. Current conditions favor well-run companies with financial resources and business acumen but will be unkind to companies that are barely scraping by. More importantly, woes at labor-intensive export companies are a litmus test for the GVN's commitment to tackling inflation. Placating exporters may help those companies in the short term but will further fuel inflation. End comment. ¶11. (U) This cable was coordinated with Embassy Hanoi and the Regional Financial Attache in Singapore. FAIRFAX