Earlier in July, the State Bank of Vietnam sprang a surprise on markets by reducing the refinancing rate, rediscount rate, overnight electronic interbank rate, and rate of loans to offset capital shortage in clearance between the central bank and domestic banks by 25 basis points.
The rate cut – which comes three years after the last one – reduced the refinancing rate to 6.25% and the rediscount rate to 4.25% and was aimed at stimulating the pace of economic growth toward the 6.7% target for the year.
2017 had started at a slow pace for the country, with economic output growing by 5.1% in Q1. The pace picked up in the second quarter, as seen by the graph above, but some economists estimate that the country needs to grow at 7.4% in H2 2017 in order to achieve the targeted growth for the entire year.
Multi-lateral institutions including the Asian Development Bank, the World Bank and the International Monetary Fund (IMF) don’t believe the growth target will be achieved as they expect the economy to grow in the 6.3%-6.5% range for the year.
The case for the rate cut
If we try to look at the circumstances which facilitated the rate cut, inflation takes pole position.
The graph above shows the change in the consumer price index. The pace in June was less than half of that seen in January and lower than the 4% target for the year.
Few would questions that there was room to reduce rates. However, it comes at a cost of putting upward pressure on prices going forward as well as potentially fueling a credit bubble.
Before Vietnam’s central bank met for its July meeting, the IMF had expressed that it should stand pat on policy rates, and check its spiraling credit growth.
Bad loans have been a big problem for local banks and a rate cut could make it worse for a country where businesses rely heavily on banks for funding requirements. In light of this fact, it may seem that the country is going overboard in order to achieve its targeted growth rate.
Interestingly, Vietnamese banks were quick to reduce their lending rates post the central bank rate cut, but have not done the same for their deposit rates. This can be hurtful to their own financial well-being.
Let’s look at the impact on the credit situation in the next article.