Explained: Implications of the Latest Fed Rate Hike on the Vietnamese Dong

The US Federal Reserve raised interest rates by 75 basis points in its latest rate hike. This will inevitably lead to a stronger US dollar, which will impact currencies around the world and the Vietnamese dong is no exception. Here’s what this latest rate hike might mean for the local currency.

The US Federal Reserve has jacked up interest rates by 75 basis points, a move that will strengthen the US dollar. This is on the back of a series of rate hikes since the beginning of the year aimed at limiting near 40-year high inflation in the United States.

A stronger US dollar has far-reaching implications for emerging economies like Vietnam.

While it can be a boon for exporters fulfilling contracts denominated in US dollars, imports become more expensive as does fulfilling debt obligations.

As a result, Vietnam, specifically the State Bank of Vietnam (SBV), has worked hard to keep the value of the Vietnamese dong (VND) stable using a number of levers and pulleys unique to the Southeast Asian nation.

How does the SBV manage the exchange rate?

The SBV has a number of tools at its disposal that it uses to stabilise the exchange rate and keep inflation in check.

A managed float

The VND is on a managed float, similar to a crawling peg, to the US dollar. The SBV sets the price of the local currency each day. The currency can then only be traded within a band either side of the SBV’s set rate.

Up until October 17 that was 3 percent either side of the daily rate set by the SBV. On October 17, however, this was widened to 5 percent giving the VND more room to move.

Earlier this week, Reuters reported that Vietnam was preparing for the possibility of widening its trading band a second time.

Vietnam’s foreign currency reserves

The SBV has also been using Vietnam’s foreign currency reserves to shore up the VND.

Vietnam has dipped into its reserves to the tune of around US$20 billion this year by some estimates (Vietnam does not regularly publish details of its foreign reserves).

At the end of 2021, according to the World Bank, Vietnam had total reserves of just over US$109 billion. That’s just over 18 percent of its reserves that have been spent buying up VND – a sizable chunk of its rainy-day fund.

Credit room limits

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These limits are set out at the beginning of the year based on the target inflation rate as well as the credit ranking of the bank (banks with healthier balance sheets get higher limits), according to SBV Governor, Nguyen Thi Hong.

That said, these limits are often readjusted. Throughout the course of 2022 this has occurred multiple times in response to higher demand for credit. With many banks already maxing out their credit limits, that demand is still strong.

Interest rates in Vietnam

Not only does the SBV set the base interest rate, it also sets maximum interest rates for both deposits and loans. It can also set different interest rates for different products.

The SBV started raising interest rates on September 9 this year after leaving rates unchanged for almost two years. This was followed by a second increase on October 25.

What are the implications of SBV interventions in the exchange rate?

Managing the exchange rate is a balancing act that presents both benefits and challenges.

The dong has been relatively stable

Since the beginning of the year, the VND has lost only about nine percent of its value to the US dollar. This is in contrast to much bigger devaluations among its regional peers.

Currency Values in Southeast Asia Against the US Dollar

Overseas remittances are worth less

Though the Vietnamese dong has remained relatively stable, freer currencies in neighbouring developed economies have had much more substantial declines against the dollar.

VN Express reported earlier this week that this is reducing the value of remittances sent from workers overseas.

Japan, Taiwan, and South Korea, which account for 90 percent of Vietnamese workers overseas, have all seen their currencies fall against the Vietnamese dong.

VND Appreciation Against Select Currencies

Credit shortages are impacting businesses

As a result of credit control limits, some businesses are struggling to access capital.

This has been particularly hard felt in the fuel industry where not only has the price of oil increased due to the decline in value of the VND, but the price of fuel itself has also risen.

This has led to challenges ensuring a steady supply of fuel and shortages in some areas.

What’s next for the Vietnamese dong?

Though it’s been only days since the US Federal Reserve raised interest rates, the value of the VND is showing signs of a continued decline.

Further intervention may be needed if that decline is to be arrested, however, these measures have their limitations. Vietnam’s foreign reserves are finite and limiting credit can only work for so long before it begins to drag on the economy.

See Also

The Euro’s Depreciation: What Should Businesses in Vietnam Expect

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