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Cablegate: Monetary Policy Pits Inflation Hawks Against Exporters

VZCZCXRO7188
OO RUEHDT RUEHPB
DE RUEHHM #0359/01 1000854
ZNR UUUUU ZZH
O P 090854Z APR 08
FM AMCONSUL HO CHI MINH CITY
TO RUEHC/SECSTATE WASHDC IMMEDIATE 3966
INFO RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHHI/AMEMBASSY HANOI PRIORITY 2604
RUCNARF/ASEAN REGIONAL FORUM COLLECTIVE
RUEHHM/AMCONSUL HO CHI MINH CITY 4188

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

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