From the New York Fed: When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency’s fixed exchange rate untenable. In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.
If there was a huge forex market in dong-trading, it would be an early Christmas for traders. Vietnam on Wednesday gave the world 24 hours notice of its impending currency devaluation, and also became the first Asian country to raise interest rates after Australia.
As Bloomberg reports, the State Bank of Vietnam devalued the dong from Thursday in efforts to curb accelerating inflation and a rapidly widening trade deficit.
The move comes after the government warned last month that Vietnam would be unlikely to stay below its target limit of a $10bn trade deficit in 2009 as it had already reached $8.7bn in the first 10 months of the year.
The central bank said on its website that it had set a dong reference rate for Thursday that is 5.2 per cent lower, at 17,961 per dollar, compared with 17,034 on Wednesday. The dong’s daily trading band meanwhile was narrowed to 3 per cent, from 5 per cent, effective Thursday, and while the benchmark interest rate was raised for the first time since January, to 8 per cent from 7 per cent.
Economists predict further rate rises, with Robert Prior-Wandesforde at HSBC telling Dow Jones newswires that the central bank is likely to raise interest rates to 11 per cent by the end of 2010.
Another analyst told Dow Jones that the devaluation was unlikely to have a significant impact on the cost of protection against default on the country’s bonds. Vietnam five-year credit default swaps were quoted flat at 210 to 220bp recently.
However, recent pressure on the dong has forced the central bank to run down its dollar reserves, the report added, citing analysts’ estimates that Vietnam’s reserves have fallen to around $16.5bn from $22bn at the start of the year.
Vietnam’s rate hike, meanwhile, is unlikely to be emulated by its Asian neighbours, who seem content to leave rates as they are amid fears that higher interest rates may encourage capital inflows that could boost their currencies and undermine financial stability.
“The rate hike is targeted towards giving the Vietnamese dong more support and the devaluation is to help exports,” said Tai Hui, Singapore-based head of Southeast Asian research at Standard Chartered. “The dynamics in Vietnam are completely different from other Asian economies.”
The Southeast Asian nation is trying to sustain economic growth in 2010 and curb inflation, the statement said. The rate increase is to help tightly control credit lending and support economic targets, the central bank said.
While most Asian governments and central banks are fighting and resisting currency appreciation and are talking about currency controls, Hanoi’s move would appear to back up Hui’s statement that Vietnam really is “the odd one out in Asia”.
Vietnam to devalue currency, raise rates – WSJ
What Australia’s rate hike means for markets – FT Alphaville
The implications of currency devaluation and revaluation – NY Fed