Monetary policy not enough to control inflation: bank strategist

Thursday, May 15, 2008
State Bank of Vietnam’s strategy director Le Xuan Nghia says the interest rate cap needs to be removed and refinancing rates increased to ensure the long-term success of the government’s anti-inflation moves.

In the following interview, Nghia discusses why he thinks the government is depending too much on monetary measures to fight inflation.

Of all the measures battling inflation, which one is having the greatest impact?

Le Xuan Nghia: The government’s monetary and other policies are showing their effects.

The consumer price index in March was much lower than it was in February, and the April index was much lower than March.

In other words, the pace of price increase is being contained and has even begun declining.

Yet, an overview reveals that most of these measures are monetary, including a credit policy designed to boost food supply.

Non-monetary policies – such as fiscal and price control policies – have not been strong and are not showing their effects.

If we only rely on monetary policies to fight inflation, such policies will eventually have a great negative effect on economic growth.

Tight monetary policy will slash liquidity throughout the whole economy, especially for businesses.

So in the future, it might be best to speed up other policies to complement a tight monetary policy.

Inflation is declining gradually, but as you say, new problems are arising. The cash shortage you mentioned is already making it difficult for businesses to invest. What do you think about this?

For one thing, monthly inflation is declining, but by the end of the year annual inflation might be higher than last year.

For middle-term goals, however, inflation will be contained as inflation in Vietnam is moving in the same direction as credit growth.

In the first four months of this year, credit growth was quite high – above 14% – because of credit contracts signed last year that have taken effect this year.

However, credit growth in April went down sharply to only 1.6% per month.

Suppose in the next eight months, credit grows by the average rate of 2% a month, then by the end of this year, it will be around 30%.

This is a considerable decline from the 54% credit growth in 2007.

This is a big success, and its downward pressure on inflation will surely be felt in the price indexes through the last months this year, as well as the beginning of next year.

But some say the economy is “bleeding.” In what part of the monetary policy do you think the problem lies?

The problem to be concerned about is liquidity – at banks and throughout the whole economy.

The State Bank of Viet Nam has promised to help ease commercial banks’ liquidity crunch.

But that is not the problem.

The problem is that with so low an interest rate cap as we now have, a large amount of cash – both businesses’ and the general public’s – is not deposited at banks.

Businesses with idle money often save it, lend it to other businesses, or even spend it to stockpile raw materials and imports.

For instance, in the first four months of this year, the amount of imported steel almost equaled last year’s total figure.

And the gold imported so far this year surpassed last year’s number.

The stockpiling of paper, agricultural tools and equipment and industrial raw materials has also become common as businesses predict that after June, the prices of various essential items such as oil and gasoline, steel, electricity, cement and fertilizer will shoot up.

Many businesses have even mobilized money from employees, friends and relatives to hoard goods, increasing the widening trade deficit.

So the fact that there is a large amount of money being circulated outside the banks is making it much more difficult for banks facing the liquidity crunch.

This is also making it difficult to control inflation.

How can banks attract deposits if they insist on keeping their current cap on interest rates?

It is necessary to provide a channel for idle public money as it is a key source to offset the liquidity shortage.

For banks to attract deposits, the only way is to remove the interest rate cap alongside the central bank’s open market operations and interest rate adjustments.

Getting rid of the interest rate cap may prompt an interest race as banks raise rates to compete with each other, but this will only be a short term problem and should not be alarming.

In the US, large commercial banks offer annual deposit interest of 3.25 to 3.75%, while smaller banks pay up to 5.25%.

The simple reason is that small banks lend to businesses that can afford high interest rates.

These are precisely the businesses that bigger banks do not target.

I think there will be difficulties if we do not remove the interest rate cap and increase the refinancing rate.

Central bank refinancing cannot replace deposits by businesses and the public. (Tuoi Tre)