Vietnam's central bank is now letting the dong weaken against the dollar, looking to close the gap between its reference rate and market forces and tap the export benefits of a softer currency.
The State Bank of Vietnam on Monday moved its reference rate for the dong from 21,890 to the dollar to 21,896, announcing that it would begin setting the rate daily by taking into account the movements of the euro, dollar, yen, yuan and other currencies. Cuts have continued nearly every day this week, mirroring a slide by China's currency.
The new policy steps away from the dong's de facto peg against the dollar. The reference rate previously has remained fixed for lengthy periods, with the central bank ensuring that the currency's value stays within a certain trading band, usually a few percent.
Pressure for change
The shift comes after months of pressure for a weaker dong, fueled by factors including speculation around U.S. interest rate hikes. The central bank in August widened the allowable deviation from the reference rate to 2% from 1%. That was followed by another expansion to 3% later in the month, alongside a cut to the rate itself.
But by the end of the year, orders to sell dong for less than allowed or buy dollars for more had become common, indicating a deep divide between central bank policy and the will of the market, said Teppei Ino of Bank of Tokyo-Mitsubishi UFJ in Singapore. The bank had made good on a statement that the August policy tweaks would be the last for a while. Insufficient foreign currency reserves, meanwhile, had made repeated dong-buying operations difficult.
Speculation on the possibility of future cuts to the reference rate compounded Vietnam's currency-market woes. Banks and investors in the country began hoarding dollars out of fear that the dong could grow even weaker, making the greenback difficult to obtain by the end of the year.
Shifting strategy
Daily adjustments to the reference rate could alleviate that problem. Because the dong now can rise and fall in line with market trends, banks and others have less reason to hold onto dollars in expectation that they will gain value. Those institutions are thought to have begun selling their dollar holdings since the start of 2016, even causing the dong to strengthen at times. It has been speculated that Vietnam's monetary authorities played a role, selling dollars for dong. Nevertheless, the dong has remained remarkably stable this week, even as other Asian currencies tumbled. The new system seems to have succeeded so far.
It appears that Vietnam is willing to let the dong slowly depreciate against the dollar. The currency fell only 5% against the dollar in 2015, less than other Asian currencies. In addition, high inflation and the current-account deficit have become less of a problem, making it easier for Vietnam to accept a weaker dong, Ino said.A stronger dong "is no longer entirely a positive for Vietnam's economy," said Satoshi Okagawa, Singapore-based senior global markets analyst for Sumitomo Mitsui Banking Corp. Vietnam's export industries are on the rise, while the large trade deficit that plagued the country is disappearing.The conclusion of negotiations on the Trans-Pacific Partnership trade pact in 2015 also gave support for a weaker dong. Vietnam is expected to reap the benefits of TPP membership as its textile industry ramps up exports. A stable currency likely will boost the country's appeal further as it tries to position itself as a key market in Asia.
original source: http://asia.nikkei.com/Markets/Currencies/Vietnam-cuts-dong-dollar-rate-to-meet-market-pressure?page=2