The effect of FED increasing interest rates on Vietnam economy

At the end of the two-day meeting in early May, the Federal Open Market Committee (FOMC) decided to raise the operating interest rates by 50 basis points to the new margin from 0.75% to 1.0%.

The decision to raise the operating interest rates by 0.50% marks the strongest increase realized in a single meeting since May 2000. The US Federal Reserve (Fed) officials also hinted that they will continue to raise the operating interest rates this year with the inflation restraining effort.

According to a survey by CME Group, Fed is said by the market to raise the operating interest rates by 175-200 basic points in the final months of 2022 to a new margin in the range of 2.5% to 3.0%.

Fed officials also decided to reduce the size of the Fed's balance sheet from June 2022, it starts with $47.5 billion a month ($30 billion in US Treasuries and $17.5 billion in mortgage-backed securities), which will increase to $95 billion a month after three months ($60 billion in U.S. Treasuries and $35 billion in mortgage-backed securities).

With this plan, Fed may shrink its balance sheet size by about $427.5 billion in half of 2022. This size is relatively small (only 5% of the Fed’s current balance sheet size), so the impact on global financial market liquidity is minimal.

5 main impacts on Vietnamese economy

According to the analyst’s assessment at VNDirect, the Fed's tightening of monetary policy causes 5 major impacts on the Vietnamese economy.

Firstly, the global financial situation tightening reduces the growth prospects of the world economy, leading to lower demand for Vietnamese exports.

Fed's tightening of monetary policy will increase lending interest rates (in USD) thereby reducing people's consumption demand as well as weakening the enterprises’ demand to expand investment.

Many research organizations around the world have recently lowered their growth forecasts for the global economy as well as the US economy, one of the main reasons is the increasingly tightening of the global financial conditions. Therefore, Vietnam's export performance is likely to slow down in the coming quarters as consumers in key export markets such as the US and Europe tighten their expenses.

 Secondly, deposit interest rates (in VND) are subject to increasing pressure in the last months of the year. As of April 26, 2022, deposit interest rates for 3-month and 12-month terms of state-owned banks are unchanged from the end of 2021 while 3-month deposit interest rates and 12-month deposit interest rates of private banks is increased by 14 basis points and 13 basic points respectively compared to the end of 2021.

Said VNDirect, deposit interest rates will continue to increase from now until the end of 2022 due to the increase in USD interest rates and high inflationary pressure in Vietnam in the coming quarters. However, the expected increase will not be high, about 30-50 basic points for the whole of 2022.

"We think that the 12-month deposit interest rates of commercial banks can increase to 5.9-6.1%/year at the end of 2022 (currently at 5.5-5.7%/year), still lower than the pre-pandemic deposit interest rates of 7.0%/year," said the report.

 Thirdly, the increase in USD interest rates puts pressure on the foreign debt repayment obligations of Vietnamese Government and enterprises. Estimated by VNDirect, Vietnam's external debt will account for 39% of GDP by the end of 2021. The context of tighter liquidity in the international financial market makes Vietnamese government and enterprises hard to raise capital in the international market and will incur the higher interest rates.

Fourthly, for the financial market, foreign indirect investment (FII) inflows may continue to be net withdrawn in the coming months due to the influence of "taper tantrum". The foreign investors, however, continuously net selling on Vietnam's stock market in the past 2 years, so the impact of foreign investors’ net selling will be moderate because the market has prepared in advance.

Meanwhile, foreign direct investment (FDI) flows into Vietnam will be less affected because Vietnam is still an attractive investment destination in the trend of the global supply chain diversification. Thirdly, the increase in USD interest rates puts pressure on the foreign debt repayment obligations of the Vietnamese Government and enterprises. As estimated by VNDirect, Vietnam's external debt will account for 39% of GDP by the end of 2021. The context of tighter liquidity in the international financial market makes the Vietnamese government and enterprises hard to raise capital in the international market and will incur higher interest rates.

Fourthly, for the financial market, foreign indirect investment (FII) inflows may continue to be net withdrawn in the coming months due to the influence of the "taper tantrum". The foreign investors, however, continuously net selling on Vietnam's stock market in the past 2 years, so the impact of foreign investors’ net selling will be moderate because the market has been prepared in advance.

Meanwhile, foreign direct investment (FDI) flows into Vietnam will be less affected because Vietnam is still an attractive investment destination in the trend of global supply chain diversification.

 Fifthly, a strong USD puts pressure on Vietnam's exchange rate. On April 31, 2022, the US dollar index (which measures the strength of the US dollar against a basket of currencies) gained 103 points, the highest rate in 20 years. The strong USD pulled USD/VND exchange rate up by about 0.6% in the first 4 months of 2022.

VND is still, however, one of the most stable currencies in the Asia-Pacific region. According to VNDirect, the basic factors to keep VND stable in recent years are still maintained, including a current account surplus and high foreign exchange reserves.

Experts expect that the current account surplus will rise up to 1.9% of GDP in 2022 from an expected deficit of 1.0% of GDP in 2021. Vietnam's foreign exchange reserves are expected to gain $122.5 billion by the end of 2022 (equivalent to 4.0 months of imports) from the current rate of $105 billion.

Said VNDirect, USD/VND exchange rate will be stable at 22,600-23,050 in 2022, and VND may fluctuate within a relatively narrow margin (+/-1%) against the USD.

Will Vietnam continue the easing policy?

Said VNDirect, the State Bank of Vietnam (SBV) will maintain an "appropriate" monetary policy with a priority on the economic recovery support, no later than the end of the second quarter of 2022.

Said the experts, although inflation pressure is expected to increase in the coming months, the average consumer price index in the first half of 2022 is forecast at 2.5% over the same period, which is still much lower than the Government's target of 4% to explain the above statement.

In addition, domestic demand is still weak and has not been fully recovered to the pre-pandemic rate and the SBV still prioritizes the goal of maintaining the low lending rates to support enterprises and the recovery of the economy.

"Any monetary tightening will only take place in the second half of 2022 (likely higher than the fourth quarter of 2022) and gains (if any) will be limited to around 0.25-0.5%, " commented VNDirect experts.

 Experts also expect that the State Bank will allow credit growth to remain at a high rate to support the economic recovery. Credit capital flows will be prioritized for the manufacturing and service sectors, especially such priority sectors as industry, import, and export, agriculture, forestry, and fishery.

In addition, the SBV will carefully control the credit capital flowing into such high-risk areas as real estate, securities, and BOT (Build-Operate-Transfer) projects. Accordingly, VNDirect forecasts credit growth to maintain a high rate of 14% in 2022.

For the lending interest rates, the State Bank is applying an interest rate compensation package with a scale of 3,000 billion Vietnamese dong. This package offers a loan interest rate of only 3-4%/year for enterprises strongly affected by the COVID-19 pandemic.

In addition, the Government plans to expand the interest rate compensation package size for enterprises to 40,000 billion Vietnamese dong, focusing on a number of priority subjects, including small and medium enterprises, enterprises participating in a number of national key projects, and trading in certain industries (tourism, aviation, transportation).

VNDirect expects that the interest rate compensation package can help reduce the average lending interest rate by 20-40 basic points in 2022. However, the actual impact of the interest rate compensation package for enterprises and the economy may be lower if commercial banks increase the lending interest rates on other conventional loans to offset the increase in deposit interest rates.

The increase in interest rates will affect the global investment, yet opportunities are still open with potential high rate of return. Under this context, investors can seize the chances and turn the table around to reap the benefits. With the effort of SBV and Vietnam government, Vietnam remains favorite investment destinations for global investors. Joining the effort, Viettonkin will also assit you through the investment journey. As a prestiged professional services firms domestically and globally, we are confident to own in-depth knowledge in Vietnam market and legal environment with a team of top-notch professionals in the industries. Let us be your trustworthy partner!