Exchange rate and interest rate: which comes first?

As a result, depending on the circumstances, it may be prudent to alternately prioritize the exchange rate and interest rates. This is also the strategy used by the State Bank of Vietnam (SBV), as evidenced by a variety of actions designed to provide market leading signals.

Exchange Rate Stable but Not Fixed

Since March 2024, the exchange rate has begun to rise on worries that the Federal Reserve would not lower interest rates this year, resulting in a rebound of the USD Index in the worldwide market. In March, the VND (as stated by Vietcombank) fell by 0.6% against the USD. Although the depreciation is lesser than in the previous two months, the overall pressure is greater.

By the end of the first quarter of 2024, SBV Deputy Governor Đào Minh Tú claimed that exchange rate changes are due to high Fed interest rates, a widening disparity between global and domestic gold prices, and increased imports of raw commodities (such as gasoline, steel, etc.) by domestic firms.

The SBV acted in April to relieve exchange rate pressures by implementing aggressive measures targeted at lowering the VND-USD interest rate gap. These steps, together with a number of measures such as net absorption through bills, increased gold supply to the market via auctions, and urgent foreign exchange interventions (estimated at half a billion USD), have helped to alleviate speculative pressure on the exchange rate. However, the current volatility level of the USD/VND exchange rate is roughly 4.5%.

Because if the variations are significant, FDI and FII flows will be harmed and may exit the country. Furthermore, the currency rate has a transmission impact on commodity prices, making inflation more volatile.

Interest Rates Hard to Increase

In April, around 20 lending institutions hiked interest rates throughout the month. By mid-May, around 13 lending institutions had raised interest rates. Deposit interest rates, on the other hand, are often modified over shorter periods of time. The interest rate level for 12-month deposits for institutional clients remains fairly low, at 4.2% per year at the big four, 4.3% at significant joint-stock commercial banks, and 4.6% at smaller such banks.

Despite massive rises in gold prices and a high exchange rate, the SBV has yet to raise direct intervention interest rates on deposits. The SBV's decision seeks to keep the present interest rate level.

So, if everything is "priority 1," what exactly is the priority? Theoretically, this is the impossible trinity, and "changing" the variables is an impossible task. Being proactive and flexible in following the main target and managing timely priorities, whether tolerating moderate depreciation or high interest rates, is heavily influenced by policymakers' choice of intervention measures.

In the future, we believe that the SBV will continue to effectively synchronize the combination of management tools such as OMO, as well as synchronized interest rate management of VND and foreign currencies, to help manage these variables on the monetary market smoothly, bringing stability to the monetary market and macro stability, and supporting growth.

Finally, it is important to realize that inflation has a tremendous influence on businesses. The same goes for the currency rate. Not to mention the interest rates. An rise in the exchange rate indicates that investment capital may depart. Businesses with foreign currency obligations denominated in USD may experience losses due to exchange rate fluctuations. A weakening of the VND versus the USD does not always benefit firms in terms of competitive devaluation; on the contrary, imported inflation poses more dangers. Furthermore, crossing the line into currency manipulation for competitive devaluation to improve export prices, as well as confronting technological impediments to dumping, has the potential to undermine all achievements and the existing status of Vietnamese industry. As inflation grows, the currency contracts and interest rates skyrocket.

Thus, the exchange rate will continue to vary within restricted limit  s. While deposit interest rates may continue to climb, operational interest rates are unlikely to increase. Credit growth is likely to rebound and improve, reaching around 13.5-14% this year.