VND weakens, a little more to come: HSBC

Following are their comments on the issue:

While we had been expecting further VND weakness this year, the move happened sooner than we had thought. However, given the extent of USD strength against most EM currencies in early 2015, and with USD-VND having been closing in on the topside of the band for the past few weeks, it does not come as a complete surprise. We think further VND weakness will only be moderate as underlying fundamentals have not deteriorated. We expect another 1% depreciation later in the year, pushing USD-VND to 21750.

Facts

Vietnam’s central bank (the SBV) announced that it would raise the daily reference rate for USDVND by 1%, effective 7 January 2015, from 21246 to 21458. The prior rate had been effective since 19 June 2014. USD-VND is allowed to trade within a +/- 1% range around the reference rate.

Implications

USD-VND had been trading closer to the top side of the band through the course of December, in line with a much stronger USD seen over the last few months. In our view, this shift in the reference rate should be seen as something of a catch up with other EM currencies. Indeed, a 1% fall in the VND versus the USD actually represents a continued outperformance versus most other Asian currencies since the start of Q4.

There has not been a significant “fundamental” deterioration in recent weeks which led the SBV to depreciate the VND, in our view. Although the trade balance flipped to USD900m deficit over the month (causing an annual USD2.0bn surplus), FDI flows were robust, registering around USD2.3bn in December (and USD15.6bn over 2014 as a whole). From a portfolio side, although moderate foreign outflows had been building in Q3 and Q4, December actually saw a relatively neutral flow.

Furthermore, inflation has continued to come lower in Vietnam, pushing real interest rates into positive territory. Interbank VND rates have actually been broadly rising since October 2014, suggesting that VND liquidity is not excessively loose. Higher real interest rates can help ease some USD demand pressures now that the VND reference rate has been adjusted. However, higher real rates also create a policy challenge. Although we expect inflation to rise moderately in 2015, if the SBV believes that higher real rates are tightening monetary conditions excessively then there is actually a risk that the central banks weakens the currency further and faster than currently expected, in order to offset those pressures.

Due to fundamental forces remaining relatively supportive, our base case is that VND will only weaken moderately from here. Alongside balanced flows, lower inflation, and higher real rates, FX policy is also more flexible in its ability to manage periods of USD demand. Although the SBV has likely utilised some of its FX reserves in recent weeks by supplying USD to the market, it is still in a better position from an FX cover perspective than it has been for some time. This should help to ensure we do not see an aggressive shift higher in USD-VND in coming months.

However, as we highlighted in our Asian FX Focus: 2015 outlook (8 December 2014), the VND’s REER has risen by around 6% in the last 12 months, and the SBV was always likely to weaken the VND slightly in order to maintain competitiveness (even with export growth having remained in double digits for the last five months). We still believe this will be the case later in 2015, and with the backdrop of a stronger USD continuing through the course of the year, we continue to expect a further 1% depreciation, bringing USD-VND to around 21750 by the end of the year.