VietFinanceNews.com – The decision by the central bank to set a cap on the dollar deposits’ interest rates and raise the compulsory reserve ratios on foreign currency deposits is believed to help stabilize the exchange rate in short term. However, experts have warned that this may lead to the kieu hoi decreases and cause bad influences to the foreign currency market in long term.
On March 19, 2011, the State Bank of Vietnam released the decision to raise the compulsory reserve ratio, imposed on foreign currency deposits, from four percent to six percent. The State Bank also decided to set a cap of three percent per annum on the interest rates of foreign currency deposits.
Positive impacts expected in short term
In principle, raising compulsory reserve ratio will make the volume of foreign currencies banks can lend from the same volume of mobilized capital decrease. In order to ensure the stability of the margin profit, banks will have to raise the lending interest rates once they have to pay higher compulsory reserve ratios.
According to Saigon Tiep Thi, once the compulsory reserve ratio increases by two percent, the lending dollar interest rates will be raised by 0.2 percent in order to ensure the same margin profit. The higher lending interest rates will force enterprises to think carefully about whether to borrow in foreign currencies or borrow Vietnam dong to buy foreign currencies.
It is very likely that the demand for dollar loans will decrease when the lending interest rates go up. As such, the decision on setting a higher compulsory reserve ratio will bring the desired effect of lessening the demand for dollars.
Meanwhile, the decision to apply the ceiling interest rate of three percent on dollar deposits, which is much lower than the currently applied interest rate of five percent, will make depositing in dollars unattractive to individuals. If so, people will try to sell foreign currencies to get Vietnam dong and then deposit dong at banks to enjoy the interest rate of 16-18 percent per annum.
In this case, analysts say, the deposits in foreign currencies will decrease. However, in return, commercial banks will be able to purchase more foreign currencies, while enterprises would rather purchase dollars at stable exchange rates than borrowing dollars at high interest rates.
Questions for long term raised
Analysts have warned that the imposition of the ceiling interest rate of three percent would make it more difficult for Vietnam to attract kieu hoi. (Kieu hoi, or overseas remittance, is the money sent by Viet Kieu, or overseas Vietnamese, to their relatives in Vietnam).
To date, analysts say, big amounts of kieu hoi have been flowing to Vietnam because the deposit interest rates in Vietnam are higher than elsewhere in the world. The kieu hoi is deposited at Vietnamese banks and brings sizable profit to overseas Vietnamese. However, as the gap between the interest rates in the world and in Vietnam will be eliminated, kieu hoi will stop flowing to Vietnam.
Analysts have every reason to believe that a part of kieu hoi has been going to Vietnam because of the big gap of the interest rates in Vietnam and in the world. The volume of kieu hoi increased steadily in 2000-2007 by 17.9 percent on average.
After that, the amount of kieu hoi increased sharply by 30.9 percent in 2008 and then 27.3 percent in 2010. It was because the three month term dollar deposits increased from four percent in 2007 to 6.5 percent in mid 2008. Similarly, the dollar deposit interest rates also increased sharply from 1.5 percent in mid 2009 to four percent in mid 2010 and reached 4.5 percent in late 2010.
The high dollar deposit interest rates in Vietnam in 2008 and 2010 were higher by 3-4 percent than the interest rates in the US. The gaps were big enough to attract dollars to Vietnam.
According to Saigon Tiep Thi, it was estimated that 600 million dollars were remitted to Vietnam in 2010 because of the reasons related to the interest rate gaps.
What will happen if the dollar flow stops? It is very likely that dollars would be withdrawn from banks to be remitted back abroad. If the money is withdrawn rapidly, and there is still an imbalance between the mobilized and lent capital, short liquidity may occur. If so, banks will have to raise the deposit interest rates to attract foreign currencies.
If dollars go back to foreign countries, the demand for dollars from import service companies would not be satisfied, which may raise the dollar price in the long term.
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