Vietnam's forex market to stay frozen for now

HANOI, Dec 23 - Vietnam's tightly-regulated foreign exchange market may have broken down completely with the authorities reluctant to let the currency significantly depreciate but unable to prop it up by intervention.

The dong <VND=> has been glued to the weak end of its central bank-mandated trading band against the dollar for several weeks and traders say there have been almost no deals.

"From the outside, it looks like the currency's stable," said Tim Condon, chief economist at ING Financial Markets in Singapore. "But what you're not seeing is that the market really has kind of broken down."

Banks have been rationing dollars for long-term customers and key clients, turning away others. Currency traders say little is being done to un-stick what HSBC has estimated to be about $300 million a day market in normal times.

These days, one local bank that said it normally did several dozen deals a day was down to a couple, at best, and foreign banks that did fewer in normal times are doing basically none.

This may be the price authorities are willing to pay for a stable exchange rate at the end of a turbulent year.

Economic overheating fuelled by soaring inflation and a widening trade deficit pushed the offshore non-deliverable forwards fix to price the dong at more than 19,000 per dollar <VNDFIX=ABSG> in June, around 12 percent weaker than the spot rate at the time. The offshore fix is what foreign bankers take as the best gauge of the dong's market value.

Fearing an all-out run on the dong in June, the State Bank of Vietnam cracked down on the black market. Then it banned banks from using currencies such as the euro, which were exempt from exchange controls, as proxies to trade dollar/dong.

To circumvent the daily exchange rate against the dollar, banks had asked local dollar buyers to buy the euro, and then convert the euro to dollars using international rates to arrive at the amount of dong they have to pay.

The crackdown worked and exchange rates snapped back, but the numbers being quoted are not true market clearing rates.

"All banks keep asking for bids, not offers, because the price is already at the ceiling," said Lai Tat Ha, deputy manager of treasury at Techcombank.

"The market now is not about rates, it's about liquidity."

The central bank's options are limited.

"If you enforce the band, you have to let the market operate within the band, which means you have to widen the band or intervene," said a senior banker at a foreign bank in Hanoi, who did not want to be named because he was not authorised to speak to the media.

Bankers suspect Vietnam lacks the muscle to defend its currency through intervention. The central bank does not regularly publish foreign exchange reserves, but governor Nguyen Van Giau estimated that at the end of September it had about $21.9 billion. That figure was smaller than the reserves of any Asian country that publishes data, except Bangladesh and Pakistan.

BAND WIDENING

Investors are betting the trading band will be expanded soon from the 3 percent that the dong is allowed to rise or fall from midpoint rate set by the central bank each day. Forward contracts were pricing a 13 percent dong depreciation in a year and a 4 percent drop in three months <PNDG>.

The band has been widened three times so far this year, from three-quarters of a percent to the current 3 percent. More widening will not be a panacea.

"It will make a little difference to the extent that people who are keeping dollars will sell, but that is not going to make the market any better in the long term," said Techcombank's Ha.

The dong would quickly be sucked to the weak end of the new band, and policymakers would be stuck in the same fix: trading liquidity for exchange rate stability in the hope that depreciation pressures will ease, or can be managed, before serious harm is done to the economy.

Already, economists have taken a machete to Vietnam's gross domestic product growth forecast for next year as an economic boom driven by flows of foreign capital crumbles. The government is forecasting 6-6.5 percent growth, and the IMF is looking at 5 percent. Last year, the economy grew 8.5 percent.

It remains to be seen whether the gamble will pay off. Foreign capital is unlikely to return until the government restores confidence in the foreign exchange market.

Economists at a coffee conference earlier this month said they think Vietnam may have to devalue next year, and say the dong should trade between 17,000-18,000 per dollar [ID:nHAN401110].

Currently, it is officially just shy of 17,000, while the NDF fix has slipped to around 17,200, its weakest since June.

But time may be on policymakers' side. The latest spell of U.S. dollar's weakness has been a windfall.

The dong came under pressure, along with most emerging market currencies, when the dollar rallied to 10-week highs against the euro and other major currencies as investors retreated from risky assets in the face of the financial crisis.

Now the dollar is back in the doldrums and the index that tracks the dollar against major currencies is down 6.5 percent this month.

"Demand for the dollar from both speculators and importers has been weakening significantly because the currency has depreciated against others such as the euro and the yen, we are sitting on a lot of unsold dollars right now," said one manager of a major gold shop that trades forex.

And three traders said some Vietnamese banks have started quietly using third currencies again to circumvent the dollar/dong band. None of them agreed to be identified because of the sensitivity of the information.

The central bank has said forex stability is a goal for next year and the appearance of stability should be welcomed in a highly dollarised economy that had an inflation scare this year, which peaked at an annual rate of 28.3 percent in August.

"There will be a cost to what's happened this year," Condon said. "Obviously, the authorities would like to minimise that... This is probably a case of time healing the wounds."