Thursday, April 15, 2010

Vietnam Faces Difficulties in Addressing Inflation Problem

The Consumer Price Index (CPI) reached 4.12 percent in the first quarter of 2010, much higher than previously forecasted. This has made the government's plan to maintain inflation rate at 7 percent in 2010 even more difficult to achieve. The 'ghost' of inflation that has constantly haunted the Vietnamese economic development has once again taken shape. This is mainly due to the lack of empirical models to help management agencies to solve the problem at its roots.
Causes of Inflation
First, the costs of inputs such as wage increases, electricity, water, coals, steel have risen.
Second, there is imported inflation. This is shown very clearly in the Vietnamese mentality of preferring imported goods. The excess of imports over exports over many years has accumulated a relatively high imported inflation.Even though the relevant data are not available to carry out an economic regression analysis, one can still visualize the fixed relationship between the trade deficit and inflation. In the years when the trade gap is large, it is usually accompanied by the high inflation rate.

The third factor is the exchange rate policy. The devaluation of local currency on the one hand has forced an increase in import goods pricing. This should lift the competitiveness of domestic goods but instead they had sought to expand their profit margin. On the other hand, the increase in exchange rate has caused an increase in the costs of raw material inputs, there by exerting pressure on selling prices.

Fourth, the inflation in Vietnam relies heavily upon people's mentality. Expectations of high inflation also lead to a tendency to increase prices of goods, especially during the holidays and New Year periods. Generally, when prices are increased to a new level, particularly in services and consumer goods, it is difficult to readjust the prices downward again.
In addition, the problems of credit growth, increase in the amount of money in circulation, and the dollarization of the economy are also factors in the inflation boost. Some studies have suggested that credit growth and inflation in Vietnam have the latency between 6 to 8 months. However, this conclusion is only based upon statistics illustrated by graphs and is not yet proven by any quantitative models.
Why is Country's Inflation Difficult To Control?
First, it is because the origin of Vietnam's inflation has started from both internal and external factors. Vietnam is an emerging economy and is export oriented. Therefore, Vietnam imports many basic raw materials, machinery and consumer goods, etc.
Consequently, the one factor that has an enormous impact on Vietnam's inflation is the prices of foreign goods. At the same time, the exchange rate policy between VND and USD plays a decisive role in determining the prices of import goods purchased using other currencies because these prices are set using the basic cross-rate between VND and USD.
Meanwhile, Vietnam cannot decide on the prices of goods in the world. It can only accept them. Hence, it cannot have a policy to control this source of inflation. Nevertheless Vietnam can utilize a policy on import restrictions as well as exchange rate policy.
The use of exchange rate policy, however, still depends on the strength of Vietnam's domestic currency and the foreign exchange reserves. Also, import restrictions cannot be unilaterally imposed when Vietnam is a member of WTO because it cannot go against the principle of an 'open market' and will have to bear the pressure of 'reciprocity' in international trade.
Second, Vietnam's price management policies are not synchronous and difficult to predict, especially price regulatory policies on essential commodities which are important inputs for production processes such as coals, electricity and water, etc. These key input factors which make up a large proportion of the production cost will exert pressure on future increase in selling prices.
Third, Vietnam lacks empirical research on the causes of inflation, as well as their impact on quantity. New research on inflation is virtually analysis that is based on estimates rather than inferred figures and data.
When it comes to inflation, anyone can point out that it is caused by "material prices increase, wage rise, hot credit growth increase, exchange rate policy and imports." However, there is no quantitative data available on how much impact does each of these factors have on inflation, or how inflation would be affected if one of these factors is increased. Even if there is, it is not publicized and not yet proven.
It is because of these limitations in inflation empirical models that the State management agencies have found it difficult to impose appropriate regulatory policies. Sometimes it is the right policy, but the timing is not right, or if it is not applied at the right level, then not only it is not effective, it also worsen the problem.
An important point to note is that it is not because Vietnam lacks of organizations which can build empirical models for inflation, but the problem lies in the fact that Vietnam does not have enough input information and necessary data to build and verify. A number of the State management agencies have reported the impacts of some elements on inflation, but they are not convincing enough because the analysis were mainly based on subjective reasoning and judgment.
The year 2010 will witness the difficulties faced by policy management agencies when there are many negatively impacting factors. Meanwhile, government agencies and the State Bank will need to be flexible in their policies so that they can decode the "classic" equation of macro economics: 'the difficult choice between maintaining growth and the risk of high inflation'.

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