The dong dropped 1.1 percent to 19,320 per dollar as of 11:22 a.m. in Hanoi, after touching a record-low 19,425 as the central bank lowered the reference rate by 2 percent. The Ho Chi Minh City Stock Exchange’s VN Index dropped 1.7 percent to 455.49, extending its decline from the May peak to 17 percent, near the 20 percent that would indicate a bear market.

A weaker currency may boost exports and demonstrates the government’s focus on boosting economic growth over further easing inflation, said Prakriti Sofat, a Singapore-based economist at Barclays Capital. Prime Minister Nguyen Tan Dung said in June the economy may expand as much as 7 percent this year, beating the 6.5 percent target, from 5.3 percent in 2009.

“The main reason for the central bank’s move is to balance onshore foreign-exchange demand-and-supply and to support exporters,” Sofat said. “Vietnam largely exports low value- added goods and typically competes on prices.”

Vietnam’s trade deficit widened in July from the previous month on falling exports. The shortfall reached $1.15 billion from a revised $742 million in June. For the seven months through July, the gap was $7.4 billion, almost twice the figure for the same period last year.

Seafood Companies

“A weaker currency should in theory improve Vietnam’s balance of trade,” said Kevin Snowball, chief executive of Ho Chi Minh City-based fund manager PXP Vietnam Asset Management Ltd. “For the markets, the immediate beneficiaries of this should be companies with earnings in foreign currencies, including seafood companies.”

The Ho Chi Minh City Stock Exchange’s VN Index, Southeast Asia’s worst-performing benchmark gauge this year, has tumbled 61 percent from the record 1,170.67 in March 2007 as the global financial crisis prompted a retreat from developing nations. Declining prices drove stocks on the VN Index to 10.1 times reported earnings, the cheapest in Asia apart from Pakistan.

Barclays Capital is maintaining a year-end forecast for the dong to trade at 19,500, the upper end of the 3 percent band either side of the 18,932 per dollar reference rate, Sofat said in a phone interview today. The currency may weaken to 20,000 per dollar during the first half of next year, Australia & New Zealand Banking Group Ltd. said today.

‘Remains Challenging’

“The outlook for exports remains challenging,” wrote Tamara Henderson, the Singapore-based head of foreign exchange research at ANZ, which also cited the risk that Fitch Ratings’ downgrade last month of Vietnam’s debt rating may hurt future inflows of external financing.

Central bank governor Nguyen Van Giau on Feb. 11 depreciated the dong by lowering the reference rate 3.4 percent to 18,544, following the previous devaluation in November 2009.

“The central bank still has a bias to support growth, especially as credit and loans growth have been relatively weak,” Sofat said. “The central bank has been encouraging local banks to reduce lending rates and now the weaker dong will help support exporters.”

The economy expanded 6.4 percent in the three months through June, compared with 5.83 percent in the first quarter. Inflation cooled for a fourth month in July, to 8.19 percent, the General Statistics Office in Hanoi reported July 24.

‘Price Pressures’

“The weaker currency will likely add to imported price pressures,” Sofat wrote separately in a research note yesterday.

Vietnam is preparing a “sustainable” development strategy for 2011 to 2020 that will lead to average annual gross domestic product growth of 7 percent to 8 percent a year for the period, Prime Minister Dung said in Hanoi today.

Vietnam’s exports rose 17.5 percent in the first seven months of the year from the same period in 2009, according to data from the General Statistics Office in Hanoi on July 27. Imports expanded 25.5 percent.

A weaker dong may also help reduce the gap between the exchange rate at banks and in the black market, according to a research note today from VinaSecurities Joint-Stock Co.

“‘It has an important signaling effect, that the State Bank of Vietnam has taken concrete steps to stabilize the exchange rate,” the note said.

By Patricia Lui & Jason Folkmanis - Bloomberg News - August 18, 2010

Vietnam devaluation fails to stem dong’s fall

HANOI - Vietnam must have hoped that Tuesday’s devaluation of the dong would stem the downward pressure on the currency, but on Wednesday it was trading even lower on the black market suggesting the possibility of further devaluations.

The central bank moved to devalue the dong by two per cent to 18,932 against the US dollar in a bid to stem the country’s ballooning trade deficit. On Wednesday, however, the dong traded even lower in the black market, falling to 19,480 from 19,320 the previous day.

Earlier this week, a gap opened between the commercial bank rate of 19,100 to the dollar and the black market rate, which hit 19,260 on Tuesday. The central bank hoped the devaluation would close the gap, but instead the black market rate continued to fall.

Vietnam’s trade deficit hit $7.4bn in the first seven months of this year, double the rate for the same period last year. Economists said the continuing pressure on the dong indicated that Vietnam’s trade deficit would continue to expand, and that the economy might have trouble meeting World Bank growth forecasts of 6.5 per cent for the year.

“I don’t think that a 2 per cent slide in the dong will do much about the trade deficit,” said Jonathan Pincus, an economist at the Fulbright Economic Training Program, a Harvard-affiliated scheme in Ho Chi Minh City. “But I think the dong is still over-valued, and this is a move in the right direction.”

Vietnam has an export-oriented economy, and runs large annual trade surpluses with the US, Japan, and European Union. But its export industries must import many of their components, so businesses have a large appetite for dollars which grows as the economy expands. In recent weeks, businesses have been unable to find enough dollars to meet their needs, and many have turned to the black market.

Meanwhile, Vietnam’s trade deficit stems almost entirely from imports from China, with which it runs an annual deficit that has outpaced its surpluses with richer countries. Vietnam exports mainly raw materials to China, while importing high value-added consumer and industrial goods. That, too, creates a demand for dollars.

Le Dang Doanh, former director of Vietnam’s Central Institute for Economic Management, said the devaluation was unlikely to be the last one this year.

“I don’t see any sign that companies will find it easier to buy dollars from banks,” Mr Doanh said. “Vietnam has not balanced its demand for dollars. In order to balance it, Vietnam needs a new inflow of dollars, but none has appeared.”

Mr Doanh said demand for dollars was also driven higher by traders trying to arbitrage the large gap in interest rates on dollar-denominated and dong-denominated bank accounts. Early this year, the government limited interest on dollar accounts to roughly 5 per cent to discourage dollarisation of the economy, while rates on dong accounts are 10 per cent or higher.

Many depositors borrowed dollars, bought dong, and deposited them to reap high interest. When a bulge of such loans came due last month, demand for dollars to repay them spiked, driving up black market exchange rates.

“Credit growth in dollars has been very fast recently, while dong credit growth is slow,” said Dao Trong Khanh, chief executive of Tien Phong Bank. “The central bank had to devalue the dong to ease the pressure.”

Ultimately, Mr Pincus says, the devaluation is the latest expression of Vietnam’s “trilemma”: the country attempts to maintain a fixed exchange rate, independent monetary policy, and an open capital account at the same time.

While the country tries to maintain capital controls, these are frustrated by the large quantity of gold and dollars held outside of official financial institutions.

By Matt Steinglass - The Financial Times - August 18, 2010