State Bank of Vietnam Banking Academy Faculty of Foreign Language ~~~~~~~~~~~~~~~~~~ GRADUATION THESIS INTEREST RATE POLICY: THE CASE IN VIETNAM (2008-2014) Student: Phung Tuyet Lien Student ID: 13A7510091 Class: ATCC K13 Supervisor: Ngo Tung Anh (MA, MBA) Hanoi, 2014 Graduation Thesis Banking Academy DEDICATION It is with my deepest gratitude and warmest affection that I dedicate this thesis to my dad and mom who always support me in whatever I to my boyfriend who loves me so much and to my advisor who has been a constant source of knowledge and inspiration Graduation Thesis Banking Academy ACKNOWLEDGEMENT I would like to express my gratitude to my supervisor, Master Ngo Tung Anh, whose expertise, understanding, and patience, added considerably to my graduate experience I appreciate his vast knowledge and skills in many areas and his assistance in writing reports which have benefited me a lot with this graduation thesis Very special thanks goes out to all of my lecturers at Banking Academy, especially the lecturers of Foreign Language Faculty, without whose motivation and encouragement I would not have considered a graduate career in psychological research In particular, Master Nguyen Manh Hung has given me numerous advices whenever I have difficulties with this work I would also like to thank my family and my friends for the support they provided me through my process Without their love, encouragement and editing assistance, I would not have finished this thesis Due to time constraints and limited capacity of the writer, this graduation thesis will certainly not be free from defects I hope the lecturers and readers will sympathize and contribute to complete the thesis Thank you! Hanoi, 26th May 2014 Graduation Thesis Banking Academy ABSTRACT It is undeniable that the need for a proper interest policy is on the increase in such a situation like present This thesis is to give out a brief understanding of interest rate and interest policy, to analyze the real situation of Vietnamese interest policy, how it works and its effects on the whole economy, and to make recommendations for the State Bank of Vietnam as well as the government in order to build up a more efficient banking system Data for this thesis were collected from the published reports, articles, and documents relevant to different interest rates in Vietnam Tables and figures were built up from information of the State Bank of Vietnam and other Departments With this thesis, the researcher hopes to make practical contributions to the strategic planning work of the State Bank of Vietnam in order to enhancing the effectiveness of the banking system’s operation Graduation Thesis Banking Academy TABLE OF CONTENTS LIST OF ABBREVIATIONS LIST OF TABLES AND FIGURES PART A INTRODUCTION Rationale of the study Aims of the study: Methodology of the study: Scope of the study: Organizational Structure: PART B DEVELOPMENT Chapter 1: Theoretical background 1.1 Interest rate: 1.1.1 Concept of Interest rate: 1.1.2 Characteristics of Interest rate: 1.1.3 Types of IRs: 1.1.4 Factors that affect the Interest rate: 10 1.1.5 Roles of IRs in the Economy: 13 1.2 Interest rate policy: 15 1.3 Summary 16 Chapter 2: Reality of Interest rate policy in Vietnam 17 2.1 The case in Vietnam from 2008 till now: 17 2.1.1 From 2008 – 2010: 17 2.1.2 From 2011 till now: 24 2.2 Evaluation: 30 2.2.1 Achievements: 30 2.2.2 Drawbacks: 32 Graduation Thesis 2.3 Banking Academy Summary: 35 Chapter 3: Development trend of Interest rate policy and Recommendations 36 3.1 Development trend of Interest rate policy: 36 3.2 Solutions and recommendations for the SBV 38 3.2.1 Solutions 38 3.2.2 Recommendations for the SBV 39 3.3 Summary 40 PART C CONCLUSION 41 REFERENCES 42 APPENDICES 43 Graduation Thesis Banking Academy LIST OF ABBREVIATIONS CBs Commercial Banks SBV State Bank of Vietnam VND Vietnam Dong USD American Dollar IMF International Monetary Fund IRs Interest Rates FDI Foreign Direct Investment US United States EU Europe Union GDP Gross Domestic Product Graduation Thesis Banking Academy LIST OF TABLES AND FIGURES Figure 1: Relationship between Interest rate, productivity and price 12 Figure 2: Vietnam's Economic Growth and CPI (1992-2008) 17 Figure 3: Vietnam's Twin Deficits (2003-2008) 18 Figure 4: Export Growth of Vietnam and Others (Jan 2008 - Jan 2009) 19 Table 1: Interest Rates in Vietnam (2008-2010) 24 Graduation Thesis Banking Academy PART A INTRODUCTION Rationale of the study Monetary policy is the most important macroeconomic policy of all nations because of its profound influence on all aspects of life: economic, political, cultural and social aspects In the particular case of a market economy, the monetary policy is considered as the "spirit" of the entire operation of the central bank Therefore, the planning and execution processes of the monetary policy always require caution and prudence in every single step, depending on the specific conditions of each period to make the correct decisions in order to achieve the ultimate goal – a stable currency Among different tools to conduct the monetary policy, the interest rate policy is very important The interest rate is one of the most pivotal factors of the economy A modern economy is naturally connected with IRs, thus their importance on the financial markets An interest rate is a vital economic category related in various fields of the economy from saving deposits, investments to the government’s inflation control The interest rate affects consumer spending The higher the rate is, the higher their loans will cost them, and the less they will be able to buy on credit That is the reason why news on IRs is often followed closely on every means of media The government uses Interest rate as a tool of monetary policy to stabilize and boost the domestic economy Due to the importance of the way government influences on the Interest rate, there have been a great number of different opinions on operating the Interest rate tool Graduation Thesis Banking Academy Aims of the study: This thesis is hoped to benefit the SBV in order to find out the most proper interest rate policy which meets the basic requirements of the domestic economy and people’s income Moreover, it is expected to explore some useful solutions to boost the economic integration of Vietnam Methodology of the study: In order to find out the most logical and reasonable solutions for the matter of operating the Interest policy, this thesis will retrieve information resources from lectures, newspapers, magazines, on the Internet and different opinions of economic and financial experts and magisterial organizations Thus, by methods of collection (collecting necessary information), deduction (drawing a conclusion by reasoning), analysis (carefully studying to learn about small parts) and statistics (analyzing or representing statistical data), as well as several personal ideas and opinions, this thesis will present the real situation of the interest rate policy operation in Vietnam Scope of the study: The interest rate policy of the SBV is based on the changes of the macro economy; simultaneously, it needs the synchronized coordination of other policies as well as other Departments There are types of IRs which are established by the SBV: the official interest rate and inter-bank interest rate Because of the limited time and knowledge, this thesis will only focus on the official interest rate policy of the SBV from 2008 till now, based on the basic theories of the interest rate and the interest rate policy Graduation Thesis  Banking Academy Firstly, the SBV has operated effectively the money supply through tools of monetary policy in order to meet the liquidity needs of the commercial and the whole economy as well as cause the market interest rate to reduce The notable part was the reduction of the required reserve ratio in foreign currency from % to % for maturity of less than 12 months, from % to % for the 12-month-and-above period  Secondly, the SBV has implemented the negotiable lending mechanism in VND, operating IRs flexibly, and coordinating with other measures to regulate the market interest rate accordingly  Thirdly, solutions were implemented to support the agricultural and rural sectors as well as the economic stimulus package in accordance with Resolution of the Government, which focused on directing credit institutions to expand and improve the credit quality and efficiency and to simplify lending procedures In the next period from 2011 till now, the domestic economy has faced many difficulties such as high inflation rates, stagnant production business, many cases of dissolution and bankruptcy, the reduction in the purchasing power, the frozen real estate market, and an increase in the number of non-performing debts Notably, there were times when the lending interest rate went up to 22-24 % per year Moreover, this along with the USD devaluation and the high deficit caused some major CBs in danger of falling into severe risks Meanwhile, the complex situation of the world market when several big economies in the world fell into debt crisis also had a negative impact on the domestic economy This fact requires a very flexible monetary policy It is said that the monetary policy really had a pivotal role in establishing the macroeconomic stability as well as the low and stable inflation at around 7% per annum in years 2012 - 2013 From the "top" deposit IRs at 18% per year in 2011which caused the lending IRs to climb at as high as 23-25 % per year, till date, the maximum deposit rate has fallen to about 7% per year and only applies with maturities 31 Graduation Thesis Banking Academy of less than months The maximum lending interest rate on priority sectors dropped to only % per year The typical loans not have to bear the “disastrous” interest rate anymore, which were adjusted to a more reasonable level at around 10-12 % per year, making the proportion of loans with IRs of about 13 % per year accounting for over 70 % of total loans in the system In short, after years of implementing the plan on economic and social development (2011 - 2015), Vietnam has achieved certain success such as: maintaining the economic growth, stabilizing the macroeconomic, curbing the inflation at a low level Nevertheless, the economy still has some slow changing sector, especially industry and agriculture So the Government is making a determined effort to remove difficulties for the economy with multiple solutions in the period of 2014-2015 By the end of February 2014, the SBV has remained all the operating rates such as: the short-term maximum lending IRs in VND of credit institutions to prior sectors, the maximum interest rate in VND and USD of organizations and individuals in banks; continued to require banks to reduce lending IRs to less than 13% per year as well as reducing IRs for the outstanding housing support loans in 2013 from 6% to 5% per annum 2.2.2 Drawbacks: Although several initial results have been achieved in the implementation of the restructuring program on credit institutions in the period of 2011 - 2015, it was only addressing the difficulties ahead Whereas, the core issues of restructuring program as clearing off non-performing debts, strengthening managing ability of the government after the restructuring and changes in the ownership structure of the credit system has not been solved and will be the major challenge for the administration of monetary policy of the central bank in 2014 32 Graduation Thesis Banking Academy Let’s take the increasing highly in interest rate in 2011 as an example When the inflation rate goes up, the value of money goes down as you can say “a dollar today is worth more than a dollar tomorrow” With a very high inflation rate in 2011, 18.6% according to BBC, people think that the interest they receive when depositing money into banks cannot balance the value of assets they will lose in the future As VND is not a safe channel for people to store the value of their assets; they turn to other kinds of investment that can secure the value more, such as real estates, US dollar or gold As a result, to attract residents’ surplus funds, CBs have to increase their interest rate In 2011, there was a period when the interest rate of deposit rose up to 20%/year That led to a rise in lending interest as well, which can reach even 26, 27%/year It was too hard for corporates to afford this rate in such a bad economic condition When money is put into circulation too much, it created the phenomenon of excess cash in the economy, which caused inflation pressures and the CPI increased after about 6-9 months That's what happened to the economy of Vietnam from 2010 to 2011 To cope with inflation, the central bank decided to decrease the money supply and increase operating interest However, many banks, in fact, are the "backyards" of real estate or infrastructure development enterprises, so the loans in the real estate field accounted for a very large proportion in these banks Thus, capital structure was not allocated reasonably between short-term loans and long-term loans, between lending investment in the field of real estate and lending investment in production Financial institutions have had to use short-term deposits from the residents and the interbank market to finance the medium and long term projects Therefore, when monetary policy is tightened suddenly, the liquidity of the banking system became difficult The banks can not withdraw funds from the real 33 Graduation Thesis Banking Academy estate loans while borrowing money from the inter-bank market was also very difficult, that lead to the liquidity tension in almost of small banks That was the main reason why “weak” banks were forced to raise the interest rate to very high to attract people’s surplus money Nevertheless, lack of liquidity was not just a story of the “weak” banks; it had a domino effect spreading throughout the system Consequently, a struggle for VND broke out among banks Mr Nguyen Duc Huong, Vice Chairman of Lien Viet Post Bank said: “When a small bank faces with liquidity risk, it will release very high IRs to attract funds In a sensitive information age, customers withdraw their money in large banks and deposited into small banks to get higher interest Then the large banks also have had to increase the interest rate to keep customers Thus, the interest rate is raised higher and higher In addition, the higher the deposit rate, the higher the lending rate 55000 or so corporations were bankrupted in 2012 due to the fact that the IRs of loan were so high (about 25%/year) that they could not approach the capital to maintain the business A large number of inventories, production activities were stagnated; the economy was deeply in crisis Many businesses cut off their labor forces which led to a rise in unemployment rate Since the consequences were extremely serious, the SBV is required to have some actions to solve this problem The SBV adjusted the key IRs like open market interest rate and refinance IRs three times However, ceiling deposit interest rate has not been adjusted So, an inevitable consequence of the non-synchronized adjustment among the monetary management tools is that CBs are launching a range of deposit services to circumvent ceiling interest rate regulations Moreover, it has been observed that while the IRs have been reduced, businesses still find it hard to access the lending fund The banks want to boost the credit growth, businesses also want to get access to the capital, but the supply and 34 Graduation Thesis Banking Academy demand still can not meet The businesses can not access these loans due to its unability to meet the standard requirements set out by the bank Meanwhile, the bank can lower IRs but not the lending standards With these shortcomings, the difficulty in the lack of funds business has not yet been solved Many businesses in shortage of capital for a long time are facing the risk of bankruptcy 2.3 Summary: Indisputably, the situation over that period of time has been extremely complicated, with many unexpected changes at sudden times which require such timely and appropriate responses and solutions of both Government and SBV Specifically, 2008 marked the worst crisis ever in the last 80 years since the Great Depression 1929-1933 leading series of collapses of countries’ economies around the world In Vietnam, the crisis was followeded by the surging inflation,the drop of national economic growth as well as the escalating interest rate At that moment, the SBV and the Government has taken numerous actions with the hope to put the IRs under the control and improve the situation of the country’s economy Not mention that these actions have been sufficient enough or not, they have still shown the willing of Government and SBV to control the situations as well as share the difficulties with CBs and other credit institutions Moreover, in fact, they have helped partly to curb the inflation rate and improve the unemployment rate which resulted in many social problems 35 Graduation Thesis Banking Academy Chapter 3: Development trend of Interest rate policy and Recommendations 3.1 Development trend of Interest rate policy: A question has been raised for the near future: in 2014, will IRs continue to decline, or be stable, or rise again? Report of the SBV stated that in general, in 2014, the SBV will operate actively, versatily the key IRs in order to control and regulate the market interest rate in line with macroeconomic developments, especially the inflation movements and to stabilize the money market Moreover, the SBV gave out some clues: "The policy will continue to apply the ceiling interest rate on deposits in VND to stabilize the average market interest rate, consider to not specifying the ceiling deposit rate when the money market is stable and the liquidity of credit institution system has been improved." More specifically, at the conference on the task deployment in HCM City in December 2013, Governor Nguyen Van Binh estimated that in 2014 the interest rate would be nearly the same as the average interest rate in 2013; if there was a signal of lower inflation rate, the SBV would make an adjustment accordingly In fact, the SBV seems to determine to reduce IRs in this year As mentioned above, in late 2013 and early 2014, Governor Nguyen Van Binh has mentioned the possibility of reducing the lending IRs by 1-2% in order to help businesses access to capital and overcome difficulties Recently, the SBV issued Directive No.01/CTNHNN stipulating that credit institutions are not allowed to charge fees related to the loans, except for the fee stipulated in Circular No 05/2011/TT- NHNN And at the 36 Graduation Thesis Banking Academy same time, they have to publicize the list of fees and charges according to the regulations According to Mr Nguyen Xuan Thanh, Director of Fulbright Economics Teaching Program, in years 2011 and 2012, the average rate of return on equity (ROE) of enterprises in HCM City was 8.13% and 9.98% respectively, lower than the lending interest rate on bank loans Therefore, despite needing funds for good business opportunities in the medium and long term, businesses still dare not borrow Meanwhile, the spread between lending rates and deposit rates now is 1-2% higher than the spread in the period of 2006-2007 Thus, the reduction in IRs is necessary to help businesses access capital more easily This has been proved partly when the recent interest rate on the interbank market declined continuously for all maturities By the date of February 14, 2014, the overnight rate and 1-week maturity were 1.65 % and 2.19% respectively, reducing sharply as compared with 3.45 % and 3.94 % in the previous week It proved that the liquidity of banks was good Thus, the pressure to lower IRs and increase loan credit growth is quite big In particular, it is likely in the near future when Circular No 02/TT-NHNN was amended towards "remaining the loan groups", the IRs will be more favorable According to Mr Nguyen Dong Tien, vice governor of SBV, in 2014, the SBV will operate flexibly and synchronously tools of monetary policy, to ensure the control of money supply in line with the overall direction of operating liquidity, credit in order to achieve the objectives of monetary policy In 2014 and subsequent years, the SBV will continue to implement drastic measures to lower the IRs to suit the popular interest rate on the international market and gradually improve the competitiveness of the economy In particular, the SBV will 37 Graduation Thesis Banking Academy continue to apply the ceiling interest rate on deposits in VND in 2014 to stabilize the interest rate market However, the ceiling deposit interest rate may be removed if the money market is stable and the liquidity is steadily improved 3.2 Solutions and recommendations for the SBV 3.2.1 Solutions The difficult situation Vietnam’s economy has experienced and the prospect it is likely to have requires immediate solutions to the problems the whole economy currently has Firstly, the SBV should improve the regulations and framework on interest rate policy in order to support CBs as well as businesses in getting updated information about the changes in policy as soon as possible A basic research on the average administrative expense of CBs in different regions is also necessary to figure out which IR is appropriate to cover up the average cost Hence, the IR policy may be advantageous for CBs to gain adequate profit to cope with the consequences of the monetary crisis Moreover, it should execute the IRs set by SBV proactively and flexibly in order to control and regulate the market interest rate in line with the macroeconomic developments Close monitoring the exchange rate movements and money and foreign exchange markets management may also help to have appropriate adjustments to avoid the "dollarized", "golden" economy and encourage people to store VND to increase foreign exchange reserves of the Government - Last but not least, the SBV needs to create a transparent and fair environment for CBs and credit institutions to have the competitiveness which does not go against the laws and the multiple-component-economic-development-policy of the 38 Graduation Thesis Banking Academy SBV and the Government It also should strengthen the information and communication on the policy of the Government and the SBV in order to stabilize the society, build up the consensus, facilitate the task implementation and enhance the effectiveness of operating monetary policy 3.2.2 Recommendations for the SBV Below are some suggestions for the government and SBV in the near future: SBV should: - Execute the monetary policy proactively and flexibly, effectively coordinating with fiscal policy to control inflation, stabilize the macroeconomic and support the economic growth Strive to control the total means of payment increasing by about 16-18 %, credit increasing by 12-14% except for the unavoidable situations; - Consider narrowing down the scale of interest subsidy and tend to stop the interest subsidy It is undeniable that restricting the money supply in the difficult situation is an extremely correct action especially when credit tends to surge and inflation rate is likely to rise - Increase the mechanism of publicizing the information of matters related to the interest rate policy The fact is that the eratic movements of the money market are affect considerably by the psychological element Thus, in the near future, the SBV ought to strengthen the effects of mass media and public orientation, consider actively and periodically announcing the changes in administration policies 39 Graduation Thesis - Banking Academy Continue to focus on implementing synchronously and drastically the restructuring scheme on credit institution system in 2011-2015 as well as the clear-off bad debts scheme to ensure safe and sustainable development of credit systems; - Strengthen the inspection and supervision to ensure safe operation and discipline in banking activities; stipulate and set out clearly the law framework and have strict punishments on law-breaking cases which are related to the monetary policy in general This matter has caught the eyes of the Government and the SBV in the recent time However, there is still an increasing need to tighten the regulations along with strengthening the supervision of the whole community and society 3.3 Summary The global economy is on its way of recovering from the 2008 crisis This situation is also applying on Vietnam which leads to the urgent need of exact and timely operation of the Government and the SBV With these aforementioned solutions and recommendations, there is little doubt that the monetary policy in general and the interest rate policy in particular will certainly be the motivation to boost the development of Vietnam’s economy and help the national economy continue to grow sustainably and stably 40 Graduation Thesis Banking Academy PART C CONCLUSION The paper has studies the reality of the Interest rate policy in Vietnam especially in the period of years from 2008 till now It goes ahead to understand the theoretical background relating to the interest rate and the interest rate policy in general before critically analyzing the data of the Vietnam’s policy from the SBV Annual Report The theory mentions five fundamental elements of Interest rate, including the concept, characteristics, different types of IRs, several factors that affect the IRs and the roles IRs play in the whole economy before giving some basic information about the Interest rate policy In particular, the study on the administration and operation of IR policy of Vietnamese Government and the SBV have been conducted with a close connection and follow-up of the real situation of Vietnamese economy and financial market from 2008 to 2013 Many changes have been set out, varying from the loosening policy to the tightening one in order to keep the market IR under control Indeed, despite several weaknesses and limitations, the operation of SBV has had a profound impact on establishing the sustainment of the economy, especially the market IR and IR-related credit operations In an attempt to make Vietnamese banking system more strong, some forecasts, solutions and recommendations have been proposed to the SBV such as increasing the effects of mass media and public orientation, narrowing down the scale of interest subsidy and strengthen the inspection and supervision In the often changing economy like this, the policy of Government is always changing that leads to the fact that all entities in the economy are affected every day The SBV, who directly establishes and executes the monetary policy, should remain the prudence to have the best decisions in order to develop the economy 41 Graduation Thesis Banking Academy REFERENCES “General Data Dissemination System” (2012) Retrieved April 20, 2014 from http://dsbb.imf.org/pages/gdds/DQAFViewPage.aspx?ctycode=VNM&catcode=FSEC 0&Type=DC International Monetary Fund (n.d.) “Chapter Classification: Financial Instruments, Functional Categories, Maturity, Currency, and Type of Interest Rate” Marcelo Sanchez (2005) “The link between Interest rates and Exchange rates Do contractionary depreciations make a difference?” Working Paper series no 548 Nham Nguyen (2011) “The World in 2011: Slow economic growth”, VOV Online Retrieved May 12, 2014 from http://vov.vn/The-gioi/Quan-sat/The-gioi-nam2011-kinh-te-tang-truong-cham/195804.vov State Bank of Vietnam (2009), Circular No 01/2009/QD-NHNN and Circular No 07/2009/QD-NHNN State Bank of Vietnam (2010), Circular No 12/2010/TT-NHNN State Bank of Vietnam (2011), Circular No 02/2011/TT-NHNN, Circular No 04/2011/TT-NHNN, Circular No 05/2011/TT- NHNN and Circular No 30/2011/TTNHNN State Bank of Vietnam (n.d.) “Interest rates in Vietnam” State Bank of Vietnam, Decision No 187, 305, 306, 1099 and 2646/QD-NHNN 10 Thanh N.T.K () “Interest rate policies: Theory and practice” Retrieved May 2, 2014 from http://www.vnbaorg.info/?option=com_content&view=article&id=1598&catid=43&Ite mid=90 11 United Nations (2013), “World Economic Situation and Prospects 2013”, United Nations publication, Sales No E.13.II.C.2 12 Van L.T.T (n.d.) “The global Crisis and Vietnam’s Policy responses” 42 Graduation Thesis Banking Academy APPENDICES Figure 5: Relationship between Interest rate, productivity and price Even point Interest Price Output Output (Source: Retrieved from www.stockbiz.vn) Figure 6: Vietnam's Economic Growth and CPI (1992-2008) (Source: IMF, General Statistics Office of Vietnam) 43 Graduation Thesis Banking Academy Figure 7: Vietnam's Twin Deficits (2003-2008) (Source: IMF, General Statistics Office of Vietnam) 2009) Figure 8: Export Growth of Vietnam and Others (Jan 2008 - Jan (Sources: Vietnam Customs; China Ministry of Commerce; Malaysia External Trade Development Corporation (MATRADE); National Statistic Office of Philippines) 44 Graduation Thesis Banking Academy Table 3: Interest Rates in Vietnam (2008-2010) Time Base Interest Rate Discount Rate Refinancing Rate Feb 2008 7.5% 6% 8.75% Jun 2008 15% 13% 14% Dec 2008 9.5% 7.5% 8.5% Feb 2009 8% 6% 7% Apr 2009 7% 5% 7% Dec 2009 8% 6% 8% Feb 2010 8% 6% 8% Nov 2010 9% 7% 9% Dec 2010 9% 7% 9% (Source: the SBV of Vietnam) 45