Monetary Policy Impact on Vietnam Economy

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Topic: Monetary policy in Vietnam and impacts of interest
rate on the economy

TABLE OF CONTENT
I. Introduction ......................................................................................................................3
II. Monetary policy..............................................................................................................3
2.1 Monetary policy in theory..........................................................................................3
2.2 Central Bank...............................................................................................................4
2.3 Applying monetary policy in recent years .................................................................5
III. Impacts of interest rate on the whole economy.............................................................8
3.1 Interest rate, savings and investment .........................................................................8
3.2 Interest rate and export activity..................................................................................9
IV. Conclusion...................................................................................................................10
REFERENCE ....................................................................................................................11

I. Introduction
Facing a peak of interest rate in the end of 2012 as well as the bankruptcy of many small
and medium enterprises, Vietnam was in emergency to adjust the monetary policy in
order to balance the whole economy and promote production. Under the circumstance,
the assignment is written to deal with three objects: monetary policy, central bank and
interest rate. These three issues mentioned in this report have an intimate relationship
with each other. That said, monetary policy is undertaken by the Central bank with the
purpose of increasing or decreasing the interest rate (Milton, 1968).
In this paper, final outcome focuses on the impacts of interest rate, which has been
modified by the Central bank through applying appropriate monetary policy. The
assignment is also expected to become a reference for both policy makers in the
macroeconomic views and businesses in changing strategies in complying with any
movement of interest rate.
To achieve these outcomes set out in the immediately above paragraph, the writer tends
to introduce some major issues of monetary policy and central bank in order to support
for analyzing interest, including how each type of policy alters it and how it influences on
the whole economy of Vietnam.
II. Monetary policy
2.1 Monetary policy in theory
Monetary policy involves the change of money supply by selling or buying securities in
the market (Mankiw, 2011), or in other words, the monetary authority employs money
supply as the policy instrument (Fuerst, 1995). The effect of this policy is illustrated by
the LM curve in the Mudell –Fleming model (Romer, 2000) as following.

Source: Romer, 2000
Figure 1: The LM curve
In addition, the rule of monetary policy can be defined as a systematic decision process
that utilizes information in a consistent and predictable way (Allan, 1993). Thus, it is
very easy for public to understand (William, 1999).
In theory, monetary policy can be implemented either expansionary or contractionary. To
be “easy” policy, Vietnamese Government should raise the money supply in the market
by purchasing bonds (Keith, 2006). Each type would be selected based on the objective
of the Government and current conditions of the economy. Theoretically, monetary
policy could achieve the adjustment of inflation, nominal interest rate, unemployment
and economy growth (David, 1999). However, Friedman (1968) indicated two limitations
of monetary policy, namely pegging nominal interest rate and unemployment rate only in
a limited period.
2.2 Central Bank
Central Bank in Vietnam is the State Bank of Vietnam (SBV), which aims to conduct
monetary policy to meets the requirements of country’s development with the helpful tool
of interest rate. According to the 1998 Law on the State Bank of Vietnam, the main
r
y
Figure 1: LM curve
y0 y1 y2
r0
r1
r2 L-M

mission of central bank is to control the fluctuation of interest rate, stabilize the value of
currency and secure the safety of banking system (Nguyen Duc Thao, 2004). However,
Vietnamese central bank has no exclusive responsibility in designing an independent
monetary policy (Camen, 2006).
According to Article 5, Decree No.53 about organizing the central bank system, SBV is
comprised of State Bank with its branches in provinces and cities, decided by the General
Director of the SBV and Specialized banks under it. In detail, Specialized Banks of SBV
include Vietnam Commercial Bank (VCB), Vietnam Bank for Agriculture and Rural
Development (Agribank), Vietnam Joint Stock Commercial Bank For Industry and Trade
(VietinBank) and Bank for Investment and Development of Vietnam (BIDV). The system
is arranged to use market-based instruments and reserves requirement to carry out
monetary policy (Le Xuan Nghia, 2005).
2.3 Applying monetary policy in recent years
For some years from 2010 to 2013, monetary policy has changed in twofold: from
tightened in 2011 to expansionary in 2013. The movement existed due to the difference
in objectives of SBV and current conditions at that time.
Dealing with monetary policy in 2011, SBV would like to control inflation as its main
purpose. In recent years, Central bank has assessed inflation targeting is worth pursuing
(Bernanke & Mishkin, 1997). In fact, the inflation of Vietnam was illustrated as
following:

Source: General Statistics Office (GSO, 2012)
Figure 2: Inflation of Vietnam from 2009 to 2012
As can be seen from 2009 to 2011, the inflation rate of Vietnam had continuously
increased, up to nearly 20% at the end of 2011. This situation put pressure on Vietnamese
policymakers to control the extremely high inflation so that it can be lower in the next
years. Thus, tightened monetary policy was conducted through decreasing money supply
in the market. Finally, as stated in the above figure, 6.81% was the inflation rate of
Vietnam in 2012 after implementing monetary policy.
In contrast, consequence of contractionary monetary policy was an increase in interest
rate because after the SBV sold bonds to public to reduce money supply, the price of
bonds tended to be lower (Friedman, 1959). This change in interest rate encumbered
enterprises to assess capital for extending production and investment. Therefore, SBV
decided to expand monetary policy in 2013. That said, the bonds and securities would be
purchased from public, then interest rate could be lower (Keith, 2006).
6.52
11.75
18.13
6.81
0
2
4
6
8
10
12
14
16
18
20
2009 2010 2011 2012
Inflation
Inflation

Source: SBV (2013)
Figure 3: Interest rate from 2012 to 2013
From the figure above, it is noted that the monetary policy had reduced interest rate
effectively, from a peak of 15% to about 6% in 2013. Up to the present time, interest
rates fall to about 7% a year while the lending rate was at 10 to 12%. This strategy of
SBV is beneficial for businesses in order to save them from bankruptcy and loss since
lower interest rate could attract more investment and loan from enterprises or reduce a
part of cost for them (Robert, 1971).
In brief, the relationship between interest rate, monetary policy and Central bank are
intimate. Central Bank applies monetary policy in influencing interest rate and inflation
rate. From two period of Vietnam economy, SBV had exercised two different types of
monetary policies. So, it indicates that adjustment this policy seems to be flexible but
planned comprehensively.
0
2
4
6
8
10
12
14
16
Interest rate
Interest rate

III. Impacts of interest rate on the whole economy
Interest rate is the important indicator for the economy growth, based on its influences on
saving and investment decisions (Lardy, 2008). In addition, the use of interest rate could
be estimated as the stimulus to economic growth (Robert, 1971), affecting GDP ratio of a
country (Julian & Jay, 2008). Additionally, change in interest rate could promote or
reduce the volume of export (Keith, 2006).
3.1 Interest rate, savings and investment
It is highlighted that the low interest rate gives more chances for investment and less
ability for saving in banks as well (ESRB, 2012). Also, IMF (2011) said that it was only
low interest rate to minimize the risks for investors in case investment projects released
negative effects. In contrast, if interest rate was pushed to increase, the economy growth
would be slower since capital outflow increases and more people prefer to keep money in
the banks.
For example, it is critical to look at the case study of Vietnam economy in 2013 when
expansionary monetary policy was implemented and interest rate was pushed to decrease
significantly.
At the end of 8/2013, credit to the economy had increased by 6.45%, the possibility of
achieving 12% credit growth in the coming years might come true. According to the
General Statistics Office, the number of social investment carried out in 2012 at current
prices was estimated at 989.3 trillion, increasing by 7% from the prior year and 33.5% of
GDP, including capital in private sector, non-state investment and foreign direct
investment. The best outcome of lower interest rate in 2013 was the access of enterprise
toward capital in order to overcome crisis and bankruptcy. Thus, the index of industrial
production increased by 5.9% (5.8% higher than in 2012 compared to 2011), contributed
5.42% to the country's GDP growth. More satisfied enterprises gained from low interest
rate, more possible it is for them to raise productions and investment.

Therefore, applying low interest rate will promote not only investment but also GDP in
the country, which certainly indicates development of the whole economy.
3.2 Interest rate and export activity
Keith (2006) explained this relationship by using the normal perspective about effects of
interest rate in exchange rate. It means when interest rate reduces, the capital usually
tends to be outflow, and then supply of foreign currency could not remain high, which
results in depreciation of domestic currency, here is VND. Since foreigners feel that they
will convert their domestic currency into more VND, they absolutely import from
Vietnam (Shiller, 1990). Finally, Vietnam will experience an increase in export activities.
In the case of low interest rate in 2013, the following figure will describe the gain of
Vietnam economy in term of export.
Source: Ministry of Industry and Trade (2013)
Figure 4: Export activity of Vietnam from 2011 to 2013
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
2011 2012 2013
Total export value
Export of domestic firms
Export of firms with foreign
investment

As can be seen, total export value of Vietnam has increased from 2011 to 2013 due to the
effect of low interest rate. Once export activities are promoted and import is limited,
balance of payment will be significantly improved and position of Vietnam in the world
market will be strengthened.
In conclusion, interest rate has many effects on the whole economy and low interest rate
may be pursued in order to promote both investment and export activities. That is reason
why the interest rates of some developed countries such as American, Sweden and Japan
are nearly zero.
IV. Conclusion
As mentioned in the introduction, the assignment concentrates on three issues and answer
two main questions: how Central bank of Vietnam undertakes monetary policy in
controlling interest rate and how interest rate affects the Vietnam economy. To recap
from the paper, it is critical to identify monetary policy of Vietnam has been changed
from 2011 to 2013 with the shift of objectives of State Bank of Vietnam (SBV), from
restraining inflation to reducing interest rate. Moreover, the key role of interest rate on
the economy lies on encouraging export and investment as well as production.
In addition to outcomes, the assignment also remains some limitations. This paper is only
an overview of monetary policy and interest rate, does not cover all advantages and
disadvantages of these two objects. Thus, it is not a thorough research in this area.

REFERENCE
Allan, H. (1993), “The Role of Judgment and Discretion in the Conduct of Monetary
Policy”, Changing capital market: Implications for Monetary Policy, Vol. 2, No. 14, p.
223
Camen, U. (2006), “Monetary policy in Vietnam: the case of a transition country”, BIS
Paper, No. 31, p. 1-12
David, W. (1999), “With Inflation Tamed, America Confronts an Unsettling Stability”,
Wall Stress Journal, Vol. 1, No. 12, p. 13
Friedman, M. (1968), “The Role of Monetary Policy”, The American Economic Review,
Vol. 58, No. 1, p. 1-17
Fuerst, T.S. (1995), “Monetary and Financial Interactions in the Business Cycle”, Journal
of Money, Credit and Banking, Vol. 27, No. 4, p. 1321-1338
Keith, P. (2006), International Finance, 3rd
ed., Palgrave Macmillan Publisher, New
York, p. 69-76
Mankiw, G. (2011), Principle of Macroeconomics, 6th
ed., South-Western Cengage
Learning Publisher, p. 340-345
Nghia, Le. (2005), “Orientations of the Banking Sector Development Strategy towards
International Integration”, Journal of Economics Perspective, p. 14-24
Romer, D. (2000), “Keynesian Macroeconomics Without The LM curve”, Journal of
Economics Perspectives, Vol. 14, No. 2, p. 146-49
Shiller, R. (1990), “The term structure of interest rates”, Handbook of Monetary
Economics, Vol. 1, p. 627-722

Thao, N. (2004), “Strategy for the Development of Banking Services in Vietnam in the
Context of International Economic Integration”, Project VIE/02/009 Banking Service
Sector

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