Vietnam: Implications of the currency truce with the US
- Vietnam’s currency agreement with the US is a positive outcome following months of engagement
- Increased FX flexibility would allow for external adjustment during shocks
- Withdrawal of tariff threat lowers business uncertainty
- Promising foreign investment and US export outlook amid increasing manufacturing exposure
- Implication for our forecasts: We revise our end-2021 FX forecast stronger to VND22,870 per USD
The US Trade Representative (USTR) initiated the Section 301 investigation on Vietnam’s currency practices in October 2020. The US was concerned that the Vietnamese dong’s undervaluation would restrict US commerce. As per the USTR’s analysis, the undervaluation has been reflected in Vietnam’s large current account surplus and bilateral goods trade surplus with the US, coupled with intervention that limited the dong’s volatility. Vietnam was subsequently named a currency manipulator by the US Treasury in December 2020 (the designation was removed in April 2021, under the Biden administration).
Following engagement with Vietnam, the USTR’s office on July 23 said that no trade action is warranted at this time, removing the lingering tariff threat since the initiation of Section 301 investigation in October 2020. Greater FX flexibility would reduce the SBV’s ‘trilemma’ while the removal of the tariff threat augurs well for foreign investment and exports to the US.
Increased FX Flexibility Bodes Well for Monetary Policy Framework Enhancement
The exchange rate serves as one of the monetary policy anchors for Vietnam, other than its 4% inflation target. In our view, SBV’s commitment to increased exchange rate flexibility would gradually help with modernising its monetary policy framework and reduce the effects of ‘trilemma’, especially during periods of external shocks. The trilemma is a trade-off that economies face among the objectives of exchange rate stability, free capital mobility, and independent monetary policy. A more flexible currency would allow for external adjustment and better management of domestic liquidity conditions to achieve its inflation target.
In any case, the SBV has been moving in this direction. Since August 2015, the central bank has widened the dong’s trading band to float +/-3% against the USD relative to the central reference rate of the trading band, which is reset daily. Recently, the currency has traded near the stronger side of the trading band. We are revising our end-2021 FX forecast stronger to VND22,870 per USD (from VND23,070 per USD previously).
The USTR, together with the US Treasury, will monitor Vietnam’s implementation of the agreement. Our estimates show that Vietnam continues to meet at least two of the three criteria, in which the US Treasury judges to be currency manipulator, and therefore Vietnam is likely to remain under close watch by the US.
Vietnam’s current account surplus remained above the threshold of 2% of GDP, standing at 2.9% in 2021Q1, while its bilateral trade surplus with the US rose to a high of USD77bn over the past 12 months as of June 2021. FX intervention is difficult to ascertain given that Vietnam does not publish such data.
FX reserves have risen to almost USD100bn as of March 2021, a 3.6% QoQ increase compared with 6.8% QoQ in the preceding quarter, likely reflecting the move away from spot intervention.
FDI and US Export Outlook
The US-Vietnam agreement, following months of engagement, prevents a deterioration in tense bilateral relations and reduces uncertainty for businesses. Vietnam has so far benefitted from US-China trade friction and remains in a favourable position. (see Understanding Vietnam: The rising star for more details). FDI remains a key engine of growth. Newly registered FDI came in at USD10bn in the first seven months of the year, 7% higher than the same period last year. Should such pace keep up for the rest of the year, new FDI is likely to exceed last year’s high of around USD15bn.
The removal of the tariff threat by the US, coupled with Vietnam’s manufacturing capability built up over the years, should also support the latter’s export-led model over the medium-term. The government, in its five-year plan, aims to increase the manufacturing sector’s share of GDP to 25% by 2025 from around 20% in 2020.
The US is Vietnam’s largest export partner, accounting for 27% of total exports in 2020, with shipments to the US more than doubling over the past five years. Above-trend US economic expansion over the coming years should serve as a tailwind. So far in 2021, the US is leading developed economies out of the deep contraction in 2020. Vietnam’s overseas shipments to the US have therefore significantly outperformed other major markets.
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