Headline inflation picked up in August from 6.6 per cent at the end-2006 to 8.6 per cent year-on-year. This represents an inflation of 7.4 per cent in the first eight months of the year, somewhat below the real GDP growth of 7.8 per cent during the first half of the year.
Rising inflation was initially induced by a rapid increase in food prices, for example in staple crops, and then later in other goods, especially pork.
Non-food prices inched up only marginally during the same period from 5 per cent to 5.2 per cent year-on-year. While broadly stable, non-food price inflation is by no means low.
Categories with rapid price increases include housing and construction materials, and other goods and services, mainly personal consumption items. Except for transportation and education, most other prices are hovering between 5 and 8 per cent.
Adjusting for seasonal variations, the recent price acceleration can be seen clearly as a supply side shock. Non-food prices have been broadly stable at below 6 per cent since the third quarter of 2006, while food prices started to increase sharply from the early part of this year.
Food price inflation in Viet Nam reflects a region-wide development with China and Indonesia, in particular, experiencing a similar upswing. However, because of lower non-food inflation in these countries, Viet Nam’s headline inflation is one of the highest in the region.
Underlying factors
There are several underlying factors that could explain the recent pick up in inflation.
First, shortages of food arising from weather related calamities, compounded by foot-and-mouth and, most recently, blue-ear disease, have driven food prices higher, such as rice and pork, along with several vegetables and cooking oil.
Second, international commodity prices rose sharply in 2007, peaking in mid-year, and filtered through to the local market. For example, from the second quarter of 2006 to mid-2007, international cereal prices rose by 21 per cent, vegetable oil by 5 per cent, meat by 9 per cent, and metals by as much as 80 per cent.
Third, aggregate demand has remained strong during the first half of 2007, not only driving non-food inflation but also merchandise imports. The increase in imports helped to release some of the pressures from domestic demand. However, higher international prices also implied a sharp increase in the unit value of imports.
Fourth, the higher inflation in Viet Nam could partly be a relative price adjustment process, although a lack of quantitative evidence makes it difficult to affirm.
Policy and responses
The regular seasonal slowdown of economic activity in the first half of 2007 was less visible as strong domestic demand and exports helped sustain a high rate of GDP growth.
Non-oil exports recorded an overall growth of 28 per cent during the first eight months in US dollar terms, while strong domestic demand in response to large capital inflows and rising household incomes through the asset boom led to a pick up in consumer demand. Furthermore, investment remained robust in part due to increasing foreign direct investment (FDI) and construction.
Domestic sales data shows an increase of 23 per cent during the first eight months of the year, and construction sector rising by 10.5 per cent in the second quarter.
Moreover, non-oil import merchandise grew by 34 per cent during the same period, reflecting not only imports of capital and intermediate goods but also final consumer products such as cars and electronics.
As such, relatively low agricultural production compared with previous years was more than compensated by the strong growth in manufacturing, construction, and services.
Macroeconomic policies were broadly accommodative of these developments. The liquidity injection arising from foreign exchange market intervention was only partly sterilised, facilitating rapid private sector credit growth. Furthermore, credit expansion had a more direct impact on consumption than indirectly through the real balance effect by fuelling an asset boom and also through direct consumer loans.
Adding to this liquidity injection are private capital inflows, which in the case of dollarised economies, can add directly to domestic liquidity.
There was no added fiscal stimulus in the first half of the year as spending was contained.
However, the non-oil fiscal balance still remains well above 10 per cent of GDP. In other words, this amount represents a net fiscal injection of money into the economy that is not raised from local sources.
Short-term outlook
Inflation outlook is subject to various conditions. On the supply side, food inflation could pick up in the fourth quarter, repeating last year’s pattern, but is subject to weather conditions. Also, pork supply has not yet been brought under control, and will be an important factor in determining food inflation in the second half.
Overall inflation, however, will be influenced by macroeconomic policies. Policies implemented to date argue for some optimism.
Various measures introduced by the Government - for example State Bank of Viet Nam (SBV) Decision 03/2007 and Directive 03, and raising commercial banks’ required reserves by 100 per cent in June - helped absorb liquidity.
The longer maturity and larger quantity of SBV bills issued in recent months also helped to tighten the interbank market condition.
Assuming that the SBV will continue to do so in an environment where inflows have moderated due to the recent global financial turmoil related to the US sub-prime mortgage market, the rate of acceleration of monetary aggregates could be contained in the second half of the year.
Nevertheless, the recent cooling on the stock market by itself cannot assure containment of the asset boom as there is still ample liquidity that will search for other assets such as property.
On the fiscal policy side, the deferment of minimum wage increases by the Government and the containment of capital spending in the second half of the year will ensure that no added fiscal stimulus is provided to the economy.
Finally, the current moderation of inflows provides an opportunity for the Government to supplement the positive effect of the temporary reduction of tariff rates by intervening less rigorously in the foreign exchange market.
Higher inflation is a concern as it affects the poor more than the rich, especially if inflation is induced by an asset boom. Moreover, what matters is not whether inflation has exceeded GDP growth, but whether uncertainties created by high inflation is starting to have an adverse impact on economic growth itself.
Source: VNS
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