Interest rate cut and the impact on Vietnam's economy

DNHN - According to Dr. Chu Thanh Tuan, Deputy Head of the Bachelor of Business program at RMIT University, the recent interest rate cuts by major central banks may impact Vietnam's export market.

General situation and assessment of ECB, BOC interest rate cuts

The recent interest rate cuts by the European Central Bank (ECB) and the Bank of Canada (BoC) are significant moves indicating a broader trend of monetary easing among major central banks. Here is an analysis of how these cuts could affect the global economy:

On June 6, 2024, the ECB reduced its deposit rate from 4.0% to 3.75%, the first cut since 2019. This decision was influenced by a drop in inflation, which has fallen from over 10% at the end of 2022 to near the ECB's target of 2%. 

However, the ECB remains cautious, indicating that further rate cuts will depend on upcoming economic data. They have raised inflation forecasts, suggesting inflation might still exceed the target next year. This cautious stance implies that while the rate cut provides immediate economic relief, the ECB is ready to tighten policy again if inflation proves persistent.

On June 5, 2024, the BoC cut its benchmark rate by 25 basis points to 4.75%, marking the end of a series of rate hikes aimed at combating inflation. This move reflects progress in controlling inflation and supporting economic growth. However, the BoC's decision contrasts with the U.S. Federal Reserve, which has kept rates steady due to higher-than-expected inflation. The BoC's rate cut is expected to lower borrowing costs for consumers and businesses, potentially stimulating economic activity and easing financial conditions.

Current trends of other Central banks worldwide

The U.S. Federal Reserve (Fed) has paused rate hikes despite previous plans for further increases, reflecting a cautious approach amid mixed economic signals, particularly persistent inflation pressures. Future rate decisions will likely depend on upcoming job and inflation data.

The Bank of England (BoE) has also maintained a high rate, currently at 5.25%, due to ongoing inflation concerns, especially in the services sector. Like the Fed, the BoE is taking a wait-and-see approach regarding future rate cuts.

In March 2024, the Bank of Japan (BoJ) made a significant shift by abandoning its negative interest rate policy for the first time in decades, raising short-term rates to around 0-0.1% from negative 0.1%. This move ends Japan's unprecedented monetary easing era. The BoJ has discussed the possibility of further rate hikes if a weak yen continues to push inflation higher, as indicated in recent meeting minutes.

The Reserve Bank of Australia (RBA) has recently paused rate hikes, focusing on assessing the impact of previous increases on the economy. However, the RBA has indicated it may resume rate hikes if inflationary pressures persist.

The People's Bank of China (PBC) has been more aggressive with easing measures, cutting key interest rate to support economic recovery amid slowing growth and deflation risks. This is part of a broader strategy to stabilize the economy and support domestic demand.

Impact of ECB and BOC rate cuts on the global economy

The ECB and BoC rate cuts could impact the global economy as follows:

- Economic Growth: Divergent monetary policies among major central banks may lead to varying economic outcomes. Countries with easing policies, like Canada and the Eurozone, may see increased consumer spending and investment, potentially boosting economic growth. In contrast, regions maintaining higher rates may experience slower growth due to high borrowing costs.

- Global Trade: Interest rate differentials can affect currency values, impacting global trade dynamics. For example, a weaker euro or Canadian dollar could make exports from these regions more competitive, potentially improving trade balances. However, it could also increase import costs, contributing to inflationary pressures.

- Financial Markets: Lower interest rates generally support higher stock prices by reducing borrowing costs for businesses and increasing consumer spending. However, this trend can also cause volatility as markets react to monetary policy changes and economic data. Bond markets, in particular, may see fluctuating yields as investors adjust their expectations based on central bank actions.

- Inflation Management: Central bank rate cuts aim to support economic activity but must balance this with the risk of reigniting inflation. This is particularly challenging given persistent inflationary pressures in many economies. Successfully managing this balance is crucial for long-term economic stability.

- Global Economic Coordination: The differing approaches of central banks reflect the varied economic conditions and challenges faced by each region. While some economies are easing to stimulate growth, others remain cautious to avoid a resurgence of inflation. This lack of coordination can complicate global economic interactions, including trade and investment flows.

Opportunities and challenges for Vietnam and policy recommendations

Vietnam, with its export-oriented economy, is highly susceptible to global economic fluctuations. The recent interest rate cuts by major central banks like the ECB and BoC could lead to currency volatility and changes in global trade dynamics, affecting Vietnam's export markets.

The ECB and BoC rate cuts might lead to the depreciation of the euro and Canadian dollar, making European and Canadian goods cheaper in global markets. This could potentially affect Vietnam's exports, making them relatively more expensive. However, reduced borrowing costs in Europe and Canada might boost economic activity in these regions, possibly increasing demand for Vietnamese exports. This could benefit sectors like textiles, electronics, and agriculture, which are significant contributors to Vietnam's exports.

Vietnam's rapid economic growth is significantly driven by foreign direct investment (FDI). Global interest rate changes can influence FDI flows, with investors potentially seeking higher returns in other markets. Lower interest rates in Europe and Canada might encourage investors to seek higher returns in emerging markets like Vietnam, potentially increasing FDI, particularly in manufacturing and technology sectors.

Vietnam could become more attractive to European and Canadian companies looking to relocate or expand due to lower operational costs and favorable investment conditions. As borrowing costs decrease, consumer spending in Europe and Canada might rise, leading to higher discretionary spending on travel. This could benefit Vietnam's tourism industry, which is recovering from the pandemic.

A weaker euro and Canadian dollar could lead to cheaper imports from these regions, potentially lowering input costs for Vietnamese businesses. However, it could also increase competition for local manufacturers.

Recommendations for Vietnam:

First, enhance trade policy through market diversification. Reduce dependence on any single market by expanding trade relations with other countries. This can help mitigate risks associated with currency fluctuations and economic downturns in specific regions. Improve export competitiveness by focusing on enhancing the quality and added value of Vietnamese exports to maintain competitiveness despite currency changes.

Second, boost economic resilience through domestic consumption. Develop policies to encourage domestic consumption to minimize the economy's vulnerability to external shocks. This includes supporting small and medium-sized enterprises and investing in consumer-oriented sectors. Focus on improving infrastructure to support efficient supply chains and logistics, making Vietnam an attractive destination for FDI and trade.

Third, attract foreign investment through a stable investment environment. Maintain a stable and predictable regulatory environment to attract and retain foreign investors. This includes transparent legal processes, property rights protection, and incentives for high-tech industries. Offer incentives for investments in high-tech and high-value sectors to diversify the economic base and reduce reliance on traditional manufacturing.

Fourth, in light of the ECB and BoC rate cuts, the government should implement a flexible exchange rate policy to respond to external shocks and maintain economic stability. This involves actively monitoring global financial markets and appropriate interventions when necessary. Build robust foreign exchange reserves to buffer against currency volatility and external economic pressures.

The recent rate cuts by the ECB and BoC are part of a broader trend among central banks reacting to specific domestic economic conditions. The impacts on the global economy include changes in growth trajectories, trade balances, financial market dynamics, and inflation management. As central banks navigate these complex conditions, their policies will continue to shape the global economic landscape.

Vietnam faces both opportunities and challenges. By diversifying trade markets, enhancing economic resilience, attracting foreign investment, managing currency risks, and boosting tourism, Vietnam can effectively navigate the impacts of global monetary policy changes and sustain economic growth.

Dr. Chu Thanh Tuan (Deputy Head of the Bachelor of Business program, RMIT University)