BACKGROUND OF INFLATION
DEFINITION OF INFLATION
Inflation is a pervasive global issue affecting nearly every capitalist country today, capturing the attention of economists worldwide Despite its significance, there remains no universally accepted definition of inflation.
“inflation” as it is a highly controversial term which has undergone many modifications
Prof Crowther describes inflation as a condition where the value of money declines due to rising prices, but this definition is incomplete It has faced criticism for not fully capturing the complexities of inflation, highlighting the need for a more comprehensive understanding of this economic phenomenon.
According to Crowther, any rise in the price level is considered inflationary and can negatively impact the economy; however, it can also act as a catalyst for economic revival.
Prof Crowther’s definition highlights that the increase in price levels is a symptom of inflation rather than its underlying cause This perspective does not adequately address the reasons behind the periodic rise in price levels.
Prof Kemmerer, an Economics and Finance professor at Princeton University, defines inflation as “Too much currency in relation to the physical volume of business being done” (High prices and Inflation, 1920) However, this definition is inadequate due to its vagueness, as it attempts to compare the volume of currency with the volume of goods and services The challenge lies in accurately determining the demand for money, as there is no reliable method to convert the physical volume of goods and services into a precise demand for currency Therefore, Kemmerer’s definition fails to provide a satisfactory understanding of inflation.
Prof Coulbourne reiterates Prof Kemmerer's definition of inflation, stating that it occurs when "too much money is chasing too few goods" (Macroeconomic Analysis, 1983) This definition highlights the relationship between the quantity of money and the supply of goods and services, yet it shares the same limitations as Kemmerer's perspective.
Kemmerer and Coulbourne provide definitions that link the supply of money to price level changes, establishing a cause-and-effect relationship Specifically, they assert that an increase in the money supply leads to a rise in the price level, where the increase in money supply is the cause and the subsequent rise in prices is the effect.
In post-World War I Germany, the traditional cause-and-effect relationship between money supply and price levels was inverted, as hyperinflation could not be solely explained by this dynamic Instead, rising prices led to an expansion of the money supply beyond business needs, further driving up prices This phenomenon, known as price inflation, represents a stage where prices increase so rapidly that the money supply struggles to keep up, culminating in hyperinflation Prof Einzing defines inflation as a state of disequilibrium where an increase in purchasing power either causes or results from rising price levels, highlighting that the increase in prices is both a consequence and a catalyst for the expansion of money supply.
According to Webster’s New Universal Unabridged Dictionary published in 1983, the second definition of inflation after “the act of inflating or the condition of being inflated” is:
An increase in the currency supply can lead to a rapid decline in its value and a rise in prices This phenomenon may occur due to a surge in paper money issuance, an increase in gold production, or higher expenditures when the supply of goods cannot keep up with demand.
Inflation is fundamentally defined not as the mere increase in prices, but as the rise in the supply of money that drives these price increases This perspective positions inflation as a cause rather than an effect, highlighting the underlying economic dynamics at play.
Between 1983 and 2000, the definition of economic factors transitioned from focusing on causes to emphasizing results This shift highlights that the underlying causes of economic changes can include either an increase in the money supply or a decrease in the availability of goods and services.
MEASURES OF INFLATION
Inflation is commonly assessed through the inflation rate of a price index, primarily the Consumer Price Index (CPI) The CPI tracks the prices of a range of goods and services typically bought by consumers The inflation rate represents the percentage change in this price index over a specific period.
Producer Price Indices (PPIs) track the average changes in prices received by domestic producers for their output, distinguishing them from Consumer Price Indices (CPIs) due to factors like price subsidization, profits, and taxes Typically, there is a lag between PPI increases and subsequent CPI rises PPIs reflect the cost pressures faced by producers from raw materials, which can either be passed on to consumers, absorbed by profits, or mitigated through increased productivity In both India and the United States, the earlier version of the PPI was known as the Wholesale Price Index.
1.2.3 Cost of Living Price Index (CLI)
A cost-of-living price index tracks the fluctuations in the expenses associated with maintaining a consistent standard of living over time This index serves as a scalar measure for specific periods, typically presenting a positive value that increases, reflecting inflation trends By comparing two incomes against this index, one can assess whether those incomes have adjusted in line with the rising cost of living.
1.2.4 Gross Domestic Product (GDP) Deflator inflation index
The GDP deflator is an economic indicator that measures the price level of all new, domestically produced final goods and services within an economy It reflects changes in the gross domestic product (GDP), which represents the total value of all final goods and services produced in a specific timeframe.
(Source: Measures of inflation, Wikipedia) Đinh Thị Huyền - ATCB – K11 6
CLASSIFICATIONS OF INFLATION
Stable nations typically manage inflation rates, aiming for a target of 1-2%, although economic conditions can cause rates to rise to 6% This phenomenon is often regarded as a natural or moderate level of inflation, which is nearly impossible to eradicate completely.
Running inflation occurs when prices rise rapidly, often exceeding 10 percent annually, and can result in price increases of over 100 percent over a decade While economists have not clearly defined the exact range, a double-digit inflation rate of 10-20 percent per year is typically considered running inflation This phenomenon is termed "chronic" due to its sustained high inflation rates, which can potentially escalate into hyperinflation if left unchecked.
During this period, prices escalate rapidly, often increasing at double or triple-digit rates, ranging from over 20% to 100% per annum or more, leading to an uncontrollable situation This scenario results in a complete breakdown of the monetary system due to the persistent decline in the purchasing power of money.
(Source: Types of inflation, www.rateinflation.com)
CAUSES AND EFECTS OF INFLATION
The demand-pull theory explains that inflation occurs when aggregate demand surpasses the available supply of goods and services, a phenomenon known as excess-demand inflation This theory posits that excess demand arises when the real demand for output exceeds the maximum feasible or full employment output at the current price level.
Demand-pull inflation occurs when the total monetary demand consistently surpasses the total supply of goods and services at existing prices, leading to rising prices due to an upward shift in aggregate demand Key factors contributing to this type of inflation include increased public expenditure, heightened investment, and a growing money supply.
Cost-push inflation, also known as cost inflation or sellers’ inflation, is primarily driven by the wage-inflation process Emerging after the mid-1950s, theories of cost-push inflation were developed in response to demand-pull inflation theories These theories share two significant common elements that help explain the dynamics of inflationary pressures in the economy.
1) That the upward push in costs is autonomous of the demand conditions in the concerned market
2) That the push forces operate through some important cost component such as wages, profits (mark up), or materials cost
Cost-push inflation occurs when rising costs, such as wages, profits, or materials, lead to increased prices for consumers This type of inflation can manifest as wage-push, profit-push, or material-cost push inflation, often combining multiple factors that drive costs higher When producers cannot absorb these costs, they pass them on to buyers, resulting in higher prices A notable consequence of rising wages is that it elevates production costs, which subsequently raises the overall price level, as prices are fundamentally linked to costs This can create an inflationary spiral, where increased wages prompt workers to demand even higher wages, perpetuating the cycle of inflation (Shaikh Saleem, Business Environment, 2nd Edition, 2006).
Figure 1.1: Demand-pull inflation and Cost-push inflation curve
Source: The Macroeconomic Theory book
If moderate inflation existing in a long period and anticipated by all members in society, this inflation rate would have positive impacts on the development of economy and society
Low inflation rates can lead to a slight depreciation of the domestic currency against foreign currencies, creating an opportunity for businesses to boost exports, enhance foreign exchange earnings, and stimulate the growth of domestic production.
When the economy operates below full capacity, moderate inflation can drive economic growth by increasing the money supply, providing additional capital for production and businesses, and encouraging consumption by both the government and consumers.
Moreover, two economic indicators closely followed are inflation and unemployment These two indicators have inverse relationship with each other The
Demand-pull inflation and cost-push inflation are key concepts in economics, as highlighted by economist Alban William Phillips in his "Theory of Inflation and Employment." This theory suggests that a country can leverage moderate inflation to reduce unemployment rates The relationship is illustrated by the short-term Phillips curve, demonstrating the trade-off between inflation and unemployment.
Figure 1.2: The short-term Phillips curve
Inflation poses significant risks not only due to its overall level but also because of its sudden emergence Unexpected changes in the inflation rate can lead to abnormal fluctuations in currency values, distorting the perception of value relationships and impacting various socio-economic factors This creates uncertainty within the macroeconomic environment.
The significant fluctuations in the inflation rate make it challenging for investors to accurately assess the benefits of their investments, often resulting in short-term decision-making, particularly for long-term projects Additionally, income instability drives investors to favor financial assets over real investment opportunities, leading to inefficient allocation of social resources and negatively impacting economic growth.
Inflation volatility leads to distorted financial decisions, causing businesses to favor short-term loans over long-term fixed-rate options to mitigate potential interest rate risks.
Inflation negatively impacts the labor market as employees seek nominal wage increases through strikes or in response to rising inflation rates, ultimately hindering economic growth Additionally, inflation leads to a redistribution of national income and affects societal wealth.
The impact of asset and debt types among the population is significant Owners who possess cash, deposits, or securities may experience losses due to the declining value of money In contrast, those who invest in gold, foreign currencies, and real estate can benefit from the appreciation of these assets, as their relative value increases.
Lenders with fixed rates face losses as borrowers benefit from repaying loans with devalued currency due to inflation Additionally, employees on fixed incomes, particularly those in lower income brackets, will experience hardship despite nominal income increases.
In the face of soaring inflation, individuals reliant on daily earnings often find themselves struggling to afford basic necessities, leading to hunger as they rush to purchase essential goods Moreover, they lack safe havens for protection during these challenging times.
Bingham IMF expert analyzed iii High interest rate
Inflation leads to an increase in nominal interest rates as a response to rising expected inflation rates Issues emerge when the expected inflation, which influences nominal interest rates, diverges from the actual inflation rate, ultimately impacting real interest rates.
INFLATION SITUATION IN SOME COUNTRIES
To gain a comprehensive understanding of inflation, this thesis examines significant historical cases, starting with Zimbabwe, which faced hyperinflation reaching astronomical percentages The analysis then delves into Venezuela, noted for its recent record-high inflation rates, and concludes with a look at inflation in China, a neighboring country with similar economic characteristics.
Zimbabwe became the first nation in the 21st century to experience hyperinflation, with its inflation rate exceeding 50% per month in February 2007 This staggering rate, equivalent to an annual inflation rate of 12,875%, marked the beginning of a severe economic crisis, leading to unprecedented inflation levels that have continued to escalate.
Due to the lack of current official money supply and inflation data, assessing the ongoing crisis in Zimbabwe remains challenging To address this issue, Cato Senior Fellow Steve Hanke has created the Hanke Hyperinflation Index for Zimbabwe (HHIZ), which utilizes market-based price data The index, covering the period from January 2007 to the present, reveals that Zimbabwe's annual inflation rate reached an astonishing 89.7 sextillion percent as of November 14, 2008.
Table 1.1: Hanke Hyperinflation index for Zimbabwe, 2007-2008
Hanke Hyperinflation Index for Zimbabwe (HHIZ)
Monthly Inflation Rate Annual Inflation Rate
Sources: Imara Asset Management Zimbabwe and author’s calculations
The high inflation in Zimbabwe has severely affected the country's impoverished residents, with a sandwich costing a staggering Zimbabwean $50 million and one kilogram of potatoes priced at Zimbabwean $17 million.
Zimbabwean dollar reached almost to zero Hence 50-million Zimbabwean dollars equaled to only US 1 dollar
Zimbabwe's hyperinflation severely impacted the economy, driving many citizens into poverty and prompting mass emigration This economic crisis eroded personal savings and depleted financial institutions' capital, as real interest rates became negative, further exacerbating the financial struggles of the population.
Zimbabwe's inflation crisis originated from land reform programs that aimed to redistribute land from white farmers to black farmers, leading to a significant decline in food production and export revenues In response to mounting expenditures, Mugabe's government and Gideon Gono's Reserve Bank resorted to printing increasingly higher denomination banknotes.
Since 2007, inflation rates have surged dramatically, resulting in hyperinflation The primary driver of this hyperinflation is government policies that have compelled the central bank to increase money printing.
Hyperinflation in Zimbabwe was effectively addressed within months through decisive government actions A key solution involved a credible commitment to halt the unlimited printing of money and designating a foreign currency as the official medium of exchange While the specific currency was less critical, the government's standardization on a single currency was essential for facilitating commerce Instead of completely abandoning the Zimbabwean dollar, the government could implement a strict monetary policy, potentially utilizing a currency board model similar to Hong Kong's, which focuses solely on maintaining a fixed exchange rate Currently, Zimbabwe relies on a mix of foreign currencies, predominantly the US dollar, to manage inflation.
Venezuela has experienced severe inflation rates in recent years, peaking at 31% in 2008, alongside Ukraine, while Sri Lanka, Vietnam, and Egypt followed with rates of 26%, 25%, and 19.7%, respectively From 1973 to 2012, Venezuela's average inflation rate was 26.5%, with a high of 115.18% in September 1996 and a low of 3.22% in January 1973 This persistent inflation has led to poor business maintenance and has pushed many companies toward bankruptcy, contributing to a fluctuating macroeconomic environment.
The government continues to insist the problem caused by "speculation" and by
Monopolies often overlook a crucial reality: they are significantly increasing the money supply without a corresponding rise in the availability of goods and services, as evidenced by Venezuela's soaring inflation rates.
In early 2012, Venezuela's monthly inflation rate, as measured by the National Consumer Price Index (INPC), dropped to 1.1% in February, marking the lowest level since the measurement system began in 2008 According to the Central Bank of Venezuela (BCV), this decline follows three consecutive months of decreasing inflation rates, which were recorded at 1.8% in December 2011 and 1.5% in January 2012 Additionally, the annualized inflation rate decreased to 25.3% from February 2011 to January 2012, down from 28.7% the previous year.
Table 1.2: Global inflation rate: CPI YoY % change, 2008
Source: Bespoke Investment Group Đinh Thị Huyền - ATCB – K11 15
The Venezuelan government attributes the recent slowdown in inflation to its social investment initiatives, particularly in health and education, along with policies aimed at boosting national agricultural production.
Bolivarian Government has made in these years is already reaching $500 billion,”
Minister Jorge Giordani said on state television channel VTV
The Venezuelan government has prioritized social spending on free health and education services, enabling citizens to allocate more resources towards food Additionally, the government's Mission Agro-Venezuela, initiated in January 2011, has been instrumental in reducing inflation by offering low-interest loans and training to farmers, emphasizing that boosting internal production is crucial for stabilizing the economy.
In the past year, the Venezuelan government has introduced various social initiatives, including a mass public housing program launched in May 2011, welfare payments aimed at families living in extreme poverty, and enhanced pension provisions initiated in December 2011 Additionally, a new employment and training program commenced its registration process in January of this year.
China and Vietnam share significant historical similarities in their economic development, both establishing socialist economies—China in 1949 and Vietnam in 1975 following its unification Initially, both nations focused on agricultural development as the foundation of their economies.
INFLATION IN VIETNAM, PERIOD 2000 TO PRESENT
HISTORY OF INFLATION IN VIETNAM FROM 2000- 2012
In general, statistics showed that the CPI from 2000 to 2003 was at low level and stable under 5%
Figure 2.1: The CPI in Vietnam, period 2000-2003
Source: General Statistic Office (GSO)
In this period, the CPI during some months was at minus level, such as in 2000, the percentage was -0.6 The economy fell down into deflation Thus, the term “Demand
The concept of "stimulation" emerged in government economic policies aimed at boosting the economy through relaxed credit conditions and increased state investment, which began in 2000 By 2002, the total development of investment capital had risen to over VND.
20 trillion compared to that in 2001; capital invested from citizens rose to 20.7% that accounted for 25.3% of total development investment capital
Thanks to these demand stimulating policies, the important change was noted in
2002 that the economy had moved from constant and prolonged deflation to slight inflation The CPI rose by 4%, which was enough for stimulating domestic investment
The CPI in Vietnam, period 2000-2003
In 2003, inflation remained low, with the Consumer Price Index (CPI) increasing by 3% However, a slight upward trend towards the end of the year raised concerns about potential inflation rates in the years to come.
Table 2.1: Situation of some socio-economic indicators in 2004 (Unit: %)
Total investment capital accounted for in GDP 36 36.30
In 2004, Vietnam experienced a significant inflation rate of 9.5%, prompting the Vietnamese Congress to take measures to reduce inflation in relation to economic growth, which was projected at 6.5% compared to a higher target of 8-8.5% During this period, total exports rose by 14-16%, and the urban unemployment rate decreased to 5.5% By 2005, inflation was successfully maintained at 8.4%, aligning with the economic growth rate (Source: GSO, 2006).
Entering 2006, the government succeeded in tackling inflation, so the rate dropped sharply by 0.9% to 6.6% compared to this figure in 2004
Table 2.2: Growth rate of consumer prices period 2004 – 2006 (Unit: %)
Source: GSO (2006) Đinh Thị Huyền - ATCB – K11 20
Figure 2.2: The CPI in Vietnam, period 2007-2009
During the observed period, Vietnam experienced a significant rise in inflation, with the Consumer Price Index (CPI) in December 2007 increasing by 2.91%, marking the highest rate in over a decade The average inflation rate for 2007 was recorded at 12.63%, which was surpassed in 2008 when the CPI surged by 18.44% in just the first six months, the highest annual increase in 15 years since 1993 Monthly inflation rates during this period varied, showing rates of 2.4%, 3.6%, 3.0%, 2.2%, 3.9%, and 2.1% Despite a GDP growth of approximately 6.8% and controlled money supply growth, along with a credit growth rate of 12%, the risk of liquidity shortages in commercial banks was mitigated by mid-July, yet inflation still reached a peak.
19.89% on average at the end of 2008 However the year of 2009 ended the period by the dramatic decline to the lowest level of 6.88% from 2007
Following the rising trend of the late 2009, inflation rose strongly in September
2010 that caused the CPI for 11 months went up to 9.58% compared 6% with the same
The CPI in Vietnam, period 2007-2009
200720082009 Đinh Thị Huyền - ATCB – K11 21 period in 2009 As a result, the inflation rate climbed to 11.8% in 2010 in comparison with the percentage of 6.88 in 2009
Figure 2.3: Vietnam - CPI inflation from 2009 to the early 2012
Source: The State bank of Vietnam (SBV)
In 2011, the global economic landscape faced significant challenges, marked by rising world prices that pushed domestic goods prices higher The average Consumer Price Index (CPI) surged by 12.79% in the first quarter compared to the previous year, with a notable spike in May where the CPI, alongside food and transportation costs, exceeded 3% This led to an inflation rate of 18.12% for the year, the highest since December 2008, and one of the highest rates globally, surpassing other ASEAN economies (Source: World Economic Outlook) Consequently, this inflation hindered the government's ability to meet the National Assembly's target of a 7-8% inflation rate.
Figure 2.4: CPI in Vietnam, period Jan 2011 – Apr 2012
In 2012, the Government and Vietnam National Assembly implemented various measures to control inflation, resulting in positive economic indicators during the first four months of the year According to the General Department of Statistics, the Consumer Price Index (CPI) in April 2012 experienced a modest increase of 0.05% compared to the previous month.
2011 With this slight increase in April, it is the first time the CPI grew at the lowest level since March 2009 with the proportion of -0.2
Over the past six months, Vietnam has witnessed a steady decline in the Consumer Price Index (CPI), leading to a significant reduction in the inflation rate, which has now dropped to 8-9%, aligning with Prime Minister Nguyen Tan Dung's expectations.
CAUSES OF INFLATION IN VIETNAM
Inflation in Vietnam since 2000 has been driven by a variety of subjective and objective factors, influenced by both domestic and international elements Key causes of inflation can be categorized into demand-pull and cost-push factors, highlighting the complex interplay of direct and indirect reasons contributing to the country's economic landscape.
Previous loose monetary policy implemented in a long time in order to stimulate aggregate demand and maintain the growth rate has brought into play its consequences.
The government's demand-stimulating policy facilitated smooth capital flow, boosted consumption, and enhanced aggregate demand; however, it ultimately resulted in an increase in the money supply.
In 2000, the State Bank of Vietnam (SBV) relaxed the interest rate ceiling and adopted a base interest rate, fostering a market-driven environment for capital demand and supply, which energized commercial banks This led to a continuous decline in deposit interest rates While the demand-stimulating policies during this period contributed to a partial economic recovery, they also laid the groundwork for the high inflation that began to emerge in mid-2007.
From 1995 to 2009, the average annual credit growth reached 28.8 percent, significantly outpacing Thailand and Indonesia by five times and exceeding China by 1.5 times Additionally, the ratio of outstanding credit to GDP tripled from 2000 onwards, highlighting a substantial increase in credit activity relative to economic growth.
2010 whereas China rose only 1.23 times, Thailand almost had no increase, Indonesia and Philippines also reduced drastically
Figure 2.5: The credit growth, money supply and inflation, period 2000 -2011
Source: SBV (2011) Đinh Thị Huyền - ATCB – K11 24
Between 2007 and 2010, Vietnam experienced significant increases in money supply, GDP, and real GDP, with growth rates of twofold, 1.73 times, and 1.2%, respectively Each year, the central bank implemented a "money supply" policy aimed at addressing various demands, including refinancing for state-owned commercial banks This led to credit growth outpacing GDP growth, surpassing the economy's absorptive capacity and contributing to high inflation in Vietnam.
Figure 2.6: The credit growth and M2 in Vietnam from 1994- the early 2012
To combat inflation effectively, it is essential to establish a positive real interest rate within the market mechanism This requires that the interest rates on loans exceed those on deposits, while the rates for mobilizing deposits must also surpass the prevailing inflation rate.
Until 2007, the State Bank of Vietnam (SBV) failed to implement key principles, leading to the devaluation of the VND and an excess of money in circulation This situation caused liquidity issues for many banks, disrupting their lending activities Although efforts to curb inflation were made in 2007 and 2008, Vietnamese banks offered loan interest rates that were higher than deposit rates, which remained significantly lower than the inflation rate.
Thus, the excessive money in circulation especially in non-manufacturing sector, including securities and real estate was still too high and also resulted in inflation
Credit and M2 growth in Vietnam, 1996-2011
Credit growth M2 growth Đinh Thị Huyền - ATCB – K11 25
In company with the loose monetary policy, the expanding fiscal policy in the period 2000-2010 had been applied as well
To support economic growth, the Government aimed to enhance infrastructure, leading to a persistent budget deficit due to insufficient revenues to meet spending demands Consequently, financing became a key strategy to address the deficit, primarily relying on long-term foreign debt, which significantly impacted the exchange rate and contributed to rising internal inflation Additionally, the expansion of fiscal policies stimulated production and business development, resulting in a notable increase in the Consumer Price Index (CPI).
Figure 2.7: Vietnam Government Budget, period 2000-2012
Investment capital primarily enters the economy through State-owned enterprises (SOEs) and state-managed projects Despite the abundance of investment projects, inefficiencies arise due to corruption, waste, and misallocation of public resources These issues lead to increased product costs in the public sector, ultimately driving up input costs across the entire economy.
Figure 2.8: The investment structure of the public sector, non-state and FDI, 1995-2010
Widespread and inefficient investments are increasingly common, particularly as many State-owned corporations venture into banking and real estate, leading to rising State expenditures These new investment areas are not their strengths, resulting in a mismatch between the growth of investment projects and their actual implementation Numerous projects, lacking proper procedures, still receive funding, while others are initiated without sufficient capital This scattering of capital allocation has caused an imbalance in demand and capacity, contributing to a significant number of incomplete investment projects and wastage of State resources.
In 2010, the Ministry of Planning and Investment reported that out of 34,607 investment projects, 3,386, or 9.78%, were behind schedule, highlighting issues with ineffective investment indicated by a high Incremental Capital Output Ratio (ICOR) Most state-invested projects were long-term, and these investments represented a significant portion of the total economic investment Consequently, increased government expenditures contributed to rising demand, which in turn elevated domestic price levels.
2.2.1.3 Weak management of foreign capital inflows into Vietnam
Foreign investment has been instrumental in driving economic growth in Vietnam, as it not only boosts the economy but also helps mitigate the trade deficit and strengthen national reserves.
Annually, offshore capital flows to Vietnam through various channels, including Official Development Assistance (ODA), Foreign Direct Investment (FDI), Foreign Indirect Investment (FII), and remittances In 2007, total offshore inflows reached approximately 19.6 billion USD, accounting for about 28% of GDP, with foreign investment contributing 6 billion USD and remittances 5.5 billion USD, excluding nearly 1 billion USD in ODA reimbursements Despite macroeconomic uncertainties in 2008, capital continued to flow into Vietnam, with reimbursements peaking at 4.9 billion USD Expectations for investment in Vietnam for 2008 were projected between 10 to 12 billion USD, although the reimbursement process did not align with the pledged amount of 35 billion USD for the year, influenced by monetary and fiscal policies amid high inflation.
The significant increase in foreign institutional investment (FII) inflows to Vietnam, which reached $56 billion in 2007 and accounted for 50% of total inflows, had detrimental effects on the economy Experts noted that while these inflows were substantial, only a small portion was effectively absorbed, leading to overheating in the stock and property markets This surge in investment contributed to rapid price increases, with property and stock values doubling by the end of 2007, ultimately resulting in a bubble that negatively impacted the Vietnamese economy.
Figure 2.9: FDA, ODA, remittance in Vietnam, period 1997-2007
Surging inflows typically exert pressure on a country's domestic currency to appreciate To uphold a stable exchange rate policy that supports both exports and imports, Vietnam injected money into the market to acquire foreign currency, thereby bolstering its foreign currency reserves In the first half of 2007, the State Bank of Vietnam (SBV) injected 112 trillion VND into circulation to purchase 7 billion USD, leading to an increased money supply However, the inadequate drainage of VND contributed to an excessive money supply, which in turn fueled inflation during this period, as reported by the SBV.
2.2.2.1 The increase in resident’ income
CONSEQUENCES OF HIGH AND UNSTABLE LEVEL OF INFLATION
In 2011, several commercial banks implicitly agreed to deposit rates of 19-20% for customers with large deposits The increase in input interest rates compelled these banks to raise their lending rates to approximately 21% per year This rise in capital expenditures resulted in higher goods prices across various enterprises, contributing to an overall inflation in the economy.
2.2.2.5 The economic effect of natural disaster and diseases
Natural disasters such as floods and droughts, along with diseases like H1N1 flu and SARS, can significantly disrupt agricultural production, resulting in increased food prices for consumers The economic impact varies based on the type and severity of the disaster Food, being the most influential commodity group, constitutes 42.85% of the basket of goods, thereby exerting a substantial influence on the overall price index.
2.3 CONSEQUENCES OF HIGH AND UNSTABLE LEVEL OF INFLATION VIETNAM
Inflation has significantly impacted various aspects of the socio-economic landscape, affecting both macroeconomic and microeconomic factors This article will focus on five key elements: the unstable macroeconomic environment, elevated nominal interest rates, declining real income and living standards, rising unemployment, and issues related to the balance of payments.
In recent years, Vietnam has experienced significant fluctuations in inflation, frequently surpassing government targets at the start of each year This unpredictability in inflation rates contributes to an unstable macroeconomic environment.
Senior economic experts have noted a decline in confidence among the public and both domestic and foreign investors due to unfavorable macroeconomic indicators, including inflation, budget and trade deficits, international payments balance, foreign debt, and exchange rates According to economist Le Dang Doanh, the economic and social conditions in the country are at their lowest point since 1991.
Inflation has complicated profitability assessments, leading to hesitancy in long-term investment decisions among businesses The overall business environment in Vietnam has not received favorable evaluations, with the World Bank and International Financial Institution reporting that Vietnam fell to 98th place out of 183 economies in 2010-2011, a decline of eight positions since 2010.
Inflation volatility has led to distorted financial decisions, with firms favoring short-term loans over long-term options Similarly, banks are inclined towards short-term lending to mitigate anticipated risks.
Inflation has led to the devaluation of the Vietnamese Dong (VND), adversely affecting the income of producers and importers and diminishing the appeal of the Vietnamese market As a result, investors are increasingly favoring financial assets over real investment projects due to income instability This shift has caused a misallocation of social resources, ultimately hindering economic growth.
In early 2011, the surge in prices led to a significant increase in strikes, with 21 occurrences within just two months, as workers demanded higher wages and shorter working hours This figure represented one-third of the total strikes recorded in the previous year.
In 2010, the insufficient minimum wage for workers and employees led to a surge in strikes and hindered economic growth.
From 2008 to the present, Vietnam's GDP growth rate has shown a downward trend, starting at 8.49% in 2008, decreasing to 6.9% in 2010, and reaching its lowest point of 4% in 2012.
Figure 2.12: Vietnam GDP growth rate from 2002 to 2012
High inflation has led to an increase in nominal interest rates, reflecting the rise in expected inflation This relationship indicates that while inflation and interest rates move in the same direction, interest rates tend to be higher To protect depositors' interests, the principle of positive real deposit interest rates is essential Historically, during periods of 5-7% inflation, interest rates below 10% were deemed acceptable, as depositors still enjoyed a real benefit of 3-4% after accounting for inflation.
In 2010, as inflation surged to 11.75%, banks were compelled to raise interest rates above the inflation rate to retain depositors This increase in interest rates also resulted in higher lending rates, making it challenging for businesses and individuals to secure bank loans and leading to reduced profits amid soaring inflation Consequently, these factors negatively impacted overall economic growth.
Figure 2.13: The real, nominal interest rate and inflation in VN, 2010 to June 2011
2.3.3 Decrease real income and living standard
The rising Consumer Price Index (CPI) is a major concern for both policymakers and everyday citizens, as escalating inflation threatens to undermine efforts to enhance living standards, particularly for low-income individuals.
In 2008, inflation led to a 15.3% increase in the average worker's income; however, this was still 4.6% lower than the rate of price growth Similarly, in 2010, the average income rose by 10.3% compared to 2009, yet it fell by 1.45% when adjusted for inflation Despite nominal salary increases, they were insufficient to keep pace with the rising cost of living, resulting in a significant decline in real income in 2010 after accounting for price changes.
SOLUTIONS APPLIED FOR CONTROLLING INFLATION IN
Inflation arises from various factors, including economic structure, import-export dynamics, money supply, credit relations, and fiscal policy However, it is primarily reflected through monetary relations To effectively manage inflation, it is crucial to implement monetary policy and utilize its instruments This approach is deemed a central and decisive solution for controlling inflation in alignment with the current economic landscape.
In this circumstance, tight monetary policy has been applied since the 5 th November
In response to heightened volatility, the implementation of a tightened monetary policy and administrative support, as outlined in Resolution 11 on February 24, 2011, proved to be a prudent strategy Consequently, credit growth significantly decreased from 27.7% in 2010 to just 10.9% in 2011 This reduction in aggregate demand contributed to a decline in inflation, which fell to a single-digit rate of 0.18% by May 2012, and also led to a notable decrease in import demand, ultimately stabilizing the domestic currency.
In 2011, the State Bank of Vietnam (SBV) implemented several support policies aimed at controlling credit growth below 20%, focusing on capital allocation for business development, agriculture, and rural initiatives The SBV prioritized assistance for small and medium enterprises while reducing credit loan ratios for the non-manufacturing sector Additionally, it regulated foreign currency sales by organizations and individuals, particularly state corporations, enforced strict controls on gold trading activities, and enhanced inspection and supervision to ensure compliance with foreign exchange regulations.
In 2011, credit growth reached approximately 12-13%, driven by increases in manufacturing, business, agriculture, and rural credit, which rose by 12%, 15%, and 24%, respectively This growth occurred despite a decline in securities and real estate credit, particularly noticeable since August.
2011, the CPI has been below 1% per month, softening the rate pressure Thus inflation has been curbed
Exchange rate and foreign exchange management have become top priorities, with the average interbank rate adjusted to 9.3%, rising from 18.932 to 20.693 VND/USD as of November 2, 2011 The trading band was also narrowed to ± 3% ± 1% to enhance market liquidity, promote exports, reduce the trade deficit, improve the balance of payments, and increase foreign exchange reserves.
The State Bank of Vietnam (SBV) has implemented strict controls on the lending and sale of foreign currency used for non-essential imports Additionally, it is crucial for the market to monitor and forecast fluctuations in global gold prices, as well as domestic supply and demand, to ensure logical gold import operations This proactive approach effectively prevents speculation, hoarding, and market manipulation.
To combat unstable inflation and stabilize the macroeconomy, the Government has directed ministries and localities to focus on implementing a tight fiscal policy This includes reducing the budget deficit, saving on public expenditures, and increasing the state budget volume, all while ensuring the effectiveness of monetary policy.
Specifically, the Ministry of Finance coordinated with the ministries, agencies and localities in an effort to increase the State budget by 7-8% compared with the prediction of the National Assembly
In 2011, the Government aimed to maintain the budget deficit below 5% of GDP while closely monitoring foreign loan repayments, particularly short-term loans, to ensure that outstanding government and public debts remained within acceptable limits.
In 2012, the Ministry of Planning and Investment will refrain from advancing the State budget and government bonds for projects It will focus on inspecting and reviewing investments made by economic corporations and state-owned enterprises, while also petitioning the Prime Minister to address and eliminate inefficient investment projects, including those involving foreign investments.
Moreover, Prime Minister instructed not to begin construction of new projects using the State budget and government bonds, except the projects for urgent prevention and disasters repairing
In 2008, public investment was significantly reduced by trillions of VND, including a nearly 7,000 billion VND cut in non-essential projects, particularly a USD 5,876 reduction in the state budget This strategic move aimed to decrease the money supply in circulation and prioritize essential expenditures that support social security stability.
In 2011, the financial sector achieved a remarkable 13.6% increase in state budget revenue, surpassing the previous year's 20.4% growth, thanks to stringent fiscal policies Notably, the budget deficit was reduced to 4.9%, which is 0.4% lower than the target set by the National Assembly.
2.4.3 Boosting production and business, encouraging export, reducing trade deficit
In response to Government Resolution No 11, the Prime Minister has tasked the Ministry of Industry and Trade with coordinating efforts among relevant ministries and localities to enhance production and business, boost exports, and manage trade deficits while ensuring energy efficiency This initiative, set for the second quarter of 2011, aims to establish regulations that balance the demand and supply of essential goods, provide effective guidelines for rice exports, stabilize domestic food prices, and collaborate with the Ministry of Finance to manage national reserves for food security, alongside implementing timely measures against speculation.
To maintain economic stability, the trade deficit should not exceed 16% of total exports It is essential to establish effective principles and procedures for regulating the importation of goods, materials, and equipment funded by the State budget and government bonds, while also limiting the import of consumer goods Additionally, the Ministry has directed the Electricity of Vietnam Group (EVN) and its subsidiaries to develop plans ensuring that power plants operate at full capacity, prioritizing adequate electricity supply for production during the dry season.
The Ministry of Finance is collaborating with various ministries and local authorities to implement effective tax and fee policies aimed at supporting exporters and traders in the steel, cement, and other sectors that utilize lower-cost inputs This includes the potential exemption, reduction, and postponement of taxes on imported inputs for export-oriented industries such as textiles, footwear, seafood, cashew nuts, wood, and pharmaceuticals Additionally, the ministry plans to continue refunding value-added tax on exported goods throughout 2012.
In 2010, Vietnam's trade deficit decreased to approximately $12 billion, down from $12.8 billion in 2009 and a record $17 billion in 2008 By 2011, the deficit narrowed significantly to $9.5 billion, the lowest in a decade, despite ongoing concerns about the country's economic stability Exports surged by 33.3% year-on-year, reaching $96.2 billion, while imports increased by 24.7% to $105.7 billion, according to preliminary data from the General Statistics Office (GSO).
In one word, although Vietnam's trade deficit has been controlled by implementing these policies with the decreasing trends, the balance of payments still has insufficiency Đinh Thị Huyền - ATCB – K11 41
Currently, the Government is gradually implementing the roadmap of wage reform and gaining a lot of positive results
Another VND 220 000 was included to the monthly minimum wage from May 1 st
2012, according to a different Government decree Accordingly, the rise is going to be applied whatsoever Condition agencies, individual’s military, socio-political organizations and Condition-possessed one-member limited companies
It's the fourth increase in the minimum wage within the last 4 years: From 2009-
2012, the increase was VND 650 000, VND 730 000,VND 830 000 and VND 1050 000 respectively
SHORTCOMINGS OF INFLATIONTORY SOLUTIONS APPLIED IN
Vietnam's economy has experienced significant progress in recent years, marked by effective inflation control measures that resulted in a reduced inflation rate in early 2012 Additionally, the stability of foreign exchange and commodity prices, along with lowered interest rates and enhanced social welfare, reflects these achievements However, despite these advancements, several shortcomings have emerged in the implementation of these solutions.
Ineffectiveness of combination between monetary and fiscal policies
Some economists have expressed concerns that implementing a combination of fiscal tightening and economic growth policies may be more challenging than the Government initially suggested The complexity of this dual approach was evident in 2011 and early 2012, as the public expected reduced public spending to alleviate the budget deficit, yet the finance authorities reported exceeding revenue and expenditure targets set in September and October, despite real GDP falling short of forecasts.
High lending interest rate maintenance
Despite a slight decrease in lending rates from commercial banks, many still maintain interest rates exceeding 20%, hindering access to loans for small and medium-sized enterprises This inefficiency in interest rate reduction policies has left numerous businesses on the brink of bankruptcy due to insufficient capital for production and high manufacturing costs that result in minimal profits.
The insignificance of raising minimum wage
Wage growth is lagging behind rising prices, rendering wage reforms ineffective Despite the government's four adjustments to the minimum wage from VND 650,000 to VND 1,050,000 between 2009 and 2012, these increases have not sufficiently countered the surge in essential commodity prices, leaving employees struggling to meet their basic needs Currently, salaries for staff and officials only fulfill about 40% of their requirements, and the existing wage structure is based on mechanical and inequitable regulations that fail to attract and retain talent This situation heightens the risk of a wage-price-money inflation spiral.
The current strategies encouraging corporations and groups to utilize domestic goods, along with increased import taxes and state bank directives to restrict foreign currency supply for non-essential imports, have proven ineffective in achieving comprehensive results.
By the end of the first quarter of 2011, Vietnam experienced a significant increase in the importation of luxury goods, which contributed to 40 percent of the country's trade deficit High-end items such as expensive cars, smartphones, cosmetics, and wine continued to flood the market, highlighting the need for stricter regulations on these imports.
Vietnam's state agencies are characterized by a complex, overlapping structure that leads to unclear functions and conflicts among officials This disorganization results in inconsistent policy implementation and slow, inefficient decision-making processes, perpetuating bureaucracy Consequently, while numerous policies are formulated, their enforcement is lax, hindering the achievement of intended outcomes.
RECOMMENDATIONS FOR FURTHER SOLUTIONS TO 44
RESTORE CONFIDENCE IN POLICIES APPLIED
Vietnam's economic reforms have consistently faced the challenge of inflation, which remains a significant concern for the economy Public perception of inflation tends to be highly sensitive, often leading to reactions that exacerbate the situation and drive inflation rates even higher This heightened sensitivity complicates the implementation of effective economic policies.
The government's responses to inflation have been slow, passive, and inconsistent, leading to a decline in public confidence in policy effectiveness This lack of trust is evident in the surge of interest in gold, dollars, and real estate, as individuals increasingly invest in alternative financial assets instead of holding the Vietnamese Dong (VND).
In early 2010, the government adopted a tight monetary policy in response to rising inflation, but later shifted to a looser approach due to business pressures and economic growth Consequently, credit growth was limited to 10% and money supply growth to 7% in the first half of the year, while the latter half saw significant increases, with credit growth reaching 31% and money supply growth at 28%.
Short-term policies have resulted in long-lasting consequences, eroding the confidence of individuals, businesses, and both domestic and foreign investors in the government's ability to manage inflation effectively.
It is crucial for the government and relevant agencies to rebuild and enhance public confidence in their policies by implementing timely and effective measures.
ECONOMIC RESTRUCTION
The ongoing process of nation building has revealed that many state agencies and economic units struggle to adapt to rapidly changing circumstances The global financial crisis and fluctuating inflation have significantly affected the economy, prompting the government to initiate a comprehensive economic reform This reform focuses on restructuring three key areas: public investments, state-owned enterprises (SOEs), and the banking finance sector, aiming to establish a more resilient and sustainable economic growth model.
The Government must focus on achievable outcomes rather than pursuing unattainable goals By restructuring the three key areas, the State can effectively manage its resources and drive meaningful results.
Public investment, managed by the State, necessitates ongoing restructuring, which includes modifying plans, amending investment mechanisms, eliminating ineffective investments, and acquiring incomplete projects for other investors.
The State can indirectly influence corporate restructuring through policies that foster self-motivation, such as amending bankruptcy laws and reforming the judicial system to build confidence Policymakers should focus on effective economic units to expand joint ventures with other enterprises Strong corporations across various sectors are essential for driving economic development and addressing social issues in the new era.
In the banking and finance sectors, key priorities include maintaining a robust financial system to manage bad debts and ensuring compliance with legal capital requirements Credit organizations are categorized into three groups: healthy institutions, those facing temporary liquidity issues, and weak institutions Healthy credit organizations promote growth and competitiveness both domestically and internationally, while weak institutions pose risks to the system and require restructuring.
In brief, restructuring is a long-term plan and it must be synchronous, prudent, and transparent Đinh Thị Huyền - ATCB – K11 46
INDEPENDENT STATE BANK OF VIETNAM
Experts from the IMF emphasize the necessity for Vietnam to establish an independent and adaptable central bank to effectively implement monetary policies aimed at price stabilization IMF senior economist Rina Bhattacharya highlighted during a seminar on Vietnam's policy challenges that the current central bank requires more defined and autonomous responsibilities.
According to Article 4, Section 1 of the 2010 State Bank Law, the central bank is tasked with stabilizing the domestic currency, ensuring the security and efficiency of both the banking and payment systems, and contributing to socio-economic development with a focus on socialism.
The government should focus on setting clear objectives rather than deeply intervening in the State Bank's tools, such as exchange rates and interest rates This approach allows the State Bank to make timely and effective decisions regarding monetary policy.
The government sets the target for exchange rates and interest rates, while the State Bank operates within these limits using various instruments, such as reserve requirements and Open Market Operations (OMO) If the interest rate target fails to align with market changes, the State Bank will seek guidance from the government's decision for necessary adjustments.
In contemporary economies, central banks operate independently, yet their objectives align with those of the government to promote national and economic welfare While their primary focus includes controlling inflation, it is essential for independent central banks to also prioritize economic growth, ensuring that both goals are harmonized for optimal outcomes.
ADMINISTRATIVE REFORM
The government must prioritize reforming the administrative system, as a streamlined and efficient legal framework significantly reduces societal costs Overlapping functions and responsibilities hinder operational effectiveness, making it crucial to eliminate bureaucratic inefficiencies for improved governance.
In 2020, the government aims to establish a modern, efficient, and professional administrative system as part of a decade-long reform initiative Key priorities include enhancing staff quality and reforming the wage policy to provide genuine incentives for officials, ultimately improving administrative and public services.
SELF- ANTI – INFLATION SOLUTIONS FOR ENTERPRISES
Inflation is driven by cost-push factors, prompting enterprises to reduce production costs to remain competitive Implementing long-term cost-cutting strategies is essential during the integration period To achieve this, businesses must adopt modern technologies and effective governance models that not only lower production expenses but also enhance labor productivity.
Vietnamese enterprises often struggle with establishing a long-term development strategy, particularly in diversifying their business lines to stabilize finances and mitigate risks Success hinges on effective business planning, which can significantly enhance their operational resilience.
Businesses must prioritize the use of risk prevention tools to safeguard their operations Implementing derivative financial instruments is crucial for enterprises to shield themselves from potential risks Companies that neglect these insurance tools may encounter significant challenges in the future.
STRENGTHEN SOCIAL WELFARE
The Ministry of Labor, Invalids and Social Affairs must collaborate with various ministries, agencies, and local authorities to effectively implement social welfare policies outlined in approved programs and projects Additionally, it is crucial to expedite the measures for ensuring social welfare as mandated by the Government’s Resolution No 02.
The government must prioritize poverty alleviation in rural regions, especially in the most impoverished communes and villages This includes supporting low-income households and localities in exporting labor, as well as offering loans to students to enhance their educational opportunities.
The Ministry of Finance must collaborate with the Ministry of Planning and Investment to allocate funds that support localities in implementing social welfare policies aligned with the updated poverty benchmark This initiative should also provide assistance to low-income households following the adjustment of electricity prices, ensuring that the support effectively reaches those in need.
ACCURACY AND SPEEDING UP INFORMATION DISSEMINATION 48
The Ministry of Information and Communications will coordinate with the Commission for Popularization and Education, along with relevant agencies, to oversee and regulate mass media organizations effectively.
Mass media agencies should align their communications with Party and State guidelines, focusing on disseminating updated information related to finance, money, pricing, and social welfare policies This includes specific measures to assist poor households impacted by electricity price adjustments, fostering social understanding and consensus within the community.
Implement stringent penalties for disseminating false information regarding the Party and State's policies aimed at controlling inflation, stabilizing the macro-economy, and ensuring social welfare.
In conclusion, this thesis highlights the theoretical framework of inflation and analyzes Vietnam's inflation trends from 2000 to early 2012, emphasizing recent years It reveals that the Government and the State Bank of Vietnam have struggled to effectively control inflation, while many enterprises have shown a lack of concern regarding its impact.
Inflation in Vietnam is influenced by various factors, particularly external ones The government's response to these changes has been relatively passive, with solutions often lagging behind current circumstances Additionally, these measures have not fully considered all potential impacts, occasionally resulting in unintended consequences.
This thesis analyzes inflation in Vietnam and applies inflationary theory to the socio-economic context, proposing several solutions aimed at controlling inflation and stabilizing the economy.
This graduation thesis has notable shortcomings, particularly in its analysis of the relationships between inflation, exchange rates, and interest rates, as well as the interplay among these factors Moving forward, I aim to address these issues with the valuable guidance and support of my supervisors, conducting further research to enhance the thesis and achieve more significant results.
Hanoi, June 2012 Đinh Thị Huyền Đinh Thị Huyền - ATCB – K11 50
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