STATE BANK OF VIETNAM BANKING ACADEMY Foreign Language Faculty GRADUATION THESIS INFLATION IN VIETNAM (2004 – 2012) Student : Le Thi Van Anh Lecturers : Dinh Thi Thanh Long (M.A) Ngo Tung Anh (M.A) 6th June 2012 1 Acknowledgement It is with immense gratitude that I acknowledge the support and help of two instructors, Master Dinh Thi Thanh Long and Master Ngo Tung Anh, throughout this graduation thesis. I sincerely thank all of my lecturers at Banking Academy, especially the lecturers of Foreign Language Faculty, who provided me useful background knowledge during the last four years. Due to time constraints and limited capacity of the writer, this graduation thesis will certainly not be free from defect. I hope the lecturers and readers will sympathize and contribute to complete the thesis.
Thank you! Hanoi, 6th June 2012. 2 Table of Contents Acknowledgment. 2 List of Tables and Figures. 5 List of Abbreviations.
9 Chapter 2: An Overview of Inflation. Causes of Inflation. Cost-Push Inflation. Demand-Full Inflation.
Consequences of Inflation. Re-distribution of Income and Wealth. Create Instability in the Economic Environment. Influence of balance of payment.
Cost-push Inflation. Social Unrest and Revolts. Shoes Leather Cost. Influence of Unemployment Rate.
16 Chapter 3: Inflation in Vietnam. An Overview of Inflation of Vietnam in Recent Years (2004-2012). Inflation in Vietnam in 2004. Inflation in Vietnam in 2007-2008.
Inflation in Vietnam in 2010. Inflation in Vietnam in 2011. Inflation in Vietnam at the Beginning of 2012. The Consequences of Inflation to Vietnam Economy.
Effects on Social and Economic Growth. Effects on Trade Balance. Effects on Unemployment. Effects on Banking Business.
33 Chapter 4: Recommendations and Conclusions. 38 4 List of Tables and Figures 1.1: Inflation Growth Rate in Vietnam (2004-2011) .1: Selected Economic Indicators of Vietnam (2005–2007) .2: Inflation growth rate of Vietnam in 2008 .3: Inflation growth rate of Vietnam in 2010 .4: Inflation growth rate of Vietnam in 2011 .5: Inflation growth rate of Vietnam at the Beginning of 2012 .5: Year on Year CPI Growth .2: GDP and Inflation Rate of Vietnam (2004 - 2011) .2: Trade Balance and Inflation Rate of Vietnam (2004 - 2011) .3: Unemployment and Inflation rate of Vietnam (2004 – 2010). 32 5 List of Abbreviations No. Abbreviations In full 1.
CPI : Consumer Price Index 2. ER : Exchange Rate 3. FDI : Foreign Direct Investment 4. FII : Foreign Indirect Investment 5.
FSAP : Financial Sector Assessment Program 6. GDP : Gross Domestic Product 7. GSO : General Statistics Office Of Vietnam 8. ICOR : Incremental Capital - Output Rate 9.
IMF : International Monetary Fund 10. MoF : Ministry of Finance 11. PPI : Producers’ Price Index 12. SBV : The State Bank of Vietnam 13.
SOCB : State-Owned Commercial Bank 14. SOE : State-Owned Enterprise 15. US : United States 16. USD : United States Dollar 6 17.
VAT : Value Added Tax 18. VND : Vietnam Dong 19. WB : World Bank 20. WTO : World Trade Organization 7 Chapter 1: Introduction 1.
Purpose Keynesian macroeconomics theory stated that inflation is a continually rising price level, which results from demand-pull and cost-push factors or increases in money supply. Unpredictably high inflation may cause unwanted instabilities in the economy; therefore every single central bank in the world wants to control inflation. The State Bank of Vietnam is no exception. In some period, the SBV might have been too focused on economic growth, or have accommodated fiscal policy of the Government, pumping too much funds into the economy, which leads to inflation.
However, that is the trade-off that any central bank has to face. It is their ability to assess the situation and make good decisions on time that counts. In practice, the SBV has all the tools of monetary policy like other central banks. In addition, it can lend funds to the Government, sell or purchase gold or foreign currency, and even directly "command" commercial banks to adjust credit growth.
Along with the SBV, the Price Management Department of the Ministry of Finance can also, at any time, set price ceilings for essential commodities, while most developed countries cannot. Therefore, it is believed that the SBV is fully capable of controlling inflation. The point is whether the Government would accept the trade-off between economic growth and inflation or not. Aiming to deepen the understanding of inflation in Vietnam, this paper analyzes price movements in the country from the beginning of 2004 up to March 2012 by applying theoretical frameworks of inflation.
This paper concludes with a number of recommendations for the Government to curb inflation in the upcoming time such as tightening monetary policy to reduce money supply, maintaining economic growth at a moderate level to ensure stability, making the most efficient use of budget in order to gradually reduce deficit, and directing the SBV towards an independent pattern. Research Questions: This graduation thesis focuses on answering the following questions: - What are the consequences of inflation to Vietnamese economy? - What have recommendations been made to curb inflation? 8 1. Scope The scope of this paper covers price movements in Vietnam from the beginning of 2004 to 2012. Methodology Compare, analyze and summarize the data of GSO related to inflation in Vietnam from 2004 until now.
Limitations The paper focuses only on the data of the 2004 – 2012 - period and mainly bases on published information by the Government which somehow may not reflect the exact macroeconomic situations of Vietnam. 9 Chapter 2: An Overview of Inflation Inflation is considered one of the most popular terms in economics. In order to have an understanding about this monetary phenomenon, it is necessary to look through definitions, causes and consequences of inflation. Definitions It is not too difficult to find a definition for inflation.
The classical theory of inflation suggests that inflation is a result of excessive growth in the money supply. This could be summarized in the well-known quotation by Milton Friedman (1963) that “Inflation is always and everywhere a monetary phenomenon” (Milton Friedman, 1963). To assess Friedman’s assertion that inflation is purely a “monetary phenomenon”, we could examine the Quantity Theory of Money. The Quantity Theory of Money (Cambridge version) states that: MV = PY Where M = nominal money stock (quantity of money) P = price level of final output Y = real income or volume of output V = velocity of circulation of money As inflation is the percentage change in the price level, the Quantity Theory of Money is also a theory on the rate of inflation.
In terms of percentage changes, we could express this theory as: (% change in M) + (% change in V) = (% change in P) + (% change in Y) Moreover, it is assumed that the velocity of circulation of money is constant: (% change in V) = 0 In the long run, real output is also constant as its full-employment level of output: (% change in Y) = 0 Hence, (% change in M) = (% change in P) Or in other word: 10 Growth in money supply = Inflation Thus, the Quantity Theory of Money states that inflation is determined by the rate of growth in the money supply. If the Central Bank keeps the money supply stable, the price level will be stable and there will be no inflation. On the other hand, an increase in the money supply (by the Central Bank) causes the price level to rise. Thus, it is arguable that inflation is purely a result of increased money supply (i.
inflation is a purely “monetary phenomenon”). Another definition can be found in the economics of Money, Banking and Financial Markets written by Mishkin, inflation is “The condition of a continually rising price level”. One common point that both of mentioned aboved agreed that inflation is “a rising price level”. In order to understand more about the relation between this phenomenon and inflation, a simple example is worth considering: 5 years ago, with VND 5,000 you can treat yourself a loaf of bread, but at the present, you have to pay VND 8,000 for the same kind of bread, and this “more expensive” phenomenon also applies to almost every commodities in Vietnam.
Causes of Inflation There are 2 types of causes of inflation: - Demand-Full Inflation - Cost-Push Inflation. Cost-Push Inflation Cost-push inflation occurs when businesses respond to rising production costs, by raising prices in order to maintain their profit margins. There are many reasons why costs might rise: - Rising imported raw materials costs - perhaps caused by inflation in countries that are heavily dependent on exports of these commodities or alternatively by a fall in the value of the pound in the foreign exchange markets which increases the price of imported inputs. A good example of cost-push inflation was the decision by British Gas and other energy suppliers to raise substantially the prices for gas and electricity that it charges to domestic and industrial consumers at various points during 2005 and 2006.
- Rising labor costs - caused by wage increases which exceed any improvement in productivity. This cause is important in those industries which 11 are ‘labor-intensive’. Firms may decide not to pass these higher costs onto their customers (they may be able to achieve some cost savings in other areas of the business) but in the long run, wage inflation tends to move closely with price inflation because there are limits to the extent to which any business can absorb higher wage expenses. - Higher indirect taxes imposed by the government – for example a rise in the rate of excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in the standard rate of Value Added Tax or an extension to the range of products to which VAT is applied.
These taxes are levied on producers (suppliers) who, depending on the price elasticity of demand and supply for their products, can opt to pass on the burden of the tax onto consumers. For example, if the government was to choose to levy a new tax on aviation fuel, then this would contribute to a rise in cost-push inflation. Demand-Pull Inflation Demand-pull inflation is likely when there is full employment of resources and when short run aggregate supply is inelastic. In these circumstances an increase in aggregate demand will lead to an increase in prices.
Aggregate demand might rise for a number of reasons – some of which occur together at the same moment of the economic cycle. - A depreciation of the exchange rate which has the effect of increasing the price of imports and reduces the foreign price of exports. If consumers buy fewer imports, while foreigners buy more exports, aggregate demand will rise. If the economy is already at full employment, prices are pulled upwards.
- A reduction in direct or indirect taxation. If direct taxes are reduced, consumers have more real disposable income causing demand to rise. A reduction in indirect taxes will mean that a given amount of income will now buy a greater real volume of goods and services. Both factors can take aggregate demand and real GDP higher and beyond potential GDP.
- The rapid growth of the money supply – perhaps as a consequence of increased bank and building society borrowing if interest rates are low. Monetarist economists believe that the root causes of inflation are monetary – in particular when the monetary authorities permit an excessive growth of the supply of money in circulation beyond that needed to finance the volume of transactions produced in the economy. 12 - Rising consumer confidence and an increase in the rate of growth of house prices – both of which would lead to an increase in total household demand for goods and services 2.