On March 31st more than 15,000 workers at a Nike-contracted factory in southern Vietnam went on strike to demand higher wages in the face of rising prices. Although the strike was called off on April 2nd—after the workers were offered a 10% pay rise—the factory has been forced to close temporarily owing to fights between returning workers and those continuing to demand higher wages. The incident is the most recent instance of a marked surge in inflation-fuelled labour unrest in Vietnam, which has primarily affected the garment and footwear sectors. There have been around 600 strikes in the past 15 months, according to the labour ministry.

Vietnam's annual inflation rate has soared to 19.4% year on year in March, from 15.7% in February, hitting double-digits for a fifth consecutive month. Food-price inflation, which holds around a 40% weighting in the consumer price index and has been accelerating rapidly since mid-2007, continues to be the main factor driving up the general price level. The cost of food and foodstuffs surged by 30.6% year on year in March, up from a 25.2% gain in February. Inflationary pressures have also been amplified by large capital inflows that have increased the money supply. The government's expansionary fiscal policy stance, combined with the central bank's inability to rein in credit growth thus far, has exacerbated the problem.

Vietnam's government is acutely aware of the challenges rampant inflation poses to the country's economic and social stability. In the past few weeks it has unveiled a raft of measures designed to dampen inflationary pressures. However, the implementation of these measures continues to pose policy dilemmas, given that they could also slow economic growth and widen the trade deficit.

Policy dilemmas

The government has begun to target consumer price inflation aggressively. In March it lowered import duties on certain products, raised interest rates and introduced a comprehensive strategy to fight rising prices. A key part of its strategy has been to require commercial banks buy a total of D20.3trn (US$1.26bn) in compulsory treasury bills, which has decreased liquidity in the market, and to cap dong deposit rates. In addition, the State Bank of Vietnam (SBV, the central bank) has raised the discount rate to 6% (from 4.5% previously) and the base rate to 8.75% (from 8.25%). The SBV has also lowered its target for credit growth in 2008, saying it will closely monitor banks' lending activities.

But the SBV faces a dilemma: it must reign in credit growth to manage inflation while simultaneously promoting overall economic growth. While its current strategy may dampen credit growth, it has also raised fears that Vietnam's economic growth rate—which fell to a two-year low of 7.4% in the first quarter of 2008—could slow further. The government has pledged to ensure that credit growth will be sufficient for continued strong real GDP growth, but it remains to be seen whether policymakers can find the right balance.

In addition to draining liquidity from the market, the SBV has widened the trading band within which the dong is allowed to fluctuate on a daily basis, from 0.75% to 1%. The dong has been appreciating against the US dollar in recent months, owing to relatively high capital inflows and buoyant inward remittances. This latest move by the SBV is intended to allow the currency to strengthen further in order to alleviate inflationary pressures. It also poses a dilemma, however. Allowing the dong to appreciate will make imports cheaper, but it could also lead to a worsening of the trade deficit. In the first quarter of 2008 the US dollar value of Vietnam's imports rose by 62.5% year on year, while exports were valued at US$13bn, up by nearly 23% year on year. The net result was a trade deficit of US$7.4bn, equivalent to 56.5% of total export value during the same period.

Outlook

As the government wrestles with these dilemmas, the pressure on prices is set to increase. Vietnam has announced plans to cut rice exports by up to 1m tonnes this year, but rising food prices are likely to continue to buoy the price index. With headline inflation exceeding the Economist Intelligence Unit's expectations, we will make a significant upwards revision to our 2008 inflation forecast, which currently stands at 13.4%. However, we still expect inflation to moderate in 2009 as the expansion of the economy slows and the effects of tighter monetary begin to be felt.