Vietnam Should Phase Out Interest-Rate Subsidy, World Bank Says

By Jason Folkmanis and Van Nguyen

June 8 (Bloomberg) -- Vietnam should phase out subsidies to bank lending as “rapid” credit growth threatens to stoke inflation, the World Bank said.

The central bank will probably bear at least 17 trillion dong ($956 million) in costs from subsidizing loans as part of the government’s stimulus measures, the World Bank said today in a report. Total lending under the program has reached 332 trillion dong, the State Bank of Vietnam said June 5.

“The interest-rate subsidy scheme, which played an important role in the initial phase of the stimulus policy, has lost its justification,” the World Bank said in a report written by economists led by Dinh Tuan Viet and Martin Rama. “Credit is growing rapidly again.”

Sharp credit growth, as well as increases in commodity prices, may drive up inflation, according to the agency. Economic growth probably bottomed in the first quarter, when gross domestic product expanded 3.1 percent, the World Bank said.

Total outstanding banking loans increased 15 percent through mid-May from December, Deputy Prime Minister Nguyen Sinh Hung told the National Assembly last month. Lower interest rates have helped revive the construction industry and domestic consumption, the Washington-based World Bank said.

“Once the figures for the first half of 2009 become available, it might be good to pause and reflect on whether sustaining economic activity should remain the single priority,” Viet and Rama wrote in the report, released at a conference in the Central Highlands city of Buon Ma Thuot.

Inflation Threat

The extra stimulus spending is “likely to have enduring macroeconomic effects in terms of greater inflation levels, increased budget deficits and increased pressure on the current- account and exchange rate,” said a separate report by the United Nations Development Program.

Inflation slowed in May to an annual rate of 5.6 percent, the lowest since 2004 and down from 28.3 percent in August.

“There are constraints on how much domestic finance can be raised, as shown by the recent experience with bond issuances,” the World Bank said. “There are also indications that upward price pressures are resurfacing.”

Vietnam’s State Treasury last week failed to sell 1 trillion dong of bonds. The lending subsidies are stifling appetite for Vietnamese bonds, HSBC Holdings Plc said last month.

The World Bank recommended Vietnam set a target for loan growth that would avoid quickening inflation. The government should also watch for an increase in bad debt, the agency said.

The bulk of the loans channeled under the program are from state-owned banks, the International Monetary Fund said in April.

“Policy lending is vulnerable to favoritism, may result in an inefficient allocation of resources and could eventually affect the quality of bank portfolios,” the World Bank said. “There are already some indications of an increase in the share of non-performing loans.”

Moody’s Investors Service last month said it was reviewing four Vietnamese banks, including the second-biggest by assets, for a downgrade, citing lower interest rates and the probability of a higher default rate.

To contact the reporters on this story: Jason Folkmanis in Ho Chi Minh City at folkmanis@bloomberg.net; Van Nguyen in Buon Ma Thuot at vnguyen23@bloomberg.net