GROUP REPORT course money and banking INTEREST RATE POLICIES AND ITS IMPACT ON VIETNAMS ECONOMY

Interest rate policy is an important instrument in managing national monetarypolicy, in order to promote economic growth and control inflation.. ● Fixed interest rate policy: Fixed inter

FOREIGN TRADE UNIVERSITY SCHOOL OF ECONOMICS AND INTERNATIONAL BUSINESS

Hà Nội – August, 2019

Table of Contents

INTRODUCTION 4

CHAPTER 1: OVERVIEW OF INTEREST RATE 5

1.1 Definition 5

1.2 Characteristics 5

1.3 Types of interest rate and interest rate policies 6

1.3.1 Types of interest rate 6

● Simple Interest 6

● Compound Interest 6

● Amortized Rates 6

● Fixed Interest 7

● Variable Interest 7

● Prime Rate 7

● Discount Rates 7

1.3.2 Interest rate policies 7

1.4 Factors affecting the interest rate 9

1.4.1 Economic Growth 9

The most important factor in determining why interest rates change is the supply of funds available from lenders and the demand from borrowers. 9

1.4.2 Fiscal deficit and government borrowing 10

1.4.3 Inflation 10

1.4.4 Global interest rates and foreign exchange rates: 11

1.5 The role of the interest rate in the economy 11

1.5.1 Macro role: 11

1.5.2 Micro role 13

CHAPTER 2: THE IMPACT OF INTEREST-RATE POLICY ON VIETNAM'S ECONOMY 15

2.1 Interest rate policy and interest rate channel in Vietnam 15

2.2 Impact of Interest rate policy 17

2.3 Expected impacts and changes in interest-rate policy to Vietnam's economy in US-China trade war 18

CHAPTER 3: RECOMMENDATIONS 20

3.1 Solutions to regulate and control interest rate 20

3.1.1 Improve interest-rate liberalization mechanism 20

3.1.2 Improve the effectiveness of interest rate instruments 22

3.2 Solutions to create conditions and foundations for the implementation of policies and mechanisms for interest rate management 23

CONCLUSION 24

REFERENCES 25

In this modern economy, the interest rates is one of the important tools forcontrolling market system Interest rates are an economic category, reflecting therelationship between lenders and borrowers, between supply of and demand formoney and the economic status of a country The fluctuation of interest rates directlyaffects the decisions of individuals, businesses as well as the credit institutions and thewhole economy Through those changes of interest rates, researchers can predictwhether the economy is going up or down Therefore, interest rates are one of themost attracted variables in the economy and its movements are globally reported day

by day Interest rate policy is an important instrument in managing national monetarypolicy, in order to promote economic growth and control inflation

Based on this practical need, we would like to choose the topic: "Interest-ratepolicy and its impact on Vietnam's economy"

Our report consists of 3 chapters:

Chapter 1: Overview of interest rate

Chapter 2: The impact of interest-rate policies on vietnam's economy

Chapter 3: Recommendations

Due to limited knowledge and experience in the field of finance and banking,our report cannot avoid some careless mistakes We are looking forward to receivingcomments and access from teacher and friends

CHAPTER 1: OVERVIEW OF INTEREST RATE 1.1 Definition

The term “interest rate” appeared when the relationships among sale, purchaseand exchange of goods were formed Interest rate is one of the most universalvariables in the economy that directly affects our daily life Interest rate (or creditinterest rate) is an extremely important and sensitive economic tool for every economywhich plays an important role of stabilizing and contributing to the completion ofmonetary policy to create a sustainable and prosperous world There have been manydifferent views when making the concept of interest rates

An interest rate is the amount of interest due per period, as a proportion of theamount lent, deposited or borrowed (called the principal sum) The total interest on anamount lent or borrowed depends on the principal sum, the interest rate, thecompounding frequency, and the length of time over which it is lent, deposited orborrowed It is defined as the proportion of an amount loaned which a lender charges

as interest to the borrower, expressed as an annual percentage or basis point It is therate a bank or other lender charges to borrow its money, or the rate a bank pays itssavers for keeping money in an account

Interest rates, in the simplest terms, are the costs to borrow money or the returnfor lending money

1.2 Characteristics

Interest rates have 2 main characteristics:

● Competitiveness: The interest rates are formed on the basis of competitionamong commercial banks or other credit institutions The competitiveness forinterest rates is more obvious when the arrival of organizations participatingand providing credit is increasing Interest rates must be attractive to takenotice of customers to join Therefore, each commercial bank and credit

institution wishing to develop their system must offer a competitive interestrate to others in order to draw customers’ attention.

● Flexibility: The interest rates are formed in a flexible and sensitive manner,adapting to all subjects or objects under any circumstances The frequentchanges of credit policies are consistent with the changes in the supply anddemand for loans, the inflation rate, the State revenues and expenditures, thepsychological factors of borrowers and lenders in the financial market

1.3 Types of interest rate and interest rate policies

1.3.1 Types of interest rate

There are several ways of dividing interest rates into groups This report shows

a breakdown of seven forms of interest, and how each might impact consumersseeking credit or a loan

● Simple Interest

Simple interest represents the most basic type of rate Simple interest is paid onlyone time and does not change To calculate simple interest, multiply the principal bythe rate and the term

interest charged on the principal decreases over time while the interest rate stays thesame.

● Fixed Interest

A fixed interest rate stays the same over the life of a loan Often used in mortgage

or other long-term loans, fixed rates are pre-determined Borrowers benefit from afixed interest rate because they know the rate won't rise The loan payment thenremains the same, making it easier to include in the family budget

● Variable Interest

Variable interest rates change depending on an underlying interest rate, usually thecurrent index value Variable interest rates are used on loans such as adjustable ratemortgages Variable interest rates usually change weekly or monthly, and can increase

or decrease

● Prime Rate

The prime rate refers to the interest rate that commercial lenders use with their best– or most credit-worthy – customers This rate is based on the federal funds rate, or adaily rate that banks use when they borrow and lend funds with each other Thoughlarge corporations are normally the recipient of prime rate loans, the prime rate affectsconsumers, as well; personal, mortgage and small business loan interest rates areinfluenced by the prime rate

● Discount Rates

When the Commercial Bank makes a short-term loan to a financial institution, theyapply an interest rate known as discount Discount rates are based on cash flowanalysis, which takes both the time value of money and the risk of future cash flowprojections into account

1.3.2 Interest rate policies

● Ceiling interest rate policy: The ceiling interest rate policy is a policy of fixingthe maximum lending interest rate This policy encourages capital mobilizationand enhances government control The Government sets a certain interest rateand imposes common rates on the whole banking system and on the wholeeconomy

● Fixed interest rate policy: Fixed interest rate is the interest rate that the Centralbank controls Commercial banks in both mobilizing and lending rates Underthis policy, there will be no interest rate competition in the credit and financialmarket and thus do not promote economic development

● Free interest rate policy: The policy of interest rate liberalization is the policythat the government will intervene when the interest rate exceeds the generalinterest rate Interest rates increase or decrease completely due to changes insupply and demand in the market However, it only works in a perfectlycompetitive environment In Vietnam, we are currently using the negotiableinterest rate policy Credit institutions are allowed to use the negotiable interestrate mechanism in commercial activities, replacing the basic interest ratemanagement mechanism In the long term, the elimination of the "ceiling" onlending rates will enable credit institutions to expand methods of capitalmobilization, lending and mobilizing with interest rates suitable to demand andsupply in the credit market This is especially beneficial for economicorganizations and producers in rural areas, especially in the context of creditgrowth is much faster than capital mobilization growth This interest ratemechanism will create favorable conditions for the reform of market-orientedbanking system This will eliminate the "differences" in the Vietnamesebanking system to gradually integrate into the international credit market

● Preferential interest rate policy: Preferential interest rate policy is a policy forsome special subjects such as the poor with low interest rates Theimplementation of this policy makes borrowers pay less attention to efficiency,

which leads to the inefficient use of capital invested in projects, which does nothelp capital growth and most of this policy is taken from the Budget.

1.4 Factors affecting the interest rate

1.4.1 Economic Growth

The most important factor in determining why interest rates change is the

supply of funds available from lenders and the demand from borrowers

Take the mortgage market as an example, in a period when many people areborrowing money to buy houses, banks need to have funds available to lend Thesefunds can come from their own depositors since the banks pay 2% interest on five-year GICs and charge 4% interest on a five-year mortgage By borrowing from theirdepositors and lending to their mortgage borrowers, a bank makes a 2% “Net InterestMargin” (NIM) and a profit But if the demand for mortgage borrowing becomeshigher than the available funds, the banks will either have to raise their GIC rates toattract more retail funds or borrow money by issuing bonds to institutions in the

“wholesale market” Institutional investors have more investment opportunities so thissource of funds is more expensive and the banks might have to pay higher interestrates

Mortgage rates will then go up to reflect the higher cost of bank mortgagefunding if funding is hard to obtain If the banks have lots of money to lend and thehousing market is slow, any borrower financing a house will get “special ratediscounts” and the lenders will be very competitive, keeping rates low

1.4.1.1 Demand for money

Typically, in a growing economy, money is in high demand Manufacturingsector companies and industries need to borrow money for their short-term and long-term needs to invest in production activities Citizens need money as they need toborrow for their homes, buy new cars, and other needs

But when an economy isn’t doing that well, companies avoid borrowing if thedemand for their products is low A very high inventory is detrimental, so theyproduce less In effect, they borrow less, ergo less demand for money Consumers alsospend less as a bad economy could result in job loss Other things remaining the same,

higher the demand for money higher the interest rates.

1.4.1.2 Supply of money

Like any other commodity, if the supply of money increases - other thingsremaining the same - interest rates go down In recessionary times the interest ratestend to go down

A case in point is the sudden dip that took place in bond yields for a shortperiod of time after the announcement of demonetization As the general publicdeposited the demonetized currency notes into bank accounts, banks were floodedwith money The banks could not lend all that money so they choose to invest ingovernment securities and that led to a fall in yields on bonds

1.4.2 Fiscal deficit and government borrowing

Fiscal deficit is a result of government expenditure exceeding governmentrevenue To fund this deficit, the government resorts to borrowing A rising fiscaldeficit (as percentage of the GDP) indicates that the government will have to borrowmore from the market This puts an indirect upward pressure on the borrowing rates inthe market

Higher the fiscal deficit, higher the government borrowing, higher the interestrates Generally, bond markets respond to higher fiscal deficits by an uptick in bondyields

Savers need to be compensated by way of higher interest rates for sacrificingtheir current consumption motives in a high inflationary scenario Investors will forgotheir current consumption and invest in fixed income investments if they get positivereal rates of return.

The real rate of return is arrived at by deducting inflation number from thenominal rate of return offered on the bonds and deposits The ideas to keep the realrate of return positive so that after inflation the saver saves something That means inhigh inflation era, the interest rates tend to stay up and vice versa

1.4.4 Global interest rates and foreign exchange rates:

With the increasing globalization over the last few years, the economicconditions of international markets have also started playing an important role indeciding the interest rate direction The global economic conditions influence thelending pattern of foreign investors to domestic companies and thus compete withdomestic sources of funds in the market

Attractive interest rates bring in capital and support the foreign exchange rate.Tweaks in the interest rates in the economy can be used by a central bank forinfluencing the exchange rate A central bank may choose to up the policy rates toindicate higher interest rates in the economy and thereby attract capital from overseasinvestors

1.5 The role of the interest rate in the economy

Interest rates are one of the most closely considered variables in the economy,because interest rates not only directly affect our lives but also an indicator of thehealth of the economy We can generalize the role of interest rates through twoaspects: the macro role and the micro role:

1.5.1 Macro role:

For the State Bank, interest rates are a macroeconomic regulation tool Thefluctuation of interest rates in the adjustment process of the State Bank affects many

aspects of the economy such as investment, consumption, savings, exchange rates thereby directly affecting macroeconomic objectives of the country.

In a market economy, consumers and businesses can do anything they wantwithin the framework of the law, as long as they have the means of payment So bycontrolling prices and the right to use money, or the interest, the State Bank in anycountry can dominate the growth of the economy By raising interest rates, the StateBank can weaken the lending capacity of commercial banks and thus implementmonetary policy, reducing the amount of money needed to expand businessproduction and consumer spending By using interest rates, the State Bank can alsofacilitate economic development To curb or promote the pace of development of acertain industry, the State Bank may increase or decrease lending rates to narrow orexpand investment in this sector

Besides guiding the economy, interest rates also play an active role in curbinginflation In March 1989, Vietnam advocated the super-deposit rate regime to quicklybring about the result of stopping inflation: from 7% in January, 9.2% in Februarydropped to 4.5% in March, 3.5% in April and continue to decrease in the followingmonths This substantiates the power of the interest rate in regulating the economy atthe macro level, even though it has a negative effect on economic activities From

1989 to the present, interest rate policy has always been used to adjust the economy inVietnam After stabilizing and keeping inflation at a stable level, the State Bank isgradually lowering the interest rate frame to encourage investment in expandingproduction and business, which will, in turn, recover the economy

It can be said that interest rate policy is a part of the monetary policy of thestate to regulate monetary circulation, stimulate, regulate and guide business andproduction activities of economic units Interest rates are used to expand moneysupply, narrow investments and curb inflation

In the role of economic leverage, interest rates are adjusted to suit theeconomic goals at different stages Incentives on interest rates, favorable conditions ofcredit supply and payment are state tools to encourage enterprises to focus on products

of priority in certain economic development strategies This is important for LDCswho want to take the leap to get right into modern technology Thus, interest rate can

be considered as a direct tool of monetary policy It directly or indirectly influencesthe amount of money supply in circulation, thereby helping to achieve the goals ofmonetary policy An adjustment in the interest rate management mechanism willaffect the amount of money in circulation, especially the amount of money supplied

by banks into circulation because the interest rate directly affects the business profits

of banks The expansion of the interest rate frame, either raising the ceiling interestrate for the old rate control mechanism or raising the basic interest rate in the newinterest rate mechanism, will have the effect of increasing the amount of money incirculation and vice versa

Another impact of interest rates is its effect on investment and savings Thereare many different opinions about the impact of interest rates on the formation ofsavings, but most economists think that interest rates have an impact on the size ofpeople's savings The higher the actual interest rate, the greater the amount of moneydeposited in the bank, which will affect the size of people's asset purchases Wheninterest rates are positive, it will stimulate people to deposit at the bank because it ismore profitable and safer than hoarding assets, thereby increasing the bank's overallcapital and the amount of money for the national economy, the impact of positive realinterest rates has created favorable conditions for financial savings

In summary, interest rates have impacts on several dimensions of the economy,

on development and economic growth A reasonable interest rate policy will be both acondition to attract idle capital and to promote investment in the economy, helping theeconomy growing steadily