The Treasury bill issue by the State Bank of Vietnam (SBV) to withdraw money from the banking system has left the market puzzled. This move appears to have multiple objectives for addressing the current challenges.

An unexpected action? In late September, the SBV, or the central bank, took the market by surprise by relaunching a T-bill issue. Notably, on September 21, T-bills worth nearly VND10 trillion were issued through an auction in which 17 participants took part, with two of them winning at a coupon rate of 0.69% per annum. On September 22, an additional VND10 trillion worth of such bills was put up for auction, and five of 16 participants won with an annual coupon rate of 0.5%. Another VND10 trillion bill auction was held on September 25, with four of 13 participants winning with a lower rate, at only 0.49% per annum. The three issues come with a 28-day term. Given that the central bank had refrained from selling T-bills for about six months (since March 10), its recent move has raised eyebrows, especially at a time when expansionary monetary policy is vital for fueling much-needed economic growth. However, in light of the current circumstances, the SBV's move, albeit unexpected, is a calculated measure to cope with the challenges which the currency and foreign exchange markets are dealing with. First, in terms of scale, VND10 trillion per issue appears modest given the huge amounts of idle cash at commercial banks. This is an indication that the SBV does not want to place pressure on the banking system, which has aggressively cut interest rates in recent months to deal with the idle cash. This might be a litmus test by the central bank, and if the market remains stable, it may consider more T-bill sales. Second, the 28-day term seems suitable. While their liquidity remains redundant and is expected to stay so for some time, banks may come under more pressure as the year-end approaches. During the final quarter, the demand for loans normally surges while deposits decrease. When these T-bills fall due, capital will flow back into the banking system, potentially alleviating this pressure. Third, interest rates play a role. Just six months ago, the winning coupon rate for seven-day T-bills was a steep 6% per annum. Now, it has plummeted to less than 0.7% per year, coinciding with the overall downward trend in interest rates across all markets. Notably, the recent T-bill batches were sold through a coupon rate auction mechanism, allowing the market forces to determine coupon rates. This approach helps insulate the current interest rate levels from external impact. The winning rates of the three above T-bill auctions are also lower than the lending rates on the interbank market, which hover around 1% per year for one-month term. Most banks are currently sitting on mountains of cash due to a sharp drop in loan demand. Banks with excess capital have had difficulty finding institutional borrowers, so they have had little or no choice but to invest in T-bills with lower interest. A multi-pronged strategy The SBV's recent action coincides with the conclusion of the U.S. Federal Reserve (Fed) policy meeting in September. While the Fed opted to keep its federal funds rate at the highest level in 22 years (5.25-5.5% per year), as anticipated, it has adopted a more stringent stance. Fed officials expect fewer interest rate cuts next year than previously projected. This is a source of concern for investors, as it suggests that U.S. interest rates may remain elevated for an extended period, thereby potentially prolonging the high valuation of the U.S. dollar. Hence, it is widely surmised that the Vietnamese central bank's move is intended to alleviate the mounting pressure on the exchange rate, which has been building up for over two months. On September 25, the central exchange rate between the U.S. dollar and the Vietnam dong increased by VND16 compared to the previous weekend, VND99 from the end of August, and nearly 2% from the beginning of the year. Concurrently, dollar buying and selling rates at banks increased by VND35-40 compared to the previous weekend, taking to 3.4% the surge in the year to date. Given surplus liquidity and sluggish lending, credit growth in the system had reached only 5.56% as of mid-September, a mere 0.23 percentage point higher than in late August. Several banks have increased foreign currency swing trading to make the most of their idle funds and the significant interest rate differential between the U.S. dollar and the dong in the interbank market. According to the latest SBV data, the overnight interbank interest rates for the dong averaged out at just 0.16% during the week of September 11 to 15. In contrast, interest rates for the U.S. dollar reached 5.04%, resulting in a substantial 4.88 percentage point gap. Similar differentials were observed in one-week, two-week, and one-month terms, ranging from 4.19 to 4.73 percentage points. Even the three-month term exhibited a gap of 1.98 percentage points in favor of the U.S. dollar. Therefore, banks are eager to promote the "carry trade" strategy to profit from this interest rate gap between the two currencies. This activity places further pressure on the exchange rate between the dollar and the dong. Thus, by absorbing excess liquidity from the system, the SBV may indirectly discourage banks from foreign currency swing trading, ultimately helping ease pressure on the foreign exchange market. Since the beginning of 2023, the SBV has actively purchased foreign currency to bolster its foreign exchange reserves. Attracting the dong through the T-bill channel hpartially offset the volume of foreign currency already injected through foreign currency purchases. As Vietnam is trying to attract more foreign capital and as Prime Minister Pham Minh Chinh, during his recent visit to the U.S., encouraged major corporations to expand their investment operations in Vietnam, the SBV policy is needed to ensure the stability of the local currency. A representative of the SBV emphasized that if the exchange rate becomes volatile, it could undermine foreign investor confidence and investment attraction policy. Given the potential resurgence of inflation, triggered by recent spikes in goods and services prices such as energy, raw material, fuel and food, letting the exchange rate rise too rapidly may reignite inflationary pressure. Many local producers remain heavily reliant on imports, making exchange rate stability a top priority, both currently and in the final months of the year. However, businesses are concerned about this move, as it may place renewed pressure on interest rates in the last quarter of the year, similar to the situation seen around the same time last year. Nevertheless, the current context differs significantly from the fourth quarter of 2022, when the market faced disruptions due to capital flow constraints following the SCB scandal, the bond market turmoil, and issues involving major real estate corporations.