COVID-19 woes to weigh on credit growth even with lower interest rates

Banking sector earnings are predicted to come under pressure in 2020.(Photo chinhphu.vn)

According to analysts from Fitch Solutions, weak economic activity would weigh heavily on credit demand, even with lower interest rates.

The State Bank of Vietnam (SBV) reduced its policy interest rates on March 17, which took its refinance rate to 5% from 6% previously, and discount rate to 3.5% from 4%. The overnight lending rate in the inter-bank market was also cut to 6% from 7%.

“We maintain our view that the ample liquidity in the banking sector technically should not warrant further interest rate cuts, as the key problem lies in a lack of loan demand amid a weak economic outlook, and accordingly forecast the refinance and discount rates to be held at 5% and 3.5%, respectively, through 2020,” the analysts said.

However, with the global economy aggressively easing monetary policy, Fitch highlighted that risks to its monetary forecasts were towards further easing through both interest rates and other macroprudential measures as the central bank attempted to lift economic growth towards the Government’s 6.8% real GDP growth target for 2020.

According to Fitch, a softening of inflation on the back of low global oil prices and softer core inflation due to weaker domestic demand would also allow for easier monetary policy if needed.

Fitch has revised its 2020 average headline inflation forecast to 3.8% from 5.7% to account for the plunge in global oil prices amid an intensifying supply glut and weakening core inflation.

“Our inflation forecast lies within the SBV's 3.2-4.2% projection for the year and also reflects our view for the SBV to succeed in its target to keep inflation below the 4% level. Headline inflation eased to 4.9% year-on-year in March, from 5.4% year-on-year in February, due to easing inflation in the housing and construction materials category and a deflation in transport prices, which offset a slight acceleration in food inflation.”

Fitch analysts believed that both domestic and external demand would face strong headwinds over the coming quarters. Income losses due to a weak economic environment, which was likely to see workers being furloughed and/or have their wages reduced, would weigh on private consumption. A weak demand outlook, both internally and externally due to a global economy in recession, would also prompt businesses to conserve cash and delay capital expenditure. These factors would reduce demand for new loans.

“Banking sector earnings will also come under pressure. We expect this to be due to weaker demand for credit, narrower interest margins, and the central bank’s COVID-19 crisis macroprudential measures.”

Based on the SBV’s policy rate cut applied last month, deposit rates have been reduced by up to 0.3 percentage points, while lending rates have been reduced by 0.5 percentage points.

Though inpidual banks were still free to set their own rates on deposit interest for deposits of over six months, Fitch believed that unless banks reduced the interest rates offered on these longer-dated deposits by a sufficiently larger margin, they were likely to experience a net compression of their interest margins, which compounded by weaker credit growth would see a fall in profitability across the sector as a whole.

Finally, Fitch said, macroprudential measures, such as rescheduling debt repayment and exempting and reducing interest and fees, announced by the SBV on March 12 to tackle the economic crisis, would also slash banking sector earnings.