Effect of budget deficit on inflation rate in Vietnam

budget deficit’s finance for period 1986–1990 
Year 
Content 
1986 1987 1988 1989 1990 
Budget deficit (billion VND) 37.20 135.70 1,093 2,203 2,250 
Amount of money issued to 
offset budget (billion VND) 
22.90 89.10 450 1,655 1,200 
Percentage of money issues (%) 61.56 65.66 41.17 75.12 53.33 
Percentage of borrowings and aids (%) 38.44 32.10 32.60 24.88 46.67 
Others (%) – 2.24 26.23 – – 
 Source: general Statistics Office 
Borrowing money 
Domestic borrowing 
 Borrowing money is the main method to finance the budget deficit, especially domestic 
borrowing in the form of issuance of Government securities. The government authorizes the 
State Treasury to issue securities that may take in the form of treasury bills, treasury bonds or 
project bonds. 
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According to Vu (2013), domestic borrowing allows the government to control the budget 
deficit without increasing its currency base or reducing its foreign reserves. Therefore, it is a 
quite effective measure that would mobilize temporary idle money, avoid the risk of a foreign 
debt crisis and easy to conduct. However, this measure may restrain the development of 
business activities in the non-state sector. 
Moreover, in Vietnam, bonds are mainly sold to credit institutions and are often 
discounted by commercial banks at the State Bank. Along with that, the large domestic debt of 
State Bank has pushed up interest rates. If the State Bank wants to achieve the goal of monetary 
policy, it has to pump money into the economy to stabilize the interest rates and promote 
business. The issuance of credit or buy-in transactions on open market of the State Bank would 
have the effect of increasing money supply and putting pressure on inflation. 
 Foreign borrowing 
 In addition to domestic borrowing, the government may borrow money from foreign 
governments and financial institutions such as the World Bank, the International Monetary 
Fund (IMF), the Asian Development Bank (ADB), intergovernmental organizations and 
international organizations, etc. Foreign borrowing can be in the form of issuing hard foreign 
currency bonds abroad and credit borrowing. 
 Foreign borrowing would increase debt repayment obligations, potential exacerbation of 
the debt crisis, dependence on foreigners both economically and politically, reducing excessive 
foreign exchange reserve, and the national storage would lead to an exchange rate crisis. At the 
same time, foreign borrowing would increase the supply of foreign currency in the market, 
causing pressure on the domestic currency. To maintain the stability of the exchange rate, the 
State Bank intervenes by increasing the domestic money supply in the market, and if the market 
does not absorb promptly, this increase would raise the inflation rate. 
 In conclusion, the funding source for the budget deficit could affect the inflation directly 
or indirectly. It could affect immediately if the government uses the money issues measure or 
impact with a certain lag through multiple channels and mechanisms of action such as the 
borrowing method. 
3.4 Effect of public expenditure on inflation 
Vietnam's economic growth has been still largely based on the capital factor, of which the 
government has a high proportion of the investment capital. As shown in figure 4, in period 
1995-2012, the investment capital for state sector fluctuated from 35% to 60%. Despite the large 
proportion of investment, the contribution of state sector to GDP was not adequate and was 
always lower than 40% (figure 5). In period 2000–2011, the average state capital investment ratio 
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was 46.55 %, but this sector contributed an average of 36.89 % in GDP over this period (To, 
2012). This partly shows that the public investment was not efficient with higher losses than 
that of other economic sectors. 
Figure 3. Structure of investment capital 
by economic sectors 
Figure 4. Structure of GDP 
by economic sectors 
Source: General Statistics Office 
The state sector had a large proportion of investment but high losses that led to the state 
budget deficit. The budget was always in a state of deficit mainly due to large public 
investment, but the public investment did not create the corresponding value of goods. There 
was an imbalance of payment, causing high inflation. Therefore, improving the efficiency of 
public spending would be a measure to control inflation. 
3.5 Independence of monetary policy and its impact on inflation 
There have been numerous studies demonstrating that the independent central bank model has 
a good impact on controlling inflation and budget deficits. There are four independence levels 
of the central bank: the highest level is "Independence in goal setting”; the second level of 
independence is "Independence in setting performance criteria"; the third level is 
"Independence in the choice of operating instrument"; and the lowest level of independence is 
"Limited independence or even no independence" (Solomon & De Wet, 2004). The State bank of 
Vietnam is currently at the lowest level of independence. This has had a certain impact on the 
State bank's capacity building. Vietnam's monetary policy is still serving economic growth and 
the government's purpose, not as independent as in other countries. 
The central bank has low independence and accordingly is in the context of a persistent 
budget deficit; it must be responsible for advancing the state budget and handle the budget 
deficit. This amount has not usually been paid in time and is non-guaranteed, and the money 
supply, therefore, also has been influenced and then partly affected the inflation. 
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4 Conclusions and solutions 
Both quantitative and qualitative analysis of many aspects of the impact has proved that the 
persistent budget deficit, the low independence of central bank, and the ineffective public 
expenditure are the main reasons for high inflation in Vietnam. Therefore, in order to control 
inflation, the government should: 
First, control the state budget deficit actively rather than passively deal with the 
consequence of the high budget deficit, manage the budget revenue well to create sustainable 
and stable revenue sources during the period of economic growth, control revenue sources and 
reduce tax loss, etc., and manage public spending and prevent losses and waste. 
Second, deal with the relationship between investment expenditures and regular 
expenditures, central budget and local budgets, closely manage and supervise borrowing loans, 
limit the use of budgetary advance, exploit other sources of revenues and control borrowing in 
such a limited amount that its effects are predictable. 
Third, enhance the independence of the State Bank, secure foreign exchange reserves, 
further administrative reforms, combine harmoniously the fiscal policy and the monetary 
policy, pay attention to the wage reform and raise the quality of forecasting, boosting domestic 
production and labor productivity. 
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