Hanoi  - Vietnam's central bank devalued the country's currency by nearly 2 per cent Wednesday and raised interest rates to fight rising trade deficits and inflation.

The bank lowered the official exchange rate of the Vietnamese to 16,461 to the dollar, from the previous peg of 16,139.

The black market exchange rate had jumped to over 18,000 over the weekend, before falling back to about 17,300 Wednesday, with the high rates driven by worries over inflation and the trade deficit.

The bank also raised the prime interest rate from 11 to 13 per cent, the third increase this year.

Prime Minister Nguyen Tan Dung told senior officials Wednesday that containing inflation should be a top government priority.

He listed Vietnam's economic challenges this year as "containing inflation, stabilizing the macro economy, and ensuring social security and sustainable economic development."

The government scaled back its estimates of economic growth for 2008 from 8.5 per cent to between 7 and 7.5 per cent, as the need to cut spending and tighten credit to fight inflation became clear.

"I think the government is clearly beginning to demonstrate serious intent to tackle the multiplicity of problems in the macro situation," said Peter Ryder, CEO of asset and real estate group Indochina Capital.

"The big issue in my mind is, are they going to be able to get away with just gradually devaluing the currency, or should they just go 'whack' and do 20 per cent at one time?"

With inflation topping 25 per cent year-on-year in May and the trade deficit rising to 14 billion dollars in the first five months, analysts at Merrill Lynch, Deutsche Bank and Morgan Stanley have speculated the country may face a currency crisis similar to the one that hit Thailand in 1997, triggering the Asian financial crisis.

Other analysts say such fears are overblown. While Vietnam has high inflation relative to Thailand in 1997, it has very little short-term foreign debt, and much of its trade deficit is a result of massive inflows of foreign direct investment over the past two years, which increase economic growth in the long run.

A Goldman Sachs report issued Wednesday said the devaluation and rate hikes "should help Vietnam avoid being forced into a more disruptive crisis with a significant one-off devaluation in currency value."

Economist Jonathan Pincus of the UN Development Programme's Hanoi office agreed that gradual devaluation of the dong, rather than a sudden shock, was the right policy.

"A large devaluation would be inflationary," Pincus said, and fighting inflation should remain the top priority.

Pincus noted that just a few months ago, analysts believed the Vietnamese dong needed to rise substantially, rather than fall, due to the pressure exerted by the influx of foreign investment capital. He said sentiment about the dong's real value was speculative.

"When people are thinking about the capital inflows, they think, well, the currency should be appreciating because of all this money flowing in," Pincus said.

"And then when they start thinking about the trade deficit, they think, well, the currency should be depreciating because of all this money flowing out. When actually they're reverse sides of the same coin." (dpa)