Hanoi  - On May 28, a currency analyst at Morgan Stanley released a report that hit Vietnam's financial community like a smack in the face.

With Vietnam's inflation and trade deficit soaring, the analyst wrote, its currency was under threat. Twelve-month futures on the Vietnam dong had "gapped" to 23,000 to the dollar, a 50 per cent premium on Hanoi's official rate of 16,600. If Vietnam did not allow rapid depreciation, the dong would likely collapse by year's end.

The Morgan Stanley report was just one of a rash of gloomy mid- year Vietnam reports. Deutsche Bank predicted a 30 per cent fall in the dong. Merrill Lynch said Vietnam was experiencing an "inflation shock" that could prompt massive capital flight.

Six months later, Merrill Lynch has sold itself to Bank of America to avoid collapse, while Morgan Stanley and Deutsche Bank are slashing executive pay amidst massive losses. Vietnam, on the other hand, has cut its inflation rate to zero over the past three months. And it has successfully defended the dong, which is trading just about where it was in May.

Vietnam has a reticent, Confucian culture, and it is hard to envision its leaders saying anything like "We were right, and you are bankrupt."

Still, Vietnam's efforts to beat inflation and hold its monetary policy together look like a precursor of the kinds of government-led interventions that have since rippled through the rest of the world's economies.

Instead of getting government out of the business of running the financial sector, Vietnam's government interfered heavily. And while analysts are still divided over the ultimate outcome, Vietnam's strategy appears to have worked well enough to avoid a domestic financial crisis.

Now it just has to deal with the global one.

Vietnam's troubles began at the start of 2008. In 2007, the country had been the darling of the global investment community, receiving pledges of over 20 billion dollars in new foreign direct investment during 2007, with over 6 billion dollars actually disbursed. In Vietnam's 80-billion-dollar economy, that represented a lot of money.

But the influx of all those dollars led the dong to rise, threatening the competitiveness of Vietnam's exports. The State Bank held the exchange rate down by buying dollars from banks with dong.

That left Vietnam's commercial banks flush with dong, which poured into the economy, causing inflation. In February, the annualized inflation rate topped 15 per cent. In May, prices rose 3.9 per cent in a single month.

Prices were also being driven up by high worldwide prices for oil and food. Vietnam, the world's number two rice exporter, helped worsen the problem in March by barring new exports of rice, due to food security concerns. World rice prices doubled.

The government tried to hold down prices, freezing prices on basic materials like petrol and steel. It raised banks' capital requirements to soak up some of the excess currency. It also hiked the prime interest rate, first to 12 per cent in May, then up to 14 per cent in June. Interest rates on loans charged by commercial banks went as high as
21 per cent.

Finally, the government did something many Western governments might find odd: it told banks to stop lending out so much money. And it told massive state-owned corporations to stop spending money on speculative ventures unrelated to their core businesses.

It is not clear how much effect the government's cajoling had. As economist Jonathan Pincus noted at the time, such collective rhetoric is part of Vietnam's political culture, but economists find it difficult to assess its effectiveness.

But whether because state-owned companies responded to government scolding and cut back on needless spending, or because global food and oil prices dropped, or simply because high interest rates made credit hard to come by, inflation began to slow. By September, it was down to a monthly rate of just 0.2 per cent.

And in October and November, prices actually fell. Analysts who had worried about runaway inflation in June are now worried about the possibility of deflation. Vietnamese consumers who hoarded rice in fear of hyperinflation in June are now hunting for bargains, as prices drop from month to month.

The credit crunch has also helped hold down Vietnam's trade deficit. Estimates in the summer had predicted a trade deficit of 20 billion dollars for 2008. It is now expected to come in below 17 billion dollars.

Slowing inflation and a more modest trade deficit have helped prevent a collapse in investor confidence, with the dong holding roughly steady against the dollar. The official rate still stands at 16,600 to the dollar - close to where it was in May.

But with the onset of the global financial crisis, Vietnam is facing new pressures. And its own house is not yet in order.

"Seriously speaking, Vietnam has not escaped macroeconomic instability yet," said Vo Tri Thanh, a senior official at the Central Institute for Economic Management.

Demand for Vietnamese exports, particularly wood products, began falling dramatically in September due to recession in the US and Europe.

The government is already responding by loosening credit, cutting the prime interest rate to 10 per cent and ordering banks to lend at low interest to agricultural exporters.

As monetary policy loosens, the dong has begun to slip on the black market, trading at 17,400 to the dollar by December 10. A report by investment firm Vietnam Asset Management said "expectations for currency depreciation to support exports" were fueling the black- market slide.

Meanwhile, Vietnam's banks are endangered by the loss of revenue to their exporting customers. A report by PriceWaterhouseCoopers warned that besides the "immediate negative effects of macroeconomic difficulties," Vietnam's banks "might in fact have negative equity? as a result of mounting unsettled and bad loans from the past."

In 2009, Vietnam will face a struggle to find enough new foreign investment to finance its trade deficit. But the chief difficulty will be the global financial crisis and the world's low appetite for investment.

And as Vietnam watchers look back at 2008, they may take a moment to reflect that the predictions of the financial world's sharpest minds turned out to be less accurate than those of the Communist government in Hanoi. (dpa)