The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .The role of vehicle currency in affecting trade balance: Empirical evidence from the trade of China and the association of South East Asian nations with the European Union .2 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY HO HOANG GIA BAO THE ROLE OF VEHICLE CURRENCY IN AFFECTING TRADE BALANCE EMPIRICAL EVIDENCE FROM THE TRADE OF CHINA AND TH.
MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY HO HOANG GIA BAO THE ROLE OF VEHICLE CURRENCY IN AFFECTING TRADE BALANCE: EMPIRICAL EVIDENCE FROM THE TRADE OF CHINA AND THE ASSOCIATION OF SOUTH EAST ASIAN NATIONS WITH THE EUROPEAN UNION MAJOR: FINANCE MAJOR ID: 9340201 DOCTORAL DISSERTATION SUMMARY HO CHI MINH CITY – 2023 The dissertation is completed at: University of Economics Ho Chi Minh City (UEH) Academic supervisors: - Assoc Prof Dr Tran Thi Hai Ly - Dr Dinh Thi Thu Hong Reviewer 1: ……………………………………………………… …………………………………………………………………… Reviewer 2: ……………………………………………………… …………………………………………………………………… Reviewer 3: ……………………………………………………… …………………………………………………………………… The dissertation will be defensed before the university-level dissertation evaluation council at: …………………………………………………………………… …………………………………………………………………… At hour day month year The dissertation can be accessed at the library: …………………………………………………………………… CHAPTER 1: INTRODUTION 1.1 Research background and motivations Manifold studies have scrutinized the links between exchange rates and trade balances in various countries However, they have the same limitation when most of them ignore the roles of vehicle currencies, which fails to reflect the common practice in global trade invoicing A vehicle currency is defined as the currency of a third country used in the trade between the other two countries (Goldberg & Tille, 2008) It is a common practice in the global trade to invoice the goods by vehicle currencies Noticeably, the USD has an overwhelming role and thus is used for invoicing the goods in the trade of many countries with their partners even when the US does not participate in such trade (Boz et al., 2022) Specifically, the share of the US in the global trade was less than 10%, but the USD was employed in nearly 40% of the total global trade value This implies that roughly 30% of the world’s trade, without the participation of the US, was settled by the USD And even the EU, the home of the world’s second most popular currency euro (EUR), substantially employed the USD in its trade with non-US partners Thus, the dominance of the USD in the global trade is indisputable Nevertheless, most existing studies on the impacts of exchange rates on trade balances ignored the role of vehicle currencies, especially the USD The inadequate investigation of vehicle currencies in the literature on exchange rate-trade balance relationship reveals some notable research gaps that need to be filled The choice of the countries in this dissertation is motivated by the following reasons: - Asian emerging market economies have dominated the global trade of all emerging market economies which have grown rapidly and increasingly contributed to the world’s total output and consumption Among those Asian countries, China and nearly all the ASEAN countries are the most noticeable representatives In addition, China and most of the ASEAN countries, similar to the other Asian emerging market economies, substantially employ the USD as a vehicle currency in their trade - Although the EU is the home of the EUR – the world’s second most utilized currency, it strongly relies on the USD as a vehicle currency in trading with non-EU partners, especially in its importation Moreover, the largest and the third largest origins of the EU’s importation from non-EU countries are China and ASEAN Therefore, it can be inferred that the USD is strongly utilized as a vehicle currency in China-EU and ASEAN-EU trade - The EU is the biggest trading partner of China and vice versa Thus, the China-EU trade is important enough to be researched And more interestingly, the China-EU trade relies much on the USD as a vehicle currency - ASEAN consists of 10 countries, and most of them have grown very fast and gained more and more importance in the global trade The market of ASEAN is very lucrative with more than 640 million customers, which is the eighth biggest economy in the world Thus, it is not surprising when the priority of the EU is to promote their exports to ASEAN through bilateral and region-to-region free trade agreements Therefore, the ASEAN-EU trade can provide valuable empirical evidences for the roles of USD as a vehicle currency in the trade between these two regions at different levels of analyses - By analyzing the China-EU and ASEAN-EU trade, the USD satisfies the definition of a vehicle currency Specifically, a vehicle currency is defined as a third-country’s currency used for invoicing the merchandise traded between the other two countries (Goldberg & Tille, 2008) Therefore, as the US is not involved in China-EU and ASEAN-EU trade, the USD is considered a vehicle currency - The choice of China-EU trade in this dissertation enables a new and distinguishable analytical approach on the exchange rate USD/CNY Particularly, although USD/CNY has been in the spotlight of manifold research, it is investigated in connection with the China-US relationship Nevertheless, virtually no paper examines the impacts of USD/CNY on China’s trade with non-US partners Thus, this dissertation provides a new perspective on the role of USD/CNY in China-EU trade, and the findings indicate that the exchange rate USD/CNY have significant impacts on China’s trade balance with the EU at different levels of analysis 1.2 Research objectives - Research Objective 1: Scrutinize the effects of the use and nonuse of the vehicle currency USD on China’s trade balance with the EU at different levels of analyses - Research Objective 2: Scrutinize the effects of the use and nonuse of the vehicle currency USD on ASEAN’s trade balance with the EU at different levels of analyses 1.3 Research questions - Research Question 1: At each level of analysis, the use and nonuse of the vehicle currency USD have distinguishable effects on China’s trade balance with the EU? - Research Question 2: At each level of analysis, the use and nonuse of the vehicle currency USD have distinguishable effects on ASEAN’s trade balance with the EU? 1.4 Research scope The dissertation explains why the standard two-country model can be employed for analyzing the role of a vehicle currency, especially the USD Also, the dissertation explores the impacts of the use and nonuse of the vehicle currency USD on China’s and ASEAN’s trade balances with the EU at different levels of analyses The time span is from 2000Q1 to 2018Q1 For the industry-level analyses, the time span is from 2002Q1 to 2018Q1 due to the unavailability of data The estimation method is Nonlinear Autoregressive Distributed Lags (NARDL) The data are collected from various sources including Asian Development Bank (ADB), Direction of Trade Statistics (DOTS), Eurostat, Federal Reserve Bank of St Louis (FRED), General Statistics Office of Vietnam (GSO), and International Financial Statistics (IFS) 1.5 The contributions of the dissertation Regarding the theoretical contributions, this dissertation is the first study to explain why the standard two-country model, which serves as the theoretical framework for most of the research about exchange rates’ impacts on trade balances, can be used for scrutinizing the role of a vehicle currency The explanation and the method suggested by this dissertation can overcome the shortage of data about the percentage of a vehicle currency used in the trade of two countries Furthermore, from the explanation and the method suggested by this dissertation, researchers can apply the standard two-country model to investigate the role of any vehicle currency in the trade of any two countries in the world Thus, this dissertation makes a theoretical contribution to the literature by strengthening the standard twocountry model to make it applicable in the presence of a vehicle currency The dissertation also has some empirical contributions to the literature Specifically, - First, the dissertation is the first research to provide the empirical evidences about the impacts of the vehicle currency USD’s exchange rate on China’s trade balance with the EU at different levels of analyses - Second, it is also the first research to provide the comparisons between the impacts of the use and nonuse of the vehicle currency USD on China’s trade balance with the EU at different levels of analyses - Third, the dissertation is the first research to provide the empirical evidences about the impacts of the vehicle currency USD’s exchange rate on ASEAN’s trade balance with the EU at different levels of analyses - Fourth, it is also the first one to compare the impacts of the use and nonuse of the vehicle currency USD on ASEAN’s trade balance with the EU at different levels of analyses - Fifth, the construction of the proxy for the exchange rate between two regions has been inadequately addressed by the existing studies This dissertation is the first research to propose the construction of the proxy for the exchange rate between two regions - Sixth, the dissertation suggests a new factor leading to the deficiency of significant findings Namely, besides the two factors causing the shortage of significant findings already found by the existing literature (i.e., the aggregation bias and symmetric assumption about exchange ratetrade balance linkage), the dissertation proposes that the neglection of the vehicle currency USD in the scrutiny of the trade between two non-US partners can be a new culprit - Seventh, the research design of this dissertation can effectively assess the role of USD as a vehicle currency which has been neglected by prior studies CHAPTER 2: LITERATURE REVIEW 2.1 The impacts of exchange rates on trade balances The Marshall-Lerner condition (Marshall, 1923; Lerner, 1944), the Jcurve effect (Magee, 1973), and the standard two-country model (Rose & Yellen, 1989) are the main theoretical frameworks for the studies on the impacts of exchange rates on trade balances They assume that the currencies used for invoicing the exported and imported goods either belong to the home country or the foreign country, and thus the role of a vehicle currency is missing The J-curve effect has been the most popular topic regarding the impacts of exchange rates on trade balances (Ali et al., 2014) Since the work of Magee (1973), numerous studies have focused on the J-curve effect to concurrently investigate the short-run and long-run impacts of exchange rates on trade balances instead of solely scrutinizing the Marshall-Lerner condition which only describes the long-run relationship (BahmaniOskooee & Mitra, 2010) The development of the literature on the J-curve effect has the following main features: - First, almost every country and territory in the world have J-curve studies devoted to them Moreover, the impacts of exchange rates on trade balances vary from country to country In addition, for a given country or territory, the support for the J-curve effect is also subject to different papers using distinctive data and methods - Second, the application of aggregated data can result in the aggregation bias and consequently causes insignificant findings about the Jcurve effect - Third, to reduce the aggregation bias, the obvious trend in the development of J-curve literature is the transition from the aggregate-level analysis to the bilateral-level and industry-level ones - Fourth, besides the aggregation bias, the symmetric assumption about the impacts of exchange rates on trade balances is another culprit for the lack of significant findings Particularly, Bahmani-Oskooee and Fariditavana (2015, 2016) criticized the prior studies that relied on the symmetric assumption (i.e., a 1% depreciation and a 1% appreciation of a country’s currency have the same magnitude of effect on its trade balance) which contributed to the inadequacy of significant results Since the pioneering articles of Bahmani-Oskooee and Fariditavana (2015, 2016), there is a clear transition of the recent studies from the symmetric assumption which mostly used the ARDL method to the asymmetric one which normally employed the NARDL method And virtually all the recently published articles indicated that the NARDL method is better than the ARDL counterpart in detecting more significant results of exchange rates’ impacts on trade balances - Fifth, almost all the studies have ignored the roles of vehicle currencies Only a few papers have empirically included vehicle currencies in their analyses (Šimáková, 2013; Nhung et al., 2018), but they did not give any theoretical framework or explanation for their work Thus, they lacked the theoretical basis and explanation why the vehicle currencies can be incorporated into the standard two-country model In addition, the literature review of this dissertation also indicates that no paper has examined the exchange rate-trade balance nexus in China’s total trade with the whole EU, China’s bilateral trade with all members of the EU, and China’s trade with the whole EU at industry level In addition, no paper has covered the role of the vehicle currency USD in the aforesaid trade Also, no paper has examined the exchange rate-trade balance nexus in ASEAN’s total trade with the whole EU, the trade of each ASEAN member of the whole EU, and the trade of the entire ASEAN with the whole EU at industry level Besides, it is noticeable that no research has covered the role of the vehicle currency USD in ASEAN’s trade with the EU at different levels of analyses 2.2 The dominance currency paradigm The dominance of USD has been one of the most noticeable patterns of the global trade for many years The leading role of USD is so remarkable that its importance cannot be disregarded in the trade between any two non-US countries (Boz et al., 2022) Realizing that both the “producer currency pricing” and “local currency pricing” paradigms failed to reflect the world with an overwhelmingly prominent currency (i.e., the USD), Gopinath et al (2020) developed a new one called the “dominant currency paradigm” to fill the gap in the literature Published in the 13 3.2 Empirical models and the computation of the variables 3.2.1 The empirical models and the computation of the variables for the Research Objective The Research Objective is about scrutinizing the effects of the use and nonuse of the vehicle currency USD on China’s trade balance with the EU at different levels of analyses Namely, this dissertation examines (a) China’s total trade balance with the whole EU, (b) China’s bilateral trade balances with each member of the EU and the UK, and (c) China’s trade balance with the whole EU at the industry level At all the aforesaid three levels, the impacts of the use of the vehicle currency USD will be inspected through the exchange rate USD/CNY In order to analyze the impacts of the real effective exchange rate and the vehicle currency USD’s exchange rate on China’s trade balance with the whole EU, the following empirical models are utilized: lnC TBt=α + α ln REER t +α lnY t + α ln YF t +ϵ t ( 44 ) ' ' ln CTB t =α +α ' ln VER t + α '2 ln Y t +α ' lnYF t +ϵ t ( 45 ) The variable “CTB ” denotes China’s trade balance with the whole EU, computed by China’s exports divided by its imports The variable “ REER ” is the real effective exchange rate between CNY and all the currencies of the EU, and an increase in this variable denotes the depreciation of CNY The variable “VER ” is the exchange rate between CNY and the vehicle currency USD Besides, “Y ” and “YF ” 14 respectively denote the incomes of China and the whole EU All variables are in real terms Regarding China’s bilateral trade balances with each of the EU members and the UK, the bilateral exchange rates between CNY and the currencies of each EU country plus the UK are employed for examining their impacts on China’s trade balances with the respective trading partners The following empirical models are utilized: lnC TB i ,t =β ,i + β ,i ln BER i ,t + β ,i ln Y t + β ,i ln GDPF i ,t +ϵ i ,t ( 48 ) ' ' ln CTB i ,t =β ,i + β ' 1, i ln VER t + β ' ,i ln Y t + β '3 ,i ln GDPF i ,t +ϵ i ,t ( 49 ) Regarding China’s trade balance with the EU at the industry level, the following empirical models will be used: lnC TB j , t=γ , j + γ , j ln REER t +γ , j ln Y t + γ , j ln YF t + ϵ j , t ( 50 ) ' ln CTB j , t=γ , j +γ ' , j ln VER t + γ ' , j ln Y t +γ ' , j ln YF t +ϵ (51 ) ' j,t 3.2.2 The empirical models and the computation of the variables for the Research Objective Regarding the Research Objective 2, this dissertation investigates (i) ASEAN’s total trade balance with the whole EU, (ii) the trade balances of each ASEAN member with the whole EU, and (iii) ASEAN’s trade balance with the EU at the industry level 15 The empirical models used for analyzing ASEAN’s total trade balance with the whole EU are specified as follows: lnA TB t=δ + δ ln AREERt + δ2 ln AY t +δ ln EY t + ε t ( 52 ) ' ' ln ATBt =δ + δ ' ln RUSD t +δ ' ln AY t +δ ' ln EY t + ε t ( 53 ) In Equations 52 and 53, the variable “ ATB ” denotes ASEAN’s trade balance with the whole EU, measured by ASEAN’s total exports divided by its total imports The variable “ AREER ” represents the real effective exchange rate between the currencies of ASEAN countries and the currencies of the EU countries An increase in “ AREER ” denotes the depreciation of ASEAN’s currencies against the EU’s currencies The variable “ RUSD ” indicates the exchange rate between ASEAN’s currencies and the vehicle currency USD An increase in “ RUSD ” denotes the depreciation of ASEAN’s currencies against the vehicle currency USD The variables “ AY ” and “ EY ” respectively represent the incomes of ASEAN and the EU All variables are in real terms Regarding the trade balances of each ASEAN member with the whole EU, the following empirical models are used: ln ATBk , t=ζ ,k +ζ ,k ln AREERk , t +ζ ,k ln AY k , t +ζ , k ln EY k , t +ε k ,t ( 58 ) ' ' ln ATBk , t=ζ ,k +ζ ' , k ln RUSDk , t +ζ ' ,k ln AY k , t +ζ ' , k ln EY k , t +ε k , t ( 59 ) 16 The variable “ AREER k ,t ” indicates the real effective exchange rate between the currency of the country “ k ” in ASEAN with all the currencies of the EU, and an increase in this variable indicates the depreciation of the currency of the country “ k ” Regarding ASEAN’s trade balance with the EU at the industry level, the following empirical models are employed: lnA TB h ,t =η0 , h+ η1 ,h ln AREER t +η2 , h ln AY t +η3 , h ln EY t + ε h ,t ( 62 ) ln ATBh ,t =η' , h+ η' ,h ln RUSD t +η ' 2, h ln AY t +η ' ,h ln EY t + ε ' h ,t ( 63 ) In Equations 62 and 63, “ h” denotes the industries traded between ASEAN and the EU Hence, “ A TB h ,t ” means ASEAN’s trade balance with the EU in the industry “ h” at the time “ t ” Moreover, all the independent variables in the Equations 62 and 63 are the same as those in the Equations 52 and 53 3.4 Estimation method The dissertation will apply the NARDL method of Shin et al (2014) to estimate the empirical models The author chooses the NARDL method because of its advantages and suitability First, the NARDL method is a convenient and effective tool to assess the asymmetric effects of exchange rates on trade balance Second, the existing literature clearly indicates that exchange rates have asymmetric effects on trade balances in many countries, and under the asymmetric assumption, more significant impacts of exchange rates on trade balances are revealed Third, similar to the ARDL method, the NARDL method can be used when the variables are 17 either I(1) or I(0) processes Fourth, the NARDL method is appropriate for small samples and reliable even when some variables are endogenous Finally, the NARDL method can estimate the short-run and long-run impacts of the independent variables on the dependent variables at the same time using only one equation Since the empirical models given in the Equations 44 and 45 only indicate the long-run impacts of the independent variables, the shortrun ones are not demonstrated Thus, in order to concurrently estimate the short-run and long-run impacts, the Equations 44 and 45 need to be converted into the error correction forms (depicted by Equations 64 and 65, respectively) following the method of Shin et al (2014): p1 p2 p3 l=1 p '1 m=0 p '2 n=0 p '3 ∆ lnCTBt =v+ ∑ ( π ,l ∆ lnCTBt −l¿ )+ ∑ (π ,m ∆ P OS REERt−m ¿ )+ ∑ (π ∆ lnCTB t =v ' +∑ (π ,l ∆ lnCTBt−l ¿)+ ∑ (π , m ∆ P OS VERt −m ¿)+ ∑ ( l=1 ' ' m=0 Regarding the Equation 64, the notations p1, p2, p3, p4 , and p5 are respectively the optimal lags of the variables, which can be selected by popular criteria such as the Akaike information criterion (AIC) Besides, λ 1, λ 2, λ 3, λ 4, and λ are respectively the coefficients of the variables in the long run The variable POS REER indicates the depreciation of CNY against the EU’s currencies The variable ¬REER ¿ indicates the appreciation of CNY against the EU’s currencies The impacts of POS REER and ¬REER ¿ on China’s trade balance with the EU n=0 18 (i.e., CTB ) can be different in both the short run and the long run Following Shin et al (2014), they are computed as: t POS REERt =∑ max ( ∆ ln REER g , ) g=1 t ( 66 ) ¬REER ¿t =∑ ( ∆ ln REER g , ) ¿ ( 67 ) g=1 Regarding the Equation 65, the symbols p ' 1, p ' 2, p ' , p ' , and p ' are respectively the optimal lags of the variables, which can be selected by popular criteria such as the Akaike information criterion (AIC) Besides, λ ' 1, λ ' 2, λ ' 3, λ ' 4, and λ ' are respectively the coefficients of the variables in the long run The variable POS VER indicates the depreciation of CNY against the vehicle currency USD The variable ¬VER ¿ indicates the appreciation of CNY against the vehicle currency USD The effects of POS VER and ¬VER ¿ can be distinctive in both the short run and the long run Following Shin et al (2014), they are computed as: t POS VERt=∑ max ( ∆ ln VER g , ) g=1 t ( 68 ) ¬VER ¿ t=∑ ( ∆ ln VER g , ) ¿ ( 69 ) g=1 The NARDL estimation procedure of Equation 64 starts with the check for the non-occurrence of I(2) process The common unit-root tests such as Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) .. . trade with the whole EU, China? ??s bilateral trade with all members of the EU, and China? ??s trade with the whole EU at industry level In addition, no paper has covered the role of the vehicle currency. .. analyzing the role of a vehicle currency, especially the USD Also, the dissertation explores the impacts of the use and nonuse of the vehicle currency USD on China? ??s and ASEAN’s trade balances with. .. Gopinath et al (2020) provided an extensive theoretical framework and compelling empirical evidences for the role of the dominant currency USD in affecting the trade of a country with the rest of