(Luận văn) exchange rate pass through to vietnam’s import and domestic prices

INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS t to UNIVERSITY OF ECONOMICS ng hi ep VIETNAM - NETHERLANDS w n lo PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS ad ju y th yi pl al n ua EXCHANGE RATE PASS-THROUGH TO VIETNAM’S IMPORT AND DOMESTIC PRICES n va ll fu m oi BY nh at CAI BAO HIEU z z ht vb k jm MASTER OF ARTS IN DEVELOPMENT ECONOMICS om l.c gm n a Lu HO CHI MINH CITY, DECEMBER 2012 n va y te re INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS t to UNIVERSITY OF ECONOMICS ng hi ep VIETNAM - NETHERLANDS w n lo PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS ad y th ju EXCHANGE RATE PASS-THROUGH TO VIETNAM’S IMPORT AND DOMESTIC PRICES yi pl al n ua A thesis submitted in partial fulfilment of the requirements for the degree of n va MASTER OF ARTS IN DEVELOPMENT ECONOMICS ll fu By oi m CAI BAO HIEU at nh z Academic Supervisor: z ht vb Dr DINH CONG KHAI k jm om l.c gm n a Lu HO CHI MINH CITY, DECEMBER 2012 n va y te re Contents t to Chapter 1: Introduction ng Problem statement 1.2 Research questions hi 1.1 ep Research objectives w 1.3 n lo Chapter 2: Overview of Vietnam’s exchange rate, import activities and inflation ad Exchange rate arrangement in Vietnam y th 2.1 Overview of Vietnam’s import activities 2.3 Overview of Vietnam’s inflation ju 2.2 yi pl ua al Chapter 3: Literature review 10 n va Linear approarch 10 3.2 Vector Error Correction Model approach 11 3.3 Vector Autoregression approach 11 n 3.1 ll fu oi m nh at Chapter 4: Research methodology, empirical framework and data description 14 z Research methodology 14 4.2 Empirical framework 16 4.3 Data description 17 z 4.1 ht vb k jm gm Chapter 5: Empirical results 20 l.c ADF tests 20 5.2 Optimal lag length 20 5.3 VAR regression 20 5.4 Impulse response function: 24 om 5.1 n a Lu Response to exchange rate of import price index 25 i y 5.4.2 te re Response to exchange rate of foreign price index 24 n va 5.4.1 t to ng hi ep 5.4.3 Response to exchange rate of consumer price index 26 5.4.4 Response to foreign price index of import price index 27 5.4.5 Response to foreign price index of consumer price index 28 5.4.6 Response to output gap of money supply 29 5.4.7 Response to output gap of consumer price index 30 w n lo 5.4.8 Response to money supply of consumer price index 31 ad 5.4.9 Response to import price index of money supply 32 y th ju 5.4.10 Response to import price index of consumer price index 33 yi pl 5.4.11 Response to consumer price index of money supply 34 al Variance decomposition 35 5.6 Granger causality test 36 5.7 VAR stable 37 5.8 Lagrange multiplier test 38 n ua 5.5 n va ll fu oi m nh Chapter 6: Conclusion, Policy Recommendation and Future Work 39 at Conclusion 39 6.2 Policy Recommendation 40 6.3 Future Work 41 z 6.1 z ht vb k jm gm References 42 om l.c Appendices 45 n a Lu n va y te re ii List of figures t to Figure 1: REER, NEER and Exchange rate 1995-2012 ng Figure 2: Import by commodity group of Vietnam 1995-2010 hi ep Figure 3: Inflation of Vietnam 1996-2010 Figure 4: NEER, IMP and CPI of Vietnam 1999-2011 w Figure 5: Response to exchange rate of foreign price index 25 n lo Figure 6: Response to exchange rate of import price index 26 ad y th Figure 7: Response to exchange rate of consumer price index 27 ju Figure 8: Response to foreign price index of import price index 28 yi Figure 9: Response to foreign price index of consumer price index 29 pl ua al Figure 10: Response to output gap of money supply 30 n Figure 11: Response to output gap of consumer price index 31 va Figure 12: Response to money supply of consumer price index 32 n ll fu Figure 13: Response to import price index of money supply 33 oi m Figure 14: Response to import price index of consumer price index 34 nh Figure 15: Response to consumer price index of money supply 35 at Figure 16: VAR stable 37 z z ht vb k jm om l.c gm n a Lu n va y te re iii List of tables t to Table 1: VAR regression for import price index 21 ng Table 2: VAR regression for consumer price index 23 hi ep Table 3: Larange multiplier test 38 Table 4: ADF test of dlneer1 46 w Table 5: ADF test of dlimp 46 n lo Table 6: ADF test of dlcpi 47 ad y th Table 7: ADF test of dlm2 47 ju Table 8: ADF test of dlopi 47 yi Table 9: ADF test of dlpi 47 pl ua al Table 10: Optimal lag length 48 n Table 11: Granger causality test 48 va Table 12: Vector Autoregression results 50 n ll fu Table 13: Impulse - Response Function 57 oi m Table 14: Variance decomposition 69 at nh z z ht vb k jm om l.c gm n a Lu n va y te re iv Abbreviations t to ng hi ep Asian Development Bank ADF Augmented Dickey-Fuller ARIC Asia Regional Integration Center CPI Consumer Price Index ERPT Exchange Rate Pass-Through ADB w n Foreign Price Index lo FPI Hodrick-Prescott Filter pl International Financial Statistics ua al International Monetary Fund n IMF yi IFS General Statistics Office Of Vietnam ju HP Output Gap y th GSO ad GAP va Import Price Index M2 Broad Money Supply NEER Nominal Effective Exchange Rate OPI Oil Price Index REER Real Effective Exchange Rate USD United States dollar VAR Vector Autoregression VECM Vector Error Correction Model VND Vietnam Dong n IMP ll fu oi m at nh z z ht vb k jm om l.c gm n a Lu n va y te re v Acknowledgement t to I would like to give my sincerest thanks to my supervisor, Dr Dinh Cong Khai, who ng has provided me valuable support throughout the process of this thesis My study hi ep would not have been possible without his patience, encouragement, insightful comments and correction in all time of doing the research and writing the paper w n I am also deeply grateful to Dr Le Van Chon for his dedicated, generous, enthusiasm lo ad and thoughtful helps about Stata technique and Econometrics model Thank to those ju y th important guidance and useful advice, I have overcome many obstacles to complete yi the research work pl ua al Last but not least, I would like to give a big gratitude to my dear family and friends who always encourage and stand beside me during my difficult moments Their love n ll fu suffice n va have inspired me a lot and lifted me up; hence my mere expression of thanks does not oi m at nh z z ht vb k jm om l.c gm n a Lu n va y te re vi Abstract t to This paper estimates the exchange rate pass through to Vietnam’s import prices and ng domestic inflation with monthly data from January 1999 to October 2011 By applying hi ep Vector Auto Regression methods, Impulse Response function, Variance Decomposition as well as combining with Granger causality, VAR stable, Lagrange w multiplier tests, the results show that exchange rate passed through almost fully to n lo import price index immediately and strongly at the first month, after that it fluctuates ad y th to go up and down next months The transmission from exchange rate to consumer ju price index is smaller than to import price index but it penetrates with longer periods yi around 10 months Expanding money supply just explains for variance of inflation pl ua al 2.48% But it is not the surprising result, because the State Bank of Vietnam conducts n monetary policy timely and appropriately The results of variance decomposition, va however, reveal that the most important factor affecting on both import and consumer n ll fu prices is domestic demand pressure (output gap) with 32% and 14% respectively oi m Therefore the policy recommendation should focus on controlling domestic demand nh pressure as a priority to cut down high inflation Government also can be confident at with easing monetary policy due to its small effect on inflation Nonetheless, the z z economy still needs the stable exchange rate policy in order to keep the trust on vb ht domestic currency k jm om l.c gm n a Lu n va y te re vii Chapter 1: Introduction t to 1.1 Problem statement ng hi Exchange rate is one of the most important factors in macro-economic management ep It affects supply and demand of foreign currencies, exports and imports, national debts and reverses When a domestic currency appreciates; the country’s exports w n become more expensive and its imports become cheaper in foreign markets and vice lo ad versa for the depreciation of domestic currency Appreciation will make balance of y th trade lower, while depreciation will increase it ju yi Vietnam is following the export-led growth strategy; therefore export activities need pl ua al to receive a priority In recent years, import activities, however, have increased significantly; reducing net import is also a main concern now Exchange rate n ll fu two goals n va adjustment to depreciate domestic currency will be the useful tool to achieve those m oi However, when the State Bank depreciates domestic currency; this will cause nh pressure on inflation through three channels: the import prices increase will directly at z affect on domestic prices, export activities are pushed up thus the supplies for z vb domestic market decrease and export prices at domestic market increase, and k jm ht aggregate demand for non-tradable goods increases also put a burden on inflation gm Furthermore, depreciation has a common aspect like easing monetary policy; it l.c means the economy will encounter with inflation risk In order to balance this om effect, the State Bank needs to manipulate tightening monetary policy such as an Lu increasing reserve ratio or capital adequacy ratio Definitely, there is a close relationship between money supply and exchange rate; and government should n va consider this connection to control inflation effectively ey t re