Dollazation in vietnam impacts and solutions,

Banking Academy Graduation Thesis STATE BANK OF VIETNAM BANKING ACADEMY Foreign Language Faculty - - GRADUATION THESIS DOLLARIZATION IN VIETNAM IMPACTS AND SOLUTIONS Lecturer : Nguyen Thi Hong Mai (M.A) Student : Nguyen Thi Khanh Huyen Class : K14-ATCB Student Code : 14A7510092 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis ACKNOWLEDMENT First and foremost, I would like to express my deepest gratitude to my supervisor, Mrs Nguyen Thi Hong Mai, for her excellent guidance, caring, patience, and providing me with an excellent atmosphere for doing the research Besides, I also would like to extend my special thanks to all the lecturers in Banking Academy, especially lecturers of Foreign Language Department, who provided me with useful background knowledge during the last four years Finally, this project is dedicated to my family, who is always supporting me and encouraging me with their best wishes They always there cheering me up and standing by me through good or bad times Although this research was carefully prepared, I am still aware of its limitations and shortcomings due to time constraints and my limited capacity It would be my pleasure to receive any comments and suggestions on the thesis in order to have better projects in the future Sincerely Hanoi, June 2015 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis ABSTRACT This paper assesses the benefits and risks associated with dollarization as well as its impacts In fact, dollarization has been a common issue in Vietnam ever since 1988 with the stepping stone of foreign currency deposit allowance in the banking system Considering dollarization in three perspectives including the use of US dollars in the society, the proportion of foreign currency deposits and credits, it is undeniable that Vietnam’s economy has been dollarized Especially, the situation is even worse when Vietnam became a member of the world trade organization (WTO) Therefore, researchs on the issue has been in great demand to clarify a number of issues: What is Dollarization? What are the forms of dollarization? Is it good or bad for the economy and whether it should be completely eliminated? How it impacts the economy? Guidelines to promote the positive influences and limit the negative impacts of dollarization? With the purpose of providing a better overview of dollarization for those who are interested, the topic "Dollarization and the situation of Vietnam” was selected by the author as the subject for graduation thesis Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis TABLE OF CONTENT ACKNOWLEDGEMENT…… … …………………………………………………… ABSTRACT……………………………………………………………………………… TABLE OF CONTENTS………… …………………………………………………… LIST OF FIGURES AND TABLES……………….………………….………………… LIST OF ABBREVIATIONS………… ……………………………………….……… INTRODUCTION………………………………………………….…………………….1 Background……………………………………………………………………… .1 Research objectives……………………………………………………………………… Methodology……………………………………………………………………………….1 Data sources……………………………………………………………………………… Research questions……………………………………………………………………… CHAPTER 1: OVERVIEW OF DOLLARIZATION………………………………….3 1.1 The concept of dollarization…………………………………………………………3 1.2 Classification of dollarization………………………………………………….…….4 1.2.1 Official dollarization…………………………………………………………………4 1.2.2 Unofficial dollarization………………………………………………………………5 1.2.3 Semidollarization…………………………………………………………………….6 1.3 Measurement of dollarization……………………………………………… ………6 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis 1.4 Origins of dollarization…………………………………………………………… 1.5 Impacts of dollarization………….…………………………………………………10 1.5.1 Positive impacts…………………………………………………………………….10 1.5.2 Negative impacts………………………………………………………………… 13 CHAPTER 2: DOLLARIZATION IN VIETNAM………………………………… 16 2.1 Dollarization situation in Vietnam……………….……………………………… 16 2.1.1 Dollarization in the past…………………………………………………………….16 2.1.2 Dollarization in recent years……………………………………………………… 22 2.2 Impacts of dollarization in Vietnam……………………………………………….27 2.2.1 Impacts on the economy………………………………………………… 27 2.2.2 Impacts on the banking system…………………………………………………… 30 2.2.3 Impacts on the government’s policy operations ………………………………… 31 CHAPTER 3: RECOMMENDATIONS AND SUGGESTED SOLUTIONS……….35 3.1 Assessment of current dedollarization measures………………………………….35 3.2 Solutions…………………………………………………………………………… 39 3.2.1 VND position improvement……………………………………………………… 39 3.2.2 Foreign exchange management………………………………………………… 42 3.2.3 Banking solutions…………………………………………………………… 43 REFERENCES………………………………………………………………………….46 APPENDICES………………………………………………………………………… 48 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis LIST OF FIGURES AND TABLES LIST OF TABLES Table Effective broad money……………………………………………………….…7 Table 2: Total exports and imports of Vietnam from 1996 to 2013…………………….28 LIST OF FIGURES Figure 1: Hyperinflation in Vietnam in the 1980s………………………………………18 Figure 2: Dollarization ratio in Vietnam from 1989 to 2003……………………………19 Figure 3: The inflation rate from 1989 to 2003 in Vietnam…………………………… 20 Figure 4: Dollarization level in Vietnam from 2000 – 2014 (percent)………………… 22 Figure 5: Exports - Imports and trade of balance in Vietnam from 2004 to 2014……….25 Figure 6: International funds inflows in Vietnam from 1995 to 2012………………… 26 Figure 7: International visits in Vietnam from 2000 – 2010……………………… 29 Figure 8: Foreign currency in circulation from 1996 to 2009 (million USD)……………32 Figure 9: Interest rate on VND and USD deposit from 2009 to 2013………… ……… 36 Figure 10: Exchange rate movements from 2012 to 2014……………………………… 37 Figure 11: Changes in FCDS and Foreign currency credits from 2001-2014……………38 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis LIST OF ABBREVIATIONS ADB Asian Development Bank CPI Consumer Price Index FCC Foreign Currency In Circulation FCD Foreign Currency Deposit FDI Foreign Direct Investment FPI Foreign Portfolio Investment GSO General Statistics Office IMF International Monetary Fund ODA Official Development Assisstance OMO Open Market Operation SBV State Bank Of Vietnam Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis INTRODUCTION Background Dollarization is a common and unavoidable phenomenon of developing countries with high inflation rates and weak local currencies In fact, foreign currencies have been widely used in trading in Vietnam since 1988 when commercial banks were allowed to accept deposits in foreign currency By 1992, the status of dollarization reached its highest level of 41% Since then, although dollarization situation has been improved to some extent, its complicated movements have posed certain influences on the operation of both the economy in general and the banking sector in particular My graduation project aims to discover dollarization and its impacts on the performance of Vietnam's economy; thereby, finding solutions to handle the problem Research Objectives The thesis deeply focuses on how dollarization works, its impact and influences on Vietnam’s economy; thereby introducing solutions for the situation Methodology In this thesis, with the purpose of making it more reliable, I approach the subject in many different methods including dialectical materialism method, data collection method, statistical method, comparison method etc Data source The analysis is carried out based on highly authorized sources of information including State bank of Vietnam Annual Reports, General Statistics Office of Vietnam, IMF Working Papers, and other reputable articles and researches of reliable market data providers Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis Research question The thesis aspires to reveal the answers for the following questions: What is dollarization? How does dollarization influence Vietnam’s economy? What are the solutions to eliminate and reduce the impacts of dollarization in Vietnam? Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis CHAPTER OVERVIEW OF DOLLARIZATION 1.1 THE CONCEPT OF DOLLARIZATION According to Connie Mack in “Basics of dollarization”, dollarization occurs when residents of a country extensively use a foreign currency alongside or instead of the domestic currency, in order to replace one or more of the money functions including medium of exchange, unit of account and store of value Additionally, International Monetary Fund (IMF) gives the definition of dollarization as “the holding by residents of a significant share of their assets in the form of foreigncurrency-denominated assets…” and “…is a common feature of developing countries and transition economies and is thereby typical -to a greater or lesser extent -of many countries that have IMF-supported adjustment programs” Normally, each independent nation had its own currency as a symbol of sovereignty However, in the process of integration, national currencies have been weakening or even disappearing In reality, the term “dollarization” refers to not only the use of US dollar but also include other strong currencies such as British pound and Japanese yen However, the US dollar has been taking over as the world's currency of account Much trade is now dollarbased, countries prefer to hold their central bank reserves in US dollars, and private companies as well as wealthy citizens often hold dollars or dollar-denominated assets Therefore, dollarization normally refers to the use of US dollar In Vietnam, dollarization implies the dominant of US dollar as a type of the second most popular currency, followed only by VND, the domestic currency Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis So as to accomplish this goal, it needs to ensure the stability of VND as well as the control over inflation Analysis shows that the elements to improve the convertibility of the currency include:  Ensuring sustainable economic growth, improving the competitiveness of goods and services This is the basic element and objective condition to build up citizens’ long-term confidence in the local currency  Financial policies - monetary must aim at controlling inflation and improving VND position in the market  Foreign exchange management policy suite open development level of the economy, including the implementation of a flexible exchange rate regime  The financial markets (money market, foreign exchange market, capital market) have to be formed, develop synchronously and operate effectively  Developing system of financial institutions and implementing monetary transactions with low-cost advantages 3.2.2 Improving effectiveness of foreign exchange management Dollarization situation on the financial markets of Vietnam are common in all functions of currency, including means of payment, medium of exchange and credit functions through commercial banks This has created an environment for speculative activities to appear whenever there are foreign currency fluctuations In order to improve the situation of dollarization in our country, foreign exchange policy should be appropriate and well controlled  Policy perspective: Do not attempt to peg VND to USD but instead the exchange rate should be determined based on the real supply and demand in the forex Besides, national reserves should be improved so that the central bank is able to increase or decrease pump foreign currency into the market when the market is volatile, which helps stabilize Nguyễn Thị Khánh Huyền 41 K14 - ATCB Banking Academy Graduation Thesis the market It also need to create mechanisms to develop foreign exchange market along with a tight control of dollarization, which includes the strong development of foreign exchange derivative transactions for market participants to protect against the risk of fluctuations in exchange rates  Management perspective: Strengthening the coordination among ministries in overseeing the implementation of foreign currency management on a national scale and in all sectors of the economy; Having strict sanctions for violations of the law on foreign exchange management; Paying attention to closely monitor foreign exchange transactions; Focusing on statistics and surveys of FX transactions within and outside the banking sector; Requiring registration of forex trading from the beginning 3.2.3 Banking system solutions: 3.2.3.1 Selection of foreign currency borrowers together with customer credit determination Seriously implementing the customer selection criteria reduces the need for foreign currency loans by determining the exact customers with legitimate demands Customers who are allowed to borrow in foreign currencies will only include enterprises with foreign currency revenue as well as having the capacity to repay in foreign currency and regenerating the supply of foreign exchange for commercial banks (This, in fact, has been mentioned in Circular 37/2012/TT-NHNN but the implementation still remains inefficient) After having finished with customer selection step, banks are required to determine credit limits in foreign currencies for each specific customer, even according to different needs such as short-term lending, L/C opening or warranty, etc based on capital needs for production and import business Commercial banks should not define the limits based on the demand and proposed collateral value merely In doing so, banks can save foreign Nguyễn Thị Khánh Huyền 42 K14 - ATCB Banking Academy Graduation Thesis currency funds and eliminate business practices unethical when we cannot eliminate the state two interest rates today On the basis of identified foreign currency credit limits, banks are able to actively set up the mobilization plan in each period to meet the customer needs while limiting negative foreign currency position (short position ) excess capital and to transfer capital abroad 3.2.3.2 Restriction on medium and long-term foreign currency borrowings by encouraging lending in Vietnam dong In addition to screening clients and establishing a proper credit limit, it is also highly recommended that medium and long-term foreign currency credits be also eliminated (since these forms of borrowings have close relationship with imbalance of maturity, interest rate risk, exchange rate risk and liquidity risk) On the one hand, in order to minimize the demand for medium and long-term borrowings, it is essential to eliminate the differences between interests on loans in foreign currency and local currency If the central bank still maintains the large interest margin, many businesses are still risky to borrow in USD despite the ability of exchange rate risk On the other hand, commercial banks should take measures to increase the attractiveness of VND loans by (1) improving the quality of services and providing customers with utilities for VND borrowings, especially optimizing credit appraisal and disbursement procedures; (2) apply market interest rate actively and flexibility (3) agree to repay ahead of maturity Nguyễn Thị Khánh Huyền 43 K14 - ATCB Banking Academy Graduation Thesis CONCLUSION In conclusion, dollarization is unavoidable situation for countries with low starting points and are in transitional phrases like Vietnam The expanding dollarization raises a number of important theoretical and political concerns Firstly, there is a concern that dollarization can reduce the effectiveness of monetary policy It affects the choice of assets that should be included in the monetary aggregates and the choice of exchange rate regimes The second concern is about the risks that dollarization poses for macroeconomic and financial stability and performance through creating currency and/or maturity balance sheet mismatches and complicating the management of a crisis by reducing the effectiveness of financial safety It is not to mention the influences of dollarization on the national sovereignty as well as the country’s culture As mentioned above, numerous solutions have been proposed to deal with dollarization However, it is sustainable economic growth promotion that plays the most important role Nguyễn Thị Khánh Huyền 44 K14 - ATCB Banking Academy Graduation Thesis in the process of dedollarization Only by improving the macroeconomic environment that the confidence of citizens in the local currency could be strengthened In order to achieve this long term target, the central bank needs to have flexible monetary policy operation to reinforce the stability of the banking system Simultaneously, the central bank should continue to raise reinforcement of foreign exchange reserves to enhance the controlling power over monetary policies REFERENCES Michaël Goujon - Fighting inflation in a dollarized economy: The case of Vietnam Saa Saamoi – Dollarization: A Literature Review of Developing Countries Institue for international economics - Advantages and Disdavantages of Dollarization Edgar L Feige –The dynamics of Currency substitutions, Asset substitution and De facto Dollarization and Euroization in ransition countries IMF Working Papers:  Revisiting the Concept of Dollarization: The Global Financial Crisis and Dollarization in Low-Income Countries  Gianni De Nicoló, Patrick Honohan, and Alain Ize - Dollarization of the Banking System: Good or Bad?  Monetary Policy in Dollarized Economies Nguyễn Thị Khánh Huyền 45 K14 - ATCB Banking Academy Graduation Thesis  Andrew Berg, Eduardo Borensztein - Full Dollarization: The Pros and Cons Bank journal, March 2015: The emphasis in foreign exchange management in 2015 and recommendations State bank of Vietnam annual reports Vietnam’s general statistic office Other links for references: http://www.tapchitaichinh.vn/Nhan-dinh-Du-bao/Chong-Dola-hoa-Bai-hoc-kinh-nghiemnao-cho-Viet-Nam/49560.tctc http://nhipcaudautu.vn/article.aspx?id=20842-2-mat-cua-do-la-hoa http://finance.tvsi.com.vn/News/2013329/237747/chong-dola-hoa-hieu-qua-nhung-moichi-dua-vao-cstt.aspx http://www.btc.edu.vn/hot-job/22-tin-tuc/tin-ngan-hang/44-phi-ola-hoa-thach-thc-i-vi-vitnam.html http://vneconomy.vn/tai-chinh/bien-dong-ty-gia-nam-nay-can-can-co-the-duong-5-ty-usd2015040109175542.htm http://www.vcci.com.vn/nghien-cuu/20140712070910188/lo-ngai-do-la-hoa-tang-tro-lai.htm http://www.ecuadornumismatics.com/numisphily/dollarization/jec/basics.htm http://www.ukessays.com/essays/economics/the-dollarization-of-world-trade-and-itsimpact-on-cambodian-economy-economics-essay.php http://thuvienphapluat.vn/archive/Quyet-dinh/Quyet-dinh-98-2007-QD-TTg-phe-duyetDe-an-nang-cao-tinh-chuyen-doi-dong-tien-Viet-Nam-khac-phuc-tinh-trang-do-la-hoanen-kinh-te-vb53369t17.aspx Nguyễn Thị Khánh Huyền 46 K14 - ATCB Banking Academy Graduation Thesis http://tinnhanhchungkhoan.vn/tien-te/tin-dung-ngoai-te-tang-cao-co-dang-lo-102407.html http://kinhdoanh.vnexpress.net/tin-tuc/ebank/ngan-hang/ngoai-te-cuu-tang-truong-tindung-3014965.html http://www.thanhnien.com.vn/kinh-te/nong-tin-dung-ngoai-te-226029.html http://vneconomy.vn/tai-chinh/dung-cho-vay-bang-ngoai-te-tu-3112-ty-gia-se-the-nao20141214094744905.htm http://vneconomy.vn/tai-chinh/chong-do-la-hoa-khong-chi-co-bat2011031010212591.htm APPENDICES Table Reported Ratios of Foreign Currency Deposits (FCD) Broad Money in Countries with IMF Arrangements Since 1986 Country 1990 1991 1992 1993 1994 1995 Highly dollarized economies (FCD/broad money > 30 percent) (18)1 Argentina Nguyễn Thị Khánh Huyền 34.2 35.1 47 37.1 40.4 43.2 43.9 K14 - ATCB Banking Academy Graduation Thesis Azerbaijan 14.8 58.9 50.3 Belarus2 40.6 54.3 30.7 Bolivia 70.8 76.8 80.8 83.9 81.9 82.3 Cambodia 26.3 38.8 51.8 56.4 Costa Rica 37.7 31.9 29.5 30.3 31.0 Croatia 53.8 50.2 57.4 Georgia 80.1 30.8 Guinea-Bissau 41.5 34.7 31.6 30.9 31.1 31.2 Lao P D R 42.0 39.4 36.8 41.4 34.4 35.6 Latvia 27.2 27.5 31.1 Mozambique3 11.8 16.7 23.2 25.3 32.6 Nicaragua 28.7 37.4 45.6 48.6 54.5 Nguyễn Thị Khánh Huyền 48 K14 - ATCB Banking Academy Graduation Thesis Peru 59.9 65.0 70.2 64.2 64.0 São Tomé and Príncipe 38.3 31.9 Tajikistan 33.7 Turkey 23.2 29.7 33.7 37.9 45.8 46.1 Uruguay 80.1 78.5 76.2 73.3 74.1 76.1 Median 41.7 36.4 36.8 40.4 48.6 39.7 Average 48.6 43.3 43.0 43.4 49.4 45.5 Moderately dollarized economies (FCD/broad money < 30 percent) (34)1 Albania 2.1 1.3 23.8 20.4 18.5 Armenia 41.6 20.4 Bulgaria 12.0 33.4 23.4 20.3 32.6 28.4 Nguyễn Thị Khánh Huyền 49 K14 - ATCB Banking Academy Graduation Thesis Czech Republic3 7.2 5.9 Dominica 3.0 3.9 3.5 2.5 1.5 Ecuador 2.8 5.4 Egypt 50.7 37.3 26.7 23.4 25.1 El Salvador 1.4 1.0 0.9 0.6 1.7 Estonia 23.0 3.8 9.9 11.4 Guinea4 6.5 6.9 10.0 9.4 9.6 Honduras 3.1 5.1 7.6 11.4 13.0 Hungary 12.2 16.5 14.3 18.7 20.4 26.6 Jamaica 21.3 19.5 28.1 25.0 Jordan 12.5 13.0 12.8 11.5 12.2 15.2 27.0 25.9 Lithuania Nguyễn Thị Khánh Huyền 50 K14 - ATCB Banking Academy Graduation Thesis Macedonia, FYR 18.1 Malawi 10.6 8.0 Mexico2 3.9 4.1 3.6 6.2 7.2 Moldova3 10.3 11.0 Mongolia 7.5 33.0 19.5 20.5 Pakistan5 2.6 8.9 11.9 13.9 13.6 Philippines 17.4 18.0 21.0 22.6 20.9 21.5 Poland 31.4 24.7 24.8 28.8 28.5 20.4 Romania 3.9 17.9 29.0 22.1 21.7 Russia 29.5 28.8 20.6 Sierra Leone 3.3 7.8 16.5 Nguyễn Thị Khánh Huyền 51 K14 - ATCB Banking Academy Graduation Thesis Slovak Republic 11.5 13.0 11.1 Trinidad and Tobago 6.9 12.6 13.6 Uganda 12.0 10.5 11.5 15.7 13.3 13.5 Ukraine 19.4 32.0 26.9 Uzbekistan2 20.1 5.1 22.5 15.5 Vietnam 25.9 20.9 20.4 19.7 10.8 12.1 19.7 20.7 20.9 8.1 16.2 Median 12.1 9.7 14.3 15.7 13.6 16.5 Average 12.8 13.3 15.9 15.0 17.2 16.4 Yemen Zambia Memorandum Nguyễn Thị Khánh Huyền 52 K14 - ATCB Banking Academy Graduation Thesis Selected industrial countries Greece Netherlands United Kingdom 11.5 13.2 14.8 16.6 15.0 21.6 8.7 7.2 7.2 3.9 4.7 4.4 11.4 7.7 10.5 10.9 12.6 15.4 Sources: IMF, IMF Staff Country Reports and International Financial Statistics (IFS) Classification based on observations for 1995; countries in bold are those selected for review Latest year's observation for March Latest year's observation for June Latest year's observation for September Fiscal year Nguyễn Thị Khánh Huyền 53 K14 - ATCB Banking Academy Nguyễn Thị Khánh Huyền Graduation Thesis 54 K14 - ATCB Banking Academy Nguyễn Thị Khánh Huyền Graduation Thesis 55 K14 - ATCB