(Tiểu luận) research paper the effect of exchange rate movements on vietnam’s trade balance in the period 2000 – 2018

Trang 1 1 SCHOOL OF ECONOMICS AND INTERNATIONAL BUSINESS ---***--- RESEARCH PAPER The effect of exchange rate movements on Vietnam’s trade balance in the period 2000 – 2018 No.. Bui121In

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SCHOOL OF ECONOMICS AND INTERNATIONAL BUSINESS

-*** -

RESEARCH PAPER The effect of exchange rate movements

on Vietnam’s trade balance in the period 2000 – 2018

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1 Bùi Quang Huy 1915513020 Section I: Theoretical

Abstract, Introduction Format Research Paper, Section I: Theoretical framework (1.1+ 1.2)

Section 3:

Recommendations + References

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on Vietnam’s trade balance

Linh H.Do1, Mai Q T Phan1, Hue T Vu1, Hung M Vu , Huy Q Bui1 2

1International Economics, Foreign Trade University

2International Business, Foreign Trade University

TAN432: English for Specific Purposes 3

M.A Phan Kim Thoa February 24, 2023

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ABSTRACT:

This study clarifies the impact of the fluctuation of the VND/ USD exchange rate on trade balance in Vietnam by using the Stata tool Variables used in this research included exchange rate and trade balance Trade balance was drawn from import and export value from the statistics of Vietnam Customs The time range for conducting data research was from 2000 to 2018, specifically data used are monthly statistics The nominal effective exchange rate data is taken from Vietnam customs from the first day of June 2000 to the first day of June 2018 for each The result of findings showed that the exchange rate appreciation had a negative effect on the trade balance In details, revaluation in exchange rate had trend to make trade deficit; and devaluation in exchange rate had trend to make trade surplus

Key words: Exchange rate, trade balance, Vietnam, Stata, effect

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INTRODUCTION:

Since the early 20th century, the term ‘globalization’ has been appeared, developed its current meaning sometime in the second half of the 20th century, and came into popular use in the 1990s The development of ‘globalization’ has continuously affected almost every countries in modern economy Thereby in the context of globalization and international economic integration, mechanisms and policies to regulate exchange rates are very important to directly affect the trade balance and macroeconomic stability in each country As a result, imbalance in the trade balance has become a favoured research topic within the community of economists

Passing many years of economic construction, Vietnam has had to face with the situation of trade deficit for a long time due to many different reasons (CEIC, 2019); and exchange rate is one of the important reasons influencing the change of trade balance The management of exchange rate and balance trade is extremely important in Vietnam which directly impacts trade balance Therefore, it is necessary

to examine the impacts of exchange rate on the trade balance in order to give recommendations for better managing exchange rate and trade balance in Vietnam

In this report, we used qualitative methods to analyze the topic "The effect of exchange rate movements on Vietnam’s trade balance in the period 2000 - 2018" The research paper is organized as follows:

SECTION 1: THEORETICAL FRAMEWORK

SECTION 2: ANALYSIS AND FINDINGS

SECTION 3: SOLUTIONS AND RECOMMENDATIONS During the process of making this research paper, due to the limited amount

of time as well as some certain limits in understanding and data collecting, despite all the efforts, the report may hardly avoid mistakes We are always willing to receive your comments so that our group can improve and complete this paper

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1.1 Concepts of exchange rate

1.1.1 Definition of exchange rate

Gary (2014) concreates exchange rate as ratio of which one of these currencies can be exchanged for any other at any given point in time Lu (2011) also states the similar definition that exchange rate is the price of some foreign currencies in terms

of home currency In particular, one foreign currency can buy how much of home currency In the macroeconomic context, the exchange rate is influenced by many factors, such as production capacity or technological developments All of these factors are subject to change based on the actual situation of each country Therefore, the exchange rate also suffers the same effects Thus, the ratio of the exchange rate is only temporary, could changes daily The ratio of today is different that of yesterday

It can increase or decrease day by day Sometimes, the ratio is remained without movement Generally speaking, exchange rate is the price of one currency in terms

of another currency The volatility of exchange rate is the increase or decrease of the price of the currency The price can be either fixed or floating Central bank has the role in deciding fixed exchange rates and floating exchange rates which are made decision based on the demand and supply of the market Every country has the exchange rate of changing its domestic currency into other currencies

1.1.2 Effect of exchange rate movements on import and export

Effect of devaluation of currency on imports and exports

Devaluation means there is a fall in value of a currency The devaluation of a currency has some effect on import and export of a country It will make imports more expensive and exports cheaper A country with its depreciated currency will have exports more competitive and appear cheaper to foreign customers Consequently, the demand for exports will increase As in the case of Vietnam, when VND is depreciated compared to USD, Vietnam goods appear cheaper and become more attractive to overseas customers Therefore, demand for exports will go up As

a result, there is an increase in Vietnamese exports Generally, devaluation makes

100 bài tập đầu tư Lập dự án đầu tư

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commodity price of a country cheaper to foreign customers; accordingly, export volume increases to match with the increasing demand of foreign customers

Devaluation makes exports price cheaper and exports volume higher; but makes imports price more expensive and imports volume lower In details, imports commodity such as petrol, food, and raw materials will be more expensive Simply understanding, when the currency of a country is depreciated, people of the country have to spend more money to buy products in overseas markets As a result, the demand for imports accordingly reduces

There is a fact that devaluation of a country’s currency will create trade surplus for the country The reason is that trade surplus equals exports minus imports When exports increase and imports decrease, trade surplus occurs as the consequence

of this phenomenon In other words, devaluation is necessary to reduce the size of trade deficit

Devaluation could cause higher economic growth Part of AD is (X-M) therefore higher exports and lower imports should increase AD (assuming demand is relatively elastic) In normal circumstances, higher AD is likely to cause higher real GDP and inflation So, devaluation causes higher inflation The reason is that expensive imports lead to high costs; and high costs cause the result of the increase

in the prices of domestic goods and services

In conclusion, devaluation is interested by exporters because they can increase the quantity of exports The profit is high although the price of commodity is low Trade deficit has opportunity to improve because exports are high imports in terms

of the quantity High quantity will create high revenue In other sentences, devaluation makes trade surplus As a result, economic growth might increase On the other hand, devaluation makes the price of imports increase Thus, costs are high which promote the increase in inflation Expensive imports will lead to high price in domestic products which is the result of high inflation

quản trị dự

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Effect of revaluation of currency on imports and exports

Being different from devaluation, revaluation means the increase in the value

of a country’s currency in relation to a foreign currency Revaluation will make exports more expensive and imports cheaper In other sentences, the price of exports commodity will be more expensive to foreigners This leads to the reduction in exports demand Consequently, there is reduction in the quantity of exports Imports become more attractive to domestic customers because the price of imports is cheaper So, demand for imports rises In the consequence, the quantity of imports also increases In the consideration of trade balance, account surplus can reduce due

to the increase of imports and decrease of exports A country wants to appreciate the value of currency at aim to delete trade surplus and reduce the situation of accumulating too many foreign reserves Revaluation stimulates import demand and curbs export demand (Quynh Anh, 2018) The success of revaluation depends much

on the response of import and export goods

Apart from the effect on trade balance, revaluation impacts inflation either high or low If the exporting country’s currency revaluates, demand for its goods will decrease, thereby leading to high inflation Conversely, if the importing country’s currency revaluates against the exporting country’s currency, low inflation may occur because of availability of cheap imports

1.1.3 VND/USD period 2000-2018

The following line chart presents the history data of VND/USD from year Jan,

2000 to Jan, 2018 The data is chosen on 1st January of each year

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Source: Vietnam customs (2019) Based on the table above, it can be seen that VND/USD has changed so much

In months of year 2000, investors can use one dollar to buy average 14 thousand VND Passing nearly 20 years, one dollar can buy average over 23 thousand VND

As a result, USD is appreciated and VND is depreciated in general There are some reasons making USD increase (Phan Minh Ngoc, 2018) Firstly, Vietnam has high foreign currency reserves It is to reserve USD in Vietnam Dollar currency reserves has reflected the difference between demand and supply of USD which is the factor deciding the change of VND/ USD In fact, high demand of USD in Vietnam is the cause of abundant USD resource In the case that if USD supply is higher than USD demand, the exchange rate has trend to decrease (VND is appreciated compared to USD) This is not good for export; so State bank has to buy USD in order to reduce the press on the increase of VND This contributes to the increase in foreign currency reserves Secondly, USD is appreciated when the reduction in USD resource from foreign investors happens It means foreign investors decrease the investment of USD

in financial operations such as stock, or financial market This is the result of weakening VND and strengthening USD

1.2.1 Definition of Trade balance

Trade balance is sometimes called balance of trade According to Romero (2012), trade balance means the difference between import and export of a particular country

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More clearly, it is the calculation of exports minus imports In the other aspects, David and Roy (1996) describe trade balance as “a reflection of how long a country has been a borrower or lender in international capital markets” Will (2019) provides

a similar definition of trade balance that the value of imports and exports of a country

in a period of time is different from each other Trade balance has the role in helping economists to evaluate the strength of the economy of a country If a country imports more goods and services than exports in term of value, the country has trade deficit Vice converse, if the country exports more goods and services than imports in term

of value, the country has trade surplus The formula for calculating trade balance is very simple as follows:

TB = total value of exports - total value of imports

1.2.2 Trade deficit and Trade surplus

Trade deficit

There are two kinds of balance of trade: trade deficit and trade surplus Countries would like to enjoy trade surplus because trade surplus proves the development of the country’s economy Actually, although being developed countries with strongly economic development, they have still put up with trade deficit in some periods Thanh Hang (2018) describes some causes leading to trade deficit Firstly, it is the difference between savings and investment Based on the survey of Carol, Finn, Katleen, Tien Quang and Duc Khai (2006), the yearly financial savings rate of Vietnamese people is low; they save only 3 percent of their income Their forms of savings include postal savings, savings in state-owned commercial banks, private banks and credit organizations and informal savings and savings by lending In recent years, the hot growth of stock market and real estate market makes people feel richer, which also increases consumption and reduces savings On the other hand, investment has trend to highly increase Monetary policy loses which leads to the reduction in domestic interest rate As a result, domestic investment increases

Secondly, Vietnam’s trade deficit is related to the structure of import and export goods In Vietnam, it is commercial issue The increase in export also means the increase in import 2/3 of export value is imported material High costs of inputs

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surely lead to trade deficit Organizations have to take much amount of money to import inputs for production and manufacture Consequently, the value of exports is lower compared to high costs of inputs Besides, the competitive ability of domestic goods is still low In other words, Vietnam has no key items on international markets

So, total value collected from international markets is not high

Trade surplus

Trade surplus occurs when the growth of exports is stronger than imports (John, 2016) In other sentences, trade surplus happens when a country exports more goods and services than it imports For example, if Vietnam exported 2 trillion USD worth

of goods and products and imported only 5 billion USD worth of goods and products;

so, it had a trade surplus of 1.5 trillion USD Higher the price of goods and products

is, higher the value of exports is As a result, trade plus is better Trade surplus is considered as a measure to watch the economic development of a country as it bases

on exports to drive economic growth

1.2.3 Important of trade balance in economy

As known that trade balance is the difference between imports and exports Thus, the increase or decrease in imports or exports shows the health of the economy

of a country; it also means the ability to compete in global markets is strong or weak Trade balance not only directly impacts the change of financial market, but also has

a fundamental effect on the value of a country's currency on the foreign exchange market

The currency of a country is very sensitive to the volatility of the economy mainly derived from the trade deficit; and this currency is only stable when the balance of trade shows that demand for goods and services from other countries is higher, leading to a trade surplus The bond market is quite sensitive to risks from imported inflation Through a trade balance report of a country, investors can comprehensively and generally identify the country's trade situation compared to other countries in the world

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In the details, trade balance has the important role to the economy of each country As analysed above, trade balance is related to imports and exports Therefore, both imports and exports play the role to the development of the economy Export is a factor that create growth stimulus In addition, export positively resolve unemployment and improve people lives It also increases GDP and national income thereby increasing domestic consumption Export is a growth factor, positively resolving unemployment and improving people's lives, increasing GDP and national income thereby increasing domestic consumption A company finds potential opportunities to sell its products in foreign markets; so, it will produce more products to meet the demand Certainly, domestic people have jobs to earn their livings; their life is also improved The improvement in human’s life is the result of the increase in consumption As a result, GDP and national income is a certainty to increase

In terms of import, it has the role in promoting the process of economic restructuring, supplementing sources of production materials and consumer goods funds Import makes the world more complete Without imports, there will not be exports Both imports and exports together promote the development of society and the global economy

Imports erase monopoly status, thoroughly disrupting closed economy This

is easy to understand that a company can find suppliers from many foreign countries over the world instead of only one supplier from one country The economy has chance to access to new markets and new opportunities Generally speaking, the increase in imports or exports all bring about the development or the expansion of business operations Relationships among countries are improved and widen in terms

of trade, culture, politics, and society It cannot deny the role of imports as well as exports in the process of developing, integrating into the world economy

1.2.4 Trade balance Vietnam 2000-2018

As seen in the following table, Vietnam had more trade deficit than trade surplus and going on for many years and many continuous years From year 2002 to year 2011, Vietnam’s trade deficit was highest at 12,78 billion USD in 2008 This

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was also the year of global economic crisis So, it can be said that the trade deficit in

2008 was the common situation of the world From 2012 to 2018, trade surplus was highest at 6, 8 billion USD in 2018 Vietnam’s import and export were considered as the most strength over nearly 20 years Trade balance in 2013 was zero

Source: Vietnam customs (2019)

In order to explain the reason for a prolonged trade deficit in Vietnam, Do Hanh Nguyen (2014) states that Vietnam's account deficit stems partly from the cause

of the state budget deficit (state budget) The high state budget deficit combined with rising public debt are a testament to Vietnam's growing current account deficit The state budget deficit (net government saving has a negative sign) that is high and persistent for a long time to serve the growth model has made a great contribution to the low domestic savings rate The current account deficit is not necessarily bad Sometimes a current account shortage represents the attraction of FDI in to develop production, increase exports and increase output

In addition, the current deficit is not necessarily a concern if the future surplus

is ensured However, considering the structure of imported goods in the balance of payments, if consumer goods account for a large proportion in import turnover, this may be a bad sign But if imported machinery, equipment and raw materials accounts for a large proportion, this structure can ensure to boost exports in the future, creating

a foreign currency surplus to offset the current balance deficit If a country suffers a current account deficit in a state of high inflation, low growth, the consequences of

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the deficit will be much more worrying than when the country is in a state of high growth and low inflation

1.3 Factor impact on trade balance

There are very many factors impacting on trade balance However, this research only states some of the main factors which clearly impact trade balance

Trade policies

It is clear that barriers and restrictions on trade impact import and export activities

of a country Policies that restrict imports or exports will make changes to the relative prices of those goods and services; consequently, import or export can be more or less attractive (Mary, 2018) According to economic rules, imports and exports will increase when tariff is low, even no tariff Business persons will not have to pay a tax payment for importing or exporting goods; and they would like to make more imports and exports Conversely, if a country applies high tariff to prevent risks or to limit import or export volumes, imports and exports are sure to decrease High fee for paying tax does not usually attract business persons to import and export goods and commodities Countries with high import tariff application may have larger trade deficits than countries with open trade policies (Kim, 1996) The reason is that high import tariff is the cause of shutting out of export markets

Inflation

In the case that inflation of a country is high, it means the price to produce a unit

of a product may be higher than the price in a lower-inflation country (Mary, 2018)

A manufacturing company must spend more money on buying materials for producing products Naturally, the price of products must be high At that time, volumes as well as value of exports may be reduced As a result, trade balance is impacted, possibly resulting in a deficit In contrast, low inflation leads to low costs Low costs create opportunities for manufacturing goods Low costs for materials are

a certainty Consequently, consumption and export are better The noise in export activities lead to the increase in volume as well as value of exports Trade balance will be positive in surplus (Krugman, 2009)

Foreign currency reserves

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In order to compete effectively in extremely competitive international markets, a country has to invest in modern equipment and machines to improve productivity Certainly, the country has to buy these equipment and machines from foreign countries Accordingly, it is necessary for the country to have enough foreign currency reserves so that it can buy inputs In other words, the country must have availability of sufficient foreign exchange to be used for payment of inputs The country cannot buy these inputs without enough foreign currency reserves As a result, there is a reduction in imports When imports decreased, exports also decreased due to the lack of inputs for production This impacts imports and exports Trade deficit may occur as the consequence of insufficiency of foreign currency reserves (Minh Uyen, 2012)

Demand for commodity

In the international market is very wide The demand for a particular product or services is an essential component of international trade A company can increase exports when satisfying the demand of the international market The increase in exports is a good sign of trade surplus (Hall, 2018) For example, when demand for oil is high, the price of oil will increase The trade balance of oil-exporting and oil-importing countries alike If a small oil importer faces a falling oil price, its overall imports might fall The oil exporter, on the other hand, might see its exports fall Depending on the relative importance of a particular good for a country, such demand shifts can have an impact on the overall balance of trade Exchange rate affects the relative price of domestically produced goods and goods on the international market When a country’s domestic currency is appreciated, the price of imported goods will become cheaper while the price of exported goods becomes more expensive for foreigners Therefore, the appreciation of domestic currency will be detrimental to exports, which is favorable for imports (Khim, Lim and Hussian, 2003) The result is the decline in exports On the contrary, when the domestic currency is depreciated, exports will have an advantage while imports are at a disadvantage and exports increase The change of imports and exports is the cause leading to a trade deficit or trade surplus

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balance

1.4.1 J-curve theory

A J Curve is an economic theory which states that, under certain assumptions,

a country's trade deficit will initially worsen after the depreciation of its currency—

mainly because in the near term higher prices on imports will have a greater impact

on total nominal imports than the reduced volume of imports This results in a characteristic letter J shape when the nominal trade balance is charted as a line graph

sh

1.4.2 Import and export elasticity and Marshall-Lerner

The Marshall Lerner condition (after Alfred Marshall and Abba P Lerner) is –the condition that an exchange rate devaluation or depreciation will only cause a balance of trade improvement if the absolute sum of the long-term export and import demand elasticity is greater than unity In the international trade literature, the arguments as to whether devaluation (for fixed exchange regime) or depreciation (for floating exchange rates regime) of the domestic currency will improve the trade balance abound and that flows of goods respond to this effect takes a time lag to reflect This led to the concept of the J-Curve effect, which is the phenomenon where

a country’s balance of trade in the first instance, at the instance of a devaluation or

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depreciation of the domestic currency, prior to its recovery to a higher level than where it started Economic theory states that depreciation of the nominal exchange rates will impact a country’s balance of trade in three dimensions as follows: First is the decrease in the volume of import resulting from increase in the price of imports sequel to the depreciation of the domestic currency Secondly, devaluation leaves the price of exports more competitive in the global market arena thus leading to increase

in demand for exports The third scenario is that the total export revenue drops in the short run due to the drop in export prices The overall effect of devaluation on the trade balance remains uncertain as it can only be determined by the relative sizes of each of these three effects, meaning that it is the price elasticity of exports and imports with respect to the exchange rate variation that will determine the final impact of the devaluation on the trade balance

1.5 Previous studies

In a Vietnamese study about the role of exchange rate in supporting trade balance in Vietnam, Lan Huong Hoang (2016) applied a multivariate Structural Vector Autoregressive (SVAR) and Vector Error correction model (VECM) to determine the effect of foreign exchange rate on trade balance of Vietnam in both long term and short term, using monthly data from 2004 to 2015 The results indicated that exchange rate had very limited impacts on trade flows in short term; however, in long term, it did not impact imports in either nominal or real terms, but had strong impact on nominal exports In another research, Cam Nhung, Tu Anh, Le Hue and Cam Huyen (2018) based on J curve effect to test the impact of exchange rate movements on trade balance between Vietnam and Japan The researchers used 5 variables including oil price, gross domestic product, consumer price index and trade balance A vector autoregressive (VAR) model, impulse response function (IRF), stationary test, Granger test and variance decomposition analysis were applied to clarify the impact of the fluctuations of exchange rate on trade balance 67 observations from 2001 to 2017 were given in the analysis Importantly, this research did not evaluate the impact of exchange rate movements towards the total trade balance between Vietnam and Japan, but to investigate the impact of exchange rate