The impact of exchange rate on trade balance between vietnam and china

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA BY TRAN QUOC KHANH CUONG MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, January, 2015 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By TRAN QUOC KHANH CUONG Academic Supervisor: NGUYEN VAN NGAI HO CHI MINH CITY, January, 2015 ACKNOWLEDGEMENT First of all, I would like to show my deepest thanks to my supervisor, Associate Professor, Ph D Nguyen Van Ngai who gave scientific guidance, useful advice and instruct me to complete this thesis I would like to thank Professor Chinn M D., Professor Bahmani-Oskooee, M and Dr Pham Khanh Nam who gave many useful comments during the process of doing my thesis I am very grateful to the lecturers and classmates who help me to much during studying Finally, I would like to give the special thanks my family who support me moral and financial during the time I study i ABSTRACTS The goal of this research is to investigate the short term and long term relationship between exchange rate and trade balance Differing test such as Johansen Cointegraion test, Vector Error Correction, Wald test etc., have been conducted The data was collected from International Financial Statistics (IFS), Organization for Economic Cooperation and Development (OECD) and Asian Regional Integration Center (ARIC) The conclusion is as follow: • Long run relationship between real exchange rate and trade balance occurs, and • The coefficient of real exchange rate is negative and significant The results implies that devaluation of currency to cure trade deficit between Vietnam and China may not an appropriate method, for instance, the trade performanceof Vietnam to China could deteriorate ii Contents CHAPTER INTRODUCTION 1.1 Problem statement 1.2 Research objectives 1.3 Research methodology 1.4 Structure of this thesis CHAPTER LITERATURE REVIEW 2.1 Definition of exchange rate, real exchange rate and misalignment 2.2 Theoretical model of real exchange rate equilibrium 2.2.1 Model – based approach 2.2.2 The fundamental equilibrium exchange rate approach 2.2.3 The purchasing power parity approach 2.3 Theory of the impact of exchange rate on trade balance 10 2.3.1 Marshall – Lerner condition 10 2.3.2 The J-Curve 10 iii 2.4 Empirical studies 11 2.4.1 Empirical studies for the PPP approach 11 2.4.2 Empirical studies for the BEER and the FEER 14 2.4.3 Empirical studies of the impact of exchange rate on trade balance 15 2.5 Conceptual framework 20 CHAPTER 22 THE EXCHANGE RATE AND TRADE 22 BETWEEN VIETNAM AND CHINA 22 3.1 Tendency of the exchange rate between Vietnam and China 22 3.2 Trade balance between Vietnam and China 23 3.3 The main commodities of import and export between Vietnam and China in recent years 24 3.3.1 The main commodities of export to China in recent years 24 3.3.2 Imported commodities from China Error! Bookmark not defined CHAPTER 29 MODEL SPECITICATION AND DATA SOURCE 29 4.1 Model for purchasing power parity approach 29 4.2 Model for trade balance 33 iv 4.3 Robustness check for VECM 37 4.3.1 Serial Correlation Test 37 4.3.2 Heteroskedasticity test: 37 4.3.3 Normality test: 38 4.4 Data source 38 4.4.1 Data for PPP approach 38 4.4.2 Data for trade balance 39 CHAPTER 41 THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA 41 5.1 The estimation of real exchange rate 41 5.1.1 Unit root test 41 5.1.2 Optimal lag for VECM 42 5.1.3 Johansen (1988) procedure for cointegration test 45 5.1.4 The estimation of real exchange rate between Vietnam and China 48 5.1.5 Robustness check for PPP model 49 5.2 The exchange rate misalignment between Vietnamese currency (VND) and Chinese currency (RMB) 51 v 5.3 The impact of the exchange rate on trade balance 53 5.3.1 Unit root test 53 5.3.2 Optimal lag for VECM 55 5.3.3 Diagnostic check for every lag 56 5.3.4 Inverse Roots of AR characteristic polynomial 57 5.3.5 Johansen procedure for cointegration test for the impact of exchange rate on trade balance 57 5.3.6 The impact of exchange rate on trade balance in long run 60 5.3.7 The impact of exchange rate on trade balance in short run 60 5.3.8 Robustness Check 61 CHAPTER 66 CONCLUSIONS AND RECOMMENDATIONS 66 6.1 Conclusions 66 6.2 Policy implications 67 6.3 Limitations and further researches 67 6.3.1 Limitations 67 6.3.2 Further researches 67 vi LISTS OF FIGURES Figure 2.1: J curve effect 11 Figure 2.2: Conceptual framework of this study 21 Figure 3.1 Nominal exchange rate between Vietnam and China, (VND/RMB) 22 Figure 3.2: Trade balance between Vietnam and China (million US dollar) 23 Figure 5.1: Inverse Roots of AR characteristic polynomial for PPP 44 Figure 5.2 Real exchange rate between Vietnam and China (VND/RMB) 48 Figure 5.3: Normality test 51 Figure 5.3: Misalignment between VND and RMB 52 Figure 5.4: Inverse Roots of AR characteristic polynomial for PPP 57 Figure 5.5: Normality test for VECM model 63 Figure 5.6: Cumulative sum of recursive 64 Figure 5.7: Cumulative sum of square of recursive 64 vii LIST OF TABLES Table 3.1: The main commodities of export to China during 2010-2013 (million USD) 24 Table 3.2: The main commodities of import from China during 2010-2013, million USD 26 Table 4.1 Data for PPP approach 39 Table 4.2: Data for trade balance approach 39 Table 5.1: Mackinon (1996) critical value 41 Table 5.2: Unit root test for PPP approach 41 Table 5.3: Lag criteria for PPP approach 43 Table 5.6: Wald test for Horvath – Watson procedure 47 Table 5.9: Unit root test on time series 54 Table 5.10: Lag selection of VECM 55 Table 5.11: Diagnostic check for every lag 56 Table 5.12: Johansen cointegration test with 18 lags 58 Table 5.13: Cointegrating equation 59 Table 5.13: The speed of adjustment coefficient of long run 60 Table 5.14: Wald test for the short run relationship 60 Table 5.16: Heteroskedasticity Test: Breusch-Pagan-Godfrey 62 viii Zhou, S &Kutan, M A (2011) Is the evidence for PPP reliable? A sustainability examination of the stationarity of real exchange rates Journal of Banking & Finance, 35(2011) 2479–2490 doi:10.1016/j.jbankfin.2011.02.006 76 APPENDIX APPENDIX 1: Vietnam’s trade balance with other countries from 2000 to 2013 (unit: million USD) 140000 120000 100000 80000 60000 40000 20000 -20000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 -40000 Goods, Value of Exports Goods, Value of Imports Trade balance Figure A.1: Vietnam’s trade balance with the rest of the world from 2000 to 2013 (million USD) Source: IFS (2014) 77 30000 25000 20000 15000 10000 5000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Value of Exports Value of Imports Trade balance Figure A.2: Vietnam’s trade balance with US and Europe from 2000 to 2013 (million USD) Source: IFS (2014) 25000 20000 15000 10000 5000 -5000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 -10000 -15000 -20000 Value of Exports Value of Imports Trade balance Figure A.3: Vietnam trade balance with Singapore, Thailand, Indonesia and Philippine countries from 2000 to 2013 (million USD) Source: IFS (2014) 78 79 APPENDIX 2: Lag length criterion from the model of the impact of exchange rate on trade balance VAR Lag Order Selection Criteria Endogenous variables: TB Q IIPVN IIPCN Exogenous variables: C Sample: 2001M01 2013M10 Included observations: 130 Lag LogL LR FPE AIC SC HQ 262.3503 NA 2.21E-07 -3.97462 -3.88639 -3.93877 720.5094 881.0752 2.45E-10 -10.7771 -10.3359* -10.5978 750.8778 56.53178 1.97E-10 -10.9981 -10.204 -10.6755 770.4075 35.15353 1.87E-10 -11.0524 -9.90541 -10.5864 820.1457 86.46788 1.12E-10 -11.5715 -10.0715 -10.962 834.9968 24.90416 1.14E-10 -11.5538 -9.70093 -10.8009 880.8911 74.13701 7.26E-11 -12.0137 -9.80791 -11.1174 900.4134 30.3347 6.96E-11 -12.0679 -9.50918 -11.0282 925.3484 37.21071 6.15E-11 -12.2054 -9.29371 -11.0223 981.9011 80.91378 3.36E-11 -12.8293 -9.56467 -11.5027 10 1011.482 40.50338 2.79E-11 -13.0382 -9.42068 -11.5683 11 1036.749 33.04168 2.50E-11 -13.1808 -9.21033 -11.5674 12 1107.86 88.61539 1.11e-11* -14.0286 -9.70526 -12.2719* 80 13 1123.818 18.90406 1.16E-11 -14.028 -9.35169 -12.1278 14 1139.04 17.09472 1.24E-11 -14.016 -8.98678 -11.9725 15 1156.559 18.59783 1.29E-11 -14.0394 -8.65724 -11.8524 16 1179.533 22.97304 1.25E-11 -14.1467 -8.41159 -11.8163 17 1188.753 8.653385 1.52E-11 -14.0424 -7.95436 -11.5686 18 1222.242 29.36657* 1.29E-11 -14.3114 -7.87049 -11.6943 19 1241.19 15.45006 1.39E-11 -14.3568 -7.56291 -11.5962 20 1260.098 14.25391 1.54E-11 -14.4015 -7.25473 -11.4975 21 1282.395 15.4365 1.65E-11 -14.4984 -6.99868 -11.451 22 1304.243 13.78089 1.85E-11 -14.5884 -6.73572 -11.3976 23 1327.124 13.02485 2.11E-11 -14.6942 -6.48866 -11.36 24 1347.744 10.4683 2.60E-11 -14.76529* -6.2068 -11.2877 * indicates lag order selected by the criterion LR: sequential modified LR test statistic (each test at 5% level) FPE: Final prediction error AIC: Akaike information criterion SC: Schwarz information criterion HQ: Hannan-Quinn information criterion 81 APPENDIX 3: Results of VECM with lag Figure A.1: 1: Inverse Roots of AR characteristic polynomial for PPP PPPwith with lag Table A.2: 2: Johansen cointegration test with lags Cointegration equation Number of Ces Trace test Eigenvalue test Statistic Critical value (5%) Statistic Critical value (5%) None* 118.6747673 47.85612716 82.85520979 27.58433779 At most 1* 35.81955748 29.79707334 29.71023701 21.1316163 At most 6.109320467 15.49471288 5.652307328 14.26460015 At most 0.457013139 3.841465501 0.457013139 3.841465501 82 Table A.3:: Serial correlation test Breusch-Godfrey Godfrey Serial Correlation LM Test: F-statistic 3.705082 Prob F(2,143) 0.027 Obs*R-squared 7.48849 Prob Chi-Square(2) Square(2) 0.024 Table A.4: Heteroskedasticity Test: Breusch Breusch-Pagan-Godfrey Heteroskedasticity Test: Breusch Breusch-Pagan-Godfrey F-statistic Obs*R-squared 4.205805 Prob F(8,143) 28.95195 Prob Square(8) Figure A.2 Normality test for VECM model with lag 83 0.0002 ChiChi 0.0003 Figure A.3: Cumulative sum of recursive for lag Figure A.4:Cumulative Cumulative sum of square of recursive 84 APPENDIX 4:: Results of VECM with lag 12 Figure A.5:Inverse Inverse Roots of AR characteristic polynomial for PPPwith with 12 lag Table A.5:: Johansen cointegration test with 112 lags Cointegration equation Number of Ces Trace test Eigenvalue test Statistic Critical Statistic value (5%) Critical value (5%) None* 47.86355 47.85613 23.75986 27.58434 At most 24.10369 29.79707 12.58503 21.13162 At most 11.51866 15.49471 6.450524 14.2646 At most 5.068138 3.841466 5.068138 3.841466 85 Table A.6: Serial correlation test Breusch-Godfrey Godfrey Serial Correlation LM Test: F-statistic 3.629442 Prob F(2,89) 0.0305 Obs*R-squared 10.63281 Prob Chi-Square(2) Square(2) 0.0049 Breusch-Pagan-Godfrey Table A.7: Heteroskedasticity Test: Breusch Heteroskedasticity Test: Breusch Breusch-Pagan-Godfrey F-statistic 0.678365 Prob F(52,88) 0.9347 Obs*R-squared 40.34699 Prob Chi-Square(52) Square(52) 0.8799 Figure A.6: Normality test for VECM model with 112 lags 86 Figure A.7: Cumulative sum of recursive for 112 lags Figure A.8: Figure A.4:Cumulative Cumulative sum of square of recursive 87 APPENDI APPENDIX 5: Results of VECM with lag 24 Figure A.9:Inverse Inverse Roots of AR characteristic polynomial for PPP PPPwith with 24 lag Table A.8: Johansen ansen cointegration test with 24 lags Cointegration equation Number of Ces Trace test Eigenvalue test Statistic Critical value (5%) Statistic Critical value (5%) None* 132.1988 47.85613 75.69756 27.58434 At most 1* 56.50123 29.79707 32.07081 21.13162 At most 2* 24.43041 15.49471 18.64864 14.2646 At most 3* 5.781772 3.841466 5.781772 3.841466 88 Table A.9: Serial correlation test Breusch-Godfrey Godfrey Serial Correlation LM Test: F-statistic 2.372718 Prob F(2,29) 0.1111 Obs*R-squared 18.14057 Prob Chi-Square(2) Square(2) 0.0001 Breusch-Pagan-Godfrey Table A.10: Heteroskedasticity Test: Breusch Heteroskedasticity Test: Breusch Breusch-Pagan-Godfrey F-statistic 1.163295 Prob F(100,28) 0.3322 Obs*R-squared 103.9739 Prob Chi-Square(100) Square(100) 0.3728 Figure A.10: Normality test for VECM model with 24 lags 89 Figure A.11: Cumulative sum of recursive for 24 lags Figure A.12:Cumulative Cumulative sum of square of recursive 90 ... estimating of the real exchange rate between Vietnam and China Second,evaluatingof the value of Vietnamese currency against Chinese currency Third, examiningthe influenceof the exchange rate on trade balance. .. Export Trade balance 21 CHAPTER THEEXCHANGE RATE AND TRADE BETWEEN VIETNAM AND CHINA This section investigatesin the nominal exchange rate first.After that ,the tendency of trade balance between Vietnam. .. (1988)cointegration and VECM are applied toinvestigate the impact of exchange rate on trade balance inlong term and short term These last techniques require the real exchange rate between Vietnam and China,