In Vietnam, since the introduction of economic reforms, moving from a subsidized economy to a socialistoriented market economy, one of the policies which determine the growth rate of Vietnam is the exchange rate policy. Vietnams exchange rate policy is flexible, suitable for international circumstances and conditions. According to statistics from 1989 up to now, Vietnam has experienced different exchange rate regimes, namely: Before 1989, there had been a complicated system of multiple fixed exchange rates: an official rate for foreign trade transactions, another for noncommercial transactions, a socalled internal settlement rate for the purpose of compensating export enterprises for their losses and a separate rate for remittances received from overseas (Vo Tri Thanh et al. 2000; Nguyen Van Tien 2006). From 1989 to 1990, the multiple exchange rates were unified into a single official rate, set and announced by the State Bank of Vietnam (IMF 1996) in March 1989, Vietnam exchange rate was pegged to the US dollar with the adjusted band, the official exchange rate was adjusted by the State Bank based on the signals of inflation and interest, the balance of payment and free market rates. Specifically, commercial banks were allowed to determine exchange rates within the band + 5% around the announced official rate, with a maximum bidask spread of 0.5%, and the use of foreign currency is strictly regulated. From 1991 to 1993, with the opening of two foreign exchange (FX) trading floors (in Ho Chi Minh City and Hanoi), the official rate became determined on a daily basis (IMF 1996). In setting this rate, the SBV would be guided to some extent by the previous day’s closing rates on the two trading floors. The exchange rate policy of Vietnam remained in the regime of the pegged exchange rate but with a much narrower band than in the previous period. Commercial banks were allowed to quote within a (narrowed) trading band of +–0.5 percent around the announced official rate. During this time, Vietnam still strictly controlled foreign currencies, restricted the carrying of money out of the border, and established official foreign trading floors for the purpose of stabilizing the exchange rate
VIETNAM NATIONAL UNIVERSITY UNIVERSITY OF ECONOMICS AND BUSINESS FACULTY OF INTERNATIONAL BUSINESS AND ECONOMICS BACHELOR THESIS THE IMPACTS OF VIETNAM'S EXCHANGE RATE POLICY ON TRADE ACTIVITIES IN THE CONTEXT OF ECONOMIC INTEGRATION Supervisor’s name: Nguyen Cam Nhung Student’s name: Phan Thanh Thao Student ID: 14050162 Intake: QH-2014-E KTQT CLC Program: Honours Hanoi – April, 2018 TABLE OF CONTENT ACKNOWLEDGEMENTS LIST OF ABBREVIATIONS LIST OF TABLES INTRODUCTION .1 Rationale .1 Literature review Objectives of the research Subject and scope of the research Research structure CHAPTER THEORETICAL FRAMEWORK OF EXCHANGE RATE AND BALANCE OF TRADE 1.1 Theoretical framework of exchange rate .5 1.1.1 The concept of exchange rate .5 1.1.2 Quoted and base currencies .6 1.1.3 Exchange rate classification .7 1.1.4 Exchange rate remiges .9 1.2 Balance of Trade 11 1.2.1 The concept of trade balance 11 1.2.2 States of trade balance 12 1.2.3 Factors affecting Trade balance in Vietnam 13 1.3 The impacts of exchange rate on trade balance 14 CHAPTER THE OVERVIEW OF VIETNAM’S EXCHANGE RATE REMIGE AND TRADE PERFORMANCE 19 2.1 Exchange rate policy in Vietnam 19 2.1.1 The 2007-2009 period .21 2.1.2 The 2010-2015 period .24 2.1.3 The 2016-2017 period .30 2.1.4 Compare the nominal exchange rate and the real exchange rate 31 2.2 Overview of Vietnam’s trade balance 33 2.2.1 The 2007-2010 period .36 2.2.2 The 2011-2015 period .40 2.2.3 The 2016-2017 period .43 2.3 Assessing the relationship between exchange rates and trading activities in Vietnam 44 2.3.1 The 2007-2010 period .44 2.3.2 The 2011-2015 period .46 2.3.3 The 2016-2017 period .47 CHAPTER 3: METHODOLOGY AND EMPIRICAL RESULTS 49 3.1 Methodology 49 3.2 Data 50 3.3 Empirical results .51 CHAPTER SOME IMPLICATIONS FOR THE EXCHANGE RATE POLICY AND TRADE ACTIVITIES IN VIETNAM 55 3.1 Implications for Vietnam's current exchange rate policy 55 3.2 Implications for Vietnam's current trade .56 REFERENCES 59 ACKNOWLEDGEMENTS First of all, I sincerely thank the teachers of the University of Economics VNU and the Faculty of Economics and International Business for facilitating me to complete this research topic In particular, I would like to send my sincere thanks to Dr Nguyen Cam Nhung Throughout the course of the study, she devoted herself to helping and directing me directly Thus, not only can I acquire more useful knowledge but also have the opportunity to study the spirit of scientific work seriously and effectively This is very necessary for me in the learning process and future work Due to limited time frame as well as limited qualifications, this paper is inevitable to the defects I hope that teachers and friends will share and give suggestions for this paper to be completed LIST OF ABBREVIATIONS No Abbreviation BOT Blance of trade BOP Balance of payment IMF International Monetary Fund SBV State Bank of Vietnam USD United States dollar VND Vietnamese Dong ECM Error Correction Model GSO General Statistic Office LIST OF TABLES No Table number Table 1.1 Table 2.1 Name Exchange rates between Vietnam Dong and foreign currencies Vietnam Trade Balance (1999-2017, Unit: Billion Page 34 USD) Table 2.2 Vietnam export - import and the exchange rate 44 period 2007-2010 Table 3.1 Data collection 51 Table 3.2 The summary of the ADF tests for a unit root 52 Table 3.3 The estimated long-run model result 52 Table 3.4 Result of cointergration test 53 Table 3.5 Results of estimates of ECM 54 LIST OF FIGURES No Figure number Figure 1.1 Figure 2.1 Figure 2.2 Figure 2.3 Figure 2.4 Figure 2.5 Figure 2.6 Figure 2.7 Figure 2.8 Name J-curve Nominal exchange rate VND/USD in the period 2000Q1-2017Q4 Nominal exchange rate VND/USD in 20072015 Exchange rate VND/USD and fluctuation band, 2008-2009 VND/USD exchange rate movements in 2010 Nominal exchange rate VND/USD in from 2010Q1-2013Q4 Nominal exchange rate VND/USD in 2014 and 2015 Nominal exchange rate VND/USD in 2016 Nominal exchange rate VND/USD in 20162017 Page 17 21 21 23 25 25 28 30 30 Nominal exchange rates VND/USD and real 10 Figure 2.9 exchange rate in the period 2007-2016 (2010 is the base year) 32 11 Figure 2.10 12 Figure 2.11 13 Figure 2.12 14 Figure 2.13 15 Figure 2.14 16 Figure 2.15 Vietnam’s NEER and REER in the period 2000-2017 Vietnam’s export, import and trade balance in 1990-1998 Vietnam’s export and import performance in 1999-2017 (Billion USD) Trade Balance and Current Account of Vietnam 2005-2008 Average Interbank Exchange Rate 20112015 (VND / USD) Vietnam's economic growth 2010-2014 (%) and export-import 33 34 35 37 46 46 INTRODUCTION Rationale At present, international trade activities in which import and export activities are always the top concern of open economies Import and export are always interested by almost all the countries, especially developing countries because this is the shortest way to accumulate wealth, solve the debt burden for most countries in the world Moreover, exchange rate has played a very important role in international trade It is considered an effective tool to promote international trade especially in such a great open world economy and many countries pursue a development strategy using exchange rate as a main intervention However, the exchange rate is a very sensitive macroeconomic variable because exchange rate fluctuates day by day, and is influenced by many factors Today's exchange rate may be different from that of yesterday, the sudden rise and fall of the currency are always a new problem for economic managers and investors When the authority adjusts the exchange rate, they will have to face other unexpected impacts, given that there has existed twin deficits for a long time – trade balance deficit and budget deficit So for Vietnam’s import and export, how does exchange rate fluctuation affect? The study "The impacts of Vietnam's exchange rate policy on trade activities in the context of economic integration" would clarify the problem Literature review There is a wide range of literature focusing on investigating the relationship between exchange rates and trade balance In addition, there are also a number of overseas literatures that examine the interaction between the two exchange rate variables and the trade balance in the context of Vietnam's economic integration, these researchs will give Vietnam better recommendations and solutions The essay divide the literatures into two main groups: The first group: including the literatures that analyze basic theories of exchange rate In addition, some researchs show the current status of Vietnam's exchange rate and trade policy in recent years Some of literatures also focus on providing long-term solustions to Vietnam's policy management These research papers have contributed much to the theoretic framework of this essay, which includes the following typical research papers: Krugman and Obstfeld (2001), Hatemi-J (2004) found evidence of J-curve when investigating the impact of exchange rate on trade balance The heart of Jcurve effect drawn from Marshall-Lerner condition is that the trade balance of a country experiences the J-curve effect when the domestic currency is devaluated At first, the total value of imports increases due to higher price of imported goods, and exceeds the total value of exports This results in a trade balance deficit However, the devaluation increases demand for exports, resulting in higher level of exports Eventually, exports recover and bring back trade balance surplus The paper "Exchange rate policy: Which option for Vietnam?" By the group of authors Pham The Anh, Dinh Tuan Minh (2014) clarified two objectives: the exchange rate mechanism and its effects on trade balance, inflation and some other macro variables in Vietnam; Basing on the arguments and analysis, the research gives policy recommendations to promote the positive effect of exchange rate policy on other variables The other paper in this group is "Solutions to enhance the role of exchange rates in the integration process for the economy in Vietnam" by Nguyen Thi Tuyet Nga, Ho Chi Minh City in 2012 The second group: consists of quantitative research papers Basing on the reality of exchange rate fluctuations and import and export activities in Vietnam 47 declined Especially in the period of 2011-2012, when there was a sharp increase in the exchange rate, the export rate decreased from 25.82% to 7.12% in 2012 Only export speed was reduced steadily over the years This could be explained by the fact that in Vietnam, exchange rates was closely controlled by the SBV This reason can be explained by several reasons: Firstly, our country has many industries that were heavily dependent on imported materials, fluctuating exchange rates will affect the input costs of these enterprises, causing difficulties for production and business Second, exchange rate is an important variable of the economy, affecting inflation, balance of payments, GDP Third, our country's financial market was still young, there were not many tools to prevent exchange rate risk, the undeveloped forex market, not favorable for the release of exchange rate Fourth, public debt of our country was high, so devaluation would cause many difficulties for repayment However, our country is deepening international integration, so gradually floating rates are inevitable Moreover, more flexible exchange rate policy can support the objective of maintaining the competitiveness of our country's goods in the international market 2.3.3 The 2016-2017 period In 2016 and 2017, the exchange rate and the foreign currency market were basically stable, contributing positively to the objective of macroeconomic stability and import restrictions Central exchange rate mechanism played a decisive role in stabilizing the exchange rate and the value of VND in the context of the sharp exchange rate fluctuations of the majority of other currencies in the region and in the world in 2016 and 2017 48 Thanks to exchange rate stability, the trade surpluses of 2016 and 2017 reached more than USD1.78 billion and USD2.92 billion, the highest level from 1999 49 CHAPTER 3: METHODOLOGY AND EMPIRICAL RESULTS 3.1 Methodology Researching secondary documents: Collecting, studying secondary documents, theoretical literature about the concepts and the purpose of the exchange rate policy in general and Vietnam in particular and documents showing the status of Vietnam’s trade activities In addition, there are relevant documents about the impacts between the two Vietnam US trade balance variables and the exchange rate from a qualitative and quantitative perspective Secondary data processing: • Descriptive statistics • Correlation analysis • Examine the stationarity characteristic of variables • Johansen Cointegration Test • Use Error Correlation Model to analyze the effect of real effective exchange rate on trade balance • Vertify the correctness of the model Econometric models: In this paper, I use Cointegration theory and ECM – Error Correction Model to verify short-term and long-term effects of exchange rate on trade balances Cointegration theory was developed by Granger (1981) and improved by Engle and Granger (1987) This theory, then is widely used in the analysis of the relationship between economic variables as the sequence of time To measure the elasticity of the trade balance with respect to the real effective exchange rate, the long-run equation can be expressed as: Ln(TB t ) = o + *Ln(REER t ) + u t 50 In which: o: Intercept; 1: Slope coefficient reflects the impact of real effective exchange rate on trade balance; ut: Residual; Bt: The trade balance defined as the ration of exports/imports; REERt: Real effective exchange rate; t: From 2000Q1 to 2017Q4 If long-run relationship among variables exits, the error correction representation also comes into play Therefore, in order to analyze the short-run relationships among variables, the ECM model is used in this paper and expressed as follows: D(Ln(Bt))=0 + 1*D(Ln(REERt)) + ut-1 + et In which: D is the first difference; is the speed of adjustment parameter and is expected to be negative; and ut-1 is the residual derived from the estimation of the long-run model 3.2 Data Quarterly time series data on exchange rate, trade balance, export and import which cover the 2000-2017 period, were used in this paper for econometric model For the dependent variable, trade balance denoted by Bt is measured by the log of exports divided by imports For independent variables, real effective exchange rate denoted by REER measured by weight average of average of the bilateral real exchange rates with trading partner countries (measured by the nominal exchange rate divided by the price in the home country) 51 Table 3.1 Data collection Data Unit Exchange rate VND/USD Index Frequency Source of data Quarterly IMF Quarterly General Department of (ER) Export volume (EX) Million USD Import volume (IM) Million Vietnam Customs, GSO Quarterly USD Trade balance (TB) Million Vietnam Customs, GSO Quarterly USD Real Effective Exchange Index General Department of General Department of Vietnam Customs, GSO Quarterly IMF, WorldBank Rate (REER) In this study, I use quarterly data from 2000Q1 to 2017Q4 to estimate the impact of exchange rate on trade balance Data for export and import values are taken from General Department of Vietnam Customs Data on average-period nominal exchange rate of VND against USD are taken from IFS (IMF’s International Financial Statistics 3.3 Empirical results Results of the unit root test The paper basically employ the Augmented Dickey-Fuller (ADF) test to examine whether the time series have a unit root The null hypothesis is that the series have a unit root In this paper, 1% is chosen to be the significane level Thus, if the p-value repoted by the ADF test is lower than 0.01, the series is said to have no unit root; otherwise, it has a unit root Accordingly, the ADF test shows that all of the series have unit root at 1% significant level since the p-values reported are more than 0.01 and need to be first differenced for stationary 52 Table 3.2 The summary of the ADF tests for a unit root Variables ADF test Mackinnon critical values for P-value statistic rejection of hypothesis of a unit root 1% 5% 10% Ln(B) -1.551508 -3.525784 -2.902734 -2.588924 0.2801 Ln(REER) 0.049954 D(Ln(B)) -4.508481 -3.527045 -2.903566 -2.589227 0.0001 D(Ln(REER)) -5.907033 -3.528515 -2.904198 -2.589562 0.0000 -3.528515 -2.904198 -2.589562 0.9594 The paper now apply the cointergration test to determine the existence of long run relationships among the variables Table 3.3 The estimated long-run model result Variables Coefficient T-statistic P-value C -2.597278 5.401284 0.0000 Ln(REER) 0.530438 5.771600 0.0000 R-square: 0.356827 F-statistic: 38.83547(0.0000) Durbin-Watson test: 1.267255 Therefore, the regression function reflecting the relationship between REERt and Bt is: Ln(Bt) = -2.597278 + 0.530438*Ln(REERt) 53 Table 3.4 Result of cointergration test Variables ADF test Mackinnon critical values for P-value statistic rejection of hypothesis of a unit root 1% U 5% 10% -5.686246 -3.525618 -2.902953 -2.588902 0.0000 The result of testing residual shows that these two variables are cointergrated with level Table 3.3 presents the results of the long-run coefficient estimates Based on the results, the trade balance is positively affected by real effective exchange rate The coefficient of Ln(REER) is 0.5304 and have statistical significance The relationship between these two variables is also affirm through the results of estimates of ECM Specifically, the variable U(-1) has statistical significance and appropriate sign However, the level of explaination of the model is not high because of R-squared (0.3568) This is also true because in fact, Vietnam's foreign trade during this period is also influenced by many other factors 54 Table 3.5 Results of estimates of ECM Variables Coefficient T-statistic P-value C -0.004917 -0.368649 0.7137 D(Ln(REER)) -0.218075 -0.383119 0.7030 D(Ln(REER)-1) 1.412215** 2.267066 0.0270 D(Ln(REER)-2) -0.383483 -0.588590 0.5583 D(Ln(REER)-3) 0.538407 -0.871034 0.3872 D(Ln(REER)-4) -0.446334 -0.780033 0.4384 U(-1) -0.598614 -5.044663 0.0000 R-squared: 0.382238 F-statistic: 6.187453(0.000043) Durbin-Watson test: 2.061577 The paper obtains the short-run parameters by estimating an ECM associated with the long-run estimates Real effective exchange rate in the short-run still has an impact on trade balance The lag in the impacts of REER on TB is high, represent by D(Ln(REER)-1) It means that, the fluctuations of exchange rate in quarter will affect current import and export This is suitable with the trade theory as well as the reality of foreign trade in Vietnam, in particular that the main export items of Vietnam are agricultural products Thus, this is the lag in production to the changes in the exchange rate On the other hand, Vietnam's imports are more affected by policies other than exchange rates 55 CHAPTER SOME IMPLICATIONS FOR THE EXCHANGE RATE POLICY AND TRADE ACTIVITIES IN VIETNAM 3.1 Implications for Vietnam's current exchange rate policy With the current exchange rate policy, the prerequisite condition for changes in exchange rate policy to positively affect the domestic economy and trade, we need to take measures to flexibly change the exchange rate When the exchange rate policy becomes more flexible, a change in the response of the trade balance will result in a change in the exchange rate's response to maintain a reasonable exchange rate for the trade balance The other condition is creating competition between banks in terms of announing exchange rates, that is, the loosening of exchange rates with large band when pegging with the US dollar, when creating this competition together with the official exchange rate, the exchange rate in the market will create flexibility both inside and outside In particular, dependence on USD, while trade and debt depend on other currencies with higher proportion, makes bilateral exchange rates between Vietnam and other major trading partners affected in the trade and investment relationships, does not reflect the economic correlation between Vietnam and its trading partners, especially in the context of USD fluctuations in the world market Pegging to the USD makes policy choices be narrow The experience of countries shows that moving to a basket of currencies is a reasonable option, not only maintaining exchange rate stability at a certain level but also ensuring policy flexibility Vietnam now respones all the conditions for pegging the currency in the basket of currencies because our country has the great economic openness but it is not dependent on a particular partner Thus, this mechanism can help Vietnam not to be strongly affected by shocks from the external money market and to prevent shocks from the international commodity markets Alongside that, Vietnam needs to implement the following combined policies in order to be able to take the initiative in managing the exchange rate 56 • The state must have sufficient reserves of foreign currency, the purposes of this policy are being able to balance international payment operations with the availability of large foreign currencies and being more active in responding to the crisis • Handling the relationship between interest rates and exchange rates because these two variables are extremely close together The change in interest rateswill lead to a dramatic change in capital flows, capital flows also have arelationship with trade balance Thus, besides operating the exchange rate policy, other macro policies should also be weighed • The SBV should set hidden band for exchange rates with annual statements on exchange rate targets, and intervene in the market to protect that target This requires the state bank to ensure the efficient operation of open market operations and other money supply regulation tools Exchange rate manipulation in this way will help limit disturbance in the foreign exchange market and automatically stabilize the exchange rate 3.2 Implications for Vietnam's current trade On the trading side, especially the trade of Vietnam with the US, the study is based on factors influencing volume effect to give policy implications for trade activities to limit the latency of J-curve effect Firstly, businesses need to take the initiative to receive and handling the information when the state changes the policy, the business channel should be one of the first known channels of policy change When knowing the changes of the policy, the business will have more time to change the model, scale and operation And to that, businesses need to have direct channels of dialogue with the state so that they can catch the development trends of the state Secondly, businesses need to improve the competitiveness of products, always changing in terms of service and quality, especially design in the time of change in 57 exchange rate policy Enhancing this competitiveness will allow foreign consumers to more easily accept domestic goods when there is a relative price comparison Thirdly, there should be more transparency in economic activity, creating an environment of fair competition, no retaliation, no protection of domestic products When both domestic and foreign this, there will be no negative price change for protection In conclusion, Vietnam with a relatively fast but not stable economic development, is necessary to have combined policies to promote trade activities in the best way 58 CONCLUSION For a small and open economy like Vietnam, the macroeconomic variables are closely linked together Therefore, in order to understand aspects of exchange rate policy on trade balance activities, we must consider the study of various aspects of the economy Based on the above findings and analysis, it can be seen that the relationship between the exchange rate and the trade balance in Vietnam is not highly correlated In order to strengthen the link between the exchange rate and the trade balance, it is necessary to float the exchange rate further, but the route must also contain specific plans as the devaluation affects public debts, GDP, interest rates, Inflation and in combination with measures to achieve results that are beneficial to the economy and contribute to improving trade balance 59 REFERENCES English Auffret, Philippe, (2003), Trade reform in Vietnam: Opportunities with emerging challenges Vol 3076 World Bank 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The study "The impacts of Vietnam's exchange rate policy on trade activities in the context of economic integration" would clarify the problem Literature... scope of analyzing the impact of the exchange rate on the trade balance between Vietnam and the United States and on the basis of the influence of the exchange rate, exchange rate is divided into... remige, the exchange rate is the main target of economic policymaking (interest rates are set to meet the target) In addition, according to the new classification of the IMF, there are three exchange