Summary of PHD thesis the impact of CNY USD exchange rate to vietnamese macroeconomic factors

MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM BANKING UNIVERSITY OF HO CHI MINH CITY LE THI THUY HANG THE IMPACT OF CNY/USD EXCHANGE RATE TO VIETNAMESE MACROECONOMIC FACT

MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM

BANKING UNIVERSITY OF HO CHI MINH CITY

LE THI THUY HANG

THE IMPACT OF CNY/USD EXCHANGE RATE TO

VIETNAMESE MACROECONOMIC FACTORS

CHAPTER 1: INTRODUCTION 1.1 RESEARCH ARGUMENTS

Many experimental studies in the world (Kinnon, 2003; Ibrahim, 2007 ) have shown that exchange rate fluctuations of the third currency will affect the economies of other countries The closer trading relationship of countries in the same region are, the more effectible exchange rate fluctuations does In fact, China is Vietnam's neighbor as well as the largest trading partner of Vietnam with steadily increasing trade surplus to Vietnam With China's growing economic and political power, CNY is increasing its influence in the world While Vietnam is still using the semi-floating exchange rate regime on USD as East Asian countries Thus it is necessary to consider the impact of the USD/CNY on Vietnamese macroeconomic factors That is a reason why the author selected the research topic "Impact of the RMB and US Dollar exchange rate on the macroeconomic factors of Vietnam"

1.2 RESEARCH OBJECTIVES

The study objective is the examination of the impact of USD / CNY exchange rate on macroeconomic factors by evaluating the specific effects of the USD / CNY exchange on economic growth, inflation and currency in Vietnam Based on the results, the study will propose some recommendations in the exchange rate policy management in order to mitigate the negative effects

of exchange rate fluctuations, then contribute to Vietnamese economic objectives

To achieve this goal, the study should answer the following questions: (1) How long does the USD / VND exchange rate affect the macroeconomic factors of Vietnam including the short and long term? (2) Is the relation between USD / VND exchange rate and USD / CNY exchange rate a causal relation? (3) How does the USD / CNY exchange rate impact on macroeconomic factors in short-term and long-term and what is its level?

1.3 OBJECT, SCOPE, AND METHODOLOGY

The study focused on the impact of the USD / CNY on macroeconomic factors in Vietnam, including the GDP index as representing economic growth, CPI is proxy for inflation and the money supply M2, the interest rate acts as the currency Data is collected quarterly from the first quarter of 2000 to the first quarter of 2017

The research use VAR model to evaluate the impact of USD / VND exchange rate to the macroeconomic factors of Vietnam to answer the question (1) the combined study of exchange rate policy analysis in Vietnam Then, in response to question (2) the study conducted an analysis

of the CNY international process, the effect of CNY on other currencies, VECM model is used to examine the causal relationship between the exchange rate USD / VND and USD / CNY exchange rate Finally, based on the results obtained in questions (1) and (2), combining with using SVAR model to analyzes the relationship between Vietnam and China to resolve question (3)

1.4 RESEARCH RESULTS

This research contributes to the following new points:

(1) Scientific mean – contributing to theorical part of research: The study has contributed

to use basis theories of exchange rate and macroeconomic to experiments in Vietnam, where has many arguments about its economy market mechanism While most researches in the world apply theoretical foundations to developed countries or well-structured market economy countries, the study chose Vietnam as a sample to illuminate the application of those scientific foundations to other economies that have similar economy structures with Vietnam From that, the results will be tested to define that they are consistent with theories and previous experimental studies

(2) Practical mean – contributing to emperical studies: Current researches in Vietnam analyze the exchange rate pass-through channel and the individual relationship between factors such as exchange rate and interest rate, or exchange rate and growth, or exchange rate and inflation

…etc This study examines the impact of exchange rates on macroeconomic factors by using commodity market and money market in the same study to provide a comprehensive view This is

a new point from other previous studies in Vietnam

In contrast to studies in the world (Kinnon, 2003; Ibrahim 2007), this study has been done

in a volatile and integration reality environment, where capital inflows are liberalized vigorously; high-fluctuation exchange rate; and up-down trends economy in recent times

The recent researches mainly deal with exchange rate policy of Vietnam and China, they only analyze the actual situations, while the impact of the exchange rate is not quantified

quantify the impact of exchange rates on macroeconomic factors, which are the basis suggestions for policy management

1.5 RESEARCH STRUCTURE

There is 6 chapters in thesis as follows:

Chapter 1: Introduction

Chapter 2: Literature Review and Experimental Studies

Chapter 3: The Impact of USD / VND exchange rate on macroeconomic factors of Vietnam

Chapter 4: The Relationship between USD / VND exchange rate and USD / CNY exchange rate

Chapter 5: The Impact of USD / CNY on macroeconomic factors in Vietnam

Chapter 6: Research Results and Recommendations

CHAPTER 2: LITERATURE REVIEW AND EMPIRICAL RESEARCHES

Economic growth is defined as an increase in the size of economic growth in a given period

of time, creating the resources needed to improve the living conditions of the population To measure economic growth, the research used gross domestic product (GDP) growth, which is the value of all final goods and services produced nationally in a given period of time

Inflation is the phenomenon of commodity prices rising by comparing with price level in the past Consumer price index is used to assess the inflation of the economy, which is defined as

an indicator to reflect the relative change in consumer prices over time

Beside the two economic factors, countries also consider other macroeconomic factors on monetary:

Money supply refers to the supply of money in the economy in order to meet the demand for the purchase of goods, services, assets, etc by entities (excluding credit institutions) The money supply in circulation is divided into sections: M1; M2; M3

Interest rate is the cost needed to get the funds to use in a certain period of time The mobilizing rate is the amount of money pays to depositors by credit institutions to use their money for a certain period of time

2.2 THEORIES

2.2.1 Exchange rate transmission mechanism

Transmission mechanisms of monetary policy are changes in monetary policy management through transmission channels: interest rate, exchange rate, asset price, credit to impact to economic variables to achieve objectives such as macroeconomic stability and price control

Exchange Rate Pass Through (ERPT) is defined as the rate of change in import prices due

to a percent exchange rate change between import countries and export countries

2.2.2 Exchange rate theory

Purchasing Power Parity (PPP) explains that the exchange rate between two currencies must be equal to the rate changes in national price level

Interest Rate Parity (IRP) holds that the exchange rate is determined between the two currencies based on the current interest rates in those countries

The Mundell-Fleming model is a combination between Fleming's equation with Mundell's policy analysis These theoretical studies show that the effectiveness of monetary policy and fiscal policy depends on the exchange rate regime and the level of capital controls Market commodity balancing is made through the appreciation of the currency, not production increasing

The Impossible Trinity or Triangle of Impossibility states that a country can not simultaneously implement three macroeconomic objectives: exchange rate stabilization, capital liberalization, independent monetary policy

The Mundell-Fleming model and The Impossible Trinity are relatively appropriate for Vietnam's monetary policy and fiscal policy Because those theories meet the conditions of the economy as the price does not change much in the short term and the capital is freely circulated

In addition, this model is suitable for the small and open economy, where can not be affected by world interest rates as well as the output of other economies

Other studies have analyzed the effect of CNY on other currencies such as Shu & ctg (2007); Kinnon & ctg (2003); Henning (2012) In Vietnam, researches by Le Xuan Sang (2013); Nguyen Quoc Thai (2013) reviews the internationalization of CNY and its impact to Vietnam's financial instability Thus it is important to study the role of CNY, but these studies are only focused on situational analysis, and does not quantify the specific impact on the economy

International studies on the USD fixed exchange rate regime and the impact of a third currency exchange rate shock on a particular country’s macroeconomy have been done many times such as Kinnon & ctg (2003), Ibarahim (2007) ) Research samples use developed countries or countries with market economies, but Vietnam is not mentioned Therefore, a research needs to be

intensive and combined several factors for more comprehensive results It is explained that calculating and quantifying the magnitude of impact of exchange rate shocks on macroeconomic factors are required Furthermore, the study applies theoretical foundations to economic conditions such as Vietnam to see if the results are consistent with previous empirical studies The results are used for policy recommendations

CHAPTER 3: THE IMPACT OF USD/VND EXCHANGE RATE TO

MACROECONOMIC FACTORS IN VIETNAM 3.1 INTRODUCTION

East Asian countries (except Japan) choose the fixed exchange rate regime in USD With this regime, which helps Vietnam's economy avoiding exchange rate shocks or not; and how much this impact is, will be solved by the results of the research

3.2 USD/VND EXCHANGE RATE POLICY IN VIETNAM

• 1999-2006

In this period, because of the application of the fixed exchange rate regime, the average interbank exchange rate announced by the State Bank was around from 14,000 VND / USD to 16,000 VND / USD In 2005, the State Bank of Vietnam (SBV) announced the Ordinance on Foreign Exchange and the International Monetary Fund (IMF) officially recognized Vietnam's liberalization of current transactions In 2006, the Vietnamese foreign exchange market began to

be underpressured by international economic integration The amount of foreign currency transferred into Vietnam increase strongly WB and IMF have warned that the SBV should increase the flexibility of the exchange rate due to the increasing capital flow into Vietnam

Figure 3.1: USD/VND Exchange rate from 1999 to 2006

Sources: SBV, VCB and author’s data collection

• 2007 - 2011

Figure 3.2: USD/VND Exchange rate from 2007 to 2011

Sources: SBV, VCB and author’s data collection

This is the time that the USD / VND exchange rate fluctuated sharply After Vietnam's accession to the WTO, the liberalization of capital account was widened, leading to increased inflows of capital into Vietnam which greatly affected the fluctuation of the exchange rate At the beginning in April 2007,the combination of international debts, deficit balance of payments due to high trade deficit and the sharp decline of foreign exchange reserves created a strong demand for USD The State Bank of Vietnam (SBV) continuously solds foreign currency to intervene the exchange rate when the market appeared the official exchange rate and the black market rate with large gap for a long time By the end of 2011, the SBV had used many approaches to control and stabilize the market

20082/ 20082/10/200

8 2/ 20092/ 20092/ 20092/10/200

9 2/ 20102/ 20102/ 20102/10/201

0 2/ 20112/ 20112/ 20113/10/201

1

30/12/20

• 2012 - 2017

The USD/VND exchange rate was stable in this stage, the SBV's exchange rate management policy was fit with market developments The SBV's monetary polices had made positive changes in the forex market, and the black market had almost ceased In addition, SBV also narrowed the difference between the interbank rates and the exchange rates listed by commercial banks (100-300 VND/USD ) Thus the psychology of holding foreign currencies of organizations and individuals had declined The SBV extended the exchange rate to +/- 3% by

2015 On 31/12/2015, the SBV issued Decision No 2730 / QD-NHNN which announced the base rate of USD / VND, cross exchange rate of VND with other foreign currencies The exchange rate management policy of the State Bank corresponded with the current conditions of Vietnam, which promoted greater flexibility and activeness with market movements

Figure 3.3: USD/VND Exchage rate from 2012 to 2017

Sources: SBV, VCB and author’s data collection

Thus, Vietnam's exchange rate policy has its main characteristics Firstly, the exchange rate policy of Vietnam in many periods tends to be fixed with USD was main foreign currency Secondly, the fixed exchange rate VND/USD had affected trade and investment with other countries Thirdly, the Average Interbank Exchange rate published daily by the State Bank of Vietnam did not always reflect the real supply and demand of the market, especially when there was a situation of excess or tension in foreign currency Finally, the inflexible and non-marketable exchange rate policy had huge impact on the economy

2012 2/11/

20122/

2013 2/

2013 2/

2013 2/

2013 3/

2013 2/11/

20132/

2014 2/

2014 2/

2014 2/

2014 2/

2014 2/11/

20142/

2015 2/

2015 2/

2015 2/

2015 2/

2015 2/11/

20152/

2016 2/

2016 2/

2016 2/

2016 2/

2016 2/11/

20162/

2017

3.3 RESEARCH METHODS

Formula Model VAR: yt = Ddt + A1 yt-1 + …+ Ap yt-p + ut

Where yt = (y1t , y2t , …ynt) is the vector series (nx1) of the endogenous variables in time series t, D is the matrix of blocking coefficient dt, Ai is the coefficient matrix (k x k) for i = 1, ,

p of endogenous variables with the delay yt-p ut is the white-noise errors in the equations covariance matrix system is the unit matrix E(ut,ut’)=1

The regression model will be considered for selection after performing the tests, especially the stopping test of time series The results show that the data series does not stop at the same level

It is necessary to conduct VAR model to test the impact of the USD / VND exchange rate on the macroeconomic factors of Vietnam, such as GDP, CPI and M2

The VAR model is used because of its many advantages Firstly, the VAR model does not distinguish endogenous and exogenous variables during regression, the variables in the endogenous model do not affect the reliability of the model Secondly, the VAR model is executed when a variable value is expressed as a linear function of the past or delay values and all other variables in the model, thus long-term data sets are not required , the model is often appropriate for regressing developing countries Thirdly, the VAR incorporates with convenient measurement tools such as push response,decomposition, etc., to aid in clarifying how each variable reacts to the shocks of other variables

3.4 MODEL AND DATA

Table 3.1: Determining variables method

Consuming Price LNCPI00 The CPI is calculated by CPI of each

year with base year (1st quarter 2000 CPI), then log

IFS

Real Exchange rate

USD/VND

LNRUSDVND00 Calculating by the ratio of annual

exchange rate with base exchange rate (1st quarter exchange rate– 2000),then log

IFS

Nominal Exchange rate

USD/VND

LNUSDVND00 Calculating by the ratio of annual

exchange rate with base exchange rate (1st quarter exchange rate– 2000),then log

IFS

Sources: Authors

3.5 THE IMPACT OF USD/VND EXCHANGE RATE ON VIETNAM’S MACROECONOMIC FACTORS TEST

3.5.1 The tests of model

Unit root test results: LNRUSDVND00 ͌ I(1); GDP ͌ I(1); LNM2 ͌ I(2); LNCPI00 ͌ I(1) Thus, the data series did not stop at the same error level

Based on the AIC criterion, the optimum latency of the model is p = 3 The remainder of the model is white-noise The VAR model is appropriate for regression

The Wald Tests reveals the endogenous variables that needed to use into the model The AR Root Test shows that individual solutions or values are less than 1 or in a unit circle, the VAR model has achieved stability

3.5.2 VAR model analysis results

3.5.2.1 Impulse Response Function – IRF

Figure 3.5: IRF LNRUSDVND00, GDP, LNCPIVN00, LNM2

Sources: summary from regression

3.5.2.2 Variance Decomposition

Table 3.10: Variance Decomposition LNRUSDVND00, GDP, LNCPIVN00, LNM2

Variance Decomposition to D(LNRUSD/VND00)

CHAPTER 4: THE RELATIONSHOP BETWEEN USD/VND EXCHANGE RATE AND

USD/CNY EXCHANGE RATE 4.1 INTRODUCTION

In chapter 3, the research showed that when the fixed exchange rate regime in Vietnam is

on USD, the economy still sufferred from impacts of exchange rate shocks When VND is tightly bonded in USD, and CNY increased against USD, then the correlation between USD and VND would also change Thus the fluctuation of USD / CNY exchange rate will affect the USD / VND

exchange rate Therefore, the process of examining the impact of USD / CNY on macroeconomic factors of Vietnam should parallelly examine the relationship between USD / CNY exchange rate and USD / VND exchange rate

4.2 Internationalization Process of CNY

4.2.1 Internationalize currency

A national currency will be considered to be international if it still performs all monetary functions including storage of values, medium of exchange and unit of accountsnot not only internal but also outside that country

4.2.2 Internationalization of CNY

The internationalization of CNY will force China to release the goal of controlling capital flow, interest rates and exchange rates In addition, those countries with international currencies must accept large deficit budget and deficit current account to increase oversea money supply Besides, China will also have great advantages

4.2.3 The achievements of the internationlization of CNY

The internationalization of CNY has achieved some results: CNY is increasingly used in international trade activities; Direct and indirect investment by CNY is encouraged to expand overseas; China has made currency swaps with many countries; Bond markets have successfully connected the foreign market to the domestic market; China has established financial centers; CNY can become a reserve currency; China's CNY debt is steady rising

4.2.4 The impact of CNY/USD exchange rate to USD/VND exchange rate

The macroeconomic indicators of Vietnam in 2015 have supported the SBV to ensure its commitment not to adjust the USD / VND exchange rate by more than 2% in 2015 However, the devaluation of 4.6% CNY against USD in August 2015 has forced Vietnam to adjust the USD/VND exchange rate + 5% in 2015

Figure 4.1: The fluctuation of USD/CNY and USD/VND

4.3 RESEARCH METHOD

VECM model:

yt -yt-1 = (A1+ A2+…+Ap - I) yt-1 - (A2+…+Ap) (yt-1-yt-2) - (A3+…+Ap) (yt-2-yt-3)-…- Ap

(yt-p+1 -yt-p) + ut

Δ yt = Π yt-1 + C1 Δ yt-1 + C2 Δ yt-2+…+ Cp-1 Δ yt-p+1+ ut

Where: Π = -(I - A1 - A2 -…- Ap ); Ci = - Σpj=i+1 Aj , i = 1,2….p-1

The model which contains the term Π yt-1 is the ECM error correction

Set ECt-1 = β yt-1: the combinations non-stop chains in yt to stop chain and ECt-1 is the combination redundancies And ECt-1 shows the inequilibrium state at period t-1, where α indicates the adjustment factor of Δyt when the imbalance occurs

Dickey-Fuller (ADF) and Phillips-Perron (PP) unit tests were used to determine the stopping behavior of time series The results show that the data series stops at the same degree: I (1) Johansen‘s test shows that there are co-ordinates between the data series The VECM model was selected for regression

Time series in the study will be used in the regression in time series quantitative economic

of VECM models The model is used because it integrates the repulsion function, variance decomposition etc.; that actively supports to conduct interaction analysis between the variables

of the model The goal of the model analysis is not to obtain parametric estimation but to evaluate the correlation between variables that is in line with the objective of the study The VECM latency

is one level lower than the VAR latency, so that the number of lost observations is lesser

4.4 RESEARCH MODEL AND DATA

Table 4.1: Variable determination method

Real Exchange

rate USD/CNY

LNRUSDCNY00 The ratio of exchange rate in year t on base year

(1st quarter – 2000), then log

IFS

Real Exchange

rate USD/VND

LNRUSDVND00 The ratio of exchange rate in year t on base year

(1st quarter – 2000), then log

Source: Author

4.5 THE RELATIONSHIP BETWEEN USD/VND AND USD/CNY TEST

4.5.1 Tests of the model

The unit root test results show that the LNRUSD / CNY00, LNRUSD / VND00, IRB, IRB CHINA stops at difference level 1 Thus, the series stops at the same difference

Using the Johansen test, the results obtained from the Trace test show that LNRUSD / CNY00, LNRUSD / VND00, IRB, IRB CHINA have a cointegration, at a significance level α = 0.05, when k = 0 (None), p -value = 0.0247 <α so that rejecting the hypothesis Ho: r = 0 (no co-link between variables), when k = 1 (At most 1), p -value = 0.3160> α so that accepting Ho : r <=

1 The strings have one way of associating co-ordinates

Similar results with the Maximum Eigenvalue test indicate that LNRUSD / CNY00, LNRUSD / VND00, IRB, IRB CHINA have a cointegration, at significance level α = 0.05, where

k = 0 (None), p -value = 0.03 <α so that rejecting Ho: r = 0 (no co-link between variables), when

k = 1 (At most 1), p -value = 0.5489> α so that accepting Ho: r <= 1 The strings have one way of co-linking

Based on the FPE, AIC, SC, HQ criteria, the optimum latency is p = 1 Results showed that p-value> α (α = 0.05) so that autocorrelation does not occur The appropriate delay of the model p

= 1, the remainder of the model is white-noise The VECM model is suitable for regression

Using the AR Root Test shows that the solutions or individual values are less than 1 or in

a unit circle, so the VECM model achieves stability

4.5.2 VECM Results

4.5.2.1 Impulse Response Function- IRF

Figure 4.4: Impulse Response Function LNRUSDVND00, LNRUSDCNY00, IRB,

IRBCHINA