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

INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM 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 a 2.2 Theoretical model of real exchange rate equilibr 2.2.1Model – based ap 2.2.2The fundamental 2.2.3The purchasing po 2.3 Theory of the impact of exchange rate on trade b 2.3.1Marshall – Lerne 2.3.2The J-Curve iii 2.4 Empirical studies 2.4.1Empirical studies 2.4.2Empirical studies 2.4.3Empirical studies 2.5 Conceptual framework CHAPTER THE EXCHANGE RATE AND TRADE BETWEEN VIETNAM AND CHINA 3.1 Tendency of the exchange rate between Vietnam 3.2 Trade balance between Vietnam and China 3.3 The main commodities of import and export bet recent years 3.3.1The main commo 3.3.2 Imported comm CHAPTER MODEL SPECITICATION AND DATA SOURCE 4.1 Model for purchasing power parity approach 4.2 Model for trade balance iv 4.3 Robustness check for VECM 4.3.1Serial Correlation 4.3.2Heteroskedasticit 4.3.3Normality test: 4.4 Data source 4.4.1Data for PPP app 4.4.2Data for trade bal CHAPTER THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA 5.1 The estimation of real exchange rate 5.1.1Unit root test 5.1.2Optimal lag for V 5.1.3Johansen (1988) p 5.1.4The estimation of 5.1.5Robustness check 5.2 The exchange rate misalignment between Vietna Chinese currency (RMB) v 5.3 The impact of the exchange rate on trade balanc 5.3.1 Unit root test 5.3.2 Optimal lag for V 5.3.3 Diagnostic check 5.3.4 Inverse Roots of A 5.3.5 Johansen procedu on trade balance 5.3.6 The impact of exc 5.3.7 The impact of exc 5.3.8 Robustness Check CHAPTER CONCLUSIONS AND RECOMMENDATIONS 6.1 Conclusions 6.2 Policy implications 6.3 Limitations and further researches 6.3.1 Limitations 6.3.2 Further researche 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 77 30000 25000 20000 15000 10000 5000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Value of Exports 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 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 262.3503 720.5094 750.8778 770.4075 820.1457 834.9968 880.8911 900.4134 925.3484 981.9011 10 1011.482 11 1036.749 12 1107.86 80 13 1123.818 14 1139.04 15 1156.559 16 1179.533 17 1188.753 18 1222.242 19 1241.19 20 1260.098 21 1282.395 22 1304.243 23 1327.124 24 1347.744 * 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 APP ENDIX 3: Results of VECM with lag Figure A.1: Inverse Roots of AR characteristic polynomial for PPPwith lag Table A.2: Johansen cointegration test with lags Number of Ces None* At most 1* At most At most Table A.3: Serial correl ation test Breusch-Godfrey Serial Correlation LM Test: F-statistic Obs*R-squared Table A.4: Heteroskeda sticity Test: Breusch-Pagan-Godfrey Heteroskedasticity Test: Breusch-Pagan-Godfrey F-statistic Obs*R-squared Figure A.2 Normality tes t for VECM model with lag 83 Figure A.3: Cumulative s um of recursive for lag Figure A.4:Cumulative s um of square of recursive 84 APPENDIX 4: Results of V ECM with lag 12 Figure A.5:Inverse Roots of AR characteristic polynomial for PPPwith 12 lag Table A.5: Johansen cointegration test with 12 lags Number of Ces None* At most At most At most Table A.6: Serial correl ation test Breusch-Godfrey Serial Correlation LM Test: F-statistic Obs*R-squared Table A.7: Heteroskeda sticity Test: Breusch-Pagan-Godfrey Heteroskedasticity Test: Breusch-Pagan-Godfrey F-statistic Obs*R-squared Figure A.6: Normality test for VECM model with 12 lags 86 Figure A.7: Cumulative s um of recursive for 12 lags Figure A.8: Figure A.4:C umulative sum of square of recursive 87 APPE NDIX 5: Results of VECM with lag 24 Figure A.9:Inverse Roots of AR characteristic polynomial for PPPwith 24 lag Table A.8: Johansen cointegration test with 24 lags Number of Ces None* At most 1* At most 2* At most 3* Table A.9: Serial correl ation test Breusch-Godfrey Serial Correlation LM Test: F-statistic Obs*R-squared Table A.10: Heterosked asticity Test: Breusch-Pagan-Godfrey Heteroskedasticity Test: Breusch-Pagan-Godfrey F-statistic Obs*R-squared 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 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. .. (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, ...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