Quang. UNIVERSITY OF ECONOMICS AND BUSINESS

UNIVERSITY OF ECONOMICS AND BUSINESS FACULTY OF FINANCE AND BAKING - - - - - - COURSE ASSIGNMENT INTERNATIONAL FINANCE INE3003-E Lecturer Student : : Ph.D Nguyen Tien Dung Nguyen The Quang Student code : 18050952 Date of birth : 18-04-2000 Class : TCNH-CLC-3 Ha Noi, 2021 Problem 1: the following table shows Vietnam’s balance of payments in 2009, when the economy was seriously affected by the global economic recession (maximum 2000 words, including figures or tables) Table: Vietnam’s International Transactions, 2009 (Unit: billions U.S dollars) A Current account balance Trade in goods Exports, f.o.b Imports, f.o.b Trade in services Exports Imports Investment incomes Receipts Payments Unilateral transfers Private (net) Official (net) 57.1 -64.7 5.8 -8.2 0.8 -3.8 0.4 B Capital and financial account balance Direct investment (net) 6.9 Foreign investment in Vietnam, liabilities 7.6 Vietnam's investment abroad, assets -0.7 Portfolio investment (net) -0.1 Medium - and long-term loans 4.5 Disbursements 6.1 ODA loans 6.9 Commercial loans -0.8 Debt payments -1.7 Short-term capital (net) -4.5 C Errors and omissions -9 D Balance of Payments -8.8 E Changes in international reserves 8.8 Source: IMF Staff Report a Calculate Vietnam’s current account balance, financial and capital account balance, t official settlement balance (or the balance of payment in short), and the changes in the official reserve assets Explain your calculations b Based on the economic situation in 2009, discuss the disequilibrium (surplus or deficits) in the current account balance, financial account balance, and the balance of payment c How did the State Bank of Vietnam (SBV) respond to this situation through exchange rate policy and foreign exchange market intervention? Show that the SBV actually moved to a more flexible exchange rate policy during this period a Calculate Vietnam’s current account balance, financial and capital account balance, the official settlement balance (or the balance of payment in short), and the changes in the official reserve assets Explain your calculations - Current account balance = (X – M) + NI + NT Balance of goods and services = Balance trade in goods – balance of trade in services = 57.1 - 64.7 +(5.8 - 8.2) = - 10 Net income = Receipts - Payment = 0.8 - 3.8 = -3 Netl current transfers = Private + Official = + 0.4 = 6.4 So the Total current account balance = 6.4 -3 –10 = - 6.6 - Financial account balance We have the following formula: Direct investment + Portfolio investment + Medium and long-term loans + Short-term capital = 6.9 - 0.1 + 4.5 - 4.5 = 6.8 Financial and capital account balance: So, the financial and capital account balance = 6.8 billion - Official account balance (or the balance of payment in short) = Current account balance + Capital account balance + Financial account balance + Errors and omissions = - 6.6 + 6.8 - = -8.8 So, the Official account balance = -8.8 billion - Official reserve asset Because the Official account balance (BOP) is deficit by 8.8 So the Reserve asset = 8.8 b Based on the economic situation in 2009, discuss the disequilibrium (surplus or deficits) in the current account balance, financial account balance, and the balance of payment Current account balance Based on the economic situation in 2009, we can see that import is way over export by $7,6 billion US, making the current account deficit But this is not a bad thing, theoretically, current account deficit is not bad nor good, and with a country that has high growth rate and at the early of development like Vietnam, a trade deficit and a current account deficit is normal and there is nothing to be afraid of In some aspect, this is a wonderful new where current account deficit mean that a lot of foreign funds are pouring into Vietnam However, a high and frequent deficit carries many risks, the fact that current account deficit (trade deficit) has caused many problems in some countries Many countries have fallen into crisis (debt crisis, currency crisis) after having large, frequent and long-term trade deficits, typically the Asian crisis in years 1997-1998 Financial account balance A country's trade and current account deficits occur when imports exceed exports, and domestic consumption exceeds production capacity To maintain this deficit, that country needs foreign currency to pay for these larger imports, the source can be from FDI, indirect investment, short-term and long-term loans, remittances, ODA and official reserves In this case, a deficit in current account was met by a surplus in financial account The direct investment and ODA loans in 2009 still maintain large proportions when respectively hit 6.9 and 6.9 billion U.S.D There is a special thing in the statistics is that the Errors and omissions are quite large: -9 billion This indicate an uncounted cash flowing out from the country The financial account balance is surplus give a positive signal, it means the money flowing into the country is greater than the money flowing out Combine this with a deficit in the current account, it shows us that the money from foreign funds is pouring into Vietnam Balance of payment (In theory, a trade deficit or a current account deficit could not affect macroeconomic stability if the financial account was in surplus or the government's foreign exchange reserves were still able to finance it for the deficit However, in reality, the larger the current account deficit, the more difficult it is to have a surplus on the capital account, the reason is very simple, when the debtor is not able to pay, the creditors will also reluctant to lend So, back to the BOP, in 2009 we see that the BOP is in a huge deficit (8.8 billion), the main reason is by a massive Errors and omissions Although the potential sources for deficit-covering such as ODA, FDI, or debt loans are still there, but in the event that the trade deficit in 2010-2011 continues to be worsen, which is very likely to happen, then the possibility for the balance of payments crisis is very large The reason is that all these funds can have a massive fall if big deficit still occur in the following years This situation has posed an urgent need to limit the trade deficit and improve the current account deficit.) c How did the State Bank of Vietnam (SBV) respond to this situation through exchange rate policy and foreign exchange market intervention? Show that the SBV actually moved to a more flexible exchange rate policy during this period Exchange rate policy: When facing this situation, the State Bank implemented many policy: Strictly control the foreign exchange activities of credit institutions in order to ensure that they follow the foreign-exchange management regulations on listing and trading The SBV pledged to strongly support the sale of foreign currency to commercial banks along with many other support measures to stabilize the foreign exchange market Using media to stabilize the people's thinking and implement measures to create consistency among commercial banks Agreed to increase the USD deposit interest rate and lower the foreign currency lending interest rate in order to overcome the imbalance between supply and demand for foreign currencies Foreign exchange market intervention: In 2009, former Governor: Nguyen Van Giau announced a series of new decisions to strongly and quickly intervene in the foreign currency market with the hope of stabilizing the market The average interbank exchange rate will be adjusted to a new record of 17,961 VND per dollar, increased 5.44% compared to the old exchange rate at that time With the increase in the interbank rate and the reduction in the band being implemented, the official exchange rate will increase by 3.44%, thus aiming to increase the ceiling rate at banks Adjusted the basic interest rate from 7%/year to 8%/year, with this, the ceiling of business interest rates at commercial banks will be 12%, instead of the old 10.5% Increased the refinancing interest rate from 7%/year to 8%/year, the discount rate increased from 5%/year to 6%/year applied from December 1, 2009 Credit institutions with a foreign currency position of minus 5% or less are supported by the State Bank's commitment to sell foreign currencies to ensure that the banking system provides enough foreign currency for import-export businesses, especially giving priority to imported goods exports for production d Using the DD-AA model, show that the adoption of a more flexible exchange rate policy assisted the economy in mitigating the adverse effects of the global economic recession (Hint: you should compare the effects of the global economic recession and the resulting fall in the aggregate demand under fixed and flexible exchange rates) a) Flexible exchange rate One of the most severe consequences of the economic crisis in 2009 was the decline in total outcome and aggregate demand in the Vietnamese economy The crisis caused the consumption of goods to stagnate, and Vietnam's export items became backlogged and difficult to consume To overcome this problem, the Vietnamese government used a combination of monetary policy as well as fiscal policy to remedy the financial situation (A rapid downturn in the economy shifted Y1 to Y2, causing the exchange rate to rise from E1 to E2, shifting the DD curve to the left To remedy this situation, the Vietnamese government adjusted and loosened the exchange rate band to the point E3, with the aim of restoring aggregate supply and aggregate demand to their original levels The new equilibrium moves from point to point 2, the AA curve shifts to the right.) (When the exchange rate rises , the rate of return on foreign U.S assets rises above the rate of return on domestic assets in the foreign exchange market This causes an immediate increase in the demand for foreign US currency, causing an appreciation of the U.S dollar and a depreciation of the VND Thus the exchange rate (EVND/$) rises This change is represented by the movement from point to on the AA-DD diagram The AA curve shifts up to reflect the new set of asset market equilibriums corresponding to the now-higher foreign interest rate Since the foreign exchange market adjusts very swiftly to changes in interest rates, the economy will not remain off the new A2A2 curve for very long.) Now that the exchange rate has risen to E3, the real exchange has also increased This implies foreign goods and services are relatively more expensive while Vietnamese’ goods and service are relatively cheaper This will raise demand for Viet Nam exports, curtail demand for Viet Nam imports, and result in an increase in current account and thereby aggregate demand As GNP rises, so does real money demand, causing an increase in Viet Nam interest rates With higher interest rates, the rate of return on Viet Nam assets rises above that in the U.S and international investors shift funds back to Viet Nam, leading to a VND appreciation, or the decrease in the exchange rate (E) This moves the economy downward, back to the A2A2 curve The adjustment in the asset market will occur quickly after the change in interest rates Thus the rightward shift from point in the diagram results in quick downward adjustment to regain equilibrium in the asset market on the A2A2 curve, as shown Continuing increases in GNP caused by excess aggregate demand, results in continuing increases in Vietnam interest rates and rates of return, With the application of a floating exchange rate, the economy will adjust itself to the E4 rate as shown in the figure A1 b) Fixed exchange rate c) Contrary to the application of a floating exchange rate, the application of a fixed exchange rate policy, the government cannot adjust the exchange rate If the government overcomes the economic crisis by increasing the money supply, then the central bank is forced to intervene by selling its reserves of dollars in exchange for VND, to ensure a fixed exchange rate As the money supply decreases, the A2A2 curve shifts back to the original After all, without the effects of expansionary monetary policy in a fixed exchange rate system, the exchange rate will remain unchanged and with no effect on GNP, the economy will return to its original state , which was already unstable due to the impact of the 2009 crisis Problem 2: The following table shows the inflation rates in the U.S and European countries at the end of 1960s and the early 1970s (maximum 2000 words) Country Britain France Germany Italy United States Source: OECD 1966 3.6 2.8 3.4 2.1 2.9 1967 2.6 2.8 1.4 2.1 3.1 1968 4.6 4.4 2.9 1.2 4.2 1969 5.2 6.5 1.9 2.8 5.5 1970 6.5 5.3 3.4 5.1 5.7 1971 9.7 5.5 5.3 5.2 4.4 1972 6.9 6.2 5.5 5.3 3.2 a Discuss the trend in the inflation rates between the U.S and European countries during this period b Explain why, with the exception of the U.S., monetary policies were ineffective under the Bretton-Woods fixed exchange rate system (Hint: you should use the DD-AA diagram for this question) c Explain the observed close relation between the inflation rates in the U.S and European countries Use the diagram of internal balance and external balance to support your arguments a) In general, we can see that the inflation rate in the US and European countries tended to increase from 1966 to 1972 In 1966, the country's inflation rate averaged 2.69%, with Italy in last place at 2.1% In the following years, all countries except the US experienced a decrease in the inflation rate, the inflation rate in the US increased from 2.9% to 3.1% From 1968 to 1970, all countries experienced an increase in the inflation rate, among them, Italy was the country with the largest growth in inflation, from 1.2% to 5.1% within year falls back The last two years, 1971-1972, we had a steady increase in all countries, with an exception of United States’s inflation went down, lowest in countries at 3.2% In 1971, Britain had a gigantic inflation which made its inflation rate went up nearly at 10%, even though it went down in 1972 but it still finished at the top with highest inflation rate at 6.9% b) Explain why, with the exception of the U.S., monetary policies were ineffective under the Bretton-Woods fixed exchange rate system (Hint: you should use the DD-AA diagram for this question) First, let's have an overview of how the Bretton-Wood fixed exchange rate system works - The dollar is pegged to gold The price of gold at that time was $35 for an - ounce of gold All currencies are pegged to the dollar, the exchange rate is set according to - the gold standard Fixed exchange rate but adjustable within 1% norm Member countries are not allowed to place restrictions on international - payments and settlements USD acts as a reserve currency to compensate for the short supply of gold - When government adopts monetary policy to improve the economy, which means injecting a large amount of money into the system, the increased money supply puts pressure on the exchange rate Interest rates fall, which reduces the profitability of residential properties, causing the local currency to depreciate - However, since the country maintains a fixed exchange rate policy, the excess demand for foreign currency will be relieved by the intervention of the central bank When the central buys local currency in private foreign exchange, the money supply decreases, causing A2A2 to return to its original position - The AA line must return to where it was since the exchange rate must be fixed at E, the reduction in the money supply due to the Forex intervention would exactly offset the expansion of the money supply due to open market activity - Finally, there is no effect of expansionary monetary policy in a fixed exchange rate system, no effect on GNP and current account balances c) Unemployment, deficit E Unemployment, surplus Deficit, inflation Surplus, inflation External balance Y a) From the table above, we can see that the inflation trend in the US and European countries is at a relatively high level The inflation rate varies from time to time, but overall, it's still a high number The reasons for the rise in the rate of inflation in the early 1970s came from the waning post-World War II 10 economic boom, increased international competition, the cost of the Vietnam War, and the decline of jobs in manufacturing Source: Figure in "How the U.S and Other Countries Experience Inflation" by OpenStaxCollege, CC BY 4.0 Economic Crisis of the 1970s In the late 1960s, the unemployment rate in the US increased by 33% from 1968 to 1970, while the consumer price index increased by 11%, as can be seen from the table above, the inflation rate also increased from 4.2 to 5.7 At the same time, real wages began to stagnate Simultaneous inflation and stagnation, nicknamed stagflation During the 1970s, Americans had poor purchasing power and American exports became expensive, becoming difficult to consume 11 The government decided not to raise taxes to compensate for the costs of the war, resulting in rising inflation Meanwhile, the US-specific manufacturing industry of automobiles has become less competitive in the international market A period of competition in a crowded labor market, driven by many women and immigrants entering the workforce The oil price In 1971, U.S president Richard Nixon tried to tackle inflation by introducing a 90day wage and freezing prices The dollar depreciated, and US exports increased, as shown in the table above, with the inflation rate falling to 4.4 in 1971, and 3.2 in 1972, but the improvement only occurred in short term without addressing the root problem Witnessing the US devaluation of the dollar, oil countries in the Middle East increased their prices, typically in Britain in the 1970s, inflation doubled and reached over 25% At the same time, the pressure from rising wages to keep up with the cost of daily living is also causing inflation This event also occurs in European countries such as Germany, France, Italy, when demand exceeds supply, the inflation rate increases rapidly 12 Reference 1) Bordo, M (1993) The Gold Standard, Bretton Woods and Other Monetary Regimes: An Historical Appraisal National Bureau of Economic Research, No w4310, University of Chicago Press 2) Bordo, M D (1993) “The Bretton Woods international monetary system: A historical overview” in M Bordo and B Eichengreen (eds), A Retrospective on the Bretton Woods System, Lessons for International Monetary Reform, University of Chicago Press: Chicago 3) Bordo, M D and B Eichengreen (2013) “Bretton Woods and the Great Inflation”, chapter in M Bordo and A Orphanides (eds), The Great Inflation, University of Chicago Press 4) Bordo, M D (2017), “The operation and demise of the Bretton Woods system: 1958 to 1971”, NBER, Working Paper No 23189 5) Nguyen, N A., D C Nguyen, C N Nguyen, and T H Bui (2011), ‘Fiscal Issues in Vietnam Economy: Assessment on the Impact of Stimulus, Fiscal Tranparency and Fiscal Risk’, in Ito, T and F Parulian (eds.), Assessment on the Impact of Stimulus, Fiscal Transparency and Fiscal Risk ERIA Research Project Report 2010-01, pp.249-282 6) Robert E Hall (1982), Inflation: Causes and Effects, University of Chicago Press, p 261 – 282 7) Hoffmann, Mathias (2005) : Fixed versus flexible exchange rates: Evidence from developing countries, CFR Working Paper, No 05-03, University of Cologne, Centre for Financial Research (CFR), Cologne 13 ... good, and with a country that has high growth rate and at the early of development like Vietnam, a trade deficit and a current account deficit is normal and there is nothing to be afraid of In... goods and service are relatively cheaper This will raise demand for Viet Nam exports, curtail demand for Viet Nam imports, and result in an increase in current account and thereby aggregate demand... Reform, University of Chicago Press: Chicago 3) Bordo, M D and B Eichengreen (2013) “Bretton Woods and the Great Inflation”, chapter in M Bordo and A Orphanides (eds), The Great Inflation, University