Factors affecting foreign exchange rate (usd vnd) in vietnam during the period of 2010 2021

This study examines the impact of several macroeconomic variables on the exchange rate of the Vietnamese dong (VND) to the US dollar (USD) using Ordinary Least Squares (OLS) regression analysis. The variables considered in the analysis are Inflation rate, Interest rate, Gross Domestic Product (GDP) growth rate, Foreign Direct Investment (FDI), and Broad money supply. The study uses monthly data from January 2010 to December 2021 to estimate the model. The results of the OLS regression reveal that the inflation rate and FDI have a positive and statistically significant effect on the VNDUSD exchange rate. This indicates that an increase in inflation rate and FDI leads to an appreciation of the VND against the USD. In contrast, GDP growth rate and interest rate have a negative and statistically significant impact on the exchange rate, suggesting that an increase in these variables leads to a depreciation of the VND against the USD. The broad money supply, however, is found to have an insignificant effect on the exchange rate.. The findings of this study have significant ramifications for Vietnamese

FACULTY OF BANKING AND FINANCE

Class: TCHE404 Supervisor: Assoc Prof PhD Mai Thu Hien Group:

Students:

Hanoi, June 2023

TABLE OF CONTENTS

ABSTRACT 5

INTRODUCTION 6

1.1 Study Background 6

1.2 Research Problem 6

1.3 Research Objectives 7

CHAPTER 2: LITERATURE REVIEW 9

2.1 Theoretical Review 9

2.2 Determinants of Exchange Rates 9

2.2.1 Inflation 9

2.2.2 Interest rate 9

2.2.3 GDP 10

2.2.4 FDI 10

2.2.5 Broad Money Supply 11

CHAPTER 3: RESEARCH METHODOLOGY 12

3.1 Model specification and research hypothesis 12

3.1.1 Econometric model specification 12

3.1.2 Research hypotheses 12

3.2 Data collection and variable description 13

CHAPTER 4: DATA ANALYSIS, RESULT AND INTERPRETATION 16

4.1 Descriptive Statistics and Interpretation for each Variables 16

4.1.1 Descriptive Statistics 16

4.1.2 Correlation matrix between variables 16

4.2 Regression model with time-series data 17

4.3 Hypothesis testing 19

4.3.2 Statistical significance of individual coefficients 20

4.4 Model errors testing 20

4.4.1 Multicollinearity Testing 20

4.4.2 Heteroscedasticity Testing (Error Variance is Nonconstant) 21

4.4.3 The serial correlation testing 22

CHAPTER 5: RECOMMENDATIONS 24

5.1 Recommendations for Viet Nam government 24

5.2 Limitations of the study and suggestion for further research 24

CONCLUSION 26

REFERENCES 28

APPENDIX 30

LIST OF TABLES

Table 1 Expected signs of variables based on theoretical researches 12

Table 2 Description variables 13

Table 3 Descriptive statistics and interpretation for each variables 16

Table 4 Correlation of each variable 16

Table 5: Result of regression model 18

Table 6 Significance of estimated coefficients of estimators 20

Table 7 Vif result 20

Table 8 Robust standard errors 21

Table 9 Result of durbin-watson tests 22

Table 10 Result of newey-west 22

This study examines the impact of several macroeconomic variables on theexchange rate of the Vietnamese dong (VND) to the US dollar (USD) usingOrdinary Least Squares (OLS) regression analysis The variables considered in theanalysis are Inflation rate, Interest rate, Gross Domestic Product (GDP) growth rate,Foreign Direct Investment (FDI), and Broad money supply The study uses monthlydata from January 2010 to December 2021 to estimate the model

The results of the OLS regression reveal that the inflation rate and FDI have apositive and statistically significant effect on the VND/USD exchange rate Thisindicates that an increase in inflation rate and FDI leads to an appreciation of theVND against the USD In contrast, GDP growth rate and interest rate have anegative and statistically significant impact on the exchange rate, suggesting that anincrease in these variables leads to a depreciation of the VND against the USD Thebroad money supply, however, is found to have an insignificant effect on theexchange rate

The findings of this study have significant ramifications for Vietnamesepolicymakers, investors, and companies doing business there According to thefindings, in order to keep the exchange rate stable, policymakers should concentrate

on reducing inflation and interest rates Investors and businesses should alsoconsider the impact of macroeconomic variables on exchange rate fluctuationswhen making investment decisions or conducting international trade

INTRODUCTION 1.1 Study Background

According to Pham, V.A (2019), the exchange rate plays an important role inrepresenting the relationship between Vietnam and the world as well as affectsmany macroeconomic factors, including inflation As a small, developing, andexport-led economy, Vietnam imports numerous intermediate goods for productionbefore reexporting them Thus, exchange rate devaluation is crucial for Vietnambecause of its impact on exports and inflation via exchange rate pass-through(ERPT)

In Vietnam, an increase in the inflation rate causes the VND to appreciate againstthe USD Increased inflation makes the domestic currency more appealing toforeign investors, resulting in increased demand for the VND and subsequentexchange rate appreciation

Interest rates are the cost of borrowing money, and they also affect the exchangerate Higher interest rates cause the VND to appreciate against the USD, making thedomestic currency more appealing to foreign investors, resulting in increaseddemand for the VND and subsequent exchange rate appreciation

GDP growth rate is the rate at which the economy is growing The VND depreciatesagainst the USD as the GDP growth rate increases This is because higher GDPgrowth and FDI inflows lead to increased demand for imports, which leads toincreased demand for foreign currency and a depreciation of the domestic currency.Typically, an increase in FDI causes the VND to depreciate against the USD It isdue to FDI inflows increasing the supply of foreign currency in the domesticmarket, resulting in a decrease in demand for the VND and a subsequent exchangerate depreciation

Changes in the broad money supply have little effect on the exchange rate inVietnam This is due to the fact that changes in the broad money supply have noeffect on the demand for or supply of foreign currency in the domestic market

1.2 Research Problem

The exchange rate is an important economic indicator in Vietnam as it reflects thevalue of the Vietnamese dong (VND) relative to other currencies, particularly the

US dollar (USD) The exchange rate can have significant implications for Vietnam'seconomy and its people

As in international trade, Vietnam is heavily dependent on exports, particularly inthe manufacturing sector A weaker VND can make Vietnamese exports morecompetitive in foreign markets, leading to increased demand and higher exportrevenues Conversely, a stronger VND can make exports more expensive and lesscompetitive, leading to reduced demand and lower export revenues

Vietnam is also vulnerable to inflation due to its high levels of economic growthand increasing demand for goods and services A weaker VND can lead to higherinflation as imported goods become more expensive, while a stronger VND can lead

to lower inflation as imported goods become cheaper

When it comes to foreign investment, a weaker VND can make Vietnam a moreattractive destination for foreign investment, as it reduces the cost of investing inVietnam in terms of foreign currency Conversely, a stronger VND can makeVietnam less attractive for foreign investment, as the cost of investing in Vietnam interms of foreign currency increases

The exchange rate can also have implications for domestic consumption inVietnam A weaker VND can increase the cost of imported goods, leading toreduced purchasing power for Vietnamese consumers Conversely, a stronger VNDcan make imported goods cheaper, leading to increased purchasing power forVietnamese consumers

- Examine the effect of Inflation rate, Interest rates, GDP growth rate, FDI and Broad money supply on the Exchange rate of USD/ VND using the OLS model.

- Give out some recommendations for the government in order to make use of fiscaland monetary policies, as well as intervention in the foreign exchange rate

- Form a base for other studies to be more complete in the future

CHAPTER 2: LITERATURE REVIEW 2.1 Theoretical Review

One of the key tools used by the Vietnamese government to implement its monetarypolicy is the USD/VND exchange rate Numerous studies have been conducted onthis topic, exploring the effects exchange has on various economic factors such asinflation, trade balance, and the performance of import and export firms

2.2 Determinants of Exchange Rates

2.2.1 Inflation

Inflation is the gradual increase in the prices of goods and services in an economy,leading to a decrease in the purchasing power of money It is measured by thepercentage change in the consumer price index (CPI) and can be caused by variousfactors High inflation can have negative effects on individuals, businesses, and theeconomy, while low or stable inflation can promote growth and stability

According to the study of Monfared and Akin (2017), there is a positive relationshipbetween exchange rates and inflation, meaning that changes in exchange rates canhave an impact on the rate of inflation in an economy Specifically, the sourcesuggests that the contribution of exchange rates to inflation is 1.33%

2.2.2 Interest rate

According to Investopedia, interest rate is the amount of money charged by a lender

to a borrower for the use of money, usually expressed as a percentage of theprincipal amount borrowed Interest rates can vary depending on a number offactors, including the creditworthiness of the borrower, the length of the loan, andprevailing market conditions

There is a significant connection between interest rate increases and exchange ratemovements in the short term However, this relationship becomes less clear in thelong term, with the impact of interest rates on exchange rates being less significantand less predictable While the short-term effect is statistically and economically

significant, the long-term relationship between interest rates and exchange rates ismore ambiguous and less pronounced (Hashchyshyn et al 2020)

2.2.3 GDP

Gross Domestic Product (GDP) is a measure of the total value of goods and servicesproduced within the borders of a country over a specific period of time, usually ayear It is often used as an indicator of a country's economic performance andgrowth

According to the Smart Currency Exchange website, there is a clear and directrelationship between a country's GDP and its exchange rate When a country'seconomy is performing poorly, international investors are less likely to invest in thatcountry, leading to a decrease in demand for its currency and a correspondingdecrease in its exchange rate There are also secondary effects to consider, such asthe role of the central bank in controlling inflation and promoting economic growth

If GDP is falling due to interest rate increases, the central bank may ease up on interestrates to support economic growth, which can lead to a weakening of the currency

2.2.4 FDI

Foreign Direct Investment (FDI) refers to the investment made by an individual or acompany in a business located in a foreign country This investment involvesacquiring ownership or control of a foreign company, either partially or wholly, and

is commonly used as a means to expand business operations into new markets FDI

is a form of investment that allows companies to establish a physical presence inforeign countries, thereby gaining access to new customers, resources, and markets

An article on World Bank Document (2018) states that FDI inflows and exchangerate volatility have a two-way relationship High movement of FDI flows due toexternal factors can induce higher exchange rate volatility, which in turn has asecondary impact on FDI The endogeneity between the variables makes it difficult

in establishing causality

2.2.5 Broad Money Supply

Broad money supply, also known as M2, is a measure of the total amount of moneyavailable for spending and investment in an economy It includes all thecomponents of M1, such as cash and demand deposits, as well as near money likesavings deposits and money market mutual funds M2 is an important indicator ofeconomic health and activity as it reflects the amount of money available forconsumption, investment, and savings Policymakers and central banks use M2 tomonitor economic activity and make decisions about monetary policy

The relationship between broad money supply and exchange rates is complex andcan be influenced by a variety of factors such as inflation, interest rates, and capitalflows Previous research indicates that an increase in the broad money supply canlead to a depreciation in the exchange rate, but the strength and direction of therelationship can vary depending on the specific context and time period Otherstudies have found no significant relationship between broad money supply andexchange rates, or have found that the relationship is dependent on other factorssuch as interest rates and inflation Overall, the relationship between broad moneysupply and exchange rates is complex and can be influenced by a variety of factors,and further research is needed to fully understand the dynamics of this relationship

CHAPTER 3: RESEARCH METHODOLOGY 3.1 Model specification and research hypothesis

3.1.1 Econometric model specification

The model used in this report is built on related public research and economictheories to examine the effects of relevant factors: Inflation rate; GDP; Interest rate;FDI; Broad money supply on the Exchange rate (USD/VND) in Vietnam fromJanuary 2010 to December 2021

The panel regression technique was used by our group The data is a mix of timeseries and cross-sectional data, so the panel regression technique is used Theprimary reason for collecting panel data in this study is to allow for the unobservedeffect, ai

- unobserved and unchanged over time - to exist and have some effects on thismodel, which makes more practical sense If ai is present, the model will beclassified as either fixed effect (FE) or random effect (RE), with equivalenttechniques for removing ai from the model

3.1.2 Research hypotheses

Table 1 Expected signs of variables based on theoretical researches

Inflation rate (%) + Martin Muchiri (2015): “Effect ofinflation and interest rates on

foreign exchange rates in Kenya”

Interest rate (%) - "Interest Rates and Exchange Rates: A Survey of the Literature"

by Cheung and Chinn (2001)

FDI (Billion USD) + A study by the InternationalMonetary Fund (IMF)

Broad money supply

(M2) (Billion USD) +

The Impact of Money Supply onExchange Rate in China" by Xin

Xu and Wei Zhang (2012)

3.2 Data collection and variable description

The research data is aggregated from “Ceic Data”; “Vietstock”; “ASIAREGIONAL INTEGRATION CENTER” with Vietnam from 2010-2021 monthly.This index is collected and verified to be highly accurate annually and publicized onthe official website

Table 2 Description variables

Variable Abbreviation in Stata Data source Description Units

Exchange

rate

(USD/VND) Exchange Investing.com

An exchange rate is a rate at which one currency will be exchanged for another currency and affects trade and the movement

of money between countries Exchange rates are impacted by both the domestic currency value and the foreign currency value

In December 2021, the exchange rate from the Vietnam Dong to theU.S Dollars was 22,825,meaning it takes

VND22,825 to buy $1

VND

Inflation

rate Inflation Ceic data

Inflation is the rate of increase in prices over agiven period of time

Inflation is typically a broad measure, such asthe overall increase in

%

the cost of living in acountry.

a broad measure of overall domestic production, it functions

as a comprehensive scorecard of a givencountry’s economichealth

BillionDong

Interest rate Interest Ceic data

The interest rate is the amount a lender charges

a borrower and is a percentage of the principal—the amount loaned The money to berepaid is usually more than the borrowed amount since lenders require compensation forthe loss of use of the money during the loanperiod

%

Foreign direct investment (FDI) is an ownership stake in a foreign company or project made by an investor, company, or government from another country FDI frequently goes beyond mere capital investment

It may include the provision of management, technology, andequipment as well

BillionUSD