Effect of remittances on the real exchange rate the case of vietnam from 2000 to 2020

Remittances are a source of external financing for many developing economies and have been estimated to exceed other types of external funding such as foreign direct investments (FDIs) and foreign aid over the past two decades. According to the World Bank (2013) remittances generally reduce the level and severity of poverty, thus leading to positive effects such as higher human capital accumulation, improved health and educational spending, enhancing small business investment, etc. According to the report on Migration and Development conducted by the World Bank (WB) and the Global Knowledge Partnership on Migration and Development (KNOMAD), Vietnam continues to be one of the 10 largest remittance recipient countries in the world. Recognizing the important influence of remittances on Vietnams economy, my team has conducted the topic The effect of remittances on foreign exchange rate: The case of Vietnam.

FOREIGN TRADE UNIVERSITY FACULTY OF FINANCE AND

BANKING

******

INTERNATIONAL FINANCE REPORT

Effect of remittances on the real exchange rate the case of

FOREIGN TRADE UNIVERSITY

FACULTY OF FINANCE AND BANKING

THE CASE OF VIETNAM FROM 2000 TO 2020

Instructor : Assoc Prof Dr Mai Thu Hien

Ha Noi, 2023

TABLE OF CONTENTS

LIST OF FIGURES 3

LIST OF TABLES 3

ABSTRACT 4

CHAPTER 1 INTRODUCTION 5

1.1 Reason to choose this topic 5

1.2 Rationale of the study 5

1.3 Literature review 5

1.4 Structure of the research 8

CHAPTER 2 THEORETICAL BACKGROUND 9

2.1 Overview of remittance 9

2.1.1 Definition 9

2.1.2 Remittance in Vietnam (2010-2020) 10

2.1.3 Pros and cons evaluation 12

2.2 Overview of the real exchange rate 17

2.2.1 Definition 17

2.2.2 The real exchange rate in Vietnam from 2010 to 2020 18

CHAPTER 3 EFFECT OF REMITTANCES ON THE REAL EXCHANGE RATE: THE CASE OF VIETNAM 21

3.1 Methodology 21

3.2 Results and evaluation 22

3.3 Effect on the real exchange rate in Vietnam 25

CHAPTER 4 RECOMMENDATIONS FOR VIETNAM 26

CHAPTER 5 CONCLUSION 28

REFERENCES 29

LIST OF FIGURES

Figure 2.1 Amount of remittances remitted to Vietnam in the period 2010-

2020 (Billion USD) 11Figure 2.2 Real exchange rate of Vietnam from 2010 to 2020 20

LIST OF TABLES

Table 3.1 Variables description 22Table 3.2 Comparison of regression models’ results 23Table 3.3 Variance Inflation Factor (VIF) result for multicollinearity test 24

Remittances are a source of external financing for many developingeconomies and have been estimated to exceed other types of external fundingsuch as foreign direct investments (FDIs) and foreign aid over the past twodecades According to the World Bank (2013) remittances generally reducethe level and severity of poverty, thus leading to positive effects such ashigher human capital accumulation, improved health and educationalspending, enhancing small business investment, etc

According to the report on Migration and Development conducted bythe World Bank (WB) and the Global Knowledge Partnership on Migrationand Development (KNOMAD), Vietnam continues to be one of the 10 largestremittance recipient countries in the world Recognizing the importantinfluence of remittances on Vietnam's economy, my team has conducted thetopic "The effect of remittances on foreign exchange rate: The case ofVietnam"

The study will provide an overview of remittances and exchange rates

as well as analyze the influence of remittances on the exchange rate in thespecific case of Vietnam

We would like to express our sincere thanks to the subject lecturer,Associate Professor PhD Mai Thu Hien for guiding and supporting usthoroughly and in detail so that we have enough knowledge and apply them tothis essay Due to the lack of experience as well as the limitations ofknowledge, the essay will certainly inevitably have shortcomings We lookforward to receiving comments and suggestions from teachers to improve theessay

Keywords: Remittance, Real Exchange Rate, Vietnam, Economic Growth.

CHAPTER 1 INTRODUCTION1.1 Reason to choose this topic

Although remittance flows can contribute to economic development, theymay come with costs Some recent studies show that it is also seen to bedetrimental to the sustainability of the economy due to exertion of pressure onthe real exchange rate These possible effects of remittance inflows on thedomestic economy raise an important area for research and have in factinduced the exploration of the relationship between remittances and the realexchange rate more closely

Hence, it raises the question of whether remittances have a positive ornegative effect on the real exchange rate

1.2 Rationale of the study

Based on previous research models and then practice collecting datafrom World Development Indicators, our team filtered out Vietnam's data onreal exchange rates, remittances, and trade exchange rates (2010-2020) andanalyzed them through STATA software The results obtained werequantified in terms of the impact of remittances on the real exchange rate ofASEAN countries

Hence, providing an explanation mechanism and concluding to propose somerecommendations to attract remittances to promote economic growth ofVietnam

1.3 Literature review

The empirical research using time series data on the relationshipbetween remittances and real exchange rates is quite limited There has beensome amount of work, mainly panel studies that have been carried out overthe last decade Research evidence shows that remittances have a favorableeffect on a large range of recipient countries' development measures.However, when flows are out of proportion to the size of the receiving

economies, as was the case in several Latin American nations, they can alsobring about a variety of undesirable issues.

Acosta, Lartey, and Mandelman (2008) used an imbalanced panel dataset to investigate the effects of remittances on the real exchange rate for 109developing and transitional countries from 1990 to 2003 An OLS nationfixed-effects model and the generalized method of moments (GMM) analysisfound that GDP per capita, the terms of trade index, and GDP growth allresulted in real exchange rate appreciation, which is statistically significant atthe 10% level Trade openness, on the other hand, was shown to bestatistically negligible They discovered that an increase in remittances indeveloping nations leads to higher spending, which leads to an increase in theprice of non-tradables As a result of this, the real exchange rate rises.Furthermore, an increase in the price of non-tradables causes resourcerelocation, which reduces manufacturing productivity

In a recent research of “Remittances, real exchange rate and the Dutchdisease in Asian developing countries” (2010), Nguyen Phuc Hien, Cao ThiHong Vinh, Vu Thi Phuong Mai, Le Thi Kim Xuyen analyze whether or notAsian developing countries have been affected by Dutch disease Toinvestigate the relationship between remittances and the actual effectiveexchange rate, they use System Generalized Methods of Moment (S-GMM)for the linear dynamic panel data (DPD) model from 32 countries from 2006

to 2016 Their findings show that for every 1% increase in remittances percapita, the real effective exchange rate (REER) of these nations rises by0.103%, undermining their competitiveness and sustaining the presence ofDutch disease Surprisingly, the Dutch sickness only manifests in countrieswith a modest ratio of remittances to GDP (less than or equal to 1%).Meanwhile, remittances cause REER depreciation in countries with a higherratio

Hassan and Holmes (2012) examined the long-run link between the realcurrency rate and remittances for less developed nations using a panel co-integration approach According to the findings, remittances cause realexchange rate appreciation Furthermore, a panel error correction model wasbuilt, which demonstrated that there is short-run causality from remittances tothe real exchange rate This finding is also consistent with Combes, Kinda,and Plane (2011), who used the same technique to examine the effects ofcapital flows and exchange rate flexibility on the real exchange rate indeveloping economies The findings reveal both public and private flows arerelated with an increase in the real exchange rate.

Some other similar research also indicates that emittances can exertpressure on the real exchange rate, leading to appreciation of the localcurrency (Amuedo-Dorantes and Pozo 2004; Acosta, Lartey, and Mandelman2007; Lopez, Molina, and Bussolo 2007; Lartey, Mandelman, and Acosta2008) Simply, this pressure on the real exchange rate is analogous to “Dutchdisease” dynamics: Developing countries receive aggregate inflows frommigrants working abroad, and this increase in financial capital puts upwardpressure on recipient countries’ local currency

Evidently, most studies that are highlighted here point to the fact that

an increase in remittances results in an appreciation of the real exchange rate

Several studies, including those mentioned above, provide evidence onthe short-run relationship between remittances and the real exchange rate.However, very few investigations explore the long-run relationship andassociated short-run dynamics associated with error correction In this respect,

we contribute to the literature through an investigation of the long-runrelationship between inflow of remittances and real exchange for a panel ofhigh remittances recipient economies

1.4 Structure of the research

Chapter 1 Introduction

Chapter 2 Theoretical Background

Chapter 3 Effect of remittances on the real exchange rate: The case of Vietnam

Chapter 4 Recommendations for Vietnam

CHAPTER 2 THEORETICAL BACKGROUND

2.1 Overview of remittance

2.1.1 Definition

Remittances are money that are moved from people residing orworking abroad to their relatives in their home country In some developingcountries, remittances can be the second-highest among income sources,outstripping international aid Remittances are contributing to creatingsignificant additional resources for the country, reducing imbalances in thebalance of payments, improving foreign exchange reserves and reducingpressure on exchange rate appreciation

In the Balance of Payments and International Investment PositionManual (BPM6) remittances are perceived as a cumulative measure buildingupon three aggregation levels:

 Personal remittances cover the transfer of household funds in cash orkind and household assets to a non-resident household, usually situated

in the migrant’s home economy (including donations to family, etc.),but also the net income being generated through employment in othereconomies, either as seasonal or border worker, or as resident with non-resident entities (e.g international institutions domiciled in theresident’s home economy)

 Total remittances additionally include social benefits, which wereacquired by the above-mentioned economic activities of households inother economies, e.g pension rights

 Total remittances and transfers to non-profit institutions servinghouseholds (NPISH) additionally include current and capital transfers

of NPISH, such as donations in cash and kind, cross-bordersponsorships, development aid programmes launched by public orprivate non-profit organizations (NGOs) in other countries

In simple terms, "remittance is the movement of money from peopleliving and working abroad to their relatives in their homeland".

Remittances are a relatively stable source of foreign currency, evenduring an economic crisis, compared with other sources of financing such asforeign direct investment and aid money It helps balance the current account,strengthens foreign currency reserves, and helps improve the lives of therecipients, even the GDP of the country where the recipients live

2.1.2 Remittance in Vietnam (2010-2020)

In the 1980s, Vietnam had fundamental changes in its remittancepolicy, thus receiving a large amount of foreign currency inflows fromoverseas Vietnamese On average, a person sends home about 1000 USD ayear These capital flows have had tremendous impacts not only onindividuals but also on Vietnam's economy and the country's development

In 2010, Vietnam received 8.26 billion USD and the amount increasedsteadily through each year With this trend, in 2020, the amount of remittance

in Vietnam reached 17.2 billion USD, an increase of about 208% Eventhough in 2019 the global economy had suffered from a serious crisis because

of COVID 19, the amount of remittance did not record a decrease but a slightgrowth, from 17 billion USD in 2019 to 17.2 billion USD in 2020

According to estimates, at present, Vietnam has more than 3 millionpeople living and working abroad, mainly in developed countries with highper capita income such as the US, France, UK, Germany, Australia, etc

2015 is considered a bumper year for remittances when paymentrevenue in Ho Chi Minh City area alone has reached more than 5.5 billionUSD, higher than the initial expected figure of 5.2 billion USD

The 2018 World Bank report said following a 10 percent decline in

2016, Vietnam received approximately 13.8 billion USD in 2017, showing ayear-on-year rise of 16 percent Ho Chi Minh City remained the biggest

USD, up 4.5 percent against the preceding year In the first quarter of thisyear alone, the city received 1.12 billion USD, an increase of 4.5 percent fromthe same period last year.

A sum of 15.9 billion USD in remittances was projected to flow intoVietnam for the full year, making the Southeast Asian country the tenthlargest remittance receiver — in dollar terms - in the world Financial andbanking expert Nguyen Tri Hieu said that remittance flow into Vietnam hadstayed on an upward trend from the beginning of this year This was mainlybecause Vietnamese people working abroad believed in the stability of theeconomy and saw better investment opportunities in the domestic market, hesaid

Positive signals about the surplus in the trade balance, control of theinflation index, people's confidence in the tendency to seize the local currency

as well as the appropriate management policy of the State bank are the mainfactors The factor that helps Vietnam's foreign currency market is forecasted

to continue to grow well in the coming years

Figure 2.1 Amount of remittances remitted to Vietnam in the period 2010-2020 (Billion USD)

Source: Authors compiled from World Bank

2.1.3 Pros and cons evaluation

2.1.3.1 Pros

Remittances into our nation have grown greatly over time, which isencouraging because it demonstrates how significantly Vietnamese livingabroad have contributed to the country's progress The reason for this rise isthat over the past few years, we have put in place a number of incentivepolicies—some of them groundbreaking—to encourage people to betransparent and trustworthy Vietnamese overseas and local relations Thegovernment has published documents over time, including:

Decision No 170/1999/QD-TT dated August 19, 1999 on encouragingVietnamese people to remit money from abroad to home country

In 1999, the law stipulates that overseas Vietnamese and foreignersmay transfer foreign currency from abroad into Vietnam in the followingthree forms:

- Transfer of foreign currency through authorized credit institutions;

- Foreign currency transfer through international postal financialservice providers;

- Individuals bring people into Vietnam

Recipients of remittances (with income from remittances) are notrequired to pay income tax on foreign currencies remitted from abroad Up tonow, “Receipts from exchange” are still exempt from personal income tax.(Clause 8, Article 4 on “Exempted incomes’, Law on Personal Income Tax

2007 (amended and supplemented in 2012, 2014))

These documents' major goal is to make it easier for Vietnameseexpatriates to send money home while protecting the rights of both sendersand recipients They also aim to broaden available methods of money transfer

to encourage foreign currency remittances to Vietnam from outside Domesticbeneficiaries are now able to receive foreign currency or Vietnam Dong on

savings at banks, and withdraw both principle and interest thanks to theaforementioned policies can use this foreign currency to send money abroadlegally in foreign currency Remittances of foreign cash are not subject to avolume cap and are not taxed The most recent is Decree 71, which permitsforeigners to purchase real estate.

Furthermore, the present laws governing the administration of foreigncurrencies have made it simple and advantageous for Vietnamese livingabroad to bring back foreign currency, such as through border gate customs.There is no maximum quantity; only the declared amount must be declared tocustoms Non-residents may open a foreign currency deposit account at abank for the quantity of foreign money brought in from abroad or foreigncurrency transferred from abroad (including overseas Vietnamese and theirrelatives) This foreign currency is acceptable in Vietnam for a wide range oflegal transactions

The second breakthrough is an improvement in the standard ofremittance payments Across the nation, remittances are made to recipients'homes In particular, domestic remittance providers reach out to the leaders ofthe community in each locality via word of mouth, through reliableindividuals, to present their products and ask them to introduce them tofriends Banks and domestic corporations charge only a fifth of what foreigncompanies do for the same type of transaction

Many remittance organizations have taken advantage of alternativemoney transfer routes in addition to the traditional cash channel Dong Tobetter track the flow of remittances, a remittance provider has implemented anonline transfer program Previously, the staff had to dig up book informationwhen the sender wanted to know if the money had reached the receiver or not,which took a lot of time The answer is now just a click away, and sendingmoney to recipients in Vietnam only takes 8–12 hours (for large cities) or 24

With the implementation of Sacombank's remittance payment servicevia card, beneficiaries can now withdraw cash from any ATM Depositors atWestern Union have the option of using the mobile money transfer servicefrom 70,000 agent transaction locations across 27 countries, or sendingmoney from their accounts through the company's 16 correspondent banks.The organization currently offers online money deposit services in 17 nationswith a sizable expat population, including the US, Canada, UK, Australia, andGermany.

2.1.3.2 Cons

There is a deficiency at the bank, to start Vietnamese expatriates whohave lived abroad for a long time or export employees who are sendingmoney home to their families send remittances to Vietnam Many people savethis amount of foreign currency, while others choose to sell it on the openmarket via a network of gold shops Because the rate is always higher than atthe bank, doing so is more than just convenient

This also explains why banks have been steadily raising interest rates

on USD deposits in the past to attract foreign currency and in the hope thatconsumers will pay more money to the bank after receiving remittances.Specifically, in 2010 the USD deposit rate in the money market was adjusted

by banks with a wide margin

In Tet 2010, USD deposit interest rates of banks in Ho Chi Minh Cityincreased from 0.1% - 0.3% compared to before and interest rates rangedfrom 3.3% - 4.5% for terms under 12 months Specifically, the internationalbank (VIB) has increased the deposit interest rate with USD from 0.43% -0.85% for a year in all terms, the highest level is up to 4.13%/year

Customers continue to misjudge the adjusted interest rate on foreigncurrency deposits, which leads to a lot of people withdrawing foreign moneyfrom banks to store, invest in other areas, or sell foreign currency for