A STUDY OF EXCHANGE RATE PASS-THROUGH IN VIETNAM DURING PERIOD 2000-2010

This research investigates the effect of exchange rate pass-through on domestic prices and import prices in Viet Nam basing on data from 2000 to 2010. This study applied to a Vector error correction model (VECM), suggested by Johansen (1990). Using Impulse response function and variance decomposition to estimate exchange rate pass-through to domestic prices and import prices. The major findings of this paper are: 1) the effect of exchange rate shock on CPI and import prices are significant in the long run; 2) in the short run, when exchange rate changes, its impacts will move to CPI after 2-3 quarters, as well as, the impact of exchange rate shock to import price has existed in Viet Nam.

NATIONAL ECONOMICS UNIVERSITY

INSTITUTE OF PUBLIC POLICY AND MANAGEMENT

ERASMUS UNIVERSITY ROTTERDAM INTERNATIONAL INSTITUTE OF SOCIAL STUDIES VIETNAM-NETHERLANDS MASTER’S PROGRAM

IN DEVELOPMENT ECONOMICS (MDE)

A thesis submitted for the Master Degree in Development Economics

at the Institute of Public Policy and Management (IPPM)

of National Economics University, Vietnam

Hanoi - 2015

Finally, I dedicate this thesis to my father and my beloved children.

Hanoi, thang ……nam ……

Tác giả

This research investigates the effect of exchange rate pass-through on domesticprices and import prices in Viet Nam basing on data from 2000 to 2010 This studyapplied to a Vector error correction model (VECM), suggested by Johansen (1990).Using Impulse response function and variance decomposition to estimate exchangerate pass-through to domestic prices and import prices The major findings of thispaper are: 1) the effect of exchange rate shock on CPI and import prices aresignificant in the long run; 2) in the short run, when exchange rate changes, itsimpacts will move to CPI after 2-3 quarters, as well as, the impact of exchange rateshock to import price has existed in Viet Nam

TABLE OF CONTENTS

ACKNOWLEDGEMENTS

ABSTRACTS

TABLE OF CONTENTS

LIST OF FIGURES

LIST OF TABLES

LIST OF ABBREVIATIONS 5

CHAPTER 1: INTRODUCTION 1

1.1 Problem statement 1

1.2 The objectives of the thesis 1

1.2.1.Objectives 1

1.2.2.Research questions 2

1.3 Research methods and data 2

1.3.1.Methodology 2

1.3.2.Data source 2

1.4 Scope and limitations 2

1.5 Expected outcomes of the thesis 3

1.6 Structure of the thesis 3

CHAPTER 2: LITERATURE REVIEW 4

2.1 Theoretical background 4

2.1.1.Integrated markets 4

2.1.2 Market segmentation and pricing to market 5

2.2 Empirical study review 6

CHAPTER 3: OVERVIEW ABOUT REGIMES OF EXCHANGE RATE IN VIET NAM 10

3.1 Legal frameworks 10

3.2 Exchange rate management policies 10

CHAPTER 4: EMPIRICAL STUDY 20

4.1 Model and data sources 20

4.2 Unit root and cointegration tests 22

4.3 Estimated results 31

4.4 Impulse Response Analysis 35

4.5 Variance Decomposition analysis 36

Results of Variance decomposition, which show the contribution of innovation in the exchange rate to the variability of both CPI and Import Prices, are presented in Table 4.9 36

CHAP TER 5: POLICY RECOMMENDATIONS AND CONCLUDING REMARKS 38

5.1 Major findings 38

5.2 Policy recommendations 38

LIST OF ABBREVIATIONS

VAR Vector Autoregressive model

VECM Vector Error Correction Model

IMF International Monetary Fund

IFS International Financial Statistics

GDP Gross Domestic Product

ERPT Exchange rate Pass-Through

CPI International Monetary Fund

BIDV Bank for Investment and Development of Viet Nam

BFTV Joint stock commercial Bank for Foreign Trade of Viet NamSBV State Bank of Viet Nam

WTO World Trade Organization

CPI Consumer Price Index of Viet Nam

USD United States Dollar

VND Vietnamese Dong

LIST OF FIGURES

Figure 3 1 Import, Export at constant prices 1994 (billions of dong) 17

Figure 3 2 CPI (December of previous year = 100) (unit: percent) 18

Figure 3 3 Money supply (M2) and GDP at constant prices 1994 (billions of dong) 18

Figure 3 4 Imports, Exports at constant prices 1994 (billions of dong) 19

Figure 3 5 CPI (December of previous year = 100) (unit: percent) 20

Figure 3 6 Money supply (M2) and GDP at constant prices 1994 (billions of dong) 20

Figure 3 7 Money supply (M2) and GDP at constant prices 1994 (billions of dong) 21

Figure 3 8 Import, Export at constant prices 1994 (billions of dong) 21

Figure 3 9 CPI (December of previous year = 100) (unit: percent) 22

Figure 3 10 Import, Export at constant prices 1994 (billions of dong) 22

Figure 3 11 CPI (December of previous year = 100) (unit: percent) 23

Figure 3 12 Money supply (M2) and GDP at constant prices 1994 (billions of dong) 23

Figure 3 13 Import, Export at constant prices 1994 (billions of dong) 24

Figure 3 14 CPI (December of previous year = 100) (unit: percent) 24

Figure 3 15 Money supply (M2) and GDP at constant prices 1994 (billions of dong) 24

Figure 5 1 : Response of CPI to Exchange Rate shock in Model 1 6

Figure 5 2: Response of IMP to Exchange Rate shock in Model 2 7

LIST OF TABLES

Table 4 1: Variables definition and data sources 22

Table 4 2 : ADF Unit Root Test Results 22

Table 4 3: Johansen Maximum Likelihood Co-integration 30

Table 4 4: Johansen Maximum Likelihood Co-integration 30

Table 4 5 Results of estimation ERPT into CPI in the long run 31

Table 4 6 Results of estimation ERPT into CPI in the short run 32

Table 4 7 Results of estimation ERPT into Import Prices in the long run.33 Table 4 8 Results of estimation ERPT into Import Prices in the short run34 Table 4.9 Variance decomposition of CPI and Import Prices 36

CHAPTER 1 INTRODUCTION

1.1 Problem statement

Prices of consumer goods have many problems that interest manyeconomists Prices of consumer goods are affected by many factors such asGDP, import price of goods, money supply, exchange rate, trade policy,psychological factors or behavior of consumers There are many studiesinvestigating the effects of factors on prices of consumer goods in the world

In facts, the main factors affecting domestic prices are the weakness ofmanufacturing and agriculture, rapid population growth, the shocks of energyprices, fluctuation of exchange rate and monetary policies These factors havebeen existed in the Vietnam’s economy and been studied broadly However, one

of the important factors that have been rarely researched is the ERPT and itsimpacts on the import prices Therefore, it is necessary to study the effects ofERPT on import price and CPI in Viet Nam

In this research, the author will investigate the impacts of exchange ratepass-through in Viet Nam to domestic prices in order to show “how domesticprices will change when exchange rate changes by one percent” and “how PTEwill play the leading role in estimating its impacts on domestic prices”

1.2. The objectives of the thesis

1.2.1 Objectives

Fredric S Mishkin (2010) showed that exchange rate plays an importantrole in an open economy Adjustments of exchange rate will affect the inflationand domestic prices Studies about how the exchange rate impacts domesticprice in other economies give us other results In developed countries, this effect

is less substantial than it is in developing countries because the developingcountries with open economies will be affected more significantly by externalshocks The fluctuation of exchange rate, therefore, surely influences localprices in developing countries (Pavlo B., 2010)

In Viet Nam, there are not many studies about this factor and their resultsare not satisfactory (e.g Vo Van Minh, 2009; Tran Mai Anh and Nguyen DinhMinh Anh, 2010) Nhat Trung and Nguyen Hong Nga (2012) showed that VietNam, as a developing country with an open economy, theoretically should have

a substantial effect of exchange rate on domestic prices However, it contradictswith the previous studies which conclude the opposite Hence, the objectives ofthis thesis are 1) to examine to see whether the theory is correct with Viet Namcase, and 2) to investigate exchange rate’s impacts in the short and long run

Akaike information criterion (AIC)

Hannan-Quinn criterion (HQC)

Schwarz criterion (SIC)

In fact, VECM is just a special case of the VAR for variables that arestationary in their differences It can take into account any co-integrationrelationships among the variables

The VECM can give the long run relationships and the short runrelationships of non-stationary variables and VECM can be applied with manydifferent types of time series variables and dates (Phan Thi Hong Thao, 2012)

1.3.2 Data source

The research will use monthly dataset in the period 2000-2010, which iscollected from General Statistic Office (GSO), International Monetary Fund(IMF), Asia Development Bank (ADB) with VECM methodology and themodel to measure ERPT effect in CPI and import price, in both the short andlong run

1.4 Scope and limitations

By the year of 1986, Viet Nam started with “Doi Moi” policy, which madethe definition of exchange rate became more popular In recent years, theinfluence of exchange rate’s fluctuation on traded goods and non-traded goodshave increased Moreover, in an open economy, these influences could beprofoundly vulnerable to external shocks

With the limitations of data sources, statistic errors and limitations of time,this thesis covers ERPT in Viet Nam that affects CPI and import price, in theshort and long run only

1.5 Expected outcomes of the thesis

Over the last three decades, transmission mechanisms of the pass-throughexchange rate to local prices have been emerged as a subject for academicresearch for various countries, industries, products Those studies from Knetter(1989), Campa and Goldberg (2002), Goldberg and Knetter(1997), Licui, ChangShu and Jian Chang (2009) mainly focus on cases of developed countries such

as the United States, European area, Japan, and other OECD countries Only afew studies investigate ERPT of developing countries such as Nusrate Aziz(2009), Takagi and Yoshida (2001) or Parsons and Sato (2006) In Viet Nam,there are a few empirical studies such as Nguyen Cam Nhung (2010), Vo VanMinh (2009) and Tran Mai Anh- Nguyen Dinh Minh Anh (2010)

However, as mentioned above, the results collected from estimatingequations are different Usually, the ERPT’s impact in developed countries islower than that in developing countries (suggested by Nhat Trung and NguyenHong Nga (2012) In Viet Nam, some previous studies show that the effect ofERPT on CPI is small (Vo Van Minh 2009; and Tran Mai Anh- Nguyen DinhMinh Anh 2010) It seems illogical for a developing country like Viet Nam

1.6. Structure of the thesis

The structure of the thesis is as follows:

Chapter 1: Introduction

Chapter 2: Literature review

This chapter will provide theoretical background and review some studiesabout exchange rate pass-through in Viet Nam and other countries withempirical findings

Chapter 3: Overview about regimes of exchange rate in Viet Nam

This chapter will present about exchange rate regimes in Viet Nam frombefore 1989 to present Besides, this chapter discusses about the import, export,CPI, money supply and GDP of Viet Nam upon each exchange rate regimes

Chapter 4: Empirical study

This chapter explains the data, methodology and the model Also, thischapter provides empirical results and analysis

Chapter 5: Policy recommendations and concluding remarks

This chapter summarizes the main findings of the thesis and give policyrecommendations based on what the thesis found

CHAPTER 2 LITERATURE REVIEW

2.1 Theoretical background

2.1.1 Integrated markets

In order to investigate ERPT, we will start with the relationship betweenexchange rate and domestic price/import price A partial ERPT means thetransmittance from percentage change of exchange rate to domestic price andimport price is not full A full ERPT means the whole percentage change ofexchange rate is transmitted to domestic price and import price

In order to answer the research questions, let’s start with the followingfundamental model- the Law of One Price exchange rate theory (Pavlov 2010,p11):

Pi = EPi*, (1)

Where:

P - The local currency of country A

P* - The local currency of country B

E - Exchange rate of A’s currency per unit of B’s

i - The ith goods

In the above equation, we use the law of one price for international goods.According to this law, all goods must have only one price and in commoncurrency This law also assumes profit maximization, no cost for transportation,distribution and resale Markets are fully integrated There is full pass-through.When the law of one price for all traded goods and preferences are same inother countries absolute PPP held In fact, transportation and distribution costsalways exist in the gap between domestic and foreign prices In casetransportation and distribution cost are constant, prices grow at the same rate,that means relative PPP would hold, and exchange rate pass-through iscomplete

However, in fact, when comparing prices between two countries,economists usually use the definition of PPP (Herzberg V., Kapetanios G andPrice S (2003) If the price levels in one country increase by a number ofpercent, the exchange rate in this country must decrease by the same percentageand vice versa In this case, we can guess the pass-through is complete

In order to keep PPP of a country, save prices and exchange rate should bechanged For example, if the price levels increase by a number of percent, thenthe exchange rate in this country must decrease by the same figure of percentand vice versa (to keep PPP unchanged) In this case, the pass-through iscomplete

In open economies, changes in exchange rates affect producing costs.Herzberg V., Kapetanios G and Price S (2003), Nhat Trung and Nguyen HongNga (2012), Pavlov B (2010) who show that when the importing country waslarge enough, then after exchange rate shock, the prices changed This means, inspite of integrated market, the exchange rate pass-through could be incomplete.

It is opposed to theoretic which showed that when the importing country waslarge, the exchange rate pass-through is complete

Also, Nhat Trung and Nguyen Hong Nga (2012) showed that changes ofexchange rate effect on domestic through direct channel and indirect channel: Devaluation of domestic currency ↓

increases increases increases increase ↓ ↓ ↓ ↓

Prices of consumer goods increase

In the research of Vo Van Minh (2009) who based on the Law of One Priceexchange rate theory to show the equation as follows:

Phm = (1-α) e + (1-α) C fx + α Ph + β y (2)) e + (1-α) e + (1-α) C fx + α Ph + β y (2)) C fx + α) e + (1-α) C fx + α Ph + β y (2) Ph + β y (2)

Where:

e - Exchange rate

C fx - Marginal cost of production of foreign firm

Ph - The home country price level

y - Market demand

Vo Van Minh has shown that when α) e + (1-α) C fx + α Ph + β y (2) = 1, ERPT is full, when α) e + (1-α) C fx + α Ph + β y (2) = 0 ERPT

is zero and ERPT is not full at 0< α) e + (1-α) C fx + α Ph + β y (2)<1

Besides, there are many studies that approached specific models andestimated the effect of relaxation assumptions in developing countries such asParsley (1998), Krugman (1978), Hung, Kim and Ohno (1993), etc

2.1.2 Market segmentation and pricing to market

Bergin and Feenstra (2001) show in general equilibrium models thatpreferences are same and demand elasticity is unchanged due to shock ofexchange rate, even in segmented markets However, imperfect competition andmarket segmentation are still insufficient to explain a persistent lack of pass-

through Valerie Herzberg, George Kapetanios and Simon Price (2003, p.11)

also comment that final ‘imported’ goods can be thought of as a productproduced with the aid of an intermediate good, imports Distribution costs are alarge part of the final good Import cost changes can lead to changes in theelasticity of demand, where there is an incomplete pass-through in the long run.

2.2 Empirical study review

There are many studies about ERPT’s effect on import price, CPI, etc.Most of ERPT empirical studies were done on developed countries Some ofthem are in NIC countries such as Rossi (2002) investigating Turkey, Rabanaland Schwartz (2001) on Brazil, Peter Rowland on Colombia as well as someother developing countries All researches about ERPT, however, could beclassified in three groups:

The first group includes papers concentrateing on the effects of ERPT on

import prices for material goods for manufacturing such as:

Isard (1977) investigated how exchange rate fluctuation affected

industrial products and found that about 30 percent of exchange rate through to the prices of industrial products In this study, Isard assumedperfect substitution between foreign products and domestic products,homogenous goods and no transportation cost as well as trade barriers Woo(1984) studied ERPT’s impact on inflation of the United States The authorexpressed the results of ERPT through four channels, which were: importedconsumer goods, imported inputs, demand and foreign prices

pass-Some other authors researched ERPT to producer price in the U.S such asPhillips (1988), Feinberg (1986) or Hooper (1989) They showed that about 50-60% change of nominal ER transferred to prices of produced imports

The second group includes economists discussing the effects of ERPT on

general import prices, namely, Hooper and Mann (1989), Campa and Goldberg(2002), Karim Burhoumi (2005), using the sample of 24 developing countries inthe period 1980-2003, data source from IFS, investigated the differences in howthe long-run ERPT affected import prices in developing countries He found outthat countries with fixed exchange rate, lower tariff barriers and higher inflationregimes exhibited a higher long-run ERPT into import prices than countries withhigher tariff barriers, floating exchange rate (ER) and lower inflation regimes.Nusrate Aziz (2009) investigated the ERPT to import, export and domesticprices using annual and quarterly data of Bangladesh The study used VARtechnique to show that ER devaluation of domestic prices was positive andlarger in the long-run than that in the short-run The study also showed that ifERPT was one-to-one, it was considered “complete ERPT” and if it was less

than one, it was “partial ERPT” The data sources, used in this study, was fromBangladesh bureau of statistics and its model was as follows:

Pjtm = Et * Pjtx

Where: Et is defined as the ER and the import prices of a country j (Pjtm) is

a transformation of the export prices of its trading partners Pjtx

The findings: ERPT to import prices is positive and significant, to export isnegative and significant, to consumer and producer prices are also significant.Recently, in some countries of ASEAN such as Indonesia, the Philippines,Singapore or Thailand, some researchers have estimated much higher exchangerate pass-through into import prices not CPI Sahminan (2005) investigated theexchange rate pass-through in import prices in Indonesia, the Philippines,Singapore and Thailand during period 1974- 2000 and he found that thereexisted ERPT into import prices and this ERPT was almost full

Viet Nam is a member of ASEAN Hence, it is reasonable to expect equallevels of exchange rate pass-through into CPI and import prices We will explainthese assumptions in the following sections

The third group includes papers about the effects of ERPT on CPI(consumer price index) and PPI (producer price index) such as McCarthy(2000), Papell (1994), Kim (1998) and Heng (1999) Mishkin (1998) shows thatexchange rate may be affected by monetary policies Also, the exchange rateimpacts CPI and import price even if floating exchange rate policy is applied.The studies of Leigh and Rossi (2000) and Rabanal and Schwartz (2001)provide stronger evidence for the impacts of ERPT on PPI than for its impact onCPI Alba and Papell (1998) expected the exchange rate pass-through into theCPI of Malaysia, the Philippines and Singapore are 0.090, 0.165 and -0.082,respectively However, Calvo and Reinhart (2000) used monthly data ofIndonesia and Malaysia to investigate the exchange rate pass-through into theCPI and gave rates of 0.062 and 0.020, respectively Bergin and Feenstra (2001),Corsetti and Dedola (2001) showed that ERPT was incomplete for imperfectlycompetitive markets That meant in markets that have price discrimination, the

ER would impact imports price not as much as predicted because manufacturerscould replace foreign inputs with local inputs Bandura Pavlo (2010) researchedthe exchange rate pass-through in Ukraine The main hypothesis that was tested

is if there is a significant effect of exchange rate on domestic prices of tradablegoods and non-tradable goods, producer goods and services in Ukraine Theauthor used monthly series data of Ukrainian interbank exchange rate in theperiod 1995-2009 to estimate PTE The choice of model was VAR and VECM(Vector Error Correction Model) The author wanted to discriminate betweenVAR and VECM based on the existence of the long-run relationship Milton

Friedman (1953) showed that, in floating exchange rate, increasing exchangerate would make price of foreign products cheaper than if calculated in domesticcurrency, and vice versa, the price of domestic products would be moreexpensive than if calculated in foreign currency As a result, this would lead toincrease in import and decrease in export In his study, Milton Friedmanassumed that the prices of goods in foreign currency of manufacturers remainedconstant, and high ERPT still existed at one hundred percent Decreasingexchange rate (devaluation of domestic currency) would increase CPI PeterRowland (2003) studied ERPT to import, producer and consumer prices inColombia The study was based on VAR models and aimed to quantify theimpact and dynamic of the ER on domestic prices in Colombia completely Thestudy used monthly data from 01/1983 to 10/2002 and nominal ER USD/COP tostudy its effect on the different stages of import, producer and consumer prices.

He found out that the import prices would be affected rapidly when ER changed(as much as 80%) while producer and consumer prices would respond slowly

In Viet Nam, Vo Van Minh (2009) with “Exchange rate pass-through andits implications for inflations in Viet Nam” showed the relationship betweeninflation persistence and ERPT and relationship between level of volatility ofinflation and ERPT He estimated the impact of ERPT to inflation, and then,gave appropriate recommendations In addition, he used VAR method toestimate ERPT and dataset from 2001 to 2007 The elasticity of import prices inthe first year average was 0.61 (meaning 61 percentage change of ER wastransferred to import prices), and ERPT average to CPI was 0.08 Besides, TranMai Anh and Nguyen Dinh Minh Anh (2010) with “Estimating the exchangerate pass-through into inflation in Viet Nam” also used VAR method Theyconcluded that the average ERPT to import prices and CPI were 0.13 and 0.065,respectively

However, all the results considered are lower than the results of developingeconomies and new economies

Nguyen Cam Nhung (2010) with “exchange rate pass-through into VietNam’s imports: empirical evidence from Japanese trade data” conducted narrowstudy on the case of trade with Japan She used the OLS regression to estimateERPT from the exporter’s side By using the generic regression model such asGoldberg and Knitter (1997) and Camp and Goldberg (2002) and the HS-9-digitlevel commodity data, the author found that ERPT was high for machineryproducts in Japanese exports to Viet Nam where US dollar invoicing was notdominant In contrast, ERPT was low for electronics products of Japaneseexporters to Viet Nam importers where US dollar invoicing was dominant Thevehicles industry was low pass-through

In general, there are a few studies to be found in Viet Nam and the results

of researches are yet satisfactory because Viet Nam is a dynamic economy and it

is affected by a broad range factors

Therefore, this study will use date set from 2000 to 2010 to estimate theeffects of ERPT on domestic prices and import prices (Import prices are formaterials used in manufacturing product) In order to investigate morecomprehensively about impact of ERPT into CPI and Import price as well as theeffect of it in the short and long run, the author will use VAR and VECM toestimate results of the models

CHAPTER 3 OVERVIEW ABOUT REGIMES OF EXCHANGE RATE IN VIET NAM

3.1 Legal frameworks

Before the year of 1986, Viet Nam economy was still a centrally plannedeconomy (Nguyen Quang Ngoc, 2006) In which, the economy operatedaccordingly to government's directions and its ER regime was multi-ER In thisperiod, there were 03 official exchange rates provided by the government andnon-official market-based ER, which existed alongside the official ones Hence,official ERs couldn't reflect the value of the country's currency as well aseconomic conditions (Nguyen Thi Thu Hang et al (2010)

Prior to 1989, Vietnamese financial system was provided for by a banking system (Nguyen Van Dinh 2010), which was controlled by the StateBank of Vietnam (SBV) SBV directed all lending activities with credit quotingfor each entity Besides, there were also two special banks to finance forinfrastructure The Bank of Investment and Development of Viet Nam (BIDV-since 1958) were responsible for public works, infrastructure projects andequipment for SOEs The Bank of Foreign Trade of Viet Nam (BFTV-since1963) financed for foreign trade and foreign exchange rate transactions (WorldBank 1991)

mono-With Decree no.53/ND in 1988 by the Government, the mono-bankingsystem was stopped and replaced by a two-tier banking system SBV hasbecome the Central Bank and there were four state-owned commercial banks

3.2 Exchange rate management policies

The management of exchange rate in controlling inflation, stablingmacroeconomic and balance of payment (BOP), has important roles in VietNam's economy Viet Nam has given much more adjustments to ER since

1989 However, all of the adjustment was around the peg ER USD is fixed as

a peg currency in Viet Nam, as SBV always announces exchange rate ofVND/USD Base on international exchange rate between USD and otherforeign currencies, commercial banks build exchange rate between that foreigncurrencies and VND

In addition of reporting ER of VND/USD daily, SBV also helps thegovernment manage monetary policies and foreign currencies (decree no.53-HDBT dated 26/03/1988) According to Ordinance no 28/2005/UBTVQH11 ofthe Standing Committee of the National Assembly - Ordinance on ForeignExchange Management: "Socialist Republic of Viet Nam implemented foreignexchange management policy to create favorable conditions and ensure thelegitimate interests for organizations and individuals engaged in foreign

exchange, contribute economic development, implemented objectives of thepolicies of national currency, improve the conversion of Viet Nam dong, carryout purpose on the territory of Viet Nam using only the Viet Nam dong, carryout commitments made by the Socialist Republic of Viet Nam in the process ofinternational economic integration, enhance the effectiveness of statemanagement of foreign exchange and improve foreign exchange managementsystem of Viet Nam."

The Exchange rate movement in Vietnam is divided into five stages:

Stage 1: Before 1989

In this stage, the Government makes monopoly of foreign exchange TheGovernment gave out three official exchange rates

Official exchange rate: the first official exchange rate is built between

Vietnam Dong and China Yuan Renminbi After that, base on exchange rate ofChina Yuan Renminbi with other currencies, Viet Nam apply “cross rate”method to calculate exchange rate with other foreign currencies An importantexchange rate in this time which is established by “cross rate” is Rup clearing Exchange rate for internal Draw the final Balance-sheet: this ER isused in payments among bank and organs for foreign trade, bank andnational budgets for Aids

Exchange rate for Overseas national currency exchange: It is establishedbase on official exchange rate with that foreign currency and plus percent ofstimulation

"Black-market" exchange rate and official exchange rate existed together.Because of monopoly of foreign exchange, Vietnam’s economy did notraise It showed BOP deficit, high inflation and GDP is almost not valuable Inthe stage, Viet Nam traded mostly with Socialist countries So, foreign trade didnot develop Balance of payment (BOP) was usually in deficit in this stage

Figure 3 1 Import, Export at constant prices 1994 (billions of dong)

Source: (GSO, 2012)

Figure 3.1 shows BOP deficits of Viet Nam In 1986, we exported 10,147billion dongs and imported up to 23,268 billion dongs Similarly, in 1987, 1988,and 1989 exports were 11,008 billion dongs, 9,903 billion dongs and 27,602

billion dongs, respectively, and imports were 27,364 billion dongs, 25,251billion dongs and 39,652 billion dong, respectively In each year from 1986 to

1989, trade deficit always passed 10 thousand billion dong

In figure 3.2 indicates CPI decreased from 774.7% in 1986 to only 36% at

1989 (source, GSO) On the contrary, money supply increased It was 112billion dongs in 1986, but in 1988, it quickly jumped up to 2,569 billion dongs,reaching 7,419 billion dongs in 1989 (ADB, 2012)

Source: (GSO, 2012)

Source: (ADB, 2012 and GSO, 2012)

In this period, GDP increased steadily after each year, from 109,189 billiondongs in 1986 to 125, 571 in 1989 (GSO, 2012)

In general, in the first period of renovation (1986-1989), we can see a bigdifference between policies and applications Unclear ER, hyperinflation andtrade deficit were the main problems of Viet Nam's economy in this period Also,

in this stage GDP increased and CPI decreased but we also raised the moneysupply (M2) Hence, we could not conclude economic growth in this period

Stage 2: 1990-1995

In 1989-1990 period, the government fixed ER with crawling bands Themost important thing in real ER regime is Official Exchange Rate (OER) OERwas adjusted by the State Bank based on signals of inflation, interest rate, BOPand ER in open market Commercial banks were allowed to establish their ER

within 5% of OER The use of foreign currencies was wider

Required reserve ratio was also built in 1988 and has been applied since

1992, in accordance with Resolution no.16/NH-QD

From 1991 to 1993, the government decided pegs ER within horizontalbands The State controlled the use of foreign currencies tightly and forbademoving money outside The State established official reserve Funds offoreign currency to stabilize ER The State also built 2 floors for foreigncurrency in Ho Chi Minh City and Ha Noi city OER in this period wasdecided by biding ER on the 2 floors SBV used powerful means to controlthese 2 floors Commercial banks were allowed to use ER within bands ofless than 0.5% of OER only With targets of managing monetary policies,controlling inflation, steadying the value of VND and boosting economicgrowth, SBV managed its monetary supplies to fasten money stabilization

In the early 1990s, SBV converted the currencies, and the three-digit level

of inflation ended Recession stopped and the economy steadied, as inflationwas calmed down The ER was pegged rigidly In the period, unofficial ERstabilized and caught up with official ER

In answer to Government’s effort, the economy’s growth is positive and

ER regime is more flexible Although Viet Nam still had trade deficit (seeFigure 3.4) in this stage but export raised from 11,084 billion dongs in 1990 to75,106 billion dongs in 1995 and import raised from 14,960 bill dongs in 1990

to 95,925 bill dongs in 1995 (GSO, 2012) Trade deficit was up to 20,819 billdongs in 1995 Even when the government had adjusted its ER policy, value ofVND still reduced compare to the value of USD Besides the targets of monetarymanagement and control of inflation (or hyperinflation), SBV also tried tosteady the value of VND In this period, all credit institutions crashed and thestabilization of VND was the first way SBV used to keep the expectations ofVietnamese people

Figure 3 4 Imports, Exports at constant prices 1994 (billions of dong)

Source: (GSO, 2012)

Finally, the hyperinflation was ended and CPI was also stabilized CPI

changed from 67.1% in 1990 down to 17, 5% in 1992, and then managed around10% in the following years Only in 1993 was CPI 5.2% (GSO.2012) (seeFigure 3.5)

This time, Viet Nam came of embargo period created by the US The twosides signed an agreement on trade That was one of the reasons for Vietnam'seconomic achievements such as controlling inflation, stabilizing the economy,economic growth and its success in supervising the value of VND

The period of 1997-1998 observed the Asia financial crisis, which alsoaffected Vietnam's financial system The State tried to find ways to preventthese influences Pegged exchange rate with crawling bands was applied.Commercial bank's ER bands varied constantly It was loosen from +/-1% to