THE IMPACTS OF VIETNAMS EXCHANGE RATE POLICY ON TRADE ACTIVITIES IN THE CONTEXT OF ECONOMIC INTEGRATION

In Vietnam, since the introduction of economic reforms, moving from a subsidized economy to a socialistoriented market economy, one of the policies which determine the growth rate of Vietnam is the exchange rate policy. Vietnams exchange rate policy is flexible, suitable for international circumstances and conditions. According to statistics from 1989 up to now, Vietnam has experienced different exchange rate regimes, namely: Before 1989, there had been a complicated system of multiple fixed exchange rates: an official rate for foreign trade transactions, another for noncommercial transactions, a socalled internal settlement rate for the purpose of compensating export enterprises for their losses and a separate rate for remittances received from overseas (Vo Tri Thanh et al. 2000; Nguyen Van Tien 2006). From 1989 to 1990, the multiple exchange rates were unified into a single official rate, set and announced by the State Bank of Vietnam (IMF 1996) in March 1989, Vietnam exchange rate was pegged to the US dollar with the adjusted band, the official exchange rate was adjusted by the State Bank based on the signals of inflation and interest, the balance of payment and free market rates. Specifically, commercial banks were allowed to determine exchange rates within the band + 5% around the announced official rate, with a maximum bidask spread of 0.5%, and the use of foreign currency is strictly regulated. From 1991 to 1993, with the opening of two foreign exchange (FX) trading floors (in Ho Chi Minh City and Hanoi), the official rate became determined on a daily basis (IMF 1996). In setting this rate, the SBV would be guided to some extent by the previous day’s closing rates on the two trading floors. The exchange rate policy of Vietnam remained in the regime of the pegged exchange rate but with a much narrower band than in the previous period. Commercial banks were allowed to quote within a (narrowed) trading band of +–0.5 percent around the announced official rate. During this time, Vietnam still strictly controlled foreign currencies, restricted the carrying of money out of the border, and established official foreign trading floors for the purpose of stabilizing the exchange rate

VIETNAM NATIONAL UNIVERSITY UNIVERSITY OF ECONOMICS AND BUSINESS FACULTY OF INTERNATIONAL BUSINESS AND ECONOMICS

Intake: QH-2014-E KTQT CLC Program: Honours

Hanoi – April, 2018

TABLE OF CONTENT

ACKNOWLEDGEMENTS

LIST OF ABBREVIATIONS

LIST OF TABLES

INTRODUCTION 1

1 Rationale 1

2 Literature review 1

3 Objectives of the research 3

4 Subject and scope of the research 4

5 Research structure 4

CHAPTER 1 THEORETICAL FRAMEWORK OF EXCHANGE RATE AND BALANCE OF TRADE 5

1.1 Theoretical framework of exchange rate 5

1.1.1 The concept of exchange rate 5

1.1.2 Quoted and base currencies 6

1.1.3 Exchange rate classification 7

1.1.4 Exchange rate remiges 9

1.2 Balance of Trade 11

1.2.1 The concept of trade balance 11

1.2.2 States of trade balance 12

1.2.3 Factors affecting Trade balance in Vietnam 13

1.3 The impacts of exchange rate on trade balance 14

CHAPTER 2 THE OVERVIEW OF VIETNAM’S EXCHANGE RATE REMIGE AND TRADE PERFORMANCE 19

2.1 Exchange rate policy in Vietnam 19

2.1.1 The 2007-2009 period 21

2.1.2 The 2010-2015 period 24

2.1.3 The 2016-2017 period 30

2.1.4 Compare the nominal exchange rate and the real exchange rate 31

2.2 Overview of Vietnam’s trade balance 33

2.2.1 The 2007-2010 period 36

2.2.2 The 2011-2015 period 40

2.2.3 The 2016-2017 period 43

2.3 Assessing the relationship between exchange rates and trading activities in Vietnam 44

2.3.1 The 2007-2010 period 44

2.3.2 The 2011-2015 period 46

2.3.3 The 2016-2017 period 47

CHAPTER 3: METHODOLOGY AND EMPIRICAL RESULTS 49

3.1 Methodology 49

3.2 Data 50

3.3 Empirical results 51

CHAPTER 4 SOME IMPLICATIONS FOR THE EXCHANGE RATE POLICY AND TRADE ACTIVITIES IN VIETNAM 55

3.1 Implications for Vietnam's current exchange rate policy 55

3.2 Implications for Vietnam's current trade 56

REFERENCES 59

ACKNOWLEDGEMENTS

First of all, I sincerely thank the teachers of the University of Economics - VNU and the Faculty of Economics and International Business for facilitating me to complete this research topic

In particular, I would like to send my sincere thanks to Dr Nguyen Cam Nhung Throughout the course of the study, she devoted herself to helping and directing me directly Thus, not only can I acquire more useful knowledge but also have the opportunity to study the spirit of scientific work seriously and effectively This is very necessary for me in the learning process and future work

Due to limited time frame as well as limited qualifications, this paper is inevitable to the defects I do hope that teachers and friends will share and give suggestions for this paper to be completed

LIST OF ABBREVIATIONS

No Abbreviation

LIST OF TABLES

No Table

1 Table 1.1 Exchange rates between Vietnam Dong and

5 Table 3.2 The summary of the ADF tests for a unit root 52

6 Table 3.3 The estimated long-run model result 52

5 Figure 2.4 VND/USD exchange rate movements in 2010 25

6 Figure 2.5 Nominal exchange rate VND/USD in from

7 Figure 2.6 Nominal exchange rate VND/USD in 2014 and

8 Figure 2.7 Nominal exchange rate VND/USD in 2016 30

9 Figure 2.8 Nominal exchange rate VND/USD in

10 Figure 2.9

Nominal exchange rates VND/USD and real exchange rate in the period 2007-2016 (2010 is the base year)

32

11 Figure 2.10 Vietnam’s NEER and REER in the period

INTRODUCTION

1 Rationale

At present, international trade activities in which import and export activities are always the top concern of open economies Import and export are always interested by almost all the countries, especially developing countries because this

is the shortest way to accumulate wealth, solve the debt burden for most countries in the world

Moreover, exchange rate has played a very important role in international trade It is considered an effective tool to promote international trade especially in such a great open world economy and many countries pursue a development strategy using exchange rate as a main intervention However, the exchange rate is a very sensitive macroeconomic variable because exchange rate fluctuates day by day, and is influenced by many factors Today's exchange rate may be different from that of yesterday, the sudden rise and fall of the currency are always a new problem for economic managers and investors

When the authority adjusts the exchange rate, they will have to face other unexpected impacts, given that there has existed twin deficits for a long time – trade balance deficit and budget deficit

So for Vietnam’s import and export, how does exchange rate fluctuation

affect? The study "The impacts of Vietnam's exchange rate policy on trade activities in the context of economic integration" would clarify the problem

2 Literature review

There is a wide range of literature focusing on investigating the relationship between exchange rates and trade balance In addition, there are also a number of overseas literatures that examine the interaction between the two exchange rate variables and the trade balance in the context of Vietnam's economic integration,

these researchs will give Vietnam better recommendations and solutions The essay divide the literatures into two main groups:

The first group: including the literatures that analyze basic theories of

exchange rate In addition, some researchs show the current status of Vietnam's exchange rate and trade policy in recent years Some of literatures also focus on providing long-term solustions to Vietnam's policy management These research papers have contributed much to the theoretic framework of this essay, which includes the following typical research papers:

Krugman and Obstfeld (2001), Hatemi-J (2004) found evidence of J-curve when investigating the impact of exchange rate on trade balance The heart of J-curve effect drawn from Marshall-Lerner condition is that the trade balance of a country experiences the J-curve effect when the domestic currency is devaluated At first, the total value of imports increases due to higher price of imported goods, and exceeds the total value of exports This results in a trade balance deficit However, the devaluation increases demand for exports, resulting in higher level of exports Eventually, exports recover and bring back trade balance surplus

The paper "Exchange rate policy: Which option for Vietnam?" By the group

of authors Pham The Anh, Dinh Tuan Minh (2014) clarified two objectives: the exchange rate mechanism and its effects on trade balance, inflation and some other macro variables in Vietnam; Basing on the arguments and analysis, the research gives policy recommendations to promote the positive effect of exchange rate policy on other variables

The other paper in this group is "Solutions to enhance the role of exchange rates in the integration process for the economy in Vietnam" by Nguyen Thi Tuyet Nga, Ho Chi Minh City in 2012

The second group: consists of quantitative research papers Basing on the

reality of exchange rate fluctuations and import and export activities in Vietnam

over the years, that indicate the relationship between these two variables and offer effective solutions

The first paper is "Exchange Rate Policy and Impact of Exchange Rate Policy

on Vietnam Trade Balance from 1989 to 2013” by Le Thi Dong - Foreign Trade University The literature has clarified policies, changes in the exchange rate and trade balance in Vietnam over the years From that point of view, there are two practical experiences that the exchange rate policy that is suitable for the open economy and wide integration is flexible mechanism and able to cope with external shocks But an exchange rate policy that adapts to such external factors means increasing fluctuations in the exchange rate and increasing the risk of capital inflows into Vietnam, while risks are always the most sensitive variable to negatively affect the investors

The second paper is the thesis "The trade balance of Vietnam in the process of industrialization and modernization of the country" by Duong Duy Hung Through the detailed statistics on turnover, structure and status of trade balance over the years, the author assessed the impact of factors such as exchange rate, international trade policy, investment policy on the trade balance of Vietnam

The third paper is “Lan Huong Hoang (2016) : The role of exchange rate in supporting trade balance in Vietnam” In this paper, the author applied a multivariate Structural Vector Autoregressive (SVAR) and Vector Error correction model (VECM) to analyze short-term and long-term effects of foreign exchange rate on trade balance of Vietnam, using monthly data from 2004-2015 Then, author suggested a number of policy implications to support policy makers in Vietnam

3 Objectives of the research

Understanding the relationship between Vietnam’s exchange rate policy and trade balance during the period from 2000 to 2017 Assessing the effectiveness of exchange rate policy through the adjustments and changes in trade balance

To achieve that objects, the paper should answer the following central research questions:

• How did Central Bank implement exchange rate policies?

• Do exchange rate policies positively affect imports and exports?

• What is the relationship between exchange rate policy and trade balance in Vietnam?

• Which exchange rate policy would be consistent with the international trade

practice in Vietnam?

4 Subject and scope of the research

Subject: Exchange rate VND/USD, export and import turnover, trade balance, real

effective exchange rate, the effect of exchange rate policies on trade balance over the period from 2000Q1 to 2017Q4

Scope of the research:

Space: Vietnam

Time: The period from 2000 to 2017, especially 2007-2017 period because of

joining the WTO in 2007, Vietnam’s trade relations have been more diversified

CHAPTER 3 METHODOLOGY AND EMPIRICAL RESULTS

CHAPTER 4 SOME IMPLICATIONS FOR THE EXCHANGE RATE POLICY

AND TRADE ACTIVITIES IN VIETNAM

CHAPTER 1 THEORETICAL FRAMEWORK OF EXCHANGE RATE AND BALANCE OF TRADE

1.1 Theoretical framework of exchange rate

1.1.1 The concept of exchange rate

Each country has its own currency, varying in size, shape, name for example: US uses dollar, European Union countries use EURO, or Vietnam has VND Each country's money plays a very important role in boosting the exchange

of goods and merchandise within the country However, along with the process of regionalization and globalization, in order to promote trade between countries, it is imperative to determine the value of one country's currency against another This is also a fundamental cause for the formation of exchange rates - as a tool for linking currencies together, facilitating cross-border trade

On that basis, the exchange rate (foreign exchange rate) is basically understood as: “The price of one country’s currency in terms of another country’s currency”1

Example: Exchange rate of VND vis-à-vis USD

USD 1 = VND 22725 (E = 22725)

1 Paul Krugman and Maurice Obstfeld, International Economics: Theory and Policy, 9 th Edition, Pearson,

2012

Table 1.1 Exchange rates between Vietnam Dong and foreign currencies

Exchange rate applied for 26/07/2017 (Unit: Vietnam Dong)

No Foreign currency Name of foreign currency Bid Ask

Source: State Bank of Vietnam

So the bank will buy the dollar with the value of 22.725 VND and sell the dollar with the value of 23.086 VND respectively

1.1.2 Quoted and base currencies 2

The term quoted currency means the currency that is variable in an exchange rate quotation; the term base currency means the currency that is fixed Thus in GBP 1 = USD 1.7250, sterling (GBP) is base currency, and the US dollar is the quoted currency For convenience, the exchange rates are written as base/quoted, in this case GBP/USD

Direct quotation takes the form of variable amounts of domestic currency against a fixed amount of foreign currency The foreign currency is the base currency A Swiss bank quoting “85.5 Swiss francs per 100 Euro” would be quoting direct – a variable amount of Swiss francs against a fixed euro amount

Indirect quotation, conversely, takes the form of fixed amounts of domestic currency against varying amounts of foreign currency A British bank quoting

“GDP 1 = CHF 2.3575” is quoting indirect

2 Julian Walmsley, The foreign exchange and money markets guide, 2 rd Eddition, 2000

Indirect quotation is usually used for GBP, USD, AUD, while direct quotation

is used for the other currencies USD is the base currency of the other currencies, except for EUR, GBP, AUD, NZD (This thesis use direct quotation)

1.1.3 Exchange rate classification

There are many ways of dividing the exchange rate, however, in the scope of analyzing the impact of the exchange rate on the trade balance between Vietnam and the United States and on the basis of the influence of the exchange rate, exchange rate is divided into nominal exchange rate, nominal effective exchange rate, real exchange rate, real effective exchange rate

Nominal exchange rate (NER)

The nominal exchange rate E is defined as the number of units of the domestic

currency that can purchase a unit of a given foreign currency (The nominal exchange rate is the exchange rate used daily on the foreign exchange market) Example:

𝐸USD/€ = 1.3467

𝐸€/USD = 0.7425

Thus, 𝐸USD/€ = 1/𝐸€/USD An increase in 𝐸USD/€ means a dollar depreciation If a currency can buy more (less) of another currency, we say it has been appreciated (depreciated)

Nominal Effective Exchange Rate (NEER)

The nominal effective exchange rate is a measure of the value of a currency against a weighted average of several foreign currencies An increases in NEER indicates an appreciation of the local currency against the weighted basket of currencies of its trading partners

Real exchange rate (RER)

The real exchange rate R is defined as the ratio of the price level abroad and the domestic price level, where the foreign price level is converted into domestic currency units via the current nominal exchange rate (Real exchange rate is the Nominal Exchange rate times the inverse of the relative price levels)

RER = 𝑁𝐸𝑅𝑡𝑃∗𝑡

𝑃 𝑡

Where

RER: Real exchange rate

NER : Nominal exchange rate

𝑃 ∗𝑡: Foreign price level

𝑃𝑡: Domestic price level

The real rate tells us how many times more or less goods and services can be purchased abroad (after conversion into a foreign currency) than in the domestic market for a given amount

A decrease in RER is termed appreciation of the real exchange rate, an increase is termed depreciation

Real effective exchange rate (REER)

Real effective exchange rate is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness

𝑅𝐸𝐸𝑅𝑡 = ∏(𝑅𝐸𝑅𝑖,𝑡)𝑤 𝑖,𝑡

𝑛

𝑖=1Where i=1….,n is trading partner country, 𝑤𝑖 is trade weight of country i in the domestic country’s total exports, and t is time

Rather than focusing on the nominal exchange rate, it is more sensible to monitor the real exchange rate when assessing the effect of exchange rates on international trade or export competitiveness of a country For simplicity, assume that the domestic price level rises by 10%, the foreign price level remains unchanged and the domestic currency depreciates nominally by 10% Then the real exchange rate, i.e the ratio of prices at home and abroad, remains unaffected, depreciation of the domestic currency notwithstanding Other things held equal, there would be no change in the demand for imports in the domestic economy and

in the demand for exports of the domestic economy abroad

1.1.4 Exchange rate remiges

An exchange rate regime is the system that a country’s monetary authority, generally the central bank, adopts to establish the exchange rate of its own currency against other currencies Each country is free to adopt the exchange-rate regime that

it considers optimal, and will do so using mostly monetary and sometimes even fiscal policies

Fixed exchange regime: the government intervenes in the foreign exchange market

in order to keep the exchange rate at a fixed level

Characteristics of fixed exchange regime:

In a fixed exchange rate regime, the domestic currency is tied to another foreign currency, mostly more widespread currencies such as the USD, EURO, GBP or a basket of currencies In a fixed exchange rate system, the government (or the central bank acting on the government's behalf) intervenes in the foreign exchange market to ensure that the exchange rate stays close to a predetermined target Under this system, exchange rate stability is achieved but if the exchange rate is fixed at the wrong rate it may be at the expense of domestic economic stability

In a fixed exchange rate system, a rise in the exchange rate of the domestic currency vis-à-vis another foreign currency is called a devaluation This means that

in order to buy 1 unit of a given foreign currency more of the domestic currency is needed On the other hand, when the exchange rate falls it is termed as a revaluation These terms imply a deliberate decision on the part of the government

to change the level of the exchange rate For example a government’s policy decision to devalue the domestic currency vis-à-vis the US dollar

Fixed rates provide greater certainty for exporters and importers as there are

no or limited exchange rate risks As businesses have the perfect knowledge that the price is fixed and therefore not going to change, it is relatively easier for them to plan ahead However, a fixed exchange rate regime may have a high administration cost and a significant gap between the official rate and that determined by the market can promote black markets In a black market the bulk of foreign exchange transactions are carried out outside the banking system This may force government

to draw down on reserves to meet its obligations and cause scarcity of foreign exchange

Advantages: High stability, be stable for a long time

Disadvantages: The rigidity and subjectivity of the fixed mechanism makes the

exchange rate less flexible and does not accurately reflect the market exchange rate

Floating Exchange Rate: the government lets the nominal exchange rate be

determined in the foreign exchange market

Characteristics of floating exchange regime:

In a floating exchange rate remige, the market’s demand and supply of the currency determine the exchange rate There is no pre-determined official target for the exchange rate set by the government The latter and the central bank indirectly influence the exchange rate by managing the level of domestic and foreign currencies in the banking system

Under a floating exchange rate remige, a rise in the exchange rate of domestic currency via-à-vis another foreign currency is called a depreciation This implies

that more rupees are required to purchase 1 unit of foreign currency Vice versa when less domestic currency is needed it is termed as an appreciation

Advantages: The floating exchange rate regime ensures the balance of payments,

monetary policy, makes the economy be independent, contributing to economic stability,stabilizing private investment and the market This policy is used by many capitalist countries with strong currencies such as the US and the UK

Disadvantages:Because the exchange rate is fully floated, there are potential risks

to the management of capital and import and export When there are fluctuations in supply and demand of currencies, currencies will tend to rise or fall automatically

Semi-fixed exchange rate: Between the two extreme exchange rate regimes there

is the managed float, (semi-fixed exchange rates) the exchange rate is given a specific target and a central bank keeps the rate from deviating too far from a target value.Under this remige, the exchange rate is the main target of economic policy-making (interest rates are set to meet the target)

In addition, according to the new classification of the IMF, there are three exchange rate regimes:

Hard peg exchange rate regime (Currency Board)

Soft peg exchange rate regime

Floating exchange rate regime (Managed floating with no preannounced path for the exchange rate or Independent floating)

1.2 Balance of Trade

1.2.1 The concept of trade balance

The balance of trade (BOT) is the difference between a country's imports and its exports for a given time period

The balance of trade is the largest component of the country's balance of payments (BOP) Economists use the BOT as a statistical tool to help them

understand the relative strength of a country's economy versus other countries' economies and the flow of trade between nations The balance of trade is also referred to as the trade balance or the international trade balance

The concept of trade balance will be studied, used in analyzes and assessments conducted on the basis of the general concept of trade balance Accordingly, the trade balance is interpreted as a measure of the difference between the value of a country's exports and imports of goods or an economy over a given period of time, usually one year

1.2.2 States of trade balance

With the concept of trade balance as can be seen, depending on the difference between the value of exports and imports of goods of a country or an economy in each period, we have the different states in the trade balance of the country or economy, namely:

• Trade balance when the export and import of a country or an economy are equal in the given period

• Trade surplus when the export of a country or an economy exceeds the import during the given period

• Trade deficit when the import of a country or an economy exceeds the export during the given period

The states of the trade balance clearly interact with other macroeconomic variables of the economy, as well as partly reflecting the state of the macroeconomy

in general In general, in principle, every economy is aiming for a long-term goal of achieving trade balance or trade surplus However, in different stages of development, the state of the trade balance fluctuates in accordance with the nature and level of economic development during that period

1.2.3 Factors affecting Trade balance in Vietnam

The first factor that affecting trade balance is oil price Oil is the essential energy resource for production activities in every country, especially in developing countries like Vietnam The response of difference economies to an increase in oil price will depend on the quantities of imports in that country, the strength of current account, the control of domestic demand management, the ability of that country to find other energy instead of oil A country that can response with a high price of oil, limit the import of oil, that country will have more ability to reduce the balance of payment deficits or trade deficits

There is a negative and significant relation between oil prices and the trade balance

in both short – time and long – time It indicates that with the increase in oil price, the cost of materials and capital goods increase and then trade deficits (trade imbalance) Oil price had impact significant especially in poor countries, developing countries and oil importing countries Poorer countries are more vulnerable to the oil price increase because they are relatively more oil intensive

The second factor affecting trade balance is foreign direct investment (FDI) Orr (1991) found the result that an increase in FDI of U.S manufacturing will have positive impact with the trade balance

The third factor that could impact on the trade balance is government spending An increase in government spending produces an expansion in output, an expansion in consumption, and decrease of the trade balance An increase in government spending will lead to an increase in GDP The trade balance will be decrease because imports increase and export fall Thus, the trade balance will be trade deficits

The fourth factor affecting trade balance is domestic price A high price expectation will cause a decrease in export, an increase in import and a decrease in competiveness Thus a high domestic price will lead a decreasing of trade balance (trade deficits) Trade flows adjusted differently to a change in price

The fifth factor impact on trade balance is manufacturing growth rate Mmanufacturing increases the FDI of the country This caused an increase in the trade balance Manufacturing in one of factors which had positive impact on trade balance Namely, when the manufacturing growth rate is increasing, it will lead an increasing on the balance of trade

The sixth factor impact on trade balance is agricultural growth rate Agricultural is one of factor very important in the developing and poor countries Namely, agricultural growth rate has a positive impact towards trade balance

The seventh factor affects trade balance is Exchange Rates, Foreign Currency Reserves

Exchange rates: A domestic currency that has appreciated significantly may pose

a challenge to the cost-competitiveness of exporters, who may find themselves priced out of export markets This may pressure a nation’s trade balance

Foreign currency reserves: To compete effectively in extremely competitive

international markets, a nation has to have access to imported machinery that enhances productivity, which may be difficult if foreign exchange market reserves are inadequate

The final factor is trade policies Barriers to trade also affect the balance of exports and imports Policies that restrict imports or subsidize exports change the relative prices of those goods, making it more or less attractive to import or export For example, agricultural subsidies might reduce the cost of agricultural activities, encouraging more production for export Import quotas raise the relative prices of imported goods, which reduces demand

1.3 The impacts of exchange rate on trade balance

Exchange rates are one of the most important and immediate factor affecting the trade balance

Accordingly, in principle, when the exchange rate rises, which means that the domestic currency depreciates against the foreign currency, foreign goods will be more expensive relative to domestic goods, and so the impact makes import tends to decrease, export tends to increase, trade balance will tend to be improved

By contrast, when the exchange rate declines, which means that the domestic currency appreciates against the foreign currency, foreign goods will be cheaper than domestic goods, thus import tends to increase, export tends to decrease, trade balance will tend to decrease

The J-Curve and the problem of improving the trade balance

One of the issues that macroeconomic policymakers are concerned with is: Will currency devaluation improve the trade balance? And what is the condition for

a successful devaluation? To answer this question, we will examine the theory of the J-curve effect

Because commodity prices are not elastic in the short run, so the devaluation

of the currency makes the real exchange rate rise; An increase in the real exchange rate stimulates export volume and limits import volume So improving international trade competitiveness Based on this conclusion, many people mistakenly believe that the trade balance has also improved as the currency devalued In fact, it’s not neccessarily like this To see the impact of dumping on trade balance, we use the Marshall-Lerner approach as follows:

Domestic currency devaluation will create an effect of increasing export volume and limiting import volume, but in terms of value, the trade balance will not necessarily be improved This happens because currency devaluation produces effects on price and volume, namely:

- For trade balance in VND: The volume effect is reflected that the devaluation leads to an increase in export volume and lower import volume, which makes the trade balance in VND to be improved The price effect is reflected that the

devaluation makes prices of imported goods in domestic currency increase, making trade balance in VND get worse

- For trade balance in USD: Volume effect is the same as trade balance in VND The price effect is reflected that the devaluation make the export price in foreign currency decrease, which reduces the trade balance in USD

The net effect of trade balances (improved or deteriorated), therefore, depends on the dominance of the volume effect or price effect:

- The first possibility reflects the dominance of the price effect This means that although the volume of exports increased and the volume of imports decreased, it was not enough to offset the decrease in export value in foreign currency and increase the value of imports in domestic currency As a result, the trade balance from equilibrium will become deficit and then the total value (ηx + ηm) <1

- The second possibility reflects the neutrality of the two effects This means that the volume of exports increases and the volume of imports falls short enough to offset the decrease in the value of exports in foreign currency and the increase in the value of imports in domestic currency As a result, the balance of the trade balance

is maintained and then the total value (ηx + ηm) = 1

- The third ability reflects the superiority of the volume effect This means that after the devaluation, export volumes increase and imports fall more than enough to offset the price effect As a result, the trade balance improved and then the total value (ηx + ηm)> 1

Thus, currency devaluation certainly makes the volume of exports increase and the volume of imports decrease, but the trade balance is not necessarily so improved According to the above analysis, the trade balance is improved or deteriorated depending on the dominance of volume effect or price effect

Because price effects are immediately effective after devaluation, while volume effects only take effect after a certain period of time.This implies that, in the short run, the price effect is superior to the volume effect, thus worsening trade balance.In

contrast, in the long term, the volume effect is superior to the price effect, so the trade balance improves This feature of currency devaluations is represented by J-curve as follows:

Figure 1.1 J-curve

Source: vi.wikipedia.org

The extent and duration of the trade deficit is dependent on many factors For industrialized countries, as the economy is characterized primarily by goods that qualify for international trade (ITG), the devaluation causes a fast increase in the volume of exports and import volume decreases quickly in short term Therefore, the effect of volume has a positive effect in the short term, leading to a temporary short-term trade deficit, and will be markedly improved in the long run For developing countries, as the economy is characterized primarily by goods that do not qualify for international trade (international non-tradeable goods), so the devaluation cause a slow increase in export volume and also a slow in import volume,

the effect of the volume effect is faint, leading to worsen the trade balance in the short term

To summary, according to the theoretical content of the J-curve , devaluation causes an increase in export volume and lower import volume, but not so the trade balance will be improved In the short run, the price effect is superior to the volume effect, leading to worsen trade balance; In the long run, the volume effect is superior to the price effect that makes the trade balance improved Moreover, devaluations are more likely to succeed with industrialized countries, but are less certain for developing countries Therefore, for a developing country, before choosing the devaluation, it is necessary to create preconditions to react positively

to the advantages that the devaluation offers Thus, the new trade balance could be improved in the long term

CHAPTER 2 THE OVERVIEW OF VIETNAM’S EXCHANGE RATE REMIGE AND TRADE PERFORMANCE

2.1 Exchange rate policy in Vietnam

In Vietnam, since the introduction of economic reforms, moving from a subsidized economy to a socialist-oriented market economy, one of the policies which determines the growth rate of Vietnam is the exchange rate policy Vietnam's exchange rate policy is flexible, suitable to international circumstances and conditions According to statistics from 1989 up to now, Vietnam has experienced different exchange rate regimes, namely:

Before 1989, there had been a complicated system of multiple fixed exchange rates: an official rate for foreign trade transactions, another for non-commercial transactions, a so-called internal settlement rate for the purpose of compensating export enterprises for their losses, and a separate rate for remittances received from overseas (Vo Tri Thanh et al 2000; Nguyen Van Tien 2006)

From 1989 to 1990, the multiple exchange rates were unified into a single official rate, set and announced by the State Bank of Vietnam (IMF 1996) in March

1989, Vietnam exchange rate was pegged to the US dollar with the adjusted band, the official exchange rate was adjusted by the State Bank based on the signals of inflation and interest, balance of payment and free market rates Specifically, commercial banks were allowed to determine exchange rates within the band +/- 5% around the announced official rate, with a maximum bid-ask spread of 0.5%, and the use of foreign currency is strictly regulated

From 1991 to 1993, with the opening of two foreign exchange (FX) trading floors (in Ho Chi Minh City and Hanoi), the official rate became determined on a daily basis (IMF 1996) In setting this rate, the SBV would be guided to some extent by the previous day’s closing rates on the two trading floors The exchange rate policy of Vietnam remained in the regime of pegged exchange rate but with a much narrower band than in the previous period Commercial banks were allowed

to quote within a (narrowed) trading band of +/–0.5 per cent around the announced official rate During this time, Vietnam still strictly controlled foreign currencies, restricted the carrying of money out of the border, and established official foreign trading floors for the purpose of stabilizing the exchange rate

From 1994 to 1996, the trading floors were replaced by a more comprehensive and sophisticated interbank FX market, the State Bank intervened strongly in interbank transactions to anchor the fixed exchange rate with small band and there were no significant changes in the underlying ER setting mechanism

Between 1997 and 1998, the fixed anchor exchange rate regime still existed but was adjusted to a wider band On October 13, 1997, the band was extended to 10% to suit the economic conditions during that period

In 1999 and 2000, Vietnam reverted to the fixed anchor exchange rate regime with extremely small fluctuation bands of 0.1%, which can be considered as pure fixed exchange rate regime at this stage

Trading band has been adjusted many time to intensify the flexibility of market exchange rate

Between 2001 and 2011, the exchange rate of Vietnam was pegged to the US dollar with the adjusted band, but from 2011 to 2013, the exchange rate regime was fixed anchorage

Figure 2.1 Nominal exchange rate VND/USD in the period 2000Q1-2017Q4

Source: IMF 2.1.1 The 2007-2009 period

Figure 2.2 Nominal exchange rate VND/USD in 2007-2015

Source: State Bank of Vietnam

In 2007, the State Bank of Vietnam (SBV) managed monetary policy towards VND was weak against USD from 1% to 2% per year In contrast, the US Federal

Reserve (Fed) continues to implement weak dollar policy to settle the nearly USD 1,000 billion debt represented in the current account of the US balance of payments.Thus, USD wasweak against strong currencies; VND was weak against USD

In early 2007, the State Bank of Vietnam introduced VND/USD in the bank foreign currency market was 16.155, while the VND / USD exchange rate in the free foreign exchange market was 16.070

inter-In the last months of 2007, the State Bank of Vietnam still offered the exchange rate VND/USD is 16.114, towards VND devalued against USD However, the exchange rate in the interbank market was still higher than the exchange rate VND/USD in the free market

Deriving from the financial crisis of the US - the largest global economy in

2008, leading to a severe downturn of the world economy, causing a great impact

on countries including Vietnam Associated with this period of high volatility is the large disparity between the official exchange rate and the exchange rate in free market The SBV has been forced to widen the band of the exchange rate or devaluate due to market pressure, thus causing VND to depreciate significantly compared to that in the previous time

Actually, in 2007 until the end of 2008, due to the strong increase of indirect investment in Vietnam, so the source of USD also increased rapidly In response to this phenomenon, the exchange rate of commercial banks3 fell to the floor band, which meant that VND appreciated However, not long after, when the world economic crisis occurred, the inflow of indirect investment into Vietnam decreased rapidly, the general trend in 2009 was the nominal depreciation of VND against USD Specifically, at the end of 2009, the official exchange rate VND/USD at the end of 2008 was 16.977 and at the end of 2009 was 17.941, about 5.7% higher than that at the end of 2008

3 The commercial bank exchange rate must be within the fluctuation band announced by the SBV

In mid-2008, the SBV decided to widen the band from 1% to +/- 2% (27/6/2008), then extended its band to +/- 3% (7/11/2008) Cause of the dollar appreciation was mainly due to the psychological instability of enterprises and people when the USD increased rapidly leading to speculation USD Demand for foreign currency to pay debts of enterprises was high; In addition, the large gap between domestic and international gold prices had led to increase demand for dollars to serve the import of gold Foreign investors were worry about the domestic economic situation, they sold stocks, increasing demand for USD, and make price

of USD increased

Figure 2.3 Exchange rate VND/USD and fluctuation band, 2008-2009

Source: Bank for Foreign Trade and State Bank, (2010)

In 2009, high pressure of USD demand together with psychological pressure caused the exchange rate in the free market to deviate more and more from the official exchange rate Although the SBV has been forced to further widen the band

of the official exchange rate from +/- 3% to +/- 5% (24/3/2009) - the largest margin over the last 10 years, commercial banks had been trading at the ceiling exchange rate

2.1.2 The 2010-2015 period

On February 11, 2010, the State Bank adjusted the average interbank exchange rate from 17.941 VND/USD to 18.544 VND/USD to encourage large corporations to sell foreign currencies to the banks, improving the state of the currency which was strained Previously, on 18/1, the SBV issued Decision No 74 / QĐ-NHNN to significantly reduce the required reserve ratio in foreign currency for credit institutions The reduction of the compulsory reserve ratio in foreign currency from 7% to 4% for the terms of less than 12 months, from 3% to 2% for the term of over 12 months, had increased the capital of about USD 500 million for commercial banks to lend on the market In order to increase the supply of USD, the State Bank

of Vietnam (SBV) continued to issue Circular No 03/2010 / TT-NHNN, which stipulated that the maximum deposit interest rate in USD of economic organizations

at credit institutions is 1% per annum Excess of foreign currency made interest rates in loans in VND and USD are very large difference

Under the pressure of the market, in August 2010, the State Bank forced to increase the interbank exchange rate by 2.1%, up to 18,932 VND / USD At the end

of November, the exchange rate soared to 21,380 - 21,450 VND / USD, in the free market exchange rate exceeded 21,500 VND / USD Exchange rate difference between the black market compared to the official exchange rate to 10% This is the highest difference in Vietnam's financial history since 1999

Figure 2.4 VND/USD exchange rate movements in 2010

Source: SBV Annual Report 2010

Figure 2.5 Nominal exchange rate VND/USD in from 2010Q1-2013Q4

Source: IMF

The foreign exchange market and the exchange rate in 2011, after years of turbulence, from the fourth quarter of 2011, the foreign exchange market gradually regained stability, the pressure on the exchange rate had strengthened the trust of the business investors and the public into VND If the exchange rate between the

official and free markets had been significantly different (in December 2010, the difference was VND 2,000, equivalent to more than 10%), from the last months of

2011, the exchange rate was maintained quite stability, the openness of the free foreign exchange market has narrowed The interbank average exchange rate remained stable with a volatility of no more than 1% in the fourth quarter of 2011, unchanged at 20.828 VND/USD for the whole of 2012 and a 1% increase in the first nine months of 2013 The average bid-rate of commercial banks in 2012 was 20.836 VND / USD, down 1.02% compared to 2011 The free market rate was always below 21.000 VND / USD, down by more than 1.62% compared to 2011 In

2012, the free market rate was equal to even lower than the ask-rate of commercial banks And for the first time in many years has fallen sharply than the official rate The stable trend of exchange rates in 2012 and 2013 completely contrasted with previous years (the free market rate in 2009 increased by 10.8% and in 2010

by 8.3%) The relatively stable stability of the domestic exchange rate has also boosted the confidence of foreign investors, so the exchange rate NDF (Forward rates, not transfer money) of VND/USD in the Singapore market Since continuously rose, having been gradually reduced and with a reduction of 4% at the end of 2012 The supply and demand of foreign currency in the market were relatively balanced The turnover of foreign currency trading with customers of credit institutions was relatively positive, with the total amount of trading with clients was about USD700 million/day The legitimate demands of enterprises and individuals were fully responsed by credit institutions because foreign currency sources were concentrated

in the system of credit institutions The dollarization situation was fundamentally overcome, the mobilization relationship - foreign currency loans were gradually transformed into foreign currency buying and selling relations, the confidence in Vietnam dong was improved

In 2014, after maintaining stable throughout the first quarter as well as in April, the foreign exchange market had shown signs of warming and there had been quite strong fluctuations By the afternoon of 18/6, the State Bank had announced