Summary of Doctoral thesis: Impact of foreign exchange reserves on macroeconomic stability in Vietnam

Systematize the theoretical issues on foreign exchange reserves and macroeconomic stability. Supplement the theoretical framework on the impact of foreign exchange reserves on some indicators related to macroeconomic stability such as GDP growth, exchange rate, balance of payment and inflation. Analyse of the macroeconomic situation, actual situation of foreign exchange reserves and the impact of the foreign exchange reserves on macroeconomic stability in Vietnam in the period of 2000 – 2016. Suggest measures to strengthen the foreign exchange reserve, contributing to the objective of macroeconomic stability and restrain macroeconomic instability in the next phase in Vietnam.

INTRODUCTION

1 Background

The recurrence of recent financial crises has prompted countries to struggle to

find ways to protect the economy from the financial risks and challenges Since the

1996-1997 East Asian financial crisis, global real foreign exchange reserves have

increased by more than three times Foreign exchange reserves are considered as a

safeguard against financial openness, namely the sudden reversal of capital flows and

financial crises As a result of the Asian financial crisis, the IMF stressed the

importance of foreign exchange reserves as means of preventing and managing the

crisis

According to Nugee (1999), foreign exchange reserves are used by the

countries to support monetary policy and foreign exchange policy as well as many

other purposes to meet macroeconomic objectives such as monetary and domestic

payment system stability and export support Recent studies by Blanchard with his

colleague (2010) and studies by Aizenman and Sun (2010) show that even the

countries with high amount of foreign exchange reserves have been forced to use (or

fall) its reserves These studies have found some evidences proving that foreign

exchange reserves are important "shock release" for the economy before the financial

crisis Actually, a high amount of pre-crisis reserve assets can help to protect the

country against speculative attacks that could result in declining stockpiles, leading to

many other potential monetary attacks In this situation, reserves can be understood

as the final lender function of the central bank Foreign exchange reserves contribute

to macroeconomic stability by affecting various macro variables such as GDP

growth, balance of payment, exchange rates and inflation How to maintain foreign

reserves effectively to help a country stand out from the bad effects of external

economic shocks is a matter of concern of many economists and policymakers The

importance of foreign exchange reserves depends on the exchange rate regime that

the country is committed to pursuing Foreign exchange reserves are particularly

important under the policy of fixed exchange rates since the central bank has to

intervene in the foreign exchange market to maintain the fixed exchange rate

(Edwards, 1983) The greater the international reserves are, the greater the central

bank's ability to intervene and the greater the confidence of the market in the

regulator's exchange rate claims is Meanwhile, under the floating exchange rate

regime, the central bank does not need to intervene to maintain the exchange rate but

the exchange rate will operate in accordance with supply and demand rules So

national reserve is not necessary (Crockett, 1978) In fact, any government that

pursues the exchange rate regime is very interested in the fluctuation of the exchange

rate Therefore, maintaining and improving foreign exchange reserves always draw

concerns of policy regulators (Calvo and Reinhart, 2000) In addition to being used to

intervene in exchange rates, as a country, particularly emerging country, increasingly

integrates into the global economy, especially financial integration, foreign exchange

reserves are not only for avoiding risks and the impact of the crisis but also be built to

neutralize, prevent in advance attacks from speculative forces It also helps the

country to better deal with macroeconomic shocks due to sudden capital reversal

2 Hedging the economy with foreign exchange reserves is also a good way to reduce dependence on international aids such as the IMF or the World Bank since these aids not only cause dependence on these institutions but also remain corollaries on political and national status issues Even, these aids sometimes make the situation worse With the countries which are not directly affected by the crisis, foreign exchange reserves also play a very important role in the event of a sudden outflow of capital due to the crisis of confidence in developing countries If a country has too too big amount of foreign exchange reserves, the cost for management of foreign exchange reserves will be arisen as the profit from foreign exchange reserve investment is often lower than the cost of borrowing foreign capital If the country has too little reserve, the solvency as well as national financial security will eventually affected

Foreign exchange reserves are also used by the countries to support monetary support and foreign exchange policy Over the past two decades, foreign exchange reserves have increased significantly, especially in Asian countries Huge amount of foreign exchange reserves in these countries is the result of the need for prevention, reflecting demands of self protecting against the limitation due to sudden loans from other countries to stabilize the macro economy Macroeconomic stability is one of the most important issues among modern macroeconomic concerns in the world Recently, macroeconomic imbalances have been affected by many factors, caused by current globalization progress Foreign exchange reserve is one of the key economic indicators for the countries, especially developing economies to be opening, liberalizing international capital transactions as Vietnam In Vietnam, after the continuous rise and peak in middle 2008, due to the negative impact of the global financial crisis and domestic macroeconomic instability, the State Bank had to use foreign exchange reserves to intervene, leading to dramatical reduction of foreign exchange reserves Since 2014, positive economic policies have helped Vietnamese economy to recover with the increase of the national foreign exchange reserves again The amount of foreign reserves as of December 2016 was about 38 billion However, compared with other countries in the region, this figure is still modest and relatively low Due to opening up and integration into the global economy, especially after recent global financial crisis, Vietnam needs to stabilize the macro economy Macroeconomic stability is also a precondition for Vietnam's economy to grow more sustainably, especially in the medium and long term Foreign exchange reserves are one of the factors contributing to the stabilization of the macro economy, which helps

us to actively deal with external economic shocks

From the above, it can be seen that the study of foreign exchange reserves, assessing the effects of foreign exchange reserves on macroeconomic stability is pratical

requirement Based on that, the author has chosen to study the topic "Impact of foreign exchange reserves on macroeconomic stability in Vietnam"

2 Research objectives, research subjects and methodology

Research objectives:

The thesis focuses on the objectives as follows:

- Systematize the theoretical issues on foreign exchange reserves and

macroeconomic stability

- Supplement the theoretical framework on the impact of foreign exchange

reserves on some indicators related to macroeconomic stability such as GDP growth,

exchange rate, balance of payment and inflation

- Analyse of the macroeconomic situation, actual situation of foreign exchange

reserves and the impact of the foreign exchange reserves on macroeconomic stability

in Vietnam in the period of 2000 - 2016

- Verify the impact of foreign exchange reserves on some variables reflecting

macroeconomic stability in Vietnam according to the quarterly frequency data from

2000 to 2016

- Suggest measures to strengthen the foreign exchange reserve, contributing to

the objective of macroeconomic stability and restrain macroeconomic instability in

the next phase in Vietnam

Research subjects:

Impact of foreign exchange reserves on macroeconomic stability in Vietnam

Research scope:

The scope of the study is the volatility of Vietnam's foreign exchange reserves in the

period of 2000 - 2016, examining the progress of macroeconomic variables,

macroeconomic instability and the impact of foreign exchange reserves on these variables in

the same period

Research question

This research will answer the following questions:

(1) How does the relationship between foreign exchange reserves and

economic indicators reflect macroeconomic instability?

(2) What are outstanding points that current situation and trends of foreign

exchange reserves in the world and Vietnam recently?

(3) What are the effects of foreign exchange reserves on growth and

macroeconomic instability in the period of 2000-2016?

(4) How to strengthen and manage well the foreign exchange reserves,

contributing to macroeconomic stability in Vietnam?

3 Approach and methodology

Approach

- With foreign exchange reserves: An overview of the rationale system for foreign

exchange reserves Determine the impact of foreign exchange reserves on some macro

variables Analyse positive and negative impact on individual macroeconomic indicators

in each field to assess the macroeconomic situation of Vietnam in the period of 2000 -

2016 Build some solutions to meet the urgent needs of the economy for the increase of

foreign exchange reserves, effective use of foreign exchange

- With macroeconomic stability: In this study, the author assesses the macroeconomic

situation of Vietnam based on the assessment of economic variables including GDP growth,

inflation, balance of payments, exchange rate and macroeconomic instability index

4

Methodolody:

- Statistical methods include data collection, processing, aggregation, figure presentation and calculation of foreign exchange reserve rates/ M2; foreign exchange reserve/ import week; foreign currency reserves/ foreign debts, macroeconomic instability index and other indicators for the analysis and evaluation process The data used in the thesis is mainly collected from statistics

of the International Monetary Fund, World Bank, State Bank of Vietnam, General Statistics Office of Vietnam, Ministry of Finance In addition, the thesis also uses information from the magazines, specialized journals and inherits the relevant research findings

- Comparative method: Based on collected and processed data, the author compared

the variation through the stages, periods to give more detailed assessment of the research problem

- Logical method: From analyzing and systematizing the theory of foreign

exchange reserves and the relationship of foreign exchange reserves with macroeconomic stability, the thesis researches the case study of Vietnam from

2000 to 2016 Based on it, the thesis synthesizes views and recommends measures to strengthen the foreign exchange reserves flexibly and proactively respond to changes in the global economy, contributing to macroeconomic stability of Vietnam in the coming time

- Modeling method: The thesis develops some models that describe the impact of foreign exchange reserves on macroeconomic indicators

- The thesis uses quantitative methods to analyze the impact of foreign exchange reserves on macroeconomic stability in Vietnam VAR model is used to examine the relationship between foreign exchange reserves and growth, investment, macroeconomic instability (calculated based on the ratio of public debt to GDP, inflation and exchange rates), the openness of the economy Using data has quarter frequency, from 2000 to 2016

4 The scientific and practical significance of the topic

(1) Theoritically:

- The thesis has systematized the theory of the impact of foreign exchange reserves on macroeconomic stability in Vietnam

- Study the experiences of some countries such as Thailand, Korea, China in using foreign exchange reserves in the crisis, from which building lessons for Vietnam

- Based on the theoretical and empirical studies conducted, the thesis develops the model to study impact of foreign exchange reserves on macroeconomic stability in Vietnam

(2) Practically:

- The thesis provides a relatively comprehensive view of the status of foreign exchange reserves and impacts on macroeconomic stability in Vietnam in the period

2000 - 2016 Quantitive models of macro variables are used to determine impact of foreign exchange reserves in Vietnam with some macroeconomic variables in the

5 period of 2000 – 2016, from which showing the importance of foreign exchange

reserve in the context of globalization nowadays

- The thesis aims to assess the impact of foreign exchange reserves on some

variables reflecting macroeconomic stability

- Based on the findings of the study, the thesis offers a number of

recommendations to increase the scale of foreign exchange reserves, contributing to

the objective of macroeconomic stability and sustainable growth in the next phase in

Vietnam

- New contributions of the thesis:

There have been many studies in the world with different approaches about

foreign exchange reserves and the impact of foreign exchange reserves on

macroeconomic stability However, the number of the researches on foreign

exchange reserves in Vietnam is still very limited No research for Vietnam has been

done with the calculation of MII macroeconomic instability index Foreign exchange

reserves impacted and correlated with the variables in empirical studies almost reflect

the theory but until now there have been no common conclusion for these studies due

to differences in research subjects, selected variables, period and method

5 Structure of the thesis

The thesis is divided into four chapters with the following contents:

Chapter 1 Overview of the researches on foreign exchange reserves and the

impact of foreign exchange reserves on macroeconomic stability

Chapter 2 Macroeconomic and Foreign Exchange Reserve Situation in

Vietnam, period of 2000-2016

Chapter 3 Quantitative analysis on the impact of foreign exchange reserves on

macroeconomic stability in Vietnam

Chapter 4 Some recommendations to strengthen foreign exchange reserves to

stabilize the macroeconomic situation in Vietnam

6

CHAPTER 1 OVERVIEW OF THE RESEARCHES ON FOREIGN EXCHANGE RESERVES AND IMPACT OF FOREIGN EXCHANGE TO

MACROECONOMIC STABILITY 1.1 Overview of foreign exchange reserves

1.1.1 Definition of foreign exchange reserves

According to the document "Handbook of International Balance of Payments"

published by the International Monetary Fund (IMF) for the sixth time (2009), that summarizes the experience of foreign exchange reserves management of the countries, foreign exchange reserves are understood as follows: "Foreign exchange reserve of a country is international assets managed and used by the central bank and the monetary administration in order to directly finance for balance of payments or intervene to control exchange rates and to finance other needs such as ensuring confidence in the value of the domestic currency as well as stability of the economy

It is also the main platform for foreign loans; Foreign exchange reserves include the following types of foreign exchange assets: foreign currency, gold currency, special drawing rights (SDR), IMF reserve funds and other foreign exchange assets

1.1.2 Sources of reserves and objectives

1.1.2.1 Sources of foreign exchange reserves

The source of foreign exchange reserves is mainly from the surplus of the balance of payments The balance of payments, as defined by the IMF in the 6th

edition of 2009 “The Handbook of International Payment Balance” is a systematic

summary of, in a given period of time, economic transactions of an economy with the rest of the world Transactions, most of which are between permanent and non-resident, include transactions in goods, services and income; and transactions of financial and indebtedness to the rest of the world

7 Imports - Exports

• Visible trade (manufactured goods)

• Invisibles (services)

Unilateral transfer (international aid)

The

Balance of

payments

Current account Net foreign income - net profit

and interest on foreign assets

Capital and Financial account

Medium/Long term capital flows

Hot' money - short term flows Foreign

exchange reserves

Net change in reserves held by the Central bank

Diagram 1.1: Relationship among the components of balance of payment

Source: self-synthesis 1.1.2.2 Objectives of foreign exchange reserves:

Firstly, implement monetary policy and exchange rate policy through

intervention in the foreign exchange market, stabilizing exchange rates

Secondly, maintain the liquidity of the foreign exchange market to limit

negative impact in case of a financial crisis;

Thirdly, adjust the balance of payment which is the reserve asset to maintain

confidence in the ability of foreign debt obligations of the economy, the ability to

support the value of the domestic currency, show the ability of the country's financial

security to attract foreign direct and indirect investment;

Fourth, reserves for national emergencies and disasters

1.1.3 Evaluation of foreign exchange reserves

- The ratio of foreign exchange reserves and import value, about 12 to 14

weeks of imports or 3 or 4 months of imports is considered sufficient

- The ratio of foreign exchange reserves and foreign short-term debts must be

greater than one to ensure liquidity

- Foreign exchange reserves and money supply levels are between 10% and

20%

1.2 Impact of foreign exchange reserves on macroeconomic stability

1.2.1 Definition of macroeconomic stability

8 The macroeconomic stability is a balanced state that is maintained for a certain period of time and within a unified limit Central parameters are prices in the economy as well as other relevant indicators The convergence criteria of the European Monetary Union on macroeconomic stability are evidenced by Mundell-Fleming's (1961) optimal monetary space theory as well as the actual establishment and operation of the Union European Monetary Union (EMS) since 1998 The Euro currency came into being in 2002, confirming the validity of the theory

In fact, when considering a stable or unstable state, there is no single threshold for each macroeconomic variable Instead, there is a series of links at different levels

of macroeconomic variables (eg growth, inflation, fiscal deficits, current account deficits, foreign exchange reserves) shows the state of instability In addition to single indicators to reflect macroeconomic instability, the Macroeconomics Instability Index (MII) has been calculated in a number of empirical studies to assess the state of the picture Macroeconomic stability or instability (Ismihan, 2003)

1.2.2 Overview of empirical studies on the impact of foreign exchange reserves on macroeconomic stability

1.2.2.1 Studies in the world

Empirical studies normally only refer to one or several indicators related to macroeconomic stability Therefore, the overview of the impact of foreign reserves

on macroeconomic stability shall be separated into sub-categories to consider the effects of foreign exchange reserves on GDP growth, exchange rates, balance of payment, inflation

Domestic liquid bonds

Domestic corporate savings

More saving instruments

Capital investment

Credit constraint less binding

Production

Collateral effects Revenue effects

Foreign reserves

Diagram 1.2: Impact when foreign exchange reserves increase

Source: Gong Cheng (2012) 1.2.2.3 Overview of studies on the impact of foreign exchange reserves on macroeconomic stability in Vietnam

In Vietnam, there is no research on the impact of foreign exchange reserves on

macroeconomic stability in Vietnam However, there are a number of studies and

thesis on various aspects of foreign exchange reserves being mentioned in some

specialized journals

1.2.2.3 Some conclusions drawn from the empirical research review:

Firstly, in developing countries, foreign exchange reserve is an important

macroeconomic factor to increase long-term economic growth as well as a buffer

against the economy Foreign exchange reserve may inhibit the decline of output due

to the sudden outflow of capital flows In developed countries, excess foreign

exchange reserve will be the basis to borrow large amounts of capital in the

international financial market when necessary

Secondly, foreign exchange reserve has a positive effect on the real exchange

rate When the exchange rate is undervalued, it will stimulate exports Foreign

exchange reserve is a factor to stabilize the exchange rate Low exchange rates as part

of overall export strategy Preventing the appreciation of the exchange rate through,

foreign exchange reserve can curb spending and imports, thereby stimulating exports,

investment and economic growth The continued appreciation of the real exchange

rate will lead to the foreign exchange crisis In developing countries, appreciation of

the exchange rate is detrimental to economic growth Countries with large foreign

exchange reserve have higher economic growth rates High economic growth is often

associated with a high ratio of trade/GDP and high rates in foreign exchange reserve/

GDP One of the ways to achieve the optimum level of international trade and receive

external revenues is the accumulation of foreign exchange, leading to undervalued

currencies and the promotion of exports Countries with large net worth have reduced

the real exchange rate, leading to an increase in the share of exports in GDP If the

exchange rate is leveled off due to the outflow of capital, it will only make the

conversion of domestic savings limited to output flows, all of which would cause

damage to investment

Thirdly, foreign exchange reserves in developing countries that are more

correlated with higher economic growth and the greater the amount of foreign

exchange reserves always better for developing countries to reduce the risk of

speculative attacks, foreign debt repayments and financial costs The impact of

foreign exchange reserves does not only increase the rate of investment/GDP but also

on the share of exports and trade in GDP The trade/GDP ratio is positively correlated

with the accumulation of foreign exchange reserves and is significant in contrast to

the exchange rate

Fourth, in the longer term, whether the foreign exchange reserves affect the

economic growth rate or not depends on actual situation of which country Some

research has shown that there is a positive impact on long-term growth in developing

countries in stead of developed countries

Fifth, the foreign trade/GDP ratio is correlated with the increase in foreign

exchange reserves, the decline of the exchange rate and the lower price that can not

10

be traded for commodities that can be traded One may think that the accumulation of foreign exchange reserves leads to inflation However, this is not always the case if the foreign exchange reserves accumulation rate does not exceed the economic growth rate Higher inflation is not necessarily harmful, especially for developing countries and emerging economies The accumulation of foreign exchange reserves does not cause inflation and affects economic growth and employment, Contrary to the rapid decline of the exchange rate caused by the persistence of excessive

exchange rates in the long run leading to foreign exchange crisis and inflation Sixth, there are many other factors that interact and interact with the foreign exchange reserves, the choice of variables in the analysis depends on the research

context as well as the existence of research data of each country

From the above synthesis, the thesis found that gaps need to be supplemented and

perfected as follows:

Firstly, in-country studies conducted in the world have approached quite adequately the methodology of studying the different aspects of the effects of foreign exchange reserves on macroeconomic stability factors This is still very limited in Vietnam None of the studies up to this point have been made for Vietnam calculating the composite MII macroeconomic indices

Second, foreign exchange reserves in different countries are formed, managed

and used differently in different countries Therefore, the assessment of the foreign

exchange reserves impact to macro-economic crisis on Vietnam may not be entirely consistent with theoretical and empirical research in the world Thus, the study of the impact of the foreign exchange reserves on economic stability in Vietnam is necessary to determine which factors influence the results of the study The thesis will focus on clarifying the gaps

1.3 Experience of some countries in the world in reserve and management

of foreign exchange reserves:

Analysis of the actual status of reserves and management of foreign exchange reserves of some countries in the world with similar economic conditions such as Thailand, Korea and China From that point, draw lessons in the management of foreign exchange reserves for Vietnam: constantly increase foreign exchange reserves, even if the economy is still stable; Improve the quality of foreign exchange management to ensure the sustainability of this reserve; The government should be more cautious in assessing the key indicators of the economy; Continue to promote export oriented policies and attract foreign investment; To build a professional independent foreign exchange reserve management apparatus

CHAPTER 2 MACROECONOMIC AND FOREIGN EXCHANGE RESERVE SITUATION

IN VIETNAM, PERIOD OF 2000-2016

2.1 Vietnam's economy in the period of 2000-2016

2.1.1 Situation of Vietnam's economic growth in the period of 2000 - 2016

Macroeconomic stability is a prerequisite for the economy to have more

sustainable growth, especially in the medium and long term This is in line with our

aim to achieve rapid and sustainable economic growth Despite many achievements

in economic growth, the economic growth of Vietnam in the period 2000-2016 was

unstable and facing macroeconomic instability GDP growth rate was unstable and

declined from over 8.2% in 2004-2007 to approximately 6.0% in 2008-2011 and

reached 6.21% in 2016 Based on Macroeconomic progress and data, it can be said

that in the past two decades, Vietnam's economy has grown mainly broad based,

mostly on continuous increase in input resources, especially capital and labor

intensive while the efficiency of using resources is low and slowly improved

2.1.2 Inflation

It can be seen that inflation and growth have connection when high economic

growth goes with high inflation and other macroeconomic instability Vietnam's

inflation rate fluctuates erratically, unstably with the highest rate at 2 digits figure and

lowest point at 0% only The reason for unstable inflation is that measures to promote

economic development are short-lived, lack of long-term vision Vietnam's

broad-based growth model results in low productivity

2.1.3 Balance of payments

In the past 17 years, the balance of payment of Vietnam has been almost

continuously surplus Current and financial account balances show that trade and

investment activities are major contributors to the balance of payments surpluses

Current account deficit from 2002 to 2011 The most serious deficit level was in 2007

- 2010, and reached a record in 2008 with $10.8 billion, equivalent to 11.8% of GDP

It is quite fortunate that Vietnam maintains a surplus in its capital account (to offset

the current account deficit), thereby avoiding the balance of payments crisis, Until

2011, current deficit is reduced to $0.7 billion, accounting for 0.5% of total GDP

However, the improvement of the balance of payments is not sustainable as it

depends mainly on exports and imports is material production without development

of the internal strength

2.1.4 Exchange rate

Exchange rate of Vietnam fluctuates flexibly with the world financial market

In general, the exchange rate management of Vietnam over the past time can be

summarized as follows: strong devaluation when the economy was in crisis, pressure

from the big market and the official exchange rate and exchange rate in the free

market are different too much and turns to be stable every time the economy comes

into stability

12

2.2 Situation of Vietnam’s foreign exchange reserves in the period of 2000-2016

2.2.1 Legal framework related to foreign exchange reserves

So far, the legal framework for the management of foreign exchange reserves has been more and more perfect It is in line with the country's development process With the promulgation of the Ordinance on Foreign Exchange and guiding documents of The State Bank of Vietnam, in the context of large economic changes, external economic activities and the trend of international economic integration has expanded to meet the new requirements of the management of foreign exchange reserves

2.2.2 Trends in foreign exchange reserves

Vietnam’s foreign exchange reserve has seen remarkable growth along with economic growth However, the number of foreign exchange reserves of Vietnam published by different organizations is not the same For example, at the end of 2010, according to the Ministry of Planning and Investment (MPI), Vietnam’s foreign exchange reserve declined to just $10 billion At the same time, according to the rating agency Moody, Vietnam’s foreign exchange reserve is 12.2 billion USD, meeting 5-6 weeks of import That is worrisome for the stability of the foreign exchange market in particular as well as the stability of the economy in general Thus, the disclosure of foreign exchange reserves is needed in the coming time to provide researchers with a complete and accurate set of data serving the analysis and evaluation

2.2.3 Progress of foreign exchange reserves structure

Vietnam’s foreign exchange reserves include foreign exchange, gold, SDRs and Vietnam’s reserve position at the International Monetary Fund In which, foreign exchange accounted for a very large proportion and increased over the years In addition, the amount of cash or foreign exchange in foreign currency sent to foreign banks also accounts for a large proportion of foreign exchange

2.2.4 Assessment of foreign exchange reserves following some indicators

2.2.4.1 Foreign Currency Reserve Ratio in compared with Short-term Debt

The reserve ratio on short-term foreign debt (including short-term debt to one year and medium and long-term loans payable in the year) has also increased over the years The growth rate is even faster than the number of months of guaranteed imports This is a positive sign showing that the ability to finance well the whole economy of foreign exchange reserves in the absence of foreign borrowings in a year Moreover, this ratio also shows the ability to pay off foreign debts in the coming year

Diagram 2.31: Foreign exchange reserves/external debt in 2000-2016

Source: International Financial Statistics, IMF

Therefore, this indicator has reached the standard level and it can be seen that

short-term external debt has not remained pressure on Vietnam’s foreign exchange

reserves

2.2.4.2 Foreign Exchange Reserve Ratio in compared with Broad Money

Supply (M2)

The period of 2010-2016 was extremely difficult for Vietnam’s foreign

exchange reserves, including the guarantee of foreign exchange reserves to maintain

financial security Foreign exchange reserves/M2 ratio was less than 15% only,

falling sharply below the benchmark This is clearly showed when three indicators

assessing the scale of foreign exchange reserves of Vietnam are much lower than the

standards of international financial institutions This is a point that Vietnam needs to

improve in the coming years

2.2.4.3 Foreign exchange reserve ratio compared with import week

Although Vietnammese foreign exchange reserves have been improved, in

compared with ASEAN countries, it can be seen that when counting by import

months, Vietnam’s foreign exchange reserves are still low in the region and only

higher than Laos or Myanmar in the same period Above comparison shows that

Vietnam needs to continue to supplement and strengthen foreign exchange reserves to

bring its ratio to equal to the regional average

2.2.5 Reason for fluctuations in foreign exchange reserves

2.3 Identify macro stability via the MII index

The MII is calculated based on a combination of four indexes reflecting

macroeconomic instability (in the author's point of view), which are inflation rate,

change in exchange rate, the budget deficit over GDP This has partly reflected the

signal of macroeconomic instability in Vietnam This index will be used in

14 quantitative analysis in the next chapter of the thesis to clarify the relationship between foreign reserves and macroeconomic stability in Vietnam

CHAPTER 3 QUANTITIVE ANALYSIS ON IMPACTS OF FOREIGN EXCHANGE

ON MACROECONOMIC STABILITY IN VIETNAM

3.1 Data Description

The database used in the empirical model was collected from the IFS database

of the International Monetary Fund (IMF) and the General Statistics Office of

Vietnam (GSO), in the period 2000Q1 to 2016Q4 with total 68 observations for each

variable Some variables with no quarterly data will be used the method of separating

yearly data into quarterly data according to the data conversion methods provided in

the Eviews software (frequency conversion method) Data used in the study included

Gross National Product (GDP) by average prices in 2010 per numbers of the

employees having jobs in the economy (GDPPR), total foreign exchange reserves

excluding gold over GDP (RESY), the index reflecting economic instability (MII),

the ratio of FDI to GDP (FDIY), trade openness of the economy (OPY), actual

exchange volatility (VREER) and Consumer Price Index volatility (VINF) Before

the transformations, all variables were assigned to the same currency, index variables

and real variables were standardized according to 2010 comparable prices Seasonal

variables such as GDPPR, FDIY, OPY, RESY are adjusted for seasonality by the

TRAMO/SEATS method These variables are then converted to the value of the

natural logarithm

3.2 Specify empirical model

3.2.1 Specify the generic model

The general model specified in the empirical study of Vietnam can be

described as follows:

LNGDPL=f(LNFDIY, LNOPY, LNRESY, MII, VREER, VINF) (3.1)

The general non-constrained VAR model will be described as follows:

(3.2)

In which Y vector is a set of endogenous variables: Y’=( LNFDIY, LNOPY,

LNRESY, MII, VREER, VINF) Exogenous variables such as dummy variables,

trend variables, and seas can be found in D t Variance decomposition analysis will be

used to examine the impact of shocks on variables in the model at the study period

At the same time, the study will also use Johansen - Juselius Method to test the

co-integration relationship among the variables in the model If there is a co-co-integration

relationship between variables, the ECM model will be used to find the long-term

relationship based on the form of the transition function from the unbound VAR

model:

(3.3)

In which, Π=αβ’, α correction parameter matrix, β is the coefficient matrix of

integrated copper vectors and ΠYt-1 is the error correction

3.2.2 Specify empirical model

*Unit testing

Table 3.2: Unit testing result (Augmented Dickey-Fuller test)

16

Variables

ADF Statistical value

Probability

Critical value (t statistics)

1 Value of the variables (Constant, Linear Trend)

LNGDPL 1.439043 1.0000 -4.100935 -3.478305 -3.166788 LNFDIY -2.972829 0.1475 -4.100935 -3.478305 -3.166788 LNOPY -2.357138 0.3982 -4.100935 -3.478305 -3.166788 LNRESY -2.942904 0.1564 -4.105534 -3.480463 -3.168039 MII -3.085185 0.1188 -4.110440 -3.482763 -3.169372 VREER -2.347670 0.4026 -4.115684 -3.485218 -3.170793 VINF -0.958180 0.9415 -4.127338 -3.490662 -3.173943

2 First differential (Constant, Linear Trend)

∆LNGDPL -6.619291 0.0000 -4.103198 -3.479367 -3.167404

∆LNFDIY -11.66278 0.0000 -4.103198 -3.479367 -3.167404

∆LNOPY -6.889986 0.0000 -4.103198 -3.479367 -3.167404

∆LNRESY -3.680545 0.0307 -4.103198 -3.479367 -3.167404

∆MII -10.01887 0.0000 -4.113017 -3.483970 -3.170071

∆VREER -5.909410 0.0000 -4.115684 -3.485218 -3.170793

∆VINF -5.992633 0.0000 -4.127338 -3.490662 -3.173943

Source: author's calculations from collected data

*Delay specification for VAR model The optimal latency for the selected VAR model is based on testing log-likelihood test

Table 3.3 With given optimal latency results of the VAR model, the LR, AIC test values all suggest 3 delays in the optimal latency of the VAR model

Table 3.3: Determine the optimal latency for the VAR model

0 268.2858 NA 1.13e-12 -7.648715 -6.437558 -7.174051

1 956.1426 1105.081 9.33e-22 -28.59484 -25.68806 -27.45564

2 1059.415 142.2115 1.76e-22 -30.37427 -25.77187* -28.57055

3 1140.155 92.65180* 8.05e-23* -31.41491* -25.11689 -28.94665*

Source: results from the VAR model

3.2.3 The cointegration test

The LR test results show that the log-likelihood value is calculated at 98,0532

At the significance level of 5% of the distribution value χ2(5)=11,07, we can except the hypothesis that H0 does not exist in the cointegrated vectors Thus, the appropriate

17 model is the model with interlocking points and trends in the co-integration

relationship and the system has 5 co-integration relationships

3.3 Experimental results

a) Variance Decomposition results

Variance Decomposition for all the variables in the model were conducted

through Decomposition method of Cholesky with the variables arranged in the

orders as follows: LNGDPL, LNFDIY, LNOPY, LNRESY, MII, VREER, VINF

The results of the decomposition show that, the forecast error tends to increase

over time

b) Long term relationship and ECM model

- The results estimated in Equation 1 (CointEq1) show that increases in foreign

exchange reserves, FDI inflows, trade openness have positive impact on real GDP

growth per capita at statistical significance level of 1% This shows that through

foreign exchange reserves, improved FDI flows and trade openness will facilitate the

growth of GDP per capita In contrast, the index of economic instability and the

fluctuation of the real exchange rate negatively impact on economic growth Among

the estimated coefficients, The coefficient of the macroeconomic instability index

that impacts on economic growth is greatest This implies that the more economic

uncertainty increases, the more economic growth tends to decline

- CointEq2 shows that FDI inflows, trade openness are the key factors

affecting changes in foreign exchange reserves This means that if FDI inflows and

trade openings increase, they tend to raise the foreign reserves accordingly

- CointEq3 gives us a very important conclusion that if foreign exchange

reserves increase, macroeconomic instability will decline at a statistically significant

of 1% This implies, in the long term, that increase in foreign exchange reserves will

help Vietnam to increase macro stability At the same time, the results also show that

exchange rate fluctuations are also considered a risk factor causing macro instability

- CointEq4 and CointEq5 show what makes negative impact on FDI inflows is

the risk caused by fluctuations in real exchange rates, fluctuations in general prices

and trade openness In addition, cause of changes in the general price level of the

economy is the impact of trade openness and FDI inflows

* Estimated results of ECM model

The results from the ECM model show that FDI inflows tend to improve

economic growth in the short term and at the same time they are also the factors that

help to reduce macroeconomic instability The macroeconomic instability is

influenced by volatility in the overall price level or the increase in inflation risk with

statistical significance of 1% At the same time, in the short-term, fluctuations in

foreign exchange reserves show unclear impact on the macro-volatility index

18

CHAPTER 4 SOME RECOMMENDATIONS TO STRENGTHEN FOREIGN EXCHANGE RESERVES TO STABILIZE THE MACROECONOMIC SITUATION IN

VIETNAM 4.1 General conclusion on research results

4.1.1 Impact of foreign exchange reserves on macroeconomic stability in Vietnam

The quantitative analysis in Chapter 3 shows the effect of foreign exchange reserves on macroeconomic stability in Vietnam in 2000-2016 Accordingly, in the short term, the two main factors leading to improved economic growth and reduced macroeconomic instability are fluctuations in FDI inflows and the impact of fluctuations in real exchange rates and volatility of the general price Fluctuations in foreign exchange reserves show unclear impact on macroeconomic volatility However, in the longer term, the increase of foreign exchange reserves, FDI inflows, trade openness has a positive impact on economic growth while reducing macroeconomic instability

4.1.2 Conditions for increasing foreign exchange reserves, contributing to the macro economy stability

Firstly, develop current investment and study to conduct new investment types

Secondly, improve trade balance and monitor current balance

Thirdly, promote the countermeasures to boost foreign investment

Fourth, strengthen attracting foreign currency to State Bank of Vietnam

Fifth, diversify foreign currency structure

4.2 Some recommendations

4.2.1 Stabilize the foreign exchange market

- To implement the foreign exchange management of foreign investment activities actively and flexibly, based on the principle of gradually liberalizing capital transactions in a prudent manner in line with the liberalization roadmap Proposals on liberalizing capital transactions are approved by the Government in each period to attract and effectively use foreign capital inflows into Vietnam, contributing to the improvement of the balance of payment, the development of financial markets and the promotion of economic growth To review and synthesize obstacles and inadequacies related to investment activities in order to complete the amendments and supplements to the system of legal documents on foreign exchange and foreign investment in order to improve the investment environment, from which attracting foreign capital inflows into Vietnam, including remittances

- To effectively manage foreign borrowing and lending activities, continue promoting the development of the domestic capital market through diversifying debt instruments, creating a diversified capital mobilization channel, especially medium and long-term capital in Vietnam dongs This is to limit the mobilization of capital from foreign countries, manage the foreign borrowing activities of self-borrowing

19 enterprises in the direction of ensuring the concentrated capital sources for production

and business activities, from which creating added value for the economy

- The policy of foreign exchange control and remittances should continue to be

smooth, facilitating both the remittance depositors and recipients In addition, the

State Bank of Vietnam should issue regulations encouraging and creating conditions

for credit institutions and money transfer companies to set up an efficient payment

infrastructure for remittance services, increase use of electronic payment instruments

and renovation of remittances to strengthen convenience and reduce costs for

remittance the recipients

- Continue to implement the principle of liberalizing payment transactions,

transferring money for current transactions between residents and residents on the

basis of control of vouchers through authorized credit institutions, ensuring the

transfer for proper purposes and in accordance with the provisions of law

- Stabilize the gold market, continue to actively implement solutions to manage

the gold market in accordance with Decree No 24/2012/NĐ-CP of the Government

in addition to measures to control monetary policy and foreign exchange to stabilize

the economy for macroeconomic stability, from which stabilizing the domestic gold

market, reducing the attractiveness of gold bars At the same time, to monitor the

domestic and international gold price movements as well as the situation of gold

purchase and selling on the market in order to promptly introduce policies and

solutions to intervene the market when necessary

4.2.2 Strengthen the conversion of the local currency

- The government should encourage the use of Vietnam Dong for offshore

investment to the countries having investment and settlement agreements in local

currency with Vietnam At the same time, allow VND to participate in offshore loan

transactions where the borrower wishes to use the loan in Vietnamese Dong to pay

directly to the beneficiary in the Vietnamese territory or the third party in local

currency or make clearing for the third party in Vietnamese Dong

- Maintaining the difference between domestic and foreign interest rates to

encourage overseas remittances to be invested into Vietnam The interest rates should

be managed in line with the macro balances, ensuring the safety of commercial

banks, improving the state management of monetary, credit and banking activities of

the State bank of Vietnam, ensuring attractive interest rates in domestic currency

Encouraging private saving through interest rate policy in the direction that when

domestic inflation tends to increase, the State bank of Vietnam can actively raise the

ceiling deposit rate to ensure real interest rates are large enough to stimulate saving

demand of the people This also motivates foreigners holding foreign currencies,

including foreign currency sent by overseas Vietnamese to change to the local

currency for profit-making

- The interest rate policy for USD and VND deposit needs to be maintained so

that the interest rate of VND deposit is kept at a reasonable level, ensuring the

difference between VND and USD, from which encouraging people to sell foreign

currencies to the banking system and transferring money in VND, reducing

20 dollarization Narrowing and gradually limitting foreign currency credit through strictly controlling foreign borrowers in order to implement the Government's consistent and consistent policy on anti-subsidization is to gradually shift from the mobilization relation - Foreign currency loans to buy - sell foreign currency The State Bank of Vietnam should continue to coordinate with the media and press agencies to conduct deep and wide propaganda so that the agencies, units and individuals are properly aware and strictly abide by the foreign exchange policy as well as purpose, significance of raising the convergence of the Vietnamese currency and gradually limit and remove dollarization in the economy

4.2.3 Monetary policy

Given policies should be based on the aggregate demand of the economy to avoid exaggeration in domestic credit and to reduce dependence on foreign credit At present, the M2/GDP ratio of Vietnam increases rapidly, showing that the financial depth is increasing strongly, meaning the fragility of the financial system Therefore,

it can be seen that Vietnam needs to have policy to adjust the money supply with overheating credit growth, although this will reduce the expansion of the economy, balance of current account is becoming healthier, while slowing the accumulation of short-term foreign debt with reserves of foreign exchange

Capital controls should be considered as temporary method in transition phase before more financial freedom under integration commitments Vietnam should make use of this time to deal with domestic issues and build a healthy financial market During this period, there are some areas to note:

- Foreign debt control: In the context that capital transactions need to be liberalized in accordance with the customary and integrated commitments, there are areas where there may be more stringent controls This means the will to innovate economic growth, restructure public investment and state-owned enterprises, establishing effective micro- and macro-surveillance mechanisms for financial-banking organizations and corporations and corporations in borrow foreign loans

- Indirect portfolio control: In addition to encouraging FDI, ODA and strengthen effective management, it is prudent to be more cautious with indirect investment because of the flexibility of this capital flow

4.2.4 Improve business investment environment

To continue stabilizing the macroeconomic environment, controlling inflation, stabilizing the monetary market and developing a sustainable banking system, creating long-term stability and competitive advantage for the investment environment in Vietnam Especially, it is important to ensure flexible exchange rate policy, adhere to market factors, ensuring stability To develop a safe and healthy business environment, creating opportunities for all economic sectors to equally compete under the law, from which speeding up the renovation of administrative procedures, minimizing and gradually removing troubles for the investors To continue to improve the legal environment for investment and business activities Policies must be transparent and consistent so that people can make their business plan Barriers in doing business should be removed At the same time, business