Balance of payments constrained growth model, the case of vietnam, 1995 2010

The author also suggests that the dominant constraint upon demand is balance of payments in an open economy and his model is so called balance of payments constrained economic growth mod

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

Balance of Payments Constrained Growth Model: The Case of

Dr DINH CONG KHAI

Ho Chi Minh City, December 2012

Table of Contents

CHAPTER I: INTRODUCTION 6

1.1 Problem statement 6

1.2 Research questions 9

1.3 Structure of Study 9

CHAPTER II: LITERATURE REVIEW 10

2.1 Theories 10

2.2 Balance of Payments in Supporting and Constraining Growth 11

2.3 Conceptual framework for the study 15

2.4 Empirical studies 19

CHAPTER III: ECONOMIC GROWTH AND BALANCE OF PAYMENT OF VIETNAM 22

3.1 Vietnam Economic Growth Overview 22

3.2 Balance of Payment of Vietnam 24

3.2.1 Current account 24

3.2.2 Capital Account 30

CHAPTER IV: MODEL SPECIFICATION AND FINDING 35

4.1 Model Specification and Data 35

4.2 Regression results and findings 36

4.3 Thirwall’s law in Vietnam 38

CHAPTER V: CONCLUSION AND RECOMENDATION 41

4.1 Conclusion 41

4.2 Recommendation 42

4.3 Limitation 44

APPENDIXES 45

References 54

List of Tables

Table 1: Unit root test for stationary 36

Table 2: Estimation results 37

Table 3: Actual Growth Rate and Estimated BOP Constrained Growth Rates 38

Table 4: Correlation coefficients of Actual Growth Rate and Estimated Growth Rates 39

List of Figures

Figure 1: GDP growth 1990-2010 8

Figure 2: Current account balance (% of GDP) 25

Figure 3: Trade balance and current account balance 26

Figure 4: Ratio of trade and gross domestic products, 1900-2010 (Trade/GDP) 27

Figure 5: Imports, Exports and Trade balance, 1990-2010 27

Figure 6: Net Transfers from abroad, 1990-2010 28

Figure 7: Net Income from abroad, 1990-2010 29

Figure 8: Foreign direct investment, 1990-2010 31

Figure 9: Total debt as percent of export and GDP (%) 33

Figure 10: Debt service ratio 34

List of Appendixes

Appendix 1: OLS Regression result 45

Appendix 2: Unit root tests for stationary 45

Appendix 3: Granger Test for Causality 48

Appendix 4: LM-test for serial correlation 48

Appendix 5: Test for Normality with Jarque-Bera test 49

Appendix 6: White's test for Heteroscedasticity 50

Appendix 7: Ramsey RESET Test 50

Appendix 8: CUSUM test for stability of the estimated parameters 51

Appendix 9: The estimated growth rate in the basic model 52

Appendix 10: The estimated growth rate in the extended model 52

Appendix 11: The estimated growth rate in the extended model with remittance 53

Appendix 12: The estimated growth rate in the extended model with debt 53

CHAPTER I: INTRODUCTION

1.1 Problem statement

There are many debates about the sources of economic growth from supply side and demand side On the supply side, economic growth can be explained by the consolidation of factors such as inputs, productivities, research and technology Krugman (1989) believes that each country has its own growth rate because of different growth of total factor productivity Solow (1957) states that total factor productivity in the Solow residual brings growth rate in the long term On the demand-led growth, Keynesian (1936) considers effects of factors in aggregate demand on growth through multipliers Thirlwall (1979), a post-Keynesian economist, considers demand, especially international trade, as a principal cause of accelerating or constraining growth in the long run, in other words, growth rate in open economies can be constrained by external demand The author also suggests that the dominant constraint upon demand is balance

of payments in an open economy and his model is so called balance of payments constrained economic growth model (BPCG) However, his first generation of BPCG model has many limitations in explaining growth performance in developing countries As a result, the extended model was later developed by Thirlwall and Hussain (1982), which is also known as the second generation of BPCG model, considering the impacts of foreign capital flows

The Balance of Payment constrained growth model with basic concepts that actual economic growth rate cannot be higher than the estimated rates used by BOP model except for having capability to finance the deficit Current account would be in deficit if import is larger than export, and thus sources of finance must be sought to meet the need of shortfall by either from borrowing abroad, and/or from net transfer, DFI, i.e via growing of capital inflows Total income or aggregate demand mentioned above is defined as a function of consumption,

investments, government expenditure, and exports In contrast to the case that all other components of aggregate demand depend on the country total income, export depends on the world total income

Assuming that there is no export and no capital inflow, aggregate demand would be repressed certain elements of aggregate demand because of insufficient foreign currency For example, if there is no foreign currency to support for importing modern machinery and equipment which are used for domestic production, it would lead to several issues such as increase in unemployment, or resources underutilization More easily, if we still have export but rate of growth of imports is higher than exports, capital inflow can initially abate aggregate demand repression in the short term However, trade deficits, in reality, cannot be financed endlessly by capital inflow and this would lead to aggregate demand will be constrained by BOP Balance of payment constraint can affect aggregate demand in the short term or long term; or this will slow down economic growth In other words, economic growth has to be run in balance of payments constraint Beside that we cannot deny the role of factors supply and technological progress in economic growth but it is very precious to bear in mind that "in most countries demand constraints tend to bite long before supply constraints are ever reached" (Thirlwall, 2002)

Considering the period from 1990 to 2010, Vietnam achieved very high annual economic growth rates, except three years 1998 (5.8%), 1999 (4.8%) after Asian financial crisis and 2009 (5.32%) after global financial crisis This is considered as one of achievements of appropriate

“open door” policies by relaxing exchange rate controls, internal and external trade impediments

As a result, export growth and import growth increase, except for 1996 and few years later when government decided to establish restrictions on import due to alarming current account deficit(1996:-11.5% of GDP) Although export growth rate is sometimes higher than import

growth rate, but it is still smaller than import growth in absolute values in most of the years in the period of 1990-2010, trade deficit therefore still exists Furthermore, trade deficit is a chronic issue in Vietnam because of imports-exports structure, as less of competiveness in exporting sector as it mainly comprises of low value-added goods, raw materials and intermediate products Current account is in deficit as a consequence of deficit in trade balance

Figure 1: GDP growth 1990-2010

Source: World Bank However, current account deficit does not always affect the balance of payments accordingly because this may be compensated by capital account surplus Obstinate current account deficit following by capital account surplus, for example, borrow from aboard, FDI, is not sustainable in the long run because one country cannot infinitely borrow abroad to finance current account deficit Financing the deficit by FDI can help the BOP balance and keep the economic growth in the short term, but in the long term this also makes unsustainable growth as

it relies on the external sources The fluctuation in FDI flow would lead to negative impacts on

domestic economy such as uncontrollable production, unemployment rate and therefore economic growth

Balance of payments problems may happen not only with developing countries but also with developed countries However, it is often referred to the developing world The aim of this paper is to re-apply the Thirwall’s law of balance of a payments constraint on economic growth

on the Vietnam economy with the new scenario recently by comparing it with potential growth rate by using time series data extending over two decades with the period 1990-2010

1.2 Research questions

This study is to examine

1 Whether balance of payments in Vietnam constrained economic growth or not?

2 Which factors behind balance of payments restrict economic growth?

3 What policy implications are for the balance of payments constrained economic growth in Vietnam?

1.3 Structure of Study

The thesis includes 5 chapters starting with the introduction in Chapter 1.Chapter 2 subsequently provides literature review for thesis Next, Chapter 3 provides the overview economic growth and balance of payments of Vietnamese scenario Chapter 4 shows the model specifications and the findings Chapter 5 eventually shows the conclusion and further recommendation

CHAPTER II: LITERATURE REVIEW

2.1 Theories

The balance of payments constrained growth model, which was developed by Thirlwall’s (1979), identifies the long run the economic growth rate of open economy constrained by trade balance By Thrilwall, the growth rate equilibrium can be defined by the ratio of export growth rate and the income elasticity of demand for imports This model has been tested not only with a large sample of developing and developed countries around the world but also tested by many different techniques and methods

With the first generation of BPCG, the author ignored international capital flows and interest payments However, capital flows and interest payments are an important part of the BOP As a result, Thirlwall and Hussain (1982) developed the extended model from the original model to allow trade deficits and capital inflow This model shows that in an open economy the growth rate may be constrained by capital inflows together with trade factors which mean that capital inflows tighten or loosen the balance of payment constrained growth

To improve the capital inflows limitation, BPCG model was redefined by Moreno-Brid (1998, 1999) with the assumption that accumulating foreign debt has sufficient condition It combines interest payments from imports of goods with non-factor services in the analysis of debt accumulation

In his research, McCombie (1997), the author tested with time series data for many nations in the short run He found that balance of payments equilibrium may delay the consistent growth rate with the exports and imports growth rate For example, if growth rates are higher than the consistent level with the external account equilibrium then the capital inflows will fulfill

the debt repayment However in longer time, balance of payments equilibrium will be consistent with exports and imports growth rate again Therefore, in the short term, the use of estimation model may be unsuccessful but in the long run the law does hold

Moreno-Brid (2003) stated that interest payments do not include in the Thirlwall’s law clearly and previous research did not count it in by the traditional way Lacking of these elements may lead to a shortcoming in analysis of long run growth which many developing countries whose have large debit in net interest payments aboard from the balance of payments Therefore the author developed the extension of balance of payments constrained growth model which includes the foreign interest payment in to the analysis model

There are many countries and region-specific studies have been introduced since Thirlwall (1979) and in general, the long-run hypothesis has held up reasonably well, especially for developing countries Based on that, McCombie (1997) summarized those conclusions from earlier studies

2.2 Balance of Payments in Supporting and Constraining Growth

As the balance of payments account consists of two crucial parts: current account and capital account Each account also contains some items that impulse and constrain the economic growth

in different ways Although there are many sub-accounts in both current and capital accounts, economists often focus on merchandize account of current account and private foreign investment, debt, official development assistance of capital account, the so-called capital inflow

or capital imports in general; otherwise some empirical researches pay much attention to other sub-accounts in balance of payments account such as debt servicing (Brid, 2001), factor income (Ferreira and Canuto, 2003), and remittance (Glytsos, 2002) Despite this, in this sub-section, it

is necessary to stress on two significant factors: trade balance and capital inflow

Role of balance of payments in economic growth is considered differently across different thought of school If post-Keynesian economists approach theory of economic growth from demand side and emphasize role of the balance of payments in economic growth, economists belonging to other thought of school, such as classical, neo-classical, and endogenous growth economists, may ignore role of demand side in economic growth when approaching from supply side These economists encourage free competition and trade and of course they could not avoid critics of post-Keynesian economists

Before stepping into post-Keynesian theory in showing the importance of balance of payments in fostering or constraining economic growth in more detailed, it is significant to point out disadvantages of free-trade doctrine from development because economists supporting free trade omitted aspects of balance-of-payments account in economic growth Firstly, the balance-of-payments effects of free trade and the effect of free trade on the terms of trade are ignored Free trade, the terms of trade, and the balance-of-payments must be put in the box and investigated together "Free-traders" convince audiences by giving its advantages but what happens if the deterioration of terms of trade exceeds the gains from trade that will impact negatively on balance of payments and this in turn affects passively the economic growth This is question without free-traders' answer Secondly, some activities are subject to increasing returns and others are subject to diminishing returns Developing countries, if basing on comparative advantage theory, will specialize in producing labor-intensive goods that are considered as having diminishing returns because developing countries are labor-abandon ones Developed countries otherwise specialize in producing and export manufactured goods that used capital-intensive technologies and have increasing returns because developed countriesare capital-abandon ones If this being so, developing countries will face with Engel's law and developed

countries have economies of scale, then deterioration of terms of trade may destroy the balance

of payments of developing countries that will in turn constrain economic growth in less developed countries Thirdly, the comparative advantage theory appeals to countries for specialization could lead to narrow excessively range of products and put economy into severe balance-of-payments instability that can demolish development Fourthly, comparative advantage may vary over time by government policies and intra-industrial trade still takes place due to differences in consumer's tastes, technologies

Furthermore, comparative advantage theory bases on private cost, what happens if social costs exceed private costs because of externalities of industrial projects that usually occur in developing countries This is an argument for protecting industry other than free trade Lastly, but not least, export growth of primary commodities has little secondary impact on other activities Conversely, expansion of manufactured goods strongly affects other activities through backward or forward linkages Comparative advantage is keystone for free trade supporters Although disadvantages of free trade for development can appear, it is hard to say that trade liberalization should be stopped despite any arguments, trade liberalization is necessary for economic growth but the questions now are that when free trade are and how sequencing of trade liberalization are

Classical, neoclassical, and new endogenous growth economists focus on trade and growth through supply side, post-Keynesian economists otherwise emphasize demand side of economic growth, the importance of current account deficits and financial aspects in capital accounts Findlay (1984, p 215) pointed out that "…Balance of Payments situation tended to be a critical constraint on the rate of growth" Keynes (1936) criticized classical economists, especially Say's

aggregate demand including consumption, investment, government expenditure, and net export Change of one of these elements will bring about variation of economic growth through multiplier such as government-purchases multiplier, investment multiplier In Keynes's point of view, components of aggregate demand play equal roles in affecting economic growth Other economists consider different importance of each component in contributing to economic growth Thirlwall (2002) stressed on exports in aggregate demand by three important respects that export can promote other components of aggregate demand and economic growth Firstly, exports are only true component emanating from outside the economic system meanwhile others depend on the growth of income

Secondly, exports impact not only directly on demand but also indirectly through its influence on other components in aggregate demand Imports can be financed by exports and consumption, investment also are partly funded by exports Thirdly, certain intermediary goods that are indispensable for development but expensive to produce domestically can be permitted

by exports This argument lies in the supply-side Current account deficit often accompanied with trade balance deficit because trade balance status plays the most crucial role in examining status of current account Foreign exchange gap can be only financed by surplus in capital account that comes from foreign debt, foreign direct investment However, the gap cannot be unceasingly financed by foreign debt when debt indicator reaches certain warning level and investor begins feeling anxiously Then the foreign exchange gap cannot be filled by capital inflow from capital account and balance of payments will constrain growth due to lacking minimum amount of foreign currencies for investing (or purchasing) on necessary inputs for production to attain targeted economic growth All analyses here assume that domestic and foreign resources cannot be substituted easily without costly and the less developed countries

usually suffer transfer problem that consists of the budgetary problem and the 'pure' transfer problem (Thirlwall, 1994)

The role of balance of payments in speeding up and constrain growth has just been seen Following subsection will in turn show models that state nexus of balance-of-payments constraint and economic growth as introduced We begin from dual-gap model

2.3 Conceptual framework for the study

Thirwall’s model identifies that the foreign multiplier determines economic growth in long run Based on Neoclassical approach, the supply factors and productivity are different therefore the growth rate varies from country to country In addition, based on the Harrod foreign trade multiplier, Thirwall’s law shows that economic growth is determined by demand factors in open economy which are presented as the balance of payments as Thirwall (1979), Thirwall&Hussain (1982),McCombie&Thirwall (1994)

For the case that developing countries that face problems with trade deficit, Thirlwall and Hussain(1982) developed the “Extended Model” with initial equilibrium condition Furthermore, Elliot and Rhodd (1999) highlighted the value of debt servicing in equilibrium condition In addition, other economists can modify the initial equilibrium condition by putting forward the significance of certain factors in balance-of-payments account such as capital flows, interest payments or debt (Brid, 2001), interest, dividends, and observed profits of current account of balance of payments (Ferreira and Canuto, 2003) in accordance with countries For the noteworthiness of remittance in filling the deficit in trade balance faced by many developing countries, especially in Vietnam, it is vital to add remittance to equation due to the fact that it is one of the notable elements to fill in the trade deficit

However, depending on the specific characteristics of each country, the balance of payments would vary and balance of payments constrained on economic growth is therefore different as well This explains the existence of various forms of model based on those conditions above

We have equilibrium in accounting form is represented as:

d is the exports price P

f is the imports price X is the volume of exports of goods and services M is the volume of imports of goods and services E is the exchange rate measured as the domestic price of foreign currency F is the value of nominal net capital inflows F > 0 expresses capital inflow, F < 0 expresses capital outflow R is value of remittance D is debt service

Taking log and derivative of both sides of above equations, we have:

pd + x = pf + m + e (5)

θ(pd + x) + (1- θ)f = pf + m + e (6)

ω(pd + x) + (1- ω)r = pf + m + e (7)

θ(pd + x) + (1- θ)f =p( pf + m + e)+ (1-p)d (8)

With lower case letters are rates of growth of variables

θ and (1-θ) are the shares of exports and capital flows ω and (1- ω) are the shares of exports and remittance ρ and (1- ρ) are the shares of imports and debt service on total expenditure

On the other hand, we have the normal multiplicative import and export demand functions with constant elasticity:

M = a[Pf E/Pd] ψ Y π (9)

X= b[Pd / Pf E] η Z ε (10)

Where, a and b are constants, ψ is the price elasticity of demand for imports (ψ < 0), η is the price elasticity of demand for exports (η> 0), Y is the domestic income, Z is the level of world income, π is the income elasticity of demand for imports, ε is the income elasticity of demand for exports

Taking log and derivative of the above two equations we have imports and export demand functions:

m = ψ (pf + e - pd) + πy Imports demand function (11)

x = η (pd - e - pf) + εz Exports demand function (12)

Substituting (11) and (12) into (5), (6), (7) and (8), we have (13), (14),(15) and (16)

Where ybasic, yext, yremit,ydebt represents the income growth rate consistent with BOP equilibrium

Finally, we can have with four forms of the balance-of-payments constrained economic growth models under different conditions

According to McCombie and Thirlwall (1994), the standard Thirlwall's growth law explains why developing countries have economic growth rate lower than of developed countries

and not convergence as predicted by classical economists Different growth rate can be explained

by different of growth rates of export and income elasticity of demand for imports Growth rate

of exports depends on income elasticity of demand for exports and world income (1994, 1997) However, it is essential to note that each country has its own specific economic condition, therefore other modified models are also applied to adapt to these characteristics

In developing countries, primary products for export are usually labor intensive products, elasticity of demand of primary products with price and income is low and inelastic; however their production activities of primary goods are facing with diminishing returns of scale and diminishing marginal product of factors of production It results in the deterioration of exporting activities in developing countries Otherwise, the other factors which determine growth is income elasticity of demand for imports are usually considerably high Developing countries usually import capital intensive products and intermediate inputs of production in supporting growth from developed countries therefore this will result in simultaneous increase in the demand for imports by more than one percent if rate of growth increases by one percent Combining both low export rate of growth and high income elasticity of demand for imports bring about low growth rate in developing countries compared with that in developed countries

Export-led growth alone can lead to balance of payments constraints in the long run if income elasticity of imports is high enough to offset increase in exports Thus the post-Keynesian tradition not only put forward the importance of exports but also the importance of income elasticity of demand for imports From this point, post-Keynesian and structuralism traditionally support structural adjustment to avoid much external dependence that needs government's policies for establishing trade barriers to protect domestic industries which have positive externalities on other economic-social activities and have social costs exceeding private

costs,as well as stimulate demand for economic growth However they should pay more attention

on balance of payments constraints which can constraint economic growth

2.4 Empirical studies

Currently, there are many empirical researches relating to balance of payments together with economic growth such as Jayme Jr (2003), Parikh A (2004), Lopez (2003), Modud.J.K (2000), Moreno-Brid (2001), Bajo-Rubio (2010), ect

Jayme Jr (2003) uses balance of payments constrained economic growth model to examine the interaction between balance of payments constraint and economic growth in Brazil

by using Thirlwall's original model to find out if predict growth rate from the model is a good indicator for actual growth rate although he applies models including capital flow and taking into account the influence of external debt accumulation in initial equilibrium conditions to enhance precise predictability He estimates the long run elasticity of demand for imports by using the Autoregressive Distributed Lag or ARDL technique for fourteen sub periods from 1973-1999 periods, so called as rolling regression through different overlapping periods The finding provided a significant improvement in income elasticity of demand for imports in this context Following this, the author concluded that the slowdown of Brazil's economic growth because of

an increase in the long run of income elasticity of imports that has not been filled up by expansion of exports In the particular case of Brazil, economic growth is constrained by the balance of payments Otherwise, economic growth affects positively exports

Jorgen and Virmantas (2004), examined economic growth in the three Baltic countries (Estonia, Latvia, and Lithuania) using balance of payment constrained growth model In the research, the author utilized the extended model with capital inflow and quarterly date from 1995

- 2003 due to limited data from these Baltic countries Economic growth rates are consistent with

balance of payment equilibrium and consistent with the growth rate of capital imports The results show that the Baltic countries that economic growth is constrained by the balance of payments position

Pham (2006) uses several models that relate to Thirlwall's law to investigate whether growth rate of Vietnam is constrained by balance of payments with the data from 1990-2004.Instead of approaching directly the question, author raised an issue of how these models can fit for precise prediction purpose of actual growth in case of Vietnam with several models which include (1) simple rule that is Thirlwall's growth law only; (2) extended model by assuming that the country incurs original trade deficit and is filled by capital inflow in capital account; (3) the financial simple rule that encompasses the values of nominal revenues and expenditures, in domestic currency, of invisible services related to production factors Although Elliot and Rhodd (1999) introduced debt servicing in the initial equilibrium condition to show its role as one constraint of economic growth, they did not consider the case that ratios could be changed according to modifications in international investors' expectation, so ratio of current account deficit and income can be high if investors are optimistic about economy performance, otherwise in case of overcast economy performance However, Pham still applied all models to estimate predicted growth rate After estimation, the author found that balance-of-payments also play role as limitation on Vietnam economic growth although deficit in trade and current account were partly relieved by external inflow of capital such as foreign direct investment, official development assistance and debt

Ferreira and Canuto (2003) using ARDL model with the data from 1949 to 1999 of Brazil

to prove the balance of payments constrained growth 1.05 of income elasticity of demand for imports and it is similar with Lopez and Cruz’s (2000) Their function was not significance during the 1980s by using rolling regression By using extended balance of payments model that

is allow capital inflows to estimate the growth rate using ARDL and have the coefficient of 0.40 with the actual growth rate With these findings they state that simple rule and financial simple rule at least partially good tools for prediction of actual growth rate The actual average income growth rate of Brazil was 5.14% per year while they were 6.18% and 5.23% per year in case of estimating by using simple rule and financial simple rule, respectively

Bajo-Rubio (2010) analyzed the case of if trade balance could constrain Spain economic growth in relation with Western Europe in the period 1850-2000 He uses Phillips and Hansen (1990) method to estimate the elasticity of exports and imports which can avoid the biases arising when estimating by OLS with using computing a class of Wald tests At the end, the author use a simple approach to calculate calculating the relative income elasticity of the demands for exports and imports, comparing them with the relative GDP growth rates of Spain together with the EU and then finding the balance of payments constrained growth rate

In short, we have just examined balance of payments constraints model and economic growth in theoretical framework, the relationship of balance of payments and economic growth, together with empirical studies In particular, we indicate basic concepts of balance of payments and economic growth as well as role of balance of payments in fostering and constraining growth Moreover, the balance-of-payments constrained economic growth model has been considered meticulously In this chapter, empirical review of some studies has also been indicated to manifest importance of balance-of-payments in economic growth As mentioned above, many empirical studies related to balance of payment constraints growth around the world, showing the evidence that Balance of Payments constrained growth rate of many nations especially in the case of developing countries Now, it is time to have a look the economic growth and balance of payments in case of Vietnam during the 1995-2010 periods which will be presented in the next chapter

CHAPTER III: ECONOMIC GROWTH AND BALANCE OF PAYMENT

OF VIETNAM

3.1 Vietnam Economic Growth Overview

After 1975, Vietnam applied the central planning economy with mainly agricultural economy The government controlled and managed means of production as physical input, output, and prices Government established trade barriers, especially in foreign trade and set dual foreign exchange rate as well as interest rate As a result, there were a very high inflation and low economic growth

In December 1986, the economic reform known as “Doi moi” was introduced; the movement from the central planning economy to market oriented It improved the economy by using strategy as market tools in order to get better economic performance by setting incentives Before economic reform, Vietnamese economy was struggle with stagnation, triple digit inflation which was caused by many economic problems was created by the system The size of state owned enterprise was reduced by government commitment With the “Doi moi” policy, Vietnamese economic system as a whole performance was very impressive in the 1990s The economy was shifted toward international trade to make FDI and capital inflows increased rapidly

While the 1997 Asian economic crisis negatively affected the Vietnamese economy, the Vietnamese economy was less inflicted to this crisis than many other countries in South East Asia that is the result of Vietnam did not have internationally traded currency and a stock market

at that time Also, Vietnam used to dollarize economy therefore it make currency more stability during the Asian economic crisis Asian financial crisis starting from Thailand and quickly spread out the negative effects over other Asian countries as Indonesia, Malaysia, and Korea in

1997 Even though the financial crisis did not impact directly on Vietnam's economy, it did have indirectly considerable influences on Vietnam's economy and stopped high economic growth in previous years Rate of growth was reduced unexpectedly to 5.76% in 1998 and was kept low growth rate in next years from 1998 to 2001 Inflation rates in the period after Asian financial crisis were dramatically low (disinflation rate) even minus in 2000 (deflation rate, just -0.6%) This information was show that it was a symbol of stagnation (low rates of inflation and growth)

In this period, Vietnam effectively became a member of APEC in 1998 and signed the Bilateral Trade Agreement with the USA in 2000 Also in the period, Vietnam was actively preparing groundwork for WTO accession

Vietnam also was hardly impacted on global dot com crisis mainly in high technological sector because our products were basic manufacturing with high labor intensive and using low end technology scale for instance footwear and apparel In 2001 US approved the bilateral trade bill with Vietnam it help Vietnam export to US market which is the largest market in the world

After Asian financial crisis, economic growth was partly restored and inflation rate soared up to higher level (4% in 2002, 3% in 2003, and even 9.5% in 2004).However, as old difficulties pass, new difficulties come Although Asian financial crisis becomes a good lesson for Vietnam in coming years, but Vietnam was forced to reform its financial institutions and economy under pressure of international competitiveness when Vietnam's economy wants to integrate into global economy with general laws and obtains high growth as well as stabilization

Between 2001 and 2007 GDP growth was 7.5% on average, reaching 8.5% in 2007 Growth was increasingly driven by the private sector with 59 000 new enterprises being registered in 2007, which is an increase of 26% when compared to the previous year Additionally, poverty rates now dropped to less than 20%, down from almost 60% in the early 1990s In January 2001, Vietnam becomes the 150th member of WTO To achieve the

requirements of WTO membership, Vietnam have to revise almost trading and investing laws as well as to improve the business environment As a consequence, not only foreign investors but also Vietnamese people would benefit from the improved legislation and lower trade barriers Beside that local firm enjoyed a range of protections in the world market; however it will face increasing competition from both inside and outside the country

From 2004 to 2007, economic growth rate was over 8 per cent annually before the global financial crisis in 2008, which started in the US and spread out to the world which also has a negative impact on Vietnamese economy (Due to the fact that the more Vietnam economy integrated into the world economy, the more affected by the up and down in the world economy)

As a result, the growth suffered and GDP declines in 2008 (6.2%) and 2009 (5.3%) and in 2010 (6.7%) Another impact of the financial crisis was high inflation in 2006 (6%), 2007 (12%), 2008 (23%)

In 2010, Vietnam made its way out of the group of poor countries and became the income country for the domestic resources as a result of increase in development and dramatic expansion of international trade and foreign direct investment in the past two decades Vietnam aims to establish steady foundation to become a modern, industrialized country by 2020

mid-3.2 Balance of Payment of Vietnam

In the balance of payments, there are two main accounts: current account and capital account

3.2.1 Current account

The current account is one of the two main elements of BOP Vietnam Current Account is in surplus with 0.20% of GDP in 2011 Retrospectively speaking, from 1990 until 2010, Vietnam Current Account to GDP averaged -3.15 with the highest percentage is 4.10% in December of

1999 and the lowest of all time is -11.88% in December of 2008 The Current account balance as

a percent of GDP is an indicator to show the international competitiveness of a country

Figure 2: Current account balance (% of GDP)

Source: World Bank

Normally, if a country has current account surplus, it will has an economy depends on exports with high saving rate but weak domestic demand However, Vietnam has current account deficit which means that Vietnam has strong imports, weak saving rate with high consumption rate as percentage of disposable A clearer picture will be shown in the next step when we look at trade balance together with imports-exports; net transfer and net income from abroad which belong to current account

3.2.1.1 Trade Balance

Trade balance is the most important part in current account Trade balance is in deficit or surplus often make current account simultaneously Trade balance tells us what is happening in current account This can be shown in following figure 3 as we can see that the trend of trade balance and current account balance almost the same

Figure 3: Trade balance and current account balance

Source: World Bank

According to Dollar and Kraay (2001), the changes in value of imports and exports divided by GDP which can be used as indicator of trade openness and according to the World Bank (2002) the trade/GDP ratio is an indicator to identify countries as globalizers or non-globalizers In Vietnam trade liberalization has been taking place during the 1990-2010 periods Several trade policies aiming at exchange rate, tariff and non-tariff (such as quotas, targets, customs surcharges, quality inspection, and customs procedure) have been relaxing barriers and focusing on more liberal and open trade especially after Vietnam joined WTO in

2007 One of the most popular indicators to measure level of how open an economy is the ratio of trade and gross domestic products as figure 4

Since 1990 until 2010, Vietnam Trade Balance averaged -3567.94 USD Million with the highest is -403.13 USD Million in December of 1992 and the lowest - 13852.57 USD Million in

2008 In 1990-2006, the deficit in trade was not too large but it is suddenly extensive in 2007

-16000 -14000 -12000 -10000 -8000 -6000 -4000 -2000 0 2000

and reached to alarming level in 2008 with the largest contributor to the current account deficit,

at US$12.3 billion

Figure 4: Ratio of trade and gross domestic products, 1900-2010 (Trade/GDP)

Source: World Bank

Exports composition includes mainly raw material, rubber, oil, seafood, and electronics The main exports destination is US, Australia, Japan, and China Beside that large parts of import are petro, steel, fabrics and plastics, intermediate production input with the most importing countries such as Japan, South Korea, China, Thailand and Singapore

Figure 5: Imports, Exports and Trade balance, 1990-2010

81.3 66.9 73.6 66.2 77.5 74.7

92.7 94.3 97.0 102.8

112.5 111.5 118.8

126.9 139.0 142.9 151.8

169.6 171.1 147.0 165.3

Since 1990, on average, growth rate of exports is higher than that of imports (16.12% for exports and 15.02% for imports) but the absolute value of exports is smaller than imports This signal is not much disappointing because the imports are to support for domestic production and exports

3.2.1.2 Net Transfers

Transfers can be considered as an important element to support the BOP in increasing the absorptive capacity of the recipient economy Although transfers are non-debt and they are less volatile as compared with other inflows of foreign exchange, even they can put potential risks of Dutch Disease and in managing and controlling money supply by dollarization threat

Figure 6: Net Transfers from abroad, 1990-2010

Source: World Bank

In Vietnam, remittance by Vietnamese oversea is a dominant part in net transfer values which

is always positive in period 1990-2010 Net transfer was at an average of US$ 142 million during 1990-1995 and it rapidly increased to US$ 1045 million in 1996 Due to the crisis in Asia

49.0 35.0 59.0 70.2 170.0 473.5

1045.8 712.1 950.9 1050.0

1341.2 1256.9 1800.0

2232.3 2488.1

3379.2 4048.7

6421.4 7378.4

672.8 8815.5