IMPACT OF EXCHANGE RATE POLICY ON VIETNAM TRADE BALANCE IN 1999 2018 PERIOD

FOREIGN TRADE UNIVERSITY FACULTY OF ENGLISH FOR SPECIFIC PURPOSES ---***---INTERNATIONAL BUSINESS ENGLISH THESIS IMPACT OF EXCHANGE RATE POLICY ON VIETNAM TRADE BALANCE IN 1999-2018 PERI

FOREIGN TRADE UNIVERSITY FACULTY OF ENGLISH FOR SPECIFIC PURPOSES

-*** -INTERNATIONAL BUSINESS ENGLISH THESIS

IMPACT OF EXCHANGE RATE POLICY ON VIETNAM

TRADE BALANCE IN 1999-2018 PERIOD

LIST OF MEMBERS

Table of Contents

Table of Contents 2

Abstract 3

Introduction 4

Chapter 1 General theory 5

1.1 Exchange rate 5

1.1.1 Definition of exchange rate 5

1.1.2 Classification of exchange rate 5

1.1.3 Main factors influencing exchange rate 6

1.2 Exchange rate policy 7

1.2.1 Definition of exchange rate policy 7

1.2.2 Classification of exchange rate policy 8

1.3 Trade balance 9

1.3.1 Definition 9

1.3.2 The relationship between exchange rate and balance of trade 10

Chapter 2 Impacts of exchange rate policy on Vietnam trade balance since 1991 - today 13

2.1 Exchange rate policy from 1999 – 2015 and its effect on Vietnam trade balance 13

2.1.1 The period from 1999 to 2007 13

2.1.2 The period from 2008 to 2010 14

2.1.3 The period from 2011 to 2015 16

2.2 Exchange rate policy from 2016-2018 and its effect on Vietnam trade balance 19 2.3 Evaluation of exchange rate policy in 1999-2018 period 21

Chapter 3 Recommendations 23

3.1 Effects of passed exchange rate policies and future market trend 23

3.2 Approaches to an appropriate exchange rate policy 24

Summary 26

References 27

This paper investigates the impact of the exchange rate policy on tradebalance in Vietnam from 1999 to 2018 The paper compares the exchange ratepolicies over the period and the results show that exchange rate in differentperiod affects differently on the export and import volume The paper shows thatthe implementation of central exchange rate has positive impact on Vietnamtrade balance after the long-lasting period of trade deficit The paper concludes

by suggesting some policy implications in managing the exchange rate systemand promoting exports of Vietnam

Exchange rate has played a very important role in international trade, especially

in such a great open world economy Many countries pursue a development strategyusing exchange rate as a main intervention, which is called the export-led growthmodel Vietnam is one among the countries pursuing such strategy The exports sectorhas experienced a structural change due to greater integration into the world economy.Although globalization and trade liberalization has been beneficial for Vietnam, it alsoincreases the exposure to external shocks Besides, one of main duties of exchange ratetool facilitating trade balance, stays remained despite the fact that the exchange rateregime has been adjusted many times during the last 20 years Notably, when theauthority 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 andbudget deficit This paper aims to deal with the question of effectiveness of exchangerate policy on trade balance, the time period chosen is from 1999 to 2018

The paper is organized as followed: In the first chapter, we will give somerudimentary knowledge of the exchange rate and foreign exchange policy Chapter 2will take a closer look into the impacts of exchange rate policy on Vietnam tradebalance from 1999 to 2018, and we conclude by putting forward some possiblerecommendations to enhance the effectiveness of foreign exchange market in the lastchapter

The purpose of this study is to help address Vietnam’s exchange rate policysince 1999 and its consequences for trade balance of Vietnam In pursuing theseobjectives, this study mainly employs analytical review and synthesis method ofanalysis, to provide an analysis of different but inter-related aspects of exchange ratepolicy and trade balance of Vietnam

Chapter 1 General theory

1.1 Exchange rate

1.1.1 Definition of exchange rate

An exchange rate is the rate at which one currency will be exchanged foranother It is also regarded as the value of one country’s currency in relation to anothercurrency For example, an interbank exchange rate of 23.150 Vietnam dong to theUnited States dollar means that VND23.150 will be exchanged for each US$1 or thatUS$1 will be exchanged for each VND23.150 In this case it is said that the price of adollar in relation to Vietnam dong is VND23.150, or equivalently that the price of aVietnam dong in relation to dollars is $1/23.150

1.1.2 Classification of exchange rate

Flexible or Floating exchange rate systems: are ones whereby the rate of a

currency is determined by the market forces of demand and supply Unlike the fixedexchange rate they do not derive their value from any underlying Some economistsargue that a floating system is more preferable since it absorbs the shocks of a globalcrisis and automatically adjusts to arrive at an equilibrium

A forward rate: is a one that is determined as per the terms of a forward

contract It stipulates the purchase or sale of a foreign currency at a predetermined rate

at some date in the future A forward contract is generally entered into by exportersand importers who are exposed to Forex fluctuations The forward rate is quoted at apremium or discount to the spot price

The spot rate: is the current exchange rate for any currency It is the rate at

which your currency shall be converted if you decided to execute a foreign transaction

“right now” They represent the day-to-day exchange rate and vary by a few basispoints every day

Dual exchange rate: In this type of system, the currency rate is maintained

separately by two values-one rates applicable for the foreign transactions and anotherfor the domestic transactions Such systems are normally adopted by countries who aretransitioning from one system to another This ensures a smooth changeover withoutcausing much disruption to the economy

1.1.3 Main factors influencing exchange rate

Inflation Rates: Changes in market inflation cause changes in currency exchange

rates A country with a lower inflation rate than another's will see an appreciation in thevalue of its currency The prices of goods and services increase at a slower rate wherethe inflation is low A country with a consistently lower inflation rate exhibits a risingcurrency value while a country with higher inflation typically sees depreciation in itscurrency and is usually accompanied by higher interest rates

Interest Rates: Changes in interest rate affect currency value and dollar exchange

rate Forex rates, interest rates, and inflation are all correlated Increases in interest ratescause a country's currency to appreciate because higher interest rates provide higher rates

to lenders, thereby attracting more foreign capital, which causes a rise in exchange rates

Country’s Current Account / Balance of Payments: A country’s current account

reflects balance of trade and earnings on foreign investment It consists of total number

of transactions including its exports, imports, debt, etc A deficit in current account due

to spending more of its currency on importing products than it is earning through sale

of exports causes depreciation Balance of payments fluctuates exchange rate of itsdomestic currency

Government Debt: Government debt is public debt or national debt owned by the

central government A country with government debt is less likely to acquire foreigncapital, leading to inflation Foreign investors will sell their bonds in the open market if

the market predicts government debt within a certain country As a result, a decrease inthe value of its exchange rate will follow.

Terms of Trade: Related to current accounts and balance of payments, the terms

of trade is the ratio of export prices to import prices A country's terms of tradeimproves if its exports prices rise at a greater rate than its imports prices This results inhigher revenue, which causes a higher demand for the country's currency and anincrease in its currency's value This results in an appreciation of exchange rate

Political Stability & Performance: A country's political state and economic

performance can affect its currency strength A country with less risk for political turmoil

is more attractive to foreign investors, as a result, drawing investment away from othercountries with more political and economic stability Increase in foreign capital, in turn,leads to an appreciation in the value of its domestic currency A country with soundfinancial and trade policy does not give any room for uncertainty in value of its currency.But, a country prone to political confusions may see a depreciation in exchange rates

Recession: When a country experiences a recession, its interest rates are likely to

fall, decreasing its chances to acquire foreign capital As a result, its currency weakens

in comparison to that of other countries, therefore lowering the exchange rate

Speculation: If a country's currency value is expected to rise, investors will

demand more of that currency in order to make a profit in the near future As a result,the value of the currency will rise due to the increase in demand With this increase incurrency value comes a rise in the exchange rate as well

1.2 Exchange rate policy

1.2.1 Definition of exchange rate policy

The exchange rate policy refers to the manner in which a country manages itscurrency in respect to foreign currencies and the foreign exchange market The exchangerate is the rate at which the domestic currency can be converted into a foreign currency

In turn, this affects the costs of domestic production and finance relative to foreignproducts and capital In formulating exchange rate policy, a balance must be foundbetween several differing, and sometimes conflicting, objectives In particular, the use

of the exchange rate to promote the competitiveness of domestically-produced goodsmust be considered alongside the implication for the international purchasing power ofthe currency and, in particular, the impact of changes in the exchange rate on domesticinflation

1.2.2 Classification of exchange rate policy

There are two major regime types: One is fixed (or pegged) exchange rate

regimes The other one is floating (or flexible) exchange rate regimes

A floating (or flexible) rate is a system in which currencies have no specific par

value; value is normally determined by supply and demand Central bank are notrequired to intervene, but they often do to avoid wild fluctuations

A floating (or flexible) rate is determined by the open market through supply

and demand on global currency markets Therefore, if the demand for the currency ishigh, the value will increase If demand is low, this will drive that currency price lower

Of course, several technical and fundamental factors will determine what peopleperceive is a fair exchange rate and alter their supply and demand accordingly

A floating (or flexible) exchange rate policy is one in which a country's

exchange rate fluctuates in a wider range and the country's monetary authority makes

no attempt to fix it against any base currency A movement in the exchange is either anappreciation or depreciation

There are two types of floating rate:

Free float: Free float, also known as clean float, signifies that a currency's value

is allowed to fluctuate in response to foreign-exchange market mechanisms withoutgovernment intervention

Managed float (or dirty float): Managed float, also known as dirty float,

involves government intervention in the market exchange rate in different forms anddegrees, in an attempt to make the exchange rate change in a direction conducive to theeconomic development of the country, especially during an extreme appreciation ordepreciation A monetary authority may, for example, allow the exchange rate to floatfreely between an upper and lower bound, a price "ceiling" and "floor."

A fixed exchange rate, sometimes called a pegged exchange rate, is one in which a

monetary authority pegs its currency's exchange rate to another currency, a basket of othercurrencies or to another measure of value (such as gold), and may allow the rate tofluctuate within a narrow range To maintain the exchange rate within that range, acountry's monetary authority usually needs to intervenes in the foreign exchange market

A movement in the peg rate is called either revaluationor devaluation

A fixed (or pegged) rate is determined by the government through its central bank.The rate is set against another major world currency (such as the U.S dollar, euro, oryen) To maintain its exchange rate, the government will buy and sell its own currencyagainst the currency to which it is pegged Some countries that choose to peg theircurrencies to the U.S dollar include China and Saudi Arabia (the currency is tied toanother currency, mostly reserve currencies such as the U.S dollar or the euro or theBritish Pound Sterling or a basket of currencies)

1.3 Trade balance

1.3.1 Definition

Balance of trade is the international trading position of a country in merchandise,

excluding invisible trade If exports are greater than imports there is a surplus (orfavourable balance of trade)

The balance of trade, commercial balance, or net exports (sometimes symbolized as NX), is the difference between the monetary value of a nation's exports

and imports over a certain time period Sometimes a distinction is made between abalance of trade for goods versus one for services The balance of trade measures aflow of exports and imports over a given period of time The notion of the balance oftrade does not mean that exports and imports are "in balance" with each other

A country that imports more goods and services than it exports in terms of valuehas a trade deficit Conversely, a country that exports more goods and services than itimports has a trade surplus The formula for calculating the balance of trade can besimplified as the total value of imports minus the total value of exports

$500 billion trade deficit $1.5 trillion in imports - $1 trillion in exports = $500billion trade deficit

1.3.2 The relationship between exchange rate and balance of trade

The balance of trade influences currency exchange rates through its effect on the supply and demand for foreign exchange When a country's trade account does not net

to zero – that is, when exports are not equal to imports – there is relatively more supply

or demand for a country's currency, which influences the price of that currency on theworld market However, the relationship between exchange rate and trade balance isindecisive both in long run and short run Commercial companies often trade fairlysmall amounts compared to those of banks or speculators, and their trades often have alittle short-term impact on market rates Nevertheless, trade flows are an importantfactor in the long-term direction of a currency's exchange rate

Trade Balance Influences Exchange Rate

These relative values are influenced by the demand for currency, which isinfluenced by trade If a country exports more than it imports, there is a high demandfor its goods, and thus, for its currency The economics of supply and demand dictatethat when demand is high, prices rise and the currency appreciates in value In contrast,

if a country imports more than it exports, there is relatively less demand for itscurrency, so prices should decline In the case of currency, it depreciates or loses value

For example, let's say that electronic components are the only product on the marketand Vietnam imports more electronic components from the USA than it exports, so itneeds to buy more dollars relative to VND sold Vietnam's demand for USD outstripsAmerica's demand for VND, meaning that the value of the VND falls In this situation,we'll surmise that VND might fall to 20,000 relative to the dollar Now, for every $1 sold,

an American gets 20,000 VND To buy $1, a Vietnamese has to sell 20,000 VND

Trade influences the demand for currency, which helps drive currency prices

Exchange Rate Influences Trade Balance

The relative attractiveness of exports from that country also grows as a currencydepreciates For instance, assume an American electronic component costs $10 Before iscurrency depreciated, a Vietnamese could buy an American electronic component for200,000 VND Afterward, the same electronic component costs 230,000 VND, a huge

price increase On the other hand, a Vietnamese electronic component costing 100,000VND has become much cheaper by comparison: $10 now buys 2.3 Vietnameseelectronic component instead of 2.

Vietnamese might start buying fewer dollars because American electroniccomponent has become quite expensive, and Americans might start buying more VNDbecause Vietnamese electronic component is now cheaper This, in turn, begins toaffect the balance of trade Vietnam would then start exporting more and importingless, reducing the trade deficit

Chapter 2 Impacts of exchange rate policy on Vietnam trade

balance since 1991 - today

2.1 Exchange rate policy from 1999 – 2015 and its effect on Vietnam trade

balance

From 26/02/1999, the central bank operated more flexible exchange rate inaccordance with the market mechanism The central bank took the average exchangerate of the trading session on the latest forex market as interbank rates

2.1.1 The period from 1999 to 2007

This period was marked by the unified circulation of EUR in all EU countries andbecoming a serious competitor of USD In this context, Vietnam has applied anoperating exchange rate anchoring mechanism, and the Vietnam exchange rate is tied

to a "currency basket" in which the proportion of EUR is raised

During this period, the exchange rate band was extended from 0.1% to 0.25% for spot operations and from +/- 0.4% to +/- 0.5 % for term service as of July 1,

+/-2002 The local currency exchange rate was squeezed higher than the real value,causing the Vietnamese dong to be valued by 10-20% higher than the USD

Vietnam's exports in this period were difficult due to not competing with Chinesegoods Export turnover increased slowly (at least more than 3% in 2001), and theexport growth rate was always smaller than the import growth rate, leading to a hightrade deficit: to October 2003, the Trade deficit was 4.55 billion USD In addition, thehigh valuation of Vietnam dong has also led to a series of imports, including those thatcan be produced domestically because the import prices are cheaper than domesticgoods prices

In summary, changes in exchange rate and trade balance of Vietnam during

1999-2007 show that the impact of exchange rates on the trade balance is relatively clear, the