Reconsidering Vietnam’s
Exchange Rate Mechanism:
A Preliminary Discussion
VND
Kenichi Ohno (VDF & GRIPS)
USD
Jan. 2004
Brief History
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Late 1980s: multiple rates and high
inflation under international isolation
Early 1990s: global integration starts,
inflation stabilization succeeds
1991-96: $1=11,000d (nominal anchor)
1996-98: stepwise devaluations, coping
with the Asian crisis
Feb.1999-now: slow depreciation
VND/USD Exchange Rate
16000
Stepwise
devaluation
14000
12000
High
inflation
Inflation stabilization
with $1=11,000d
Slow depreciation
under daily averaging
10000
8000
Asian
crisis
6000
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
Dec-93
Dec-92
Dec-91
Dec-90
Dec-89
4000
Vietnam: Real Effective Exchange Rate
(Dec. 1989 = 100)
110.0
Depreciate
100.0
90.0
Appreciate
80.0
70.0
60.0
50.0
2003M12
2002M12
2001M12
2000M12
1999M12
1998M12
1997M12
1996M12
1995M12
1994M12
1993M12
1992M12
1991M12
1990M12
1989M12
40.0
Current System
The central rate is set daily at the average of
interbank exchange rates on the previous
transaction day, with a band of ±0.1%
Problems:
--It is merely a technical procedure without links to
policy goals or economic fundamentals.
--Policy intention of SBV is not transmitted to the
market.
--No criteria to judge the appropriateness of VND’s
level or system.
Vietnam (SBV) Should
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Define exchange policy goals
Adopt a system which can attain
these goals
Within that system, have operational
rules for daily management
Discuss exchange rate policy more
openly and consistently (accountability,
dialogue with market and investors)
Issues to be considered
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Which policy goals?
Use and limits of REER
Ambiguity of “competitiveness”
Menu of exchange rate mechanisms
Exchange rate smoothing
Exit policy problem
China factor
1. Which Policy Goals?
Possible goals of exchange rate policy
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Competitiveness
Price stability
Current-account
adjustment
Financial stability
(bal.sheet problem)
Public debt manage
-ment (ODA loans)
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Prevention of
currency crisis
Coping with
external shocks
Growth, FDI,
industrialization
Balancing Flexibility & Stability
Competitiveness requires ex.rate flexibility
 Price stability requires ex.rate stability
But this is not a dilemma in dynamic context
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A developing country receives various shocks.
Proper policy response sometimes requires
flexibility, other times stability.
Goals: General Advice
--In normal times, the goal should be balancing
exchange rate flexibility and stability: maintain
competitiveness under price stability
--Policy judgment should always be exercised.
VND cannot be put on an autopilot. Do not
expect a simple formula.
--Adopt a system in which the degree of flexibility
and stability can be adjusted at any time without
causing crisis or political problem (both free float and
rigid fix are undesirable since they do not satisfy this condition.)
2. Real Effective Exchange Rate
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REER should be regularly calculated by
SBV as a basic indicator of overall
competitiveness.
However, limits of REER should also be
recognized:
--Base year problem
--Choice of price index
--Choice of partner countries --Data availability
--International comparability of commodity baskets
3. Ambiguity of “Competitiveness”
Apart from REER limits, the concept of competitiveness
faces fundamental problems in developing countries.
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Vertical trade structure
--Major trading partners (Japan/EU/US) are not true competitors
(China/ASEAN/Mexico...)
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Low domestic content of major exports
--primary commodities, garment, footwear, electronics
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High exchange rate pass-through
--As prices adjust, any VND/USD rate can be the “correct” rate
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Structural changes under doi moi & global
integration
SBV Should:
--Calculate REER regularly for policy input.
--Also systematically monitor a large number of
economic variables including:
growth, prices, money, budget, trade & BOP,
forex market, FDI & investment, banks,
business conditions, asset markets, etc.
--Use judgment and information above to make a
policy decision.
--Conduct research on measuring competitiveness,
pass-through, global & regional trends, etc.
4. Exchange Policy Menu
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Free float
Managed float
Bipolar view (free
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--Soft vs. hard
--Real vs. nominal
--Announced or not
--Narrow or wide, etc.
float or rigid fix)
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Currency board
Dollarization
Currency basket
(Dollar/Euro/Yen)
Crawl
Adjustable peg
Target zone
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Soft dollar peg
Eclectic view
--Names do not matter much. Actual
operation is the key.
--Pick a system which allows a mix of
exchange rate stability and flexibility.
As a general rule, I recommend:
Short-term stability against USD
Long-term flexibility against USD
Namely, exchange-rate smoothing (filtering out
high-frequency movement)
5.Exchange Rate Smoothing
WHY SMOOTH?
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Short-term fluctuation contains more noise
and less fundamentals.
Prevention of one-way swings such as bubble,
herding, etc.
Demand & supply do not meet or the rate
would be too volatile without intervention.
Official provision of “hedging” when forward
markets, options, etc. do not exist.
Distribution of Exchange Rate Changes
After
smoothing
Smoothing
with a trend
Before
smoothing
(-)
0
(+)
Exchange Rate Smoothing: An Illustration
Movement driven by market forces
without intervention
Managed float
Crawling peg with variable speed
Adjustable peg with frequent revisions
6. Exit Policy Problem
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How to transit from a fixed to a more
flexible exchange rate system without
crisis.
Again, the key is to adopt a system
where the mix of flexibility and stability
can be adjusted.
Normal operation and crisis response
must be clearly distinguished.
Sometimes, the exchange rate comes
under severe pressure
--The critical decision is whether to resist the
pressure or to float. If float, the timing of floating
is important.
--If it is decided to float, prepare measures that
minimize the shock and the period of floating:
Temporary trade & capital controls, social protection, protection of
banks & firms, etc (Kazakhstan in 1999). Don’t accelerate reforms or
tighten macro policies during attack.
--In a typical currency crisis, a 30% depreciation is
normal. But shocks may be heavy or light
depending on policies.
7. China Factor
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Lessons for Vietnam
China as a risk factor for Vietnam
--Bursting of the Chinese bubble (consumption
and housing)
--Mishandling of RMB policy and regional
currency repercussions (China now faces a
sort of the exit policy problem)
My Recommendation:
Variable Crawl with Monthly Evaluation
VND/USD
Crawl speed adjustments
Monthly monitoring
Time
Variable Crawl for Vietnam
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SBV mainly sets the rate, while market
force is used as a supplementary input.
(VN’s financial markets are still primitive.)
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SBV monitors the situation monthly and
adjusts the crawling speed if necessary.
The actual movement may not be very
different from today, but SBV assumes
more accountability based on proper
analysis.
The End
If enough interest exists,
VDF will start research on
exchange rate management