Vietnam’s exchange
rate regime
Tutorial class: Tut2BA12
Group 3 : Trần Tuấn Minh - 1204000063
Ngô Minh Anh - 1204000008
Mai Anh Đào - 1204000021
Lê Thanh Thảo - 1204000088
Contents
A.
Introduction ...................................................................................................................................... 3
B.
Discussion.............................................................................................................................................. 3
I.
Vietnam’s exchange rate regime .......................................................................................................... 3
1.
Definition .............................................................................................................................................. 4
2.
Strength................................................................................................................................................. 4
3.
Weakness .............................................................................................................................................. 5
4.
Threats .................................................................................................................................................. 7
II. Exchange rate regime of China and Australia. ......................................................................................... 8
1.
Australia’s exchange rate regime.......................................................................................................... 8
2.
China’s exchange rate regime ............................................................................................................... 9
III. Effects to economic prosperity: ............................................................................................................ 10
1.
Negative: ............................................................................................................................................. 10
2.
Positive: ............................................................................................................................................... 11
III.Conclusion: ...................................................................................................................................... 12
References: ................................................................................................................................................. 14
A. Introduction
With the rapid growth rate of world’s economy, the demand to buy and sell
foreign currencies arising from the financial flow associated with
international trade of goods and services, cross-border investment and
borrowing of funds and central banks transaction continues to rise in recent
year. Each country manages their own foreign exchange market through
their central bank. The method of managing and calculating the exchange
rate of the domestic currency is called an exchange rate regime. Different
country adopts different method which is suitable for their policies and
economic situation. This research focus on the exchange regime of Vietnam
in comparison with Australia’s and China’s, two countries with two
exchange rate regime different to Vietnam’s, and the effect of Vietnam’s
exchange rate regime to economic prosperity. This research is based on
secondary data collected from published papers and articles.
B. Discussion
I. Vietnam’s exchange rate regime
The importance of the exchange rate associates with the continuous growth
of world economy and international economic relations. In Vietnam, the
exchange rate regime plays a big role in promoting the growth of national
economy.
1. Definition
Each nation-state, or monetary union, around the world is responsible for the
determination of the country’s exchange rate regime, that is, the method by
which the exchange rate of the currency is calculated (Exchange rate: The
value of one currency relative to another currency). An exchange rate is
determined by supply and demand factors in the FX markets.
In the case of Vietnam, the exchange rate regime has changed many times
due to both political and economical situation. Before 1989, Vietnam
followed a system of multiple exchange rates. The central bank created
several rates, which are the Commercial rate, Non-commercial rate and
Basic rate. However, after the economic reformation in 1989 to shift the
economy to a market-oriented and decentralized system, Vietnam’s
exchange rate regime has evolved into a single announced rate, then to the
current system of a narrow adjustable band around the fixed rate, which is
set up on a daily basis as an interaction to the market forces (Nguyen Tran
Phuc and Nguyen Duc Tho ,2009) .The central of this policy is the nominal,
bilateral VND/USD exchange rate.
2. Strength
In Vietnam exchange rate regime, fixed exchange rate brings many
advantages for Vietnamese economy.
- Reduced risk in international trade: By maintaining a fixed rate, buyers
and sellers of goods internationally can agree a price and not be subject
to the risk of later changes in the exchange rate before contracts are
settled. The greater certainty should help encourage investment.
- Introduces discipline in economic management: As the burden or pain of
adjustment to equilibrium is thrown onto the domestic economy then
governments have a built-in incentive not to follow inflationary policies.
If they do, then unemployment and balance of payments problems are
certain to result as the economy becomes uncompetitive.
Moreover, free rate is also considered to be effective in Vietnam economy
that brings positive effects.
- Free rate can improve the balance of payment.
- Helps countries avoid exchange rate fluctuations among strong
currencies.
3. Weakness
Exchange rate regime (ERR) has always been a critical issue in
macroeconomic policy of each nation. In Vietnam, exchange rate regime not
only has significant influences on export and import, national debt and direct
investment attraction but also impacts on public confidence in the domestic
currency. Over years, Vietnamese ERR has revealed some weaknesses
besides achievements.
Before 1990s, Vietnam held the fixed exchange rate regimes. There were
many ERRs which were justified by the government; however, the gap
between the fixed and the actual ERR at this time was too big combining
with long maintenance of this policy resulting serious consequences on the
contemporary economy. On top of that, ERRs were decided with a view to
support for plans and purposes of the authority and did not follow the
economic principles. In fact, Vietnamese currency was overestimated in
comparison with actual situation; therefore, a lot of difficulties in the
exchange of money and control the financial system occurred.
From 1990 to 2007, the government has changed into the crawling pegged
ERR. By anchoring and converting VND into some foreign currencies,
which focuses on USD, government allowed others commercial banks to
decide the exchange rate provided that it could not excess or below the
bands based on the unified exchange rate. It was clear that this policy made
no encouragement on export as well as producing products for export. Due
to a narrow crawling band between banks in 2001, there was little
competition among banks, leading to a passive financial market. In
particular, State Bank faced difficulties in controlling the need and demand
for money.
Up to now, a managed floating exchange rate regime has been applied. It is
clearly stipulated in the Decree 70/2014/ND-CP that Vietnamese exchange
rate regime policy is the floating exchange rate regime managed by State
Bank of Vietnamese, which is determined on the basis of a basket of
currencies of countries that occur trade relations, loans, debt, investing with
Vietnam. 2008 witnessed a significant fluctuation in the exchange rate. From
2007, there was an increase in the number of investments into Vietnam,
which exceeded the amount of USD and raised the value of VND.
Nevertheless, the influence of recession in 2008 accompanying with high
inflation rate made the flow of investment inversed, causing the fluctuation
in the exchange rate. In the market, trade deficit, which was over 2 million
USD in this year, greatly impacted on the public confidence. They were
expected of Vietnamese currency devaluation and in fact, it happened in
2009.
4. Threats
Although Vietnamese State Bank has taken some actions to get the exchange
rate stable, it is difficult to foresee its trend. To avoid negative
consequences, State Bank has to control the money market as well as
applying risk management tools carefully. In another words, there are three
main pressures to be dealt with.
First and foremost, the key challenge is to create a more flexible exchange
rate framework to point out the disequilibrium in foreign exchange market.
In the first half of 2014, there were active developments in global economy,
especially the recovery of some leading countries after recession; however
core challenges have not been solved entirely. For instance, high
unemployment rate and unsolved public debt issue can greatly affect trade
activities domestically, causing the movements of the investment.
Undoubtedly, the result is difficulties in controlling exchange rate regime
without causing rate fluctuation as well as devaluation of VND.
Secondly, Vietnamese potential development is on the downward trend. The
economy is mainly based on export while the domestic buying power is
weak along with the threat of high inflation. On top of that, high level of bad
debt and pressure of budget deficit pushing a big question: whether adjusting
exchange rare regime is a good method to encourage export and deduct
import? In fact, 70-80% of materials needed to produce products for
exporting is imported, which is mainly depended on the fluctuation of price
and market demand. Therefore, growth in the exchange rate would help
boosting export and decreasing the dependence on international market.
However, the national debt is mainly from foreign countries, increasing the
rate means the risk of interest rate rises also. For this reason, exchange rate
justification needs to be put under careful consideration.
Thirdly, expectations play an important role in managing the exchange rate
regime. Public still expect the domestic currency to be devalued, which
results in market unstableness. How to increase the value of VND and build
a positive public confidence are challenged. Undoubtedly, it is necessary to
change the public beliefs in the domestic currency since they tend to reserve
gold and foreign currencies while the foreign currency reservation of State
Bank is not strong. Hence, the problem of improvement of foreign
currencies reservation system to quickly response to dynamic environment
should be concerned as a result.
II. Exchange rate regime of China and Australia.
1. Australia’s exchange rate regime.
Since 1971, Australia has changed its exchange rate policy many times. In
the period of 1971-1976, it followed a fixed exchange rate regime with
different pegs, from USD to basket of foreign currency to reduce the
Australia Dollar’s exposure to the USD’s fluctuation. From 1976 to 1983,
Australia’s exchange rate regime changed to a crawling peg regime,
allowing the exchange rate to be adjusted on a daily basis. At first, the
adjustment was small and not very frequent. However, the crawling pegs
become larger and more frequent as it was clear that they were insufficient
to give the Reserve Bank control to the monetary situation of a volatile
capital flow. From 1983 until now, Australia’s exchange rate has floated
freely. The Reserve Bank occasionally intervenes but no longer sought to
change the exchange rate. This has left the Bank free to set domestic
monetary conditions without having to deal simultaneously with the effects
of capital flows on domestic monetary conditions. Changes in the exchange
rate, whatever their source, have been less destabilising than the volatility in
domestic financial conditions Australia experienced under earlier fixed-rate
regimes. The economy has coped relatively well with large movements in
the exchange rate; indeed they have been an important part of adjustment to
substantial changes in the terms of trade, both upwards and downwards. As
noted above, when the exchange rate has fallen sharply, the pass through
into domestic prices has not been as great as was initially expected. There
have been a number of factors behind this result, including more competitive
product markets both in Australia and abroad, and an increasingly more
flexible industrial relations system in Australia.
2. China’s exchange rate regime
From 1994 to 2005, China followed a purely fixed exchange regime when
the yuan was pegged to US dollar at 8.28 to the dollar. At 2005, China
announced a revaluation of the yuan and pegged it to a basket of foreign
currency, including USD, EUR, Japanese yen and Korean won. This
reformation created a “managed float” or a crawling peg. This regime
resembles a hybrid between a fixed regime and a free float regime. In China
case, the yuan is expected to appreciate as in a free float regime. However,
like in a fixed system, Beijing actively controls how fast the value of the
yuan rises. From July 2005 to February 2010, the yuan appreciated 17.5
percent against the U.S. dollar. Many U.S policy makers argue that the yuan
is still undervalued than it would be under a completely free floating
exchange system. Chinese policy makers suppress the value of yuan to boost
their economy growth. The low value of the yuan makes exports cheaper,
boosting China’s export-led growth. In 2007, China was the second largest
exporter in the world with over $1.22 trillion in exports. The high growth
also provide new job for new entrant in the labor force, resulting from the
reformation of a mainly state-owned economy to a more capitalist oriented
ones. This policy keeps social unrest at bay. However, to achieve this goal
with a population of over a billion, Beijing estimates a minimum of 8%
annual growth in GDP. To sustain such growth, they need to continue to
devalue their currency,
III. Effects to economic prosperity:
In order to study about the effects of exchange rate regime to economic
prosperity in Vietnam, three main issues will be discussed: inflation, balance
of trade and international investment. These elements have two- sided
influence on exchange rate, negative and positive.
1. Negative:
In theory, the change in exchange rate may cause damage to economy. The
amount of trading domestic money in an inflation country may decrease
while the foreign products and services have lower price than local ones.
This situation results in the increase in using foreign products among
residents. Apparently, the import will grow, which raise the exchange rate.
The residents will turn into storing assets by foreign units and the value of
domestic unit will fall.
In one side, the rise in import may turn Vietnam into a deficit country, which
will harm to the development of Vietnamese economy. The increases in
exchange rate will the situation of not using Vietnam products of foreign
customers.
In other side, because Vietnam has already been in inflation, the rise in
exchange rate cannot be avoided. However, this increase does not affect
much on Vietnamese economy. Although the total import is 150% for
essential products for producing, the real cost of importer will not be
influenced by the change in exchange rate because they have to buy USD in
black market. According to Mr.Tran Hoang Ngan, This effect will no be a
concern for Vietnamese macroeconomics.
In conclusion, the exchange rate regime has negative effect mainly on the
international trading. The import will exceed the export, which causes a big
loses to domestic organization. Additionally, a country cannot survive based
on import.
2. Positive:
There are two sides to everything; the exchange rate regime is not an
exception. This part, positive effect will be introduced.
The downward in value of VND is an advantage in international trading.
Vietnamese products and services may be more competitive than same
quality and higher price products. As a result, the regime adjust exchange
rate, which benefit export, especially the agriculture (rice and seafood).
Foreign residents view Vietnamese rice and seafood as top shopping list. In
addition, the cost of products is fixed so the revenue of exporter will be
raised. The export - organization gains the competitive and income
advantages.
The second influence is that the ratio between import and export will
decrease. The amount of import is constant, while the export rises. These
helps the Vietnam trading is approximately in balance.
Therefore, these positive effects are not macro but micro. Subsequently, they
do not benefit too much in Vietnam market. In a near future, Vietnam needs
a more effective solution for it.
III.Conclusion:
Vietnam has joined WTO in the recent year. This case not only provides the
opportunity in international trading but also causes some disadvantages to
local market. Apparently, exchange rate regime take an important role in
Vietnamese market. Besides the positive effect, Vietnam regime has some
negative influence. Vietnam economists have to try harder to solve these
problems. Because of lacking experience in economics, we should learn the
lessons from another countries such as: Britain, USA or Japan, who has a
long history in managing trading market.
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