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Vietnam’s exchange rate regime

ContentsA. Introduction.....................................................................................................................................2

B. Discussion............................................................................................................................................3

I. Vietnam’s exchange rate regime.........................................................................................................3

1. Definition.............................................................................................................................................3

2. Strength...............................................................................................................................................4

3. Weakness............................................................................................................................................5

4. Threats.................................................................................................................................................6

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.

References:

Nguyen Tran Phuc, Nguyen Duc Tho, 2009, 'Exchange Rate Policy in Vietnam,

1985-2008', ASEAN Economic Bulletin, Vol. 26, No. 2, pp. 37-63.

http://www.vietinbank.vn/web/home/vn/research/10/100917.html

http://vepr.ueb.edu.vn/upload/Colombo/533/20120831/173.pdf

http://www.tinkinhte.com/tai-chinh-dau-tu/phan-tich-nhan-dinh/chinh-sach-tien-

te-dieu-chinh-ty-gia-hoi-doai-va-nhung-tac-dong.nd5-dt.87018.123131.html

Morrison, Wayne M, and Marc Labonte, 2008, “China’s Currency: Economic Issues and Options for US Trade Policy,” CRS Report for Congress, Washington, Congressional Research Service.

Morrison, Wayne M, 2008, “China's Economic Conditions,” CRS Report for Congress, Washington, Congressional Research Service.

Central Intelligence Agency, 2008, “China”, The World Factbook, https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html#Econ.

The Economist, 2008, “The great wall of unemployed”, http://www.economist.com/finance/displaystory.cfm?story_id=12677296.