MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY PHAM THI TUYET TRINH THE IMPACT OF EXCHANGE RATE FLUCTUATION ON TRADE BALANCE IN SHORT AND LONG RUN THESIS OF MASTER IN ECONOMICS HO CHI MINH CITY – 2011 TIEU LUAN MOI download : skknchat@gmail.com MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY PHAM THI TUYET TRINH THE IMPACT OF EXCHANGE RATE FLUCTUATION ON TRADE BALANCE IN SHORT AND LONG RUN Major: Finance and Banking Major code: 60.12 THESIS OF MASTER IN ECONOMICS ACADEMIC SUPERVISOR: Ph.D NGUYEN VAN PHUC HO CHI MINH CITY – 2011 TIEU LUAN MOI download : skknchat@gmail.com ACKNOWLEDGEMENTS I would like to send special thanks to all the teachers who gave interesting lecture to me for their devoted instruction during my studying in this master course. I am specially thankful to Ms. Ha Thi Thieu Dao for her precious data without which I could not finish this study and for her carefully reading, editing and detailed comments on my study. I express my profound sense of gratitude and sincere thanks to Mr.
Nguyen Van Phuc, academic supervisor, for suggesting research problems, giving valuable guidance and providing constant encouragement. I am particularly indebted to my family, especially my mother and my daughter, who have given me great emotion and encouragement. i TIEU LUAN MOI download : skknchat@gmail.com ABSTRACT This study shows the short and long-run impact of exchange rate on trade balance in Vietnam. Following a depreciation of real exchange rate, trade balance initially deteriorates.
Trade balance will improve after two quarters and new equilibrium will be set after twelve quarters. Johansen’s cointegration analysis and autoregressive distributed lag (ADRL) are respectively used to explore long-run impact, giving similar estimation results, showing trade balance improvement following a depreciation. Corresponding error correction modes (ECM) based on long-run cointegration equations also come to consistent results, indicating immediate deterioration of trade balance after a depreciation. Impulse response functions based on ECM and unrestricted Vector AutoRegression (VAR) exhibit J-curve pattern of trade balance when there is a permanent depreciation.
Key word: exchange rate and trade balance, cointegration, autoregressive distributed lag, J-curve ii TIEU LUAN MOI download : skknchat@gmail.com CONTENTS Acknowledgement. iii List of tables. vii List of figures. ix CHAPTER 1: INTRODUCTION 1.1 Background to the study and statement of problem.
Organization of the study. 3 CHAPTER 2: LITERATURE REVIEW 2. General arguments about exchange rate. Exchange rate concepts.
Nominal exchange rate and real exchange rate. Bilateral nominal and real exchange rate. Real effective exchange rate. Main determinants of exchange rate movement.
Differential in inflation. Terms of trade. Differential in interest rates. Political stability and economic performance.
Condition of balance of payment. Trade balance concepts. Trade balance as an account on the balance of payment. Determinants of trade balance.
12 iii TIEU LUAN MOI download : skknchat@gmail. Relationship between exchange rate and trade balance. The elasticities approach. Marshall-Lerner condition.
The J-curve effect. Keynesians multiplier approach. Brief of empirical studies on developed countries. Brief of empirical studies on developing countries.
Summary of empirical studies on Vietnam. The role of exchange rate policy to trade balance. Exchange rate policy concepts. Exchange rate regimes.
Instruments of exchange rate policy. The importance of exchange rate policy to trade balance. 26 CHAPTER 3: PERFORMANACE OF TRADE BALANCE AND EXCHANGE RATE IN VIETNAM IN 2000-2010 3. The background of Vietnam’s economy in 2000-2010 period.
The performance of trade balance in 2000-2010 period. In terms of value. In terms of structure by products. In terms of structure by trading partners.
The fluctuation of exchange rate in 2000-2010 period. Nominal exchange rate under management of The State bank of Vietnam and the role of US Dollar. Movement of real exchange rates. 41 iv TIEU LUAN MOI download : skknchat@gmail.
Real exchange rates computation. Analysis bilateral real exchange rate and real effective exchange rate. 48 CHAPTER 4: ESTIMATING THE IMPACT OF REAL EXCHANGE RATE ON TRADE BALANCE IN VIETNAM IN 2000-2010 4. Technical data description.
Econometric characteristics of the data. Model for estimation. Estimation of long-run effect. Johansen’s cointegration analysis.
Autoregressive distributed lag (ARDL) approach. Estimation of short-run effect. Error-correction model (ECM). 67 CHATER 5: CONCLUSION AND POLICY RECOMMENDATION 5.
Exchange rate policy should take into account trade competitiveness. Determining value of VND based on currency basket. Establishing condition for a successful depreciation. Depreciating currency to improve trade balance.
78 v TIEU LUAN MOI download : skknchat@gmail. 80 APPENDIX A: REER computation. 86 APPENDIX B: Estimation output and relevant test for long-run impact of real exchange rate on trade balance. 99 APPENDIX C: Estimation output of Johansen’s cointegration test for long- run impact of real exchange rate on exports and imports.
102 APPENDIX D: Output of ECM model estimation based on cointegrating equation obtained by Johansen’s procedure and ARDL approach. 103 APPENDIX E: Narayan’s new set of critical values for the bound F-test. 106 vi TIEU LUAN MOI download : skknchat@gmail.com LIST OF TABLES Table 2. Exchange rate regime classification by IMF.
GDP, Inflation, FDI, FII, ODA, Current transfer in 2000-2010. Structure of exports by foreign trade standard in 2000-2010. Structure of imports in 2000-2010. Trade balances (million USD) with 17 largest trading partners.
Real exchange rates of some currencies. Fluctuation bands applied from 1999-2010. Nominal exchange rate between VND and USD in 2000-2010. VND/USD RER and REER.
ADF and PP tests results for non-stationarity of variables. Correlation matrix of variables. Cointegration Rank Test: Trace and Maximum Eigenvalue Statistics. Granger Causality Test in Vector AutoRegression (VAR).
Statistic of selecting lag order (SBC and AIC) and F-Statisctics for testing the existence of a levels trade balance equation. Estimated ARDL(2,3,0) model. Ramsay RESET test for estimated ARDL(2,3,0) model. Breusch-Godfrey Serial Correlation LM Test for estimated ARDL(2,3,0) model.
ECM for trade balance based Johansen’s procedure. ECM for trade balance based on ARDL (2,3,0). Breusch-Godfrey Serial Correlation LM Test for ECM. Ramsey RESET Test for ECM.
Impulse response of trade balance following real exchange rate shock. Shares of main trading partners (percent) of neighboring countries, 2004. 72 vii TIEU LUAN MOI download : skknchat@gmail.com LIST OF FIGURES Figure 2. The J-curve effect.
The trade balance, current account of Vietnam in 2000-2010. Values of exports and imports (million USD) in 2000-2010. Growth of export and import (percent) in 2000-2010. Trade balance in FOB prices and CIF prices in 2000-2010.
VND/USD exchange rate and trade balance in 2000-2010. RER and trade balance. VND/USD RER, VND’s REER and USD’s REER. REER and trade balance with major trading partners.
Series used in empirical analysis: TB, REER, GDP,GDP*. Seasonally adjusted series: TB, REER, GDP,GDP*. CUSUM test for estimated ARDL(2,3,0) model. CUSUM Test for ECM.
Evolution of trade balance following real depreciation. VND/USD exchange rate and RER, NEER, REER of VND 2000-2010. NEER, REER of some countries. 79 viii TIEU LUAN MOI download : skknchat@gmail.com ABBREVIATION ADB: Asian Development Bank ADF: Augmented Dickey-Fuller ADRL: Autoregressive Distributed Lag AIC: Akaike Information Criterion CPI: Consumer Price Index ECM: Error Correction Model GDP: Gross Domestic Product GSO: General Statistical Office IFS: International Financial Statistics IMF: International Monetary Fund NEER: Nominal Effective Exchange Rate NER: Bilateral Nominal Exchange Rate OECD: Organization for Economic Cooperation and Development PP: Phillips-Perron PPI: Producer Price Index REER: Real Effective Exchange Rate RER: Bilateral Real Exchange Rate SBC: Schwarz Bayesian Criterion SBV: State Bank of Vietnam TB: Trade Balance USD: United States Dollar VAR: Vector AutoRegression VND: Vietnam Dong WPI: Wholesale Price Index ix TIEU LUAN MOI download : skknchat@gmail.com CHAPTER 1 INTRODUCTION 1.
Background to the study and statement of problem Vietnam is a young open economy on the process of industrialization in which exports are considered to be motivation for developing. The export-driven industrialization of Vietnam has achieved success with impressive increase in export volume at 20 percent on annual average during the past ten years. However, that figure is still lower than annual average increase of import volume for the same period, about 22 percent, which leads to lasting trade-balance deficit. The performance of Vietnam’s trade balance is the consequence of low competitiveness which could be changed by two approaches: internal and external.
While internal approach relies on supply-side policies such as influencing labor productivity or wages, the latter deals with exchange rate policy to devaluating/ appreciating local currency against foreign currencies. In this study, we take the latter approach to explore the trade balance. In literature, there are many empirical studies focusing on the relationship between exchange rate and trade balance which have come to various conclusions. Some studies show undeniable evidences on long-run and short-run relationships between exchange rate and trade balance.
Some come to contrary conclusion that there is no relation between them. The others conclude existing relation in the long run but not in the short run. Reasons standing behind these different results mainly rest on countries, observation periods and econometrics methodologies employed. However, all researches concluding that exchange rate fluctuation has significant influence on trade balance also prove that depreciation would increase export, restrain import, and improve trade balance.
In Vietnam, since trade-balance deficit became serious, some researchers have turned their attention to examine the role of exchange rate. Although most studies conclude the fluctuation of exchange rate in Vietnam has impacts on trade balance in the long run, the short-run impact is still an open question. Besides, the most popular 1 TIEU LUAN MOI download : skknchat@gmail.com method used to explore relationship between exchange rate and trade balance in global literature has not been applied for the case of Vietnam. The traditional method as Ordinary Least Square (OLS) which is popularly used in studies in Vietnam on exchange rate-trade balance relationship is proved to be inappropriate to explore this relationship because of time series’ characteristics.
The purpose of this thesis is to find a robust and reliable quantitative relationship between exchange rate and trade balance for Vietnam’s case. In order words, the thesis examines the role of exchange rate in long-lasting trade deficit. Based on its exploration, the thesis also proposes solutions in order to improve the trade balance by using exchange rate measurement. Research question The study tries to explore complete impact of exchange rate on trade balance in both short and long run.
Correspondingly, the study aims to answer the following questions: 1. Whether there is a stable long-run relationship between the exchange rate and the trade balance of Vietnam? If that stable long-run relationship does exist, whether a permanent depreciation of exchange rate would lead to improvement of the trade balance? 2. Whether depreciation of exchange rate causes negative short-run impact on trade balance? How long does it take for positive impact of that depreciation to occur? (Does J-curve effect exist in Vietnam’s exchange rate-trade balance relationship?). What are the solutions to improve the trade balance of Vietnam by using exchange rate tool? 1.3 Research objectives To answer research questions, the study proceeds - To calculate real effective exchange rate (REER) of Vietnam Dong against main trading partners’ currency as a proxy for measuring the competitiveness of merchandise trade.
2 TIEU LUAN MOI download : skknchat@gmail.com - To test the robust relationship between REER and trade balance and estimate the responsiveness of trade balance to REER fluctuation in the long-run. - To test the existence of negative short-run impact of REER depreciation on trade balance and measure the duration of negative short-run impact as well as estimate the time for trade balance to setup a new equilibrium level.