Banking Academy Graduation Thesis STATE BANK OF VIETNAM BANKING ACADEMY Foreign Language Faculty ---------- GRADUATION THESIS DOLLARIZATION IN VIETNAM IMPACTS AND SOLUTIONS Lecturer : Nguyen Thi Hong Mai (M.A) Student : Nguyen Thi Khanh Huyen Class : K14-ATCB Student Code : 14A7510092 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis ACKNOWLEDMENT First and foremost, I would like to express my deepest gratitude to my supervisor, Mrs. Nguyen Thi Hong Mai, for her excellent guidance, caring, patience, and providing me with an excellent atmosphere for doing the research. Besides, I also would like to extend my special thanks to all the lecturers in Banking Academy, especially lecturers of Foreign Language Department, who provided me with useful background knowledge during the last four years. Finally, this project is dedicated to my family, who is always supporting me and encouraging me with their best wishes.
They always there cheering me up and standing by me through good or bad times. Although this research was carefully prepared, I am still aware of its limitations and shortcomings due to time constraints and my limited capacity. It would be my pleasure to receive any comments and suggestions on the thesis in order to have better projects in the future. Sincerely Hanoi, June 2015 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis ABSTRACT This paper assesses the benefits and risks associated with dollarization as well as its impacts.
In fact, dollarization has been a common issue in Vietnam ever since 1988 with the stepping stone of foreign currency deposit allowance in the banking system. Considering dollarization in three perspectives including the use of US dollars in the society, the proportion of foreign currency deposits and credits, it is undeniable that Vietnam’s economy has been dollarized. Especially, the situation is even worse when Vietnam became a member of the world trade organization (WTO). Therefore, researchs on the issue has been in great demand to clarify a number of issues: What is Dollarization? What are the forms of dollarization? Is it good or bad for the economy and whether it should be completely eliminated? How it impacts the economy? Guidelines to promote the positive influences and limit the negative impacts of dollarization? With the purpose of providing a better overview of dollarization for those who are interested, the topic "Dollarization and the situation of Vietnam” was selected by the author as the subject for graduation thesis.
Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis TABLE OF CONTENT ACKNOWLEDGEMENT……. TABLE OF CONTENTS…………. LIST OF FIGURES AND TABLES………………. LIST OF ABBREVIATIONS………….2 CHAPTER 1: OVERVIEW OF DOLLARIZATION………………………………….1 The concept of dollarization…………………………………………………………3 1.2 Classification of dollarization………………………………………………….3 Measurement of dollarization……………………………………………….………6 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis 1.4 Origins of dollarization…………………………………………………………….5 Impacts of dollarization………….13 CHAPTER 2: DOLLARIZATION IN VIETNAM………………………………….1 Dollarization situation in Vietnam……………….1 Dollarization in the past…………………………………………………………….2 Dollarization in recent years……………………………………………………….2 Impacts of dollarization in Vietnam……………………………………………….1 Impacts on the economy………………………………………………….2 Impacts on the banking system…………………………………………………….3 Impacts on the government’s policy operations ………………………………….31 CHAPTER 3: RECOMMENDATIONS AND SUGGESTED SOLUTIONS……….1 Assessment of current dedollarization measures………………………………….1 VND position improvement……………………………………………………….2 Foreign exchange management………………………………………………….48 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis LIST OF FIGURES AND TABLES LIST OF TABLES Table 1.
Effective broad money……………………………………………………….…7 Table 2: Total exports and imports of Vietnam from 1996 to 2013…………………….28 LIST OF FIGURES Figure 1: Hyperinflation in Vietnam in the 1980s………………………………………18 Figure 2: Dollarization ratio in Vietnam from 1989 to 2003……………………………19 Figure 3: The inflation rate from 1989 to 2003 in Vietnam…………………………….20 Figure 4: Dollarization level in Vietnam from 2000 – 2014 (percent)………………….22 Figure 5: Exports - Imports and trade of balance in Vietnam from 2004 to 2014……….25 Figure 6: International funds inflows in Vietnam from 1995 to 2012………………….26 Figure 7: International visits in Vietnam from 2000 – 2010……………………….29 Figure 8: Foreign currency in circulation from 1996 to 2009 (million USD)……………32 Figure 9: Interest rate on VND and USD deposit from 2009 to 2013………….……… 36 Figure 10: Exchange rate movements from 2012 to 2014……………………………….37 Figure 11: Changes in FCDS and Foreign currency credits from 2001-2014……………38 Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis LIST OF ABBREVIATIONS ADB Asian Development Bank CPI Consumer Price Index FCC Foreign Currency In Circulation FCD Foreign Currency Deposit FDI Foreign Direct Investment FPI Foreign Portfolio Investment GSO General Statistics Office IMF International Monetary Fund ODA Official Development Assisstance OMO Open Market Operation SBV State Bank Of Vietnam Nguyễn Thị Khánh Huyền K14 - ATCB Banking Academy Graduation Thesis INTRODUCTION Background Dollarization is a common and unavoidable phenomenon of developing countries with high inflation rates and weak local currencies. In fact, foreign currencies have been widely used in trading in Vietnam since 1988 when commercial banks were allowed to accept deposits in foreign currency. By 1992, the status of dollarization reached its highest level of 41%. Since then, although dollarization situation has been improved to some extent, its complicated movements have posed certain influences on the operation of both the economy in general and the banking sector in particular.
My graduation project aims to discover dollarization and its impacts on the performance of Vietnam's economy; thereby, finding solutions to handle the problem. Research Objectives The thesis deeply focuses on how dollarization works, its impact and influences on Vietnam’s economy; thereby introducing solutions for the situation. Methodology In this thesis, with the purpose of making it more reliable, I approach the subject in many different methods including dialectical materialism method, data collection method, statistical method, comparison method etc. Data source The analysis is carried out based on highly authorized sources of information including State bank of Vietnam Annual Reports, General Statistics Office of Vietnam, IMF Working Papers, and other reputable articles and researches of reliable market data providers.
Nguyễn Thị Khánh Huyền 1 K14 - ATCB Banking Academy Graduation Thesis Research question The thesis aspires to reveal the answers for the following questions: What is dollarization? How does dollarization influence Vietnam’s economy? What are the solutions to eliminate and reduce the impacts of dollarization in Vietnam? Nguyễn Thị Khánh Huyền 2 K14 - ATCB Banking Academy Graduation Thesis CHAPTER 1 OVERVIEW OF DOLLARIZATION 1.1 THE CONCEPT OF DOLLARIZATION According to Connie Mack in “Basics of dollarization”, dollarization occurs when residents of a country extensively use a foreign currency alongside or instead of the domestic currency, in order to replace one or more of the money functions including medium of exchange, unit of account and store of value. Additionally, International Monetary Fund (IMF) gives the definition of dollarization as “the holding by residents of a significant share of their assets in the form of foreign- currency-denominated assets…” and “…is a common feature of developing countries and transition economies and is thereby typical -to a greater or lesser extent -of many countries that have IMF-supported adjustment programs”. Normally, each independent nation had its own currency as a symbol of sovereignty. However, in the process of integration, national currencies have been weakening or even disappearing.
In reality, the term “dollarization” refers to not only the use of US dollar but also include other strong currencies such as British pound and Japanese yen. However, the US dollar has been taking over as the world's currency of account. Much trade is now dollar- based, countries prefer to hold their central bank reserves in US dollars, and private companies as well as wealthy citizens often hold dollars or dollar-denominated assets. Therefore, dollarization normally refers to the use of US dollar.
In Vietnam, dollarization implies the dominant of US dollar as a type of the second most popular currency, followed only by VND, the domestic currency. Nguyễn Thị Khánh Huyền 3 K14 - ATCB Banking Academy Graduation Thesis Dollarization is a common issue in countries with low starting point and in the process of transition. Eliminating dollarization does not guarantee a better economical environment. In spite of some disadvantages, which will be mentioned later, dollarization should be kept at a proper and stable level (similar to the situation of inflation), so that it could become a simulative component in the process of development.2 CLASSIFCATION OF DOLLARIZATION Dollarization is classified into three types included unofficial dollarization, semiofficial dollarization, and official dollarization.1 Official (de jure) dollarization Official dollarization occurs when a specific foreign currency is considered the only legal tender, approved by the government.
Official or de jure dollarization has existed in many countries (see Appendix 1). Argentina, Ecuador and Panama are the most well - known examples of full dollarization. In these countries, it is legal to use foreign currencies in both private entity transactions and government payments. If the domestic currency ever exists, it only plays a minor role with relative small denominations.
By going full dollarization, these countries can gain benefits from lower transaction costs, which are the costs of exchanging on currency for another or converting domestic into foreign currency. Besides, officially - dollarized economies will be able to keep their inflation rate to or similar to the inflation rate of nations of which foreign currencies are originated from. However, the pitfall of formalizing dollarization is that these governments may lose their control over monetary policy.2 Unofficial (de facto) dollarization Unofficial dollarization takes place when a typical foreign currency is widely used in an economy, although the use of that currency is not officially accepted. The situation happens in many developing countries which have high inflation rate and the belief of citizens on the country’s monetary policy is low.
In these countries, people tend to keep and use foreign Nguyễn Thị Khánh Huyền 4 K14 - ATCB Banking Academy Graduation Thesis currency in many ways, without a legal approval, in order to avoid the fluctuation of their asset’s values due to inflation. It means that foreign currencies are not accepted in payments in general but individuals still hold them. A typical example of unofficially-dollarized economy is Vietnam. According to IMF, dollarization in Vietnam is unofficial dollarization because U.S dollar is widely use and accepted in transactions in Vietnam, however Vietnam’s government does not consider U.S dollar as Vietnam legal tender.
The domestic currency is commonly used in daily transactions. However, in terms of value storage, people would prefer keeping the US dollar, marking the born of the gray market. Since people tend to keep foreign currency without legal approval, it would be very difficult to determine a precise degree of dollarization. The amount of foreign currency in unofficially-dollarized countries is mostly in form of cash held, some others are in bond and bank deposits; therefore, the foreign currency in circulation is hardly observable.3 Semi dollarization Semiofficially dollarized countries are those that the IMF (1998) identifies as having foreign currency as "other legal tender," meaning that foreign currency circulates widely but plays a secondary legal role to the domestic currency.
A few other countries, notably Argentina and Bolivia, allow foreign currency a legal role but apparently not as extensive as in semiofficially dollarized countries. Additionally, semi-official dollarization can be known as a country using both its own currency and the U. dollar interchangeably as legal tender. Under semi-official dollarization, foreign currency is legal tender and may even dominate bank deposits, but plays a secondary role to domestic currency in paying wages, taxes, and everyday expenses such as grocery and electric bills.
The latter does not happen in official dollarization where the payments and the everyday expenses are released in the foreign currency, usually the U. For example, Lebanon and Cambodia are two countries which are considered as semi-official dollarization. Nguyễn Thị Khánh Huyền 5 K14 - ATCB Banking Academy Graduation Thesis 1.3 MEASUREMENT OF DOLLARIZATION 1.1 Nominal indicator Economists have computed the dollarization ratio in nominal terms as a ratio of FCDs (foreign currency deposits) to broad money in which broad money referred to currency in circulation, demand deposit, time deposit and foreign currency deposit. Dollarization index (DI): DI = FCD/BM Pursuant to IMF’s criteria, a country with high level of dollarization has more than 30% of the broad money (M2) in FCD.