THE IMPACTS OF VIETNAMS EXCHANGE RATE POLICY ON TRADE ACTIVITIES IN THE CONTEXT OF ECONOMIC INTEGRATION

VIETNAM NATIONAL UNIVERSITY
UNIVERSITY OF ECONOMICS AND BUSINESS
FACULTY OF INTERNATIONAL BUSINESS AND ECONOMICS

BACHELOR THESIS
THE IMPACTS OF VIETNAM'S EXCHANGE RATE POLICY ON
TRADE ACTIVITIES IN THE CONTEXT OF ECONOMIC
INTEGRATION

Supervisor’s name: Nguyen Cam Nhung
Student’s name: Phan Thanh Thao
Student ID: 14050162
Intake: QH-2014-E KTQT CLC
Program: Honours

Hanoi – April, 2018


TABLE OF CONTENT
ACKNOWLEDGEMENTS
LIST OF ABBREVIATIONS
LIST OF TABLES
INTRODUCTION .....................................................................................................1
1. Rationale .............................................................................................................1
2. Literature review .................................................................................................1
3. Objectives of the research ..................................................................................3
4. Subject and scope of the research ......................................................................4
5. Research structure ..............................................................................................4
CHAPTER 1. THEORETICAL FRAMEWORK OF EXCHANGE RATE
AND BALANCE OF TRADE ..................................................................................5
1.1 Theoretical framework of exchange rate.........................................................5

1.1.1 The concept of exchange rate .....................................................................5
1.1.2 Quoted and base currencies .......................................................................6
1.1.3 Exchange rate classification .......................................................................7
1.1.4 Exchange rate remiges ...............................................................................9
1.2 Balance of Trade ............................................................................................11
1.2.1 The concept of trade balance ....................................................................11
1.2.2 States of trade balance..............................................................................12
1.2.3 Factors affecting Trade balance in Vietnam ............................................13
1.3 The impacts of exchange rate on trade balance ............................................14
CHAPTER 2. THE OVERVIEW OF VIETNAM’S EXCHANGE RATE
REMIGE AND TRADE PERFORMANCE .........................................................19
2.1 Exchange rate policy in Vietnam ...................................................................19
2.1.1 The 2007-2009 period...............................................................................21
2.1.2 The 2010-2015 period...............................................................................24
2.1.3 The 2016-2017 period...............................................................................30
2.1.4 Compare the nominal exchange rate and the real exchange rate ............31
2.2 Overview of Vietnam’s trade balance ............................................................33
2.2.1 The 2007-2010 period...............................................................................36
2.2.2 The 2011-2015 period...............................................................................40
2.2.3 The 2016-2017 period...............................................................................43
2.3 Assessing the relationship between exchange rates and trading activities in
Vietnam .................................................................................................................44
2.3.1 The 2007-2010 period...............................................................................44
2.3.2 The 2011-2015 period...............................................................................46
2.3.3 The 2016-2017 period...............................................................................47
CHAPTER 3: METHODOLOGY AND EMPIRICAL RESULTS ...................49


3.1 Methodology....................................................................................................49
3.2 Data .................................................................................................................50

3.3 Empirical results .............................................................................................51
CHAPTER 4. SOME IMPLICATIONS FOR THE EXCHANGE RATE
POLICY AND TRADE ACTIVITIES IN VIETNAM ........................................55
3.1. Implications for Vietnam's current exchange rate policy ...........................55
3.2. Implications for Vietnam's current trade .....................................................56
REFERENCES ........................................................................................................59


ACKNOWLEDGEMENTS
First of all, I sincerely thank the teachers of the University of Economics VNU and the Faculty of Economics and International Business for facilitating me to
complete this research topic.
In particular, I would like to send my sincere thanks to Dr. Nguyen Cam
Nhung. Throughout the course of the study, she devoted herself to helping and
directing me directly. Thus, not only can I acquire more useful knowledge but also
have the opportunity to study the spirit of scientific work seriously and effectively.
This is very necessary for me in the learning process and future work.
Due to limited time frame as well as limited qualifications, this paper is
inevitable to the defects. I do hope that teachers and friends will share and give
suggestions for this paper to be completed.


LIST OF ABBREVIATIONS
No.

Abbreviation

1

BOT

Blance of trade

2

BOP

Balance of payment

3

IMF

International Monetary Fund

4

SBV

State Bank of Vietnam

5

USD

United States dollar

6

VND

Vietnamese Dong

7

ECM

Error Correction Model

8

GSO

General Statistic Office


LIST OF TABLES
No.

Table
number

1

Table 1.1

2

Table 2.1

Name

Exchange rates between Vietnam Dong and
foreign currencies
Vietnam Trade Balance (1999-2017, Unit: Billion

Page

6

34

USD)
3

Table 2.2

Vietnam export - import and the exchange rate

44

period 2007-2010
4

Table 3.1

Data collection

51

5

Table 3.2

The summary of the ADF tests for a unit root

52

6

Table 3.3

The estimated long-run model result

52

7

Table 3.4

Result of cointergration test

53

8

Table 3.5

Results of estimates of ECM

54

LIST OF FIGURES

No.

Figure
number

1

Figure 1.1

2

Figure 2.1

3

Figure 2.2

4

Figure 2.3

5

Figure 2.4

6

Figure 2.5

7

Figure 2.6

8

Figure 2.7

9

Figure 2.8

Name

J-curve
Nominal exchange rate VND/USD in the
period 2000Q1-2017Q4
Nominal exchange rate VND/USD in 20072015
Exchange rate VND/USD and fluctuation
band, 2008-2009
VND/USD exchange rate movements in 2010
Nominal exchange rate VND/USD in from
2010Q1-2013Q4
Nominal exchange rate VND/USD in 2014 and
2015
Nominal exchange rate VND/USD in 2016
Nominal exchange rate VND/USD in 20162017

Page

17

21

21

23

25

25

28

30

30

Nominal exchange rates VND/USD and real
10

Figure 2.9

exchange rate in the period 2007-2016 (2010 is
the base year)

32

11

Figure 2.10

12

Figure 2.11

13

Figure 2.12

14

Figure 2.13

15

Figure 2.14

16

Figure 2.15

Vietnam’s NEER and REER in the period
2000-2017
Vietnam’s export, import and trade balance
in 1990-1998

Vietnam’s export and import performance
in 1999-2017 (Billion USD)
Trade Balance and Current Account of
Vietnam 2005-2008
Average Interbank Exchange Rate 20112015 (VND / USD)
Vietnam's

economic

growth 2010-2014 (%)

and

export-import

33

34

35

37

46

46


1

INTRODUCTION
1. Rationale
At present, international trade activities in which import and export activities
are always the top concern of open economies. Import and export are always
interested by almost all the countries, especially developing countries because this
is the shortest way to accumulate wealth, solve the debt burden for most countries in
the world.
Moreover, exchange rate has played a very important role in international
trade. It is considered an effective tool to promote international trade especially in
such a great open world economy and many countries pursue a development
strategy using exchange rate as a main intervention. However, the exchange rate is a
very sensitive macroeconomic variable because exchange rate fluctuates day by
day, and is influenced by many factors. Today's exchange rate may be different
from that of yesterday, the sudden rise and fall of the currency are always a new
problem for economic managers and investors.
When the authority adjusts the exchange rate, they will have to face other
unexpected impacts, given that there has existed twin deficits for a long time – trade
balance deficit and budget deficit.
So for Vietnam’s import and export, how does exchange rate fluctuation
affect? The study "The impacts of Vietnam's exchange rate policy on trade
activities in the context of economic integration" would clarify the problem.
2. Literature review
There is a wide range of literature focusing on investigating the relationship
between exchange rates and trade balance. In addition, there are also a number of
overseas literatures that examine the interaction between the two exchange rate
variables and the trade balance in the context of Vietnam's economic integration,


2

these researchs will give Vietnam better recommendations and solutions. The essay
divide the literatures into two main groups:
The first group: including the literatures that analyze basic theories of
exchange rate. In addition, some researchs show the current status of Vietnam's
exchange rate and trade policy in recent years. Some of literatures also focus on
providing long-term solustions to Vietnam's policy management. These research
papers have contributed much to the theoretic framework of this essay, which
includes the following typical research papers:
Krugman and Obstfeld (2001), Hatemi-J (2004) found evidence of J-curve
when investigating the impact of exchange rate on trade balance. The heart of Jcurve effect drawn from Marshall-Lerner condition is that the trade balance of a
country experiences the J-curve effect when the domestic currency is devaluated. At
first, the total value of imports increases due to higher price of imported goods, and
exceeds the total value of exports. This results in a trade balance deficit. However,
the devaluation increases demand for exports, resulting in higher level of exports.
Eventually, exports recover and bring back trade balance surplus.
The paper "Exchange rate policy: Which option for Vietnam?" By the group
of authors Pham The Anh, Dinh Tuan Minh (2014) clarified two objectives: the
exchange rate mechanism and its effects on trade balance, inflation and some other
macro variables in Vietnam; Basing on the arguments and analysis, the research
gives policy recommendations to promote the positive effect of exchange rate
policy on other variables.
The other paper in this group is "Solutions to enhance the role of exchange
rates in the integration process for the economy in Vietnam" by Nguyen Thi Tuyet
Nga, Ho Chi Minh City in 2012.
The second group: consists of quantitative research papers. Basing on the
reality of exchange rate fluctuations and import and export activities in Vietnam


3

over the years, that indicate the relationship between these two variables and offer
effective solutions.
The first paper is "Exchange Rate Policy and Impact of Exchange Rate Policy
on Vietnam Trade Balance from 1989 to 2013” by Le Thi Dong - Foreign Trade
University. The literature has clarified policies, changes in the exchange rate and
trade balance in Vietnam over the years. From that point of view, there are two
practical experiences that the exchange rate policy that is suitable for the open
economy and wide integration is flexible mechanism and able to cope with external
shocks. But an exchange rate policy that adapts to such external factors means
increasing fluctuations in the exchange rate and increasing the risk of capital
inflows into Vietnam, while risks are always the most sensitive variable to
negatively affect the investors
The second paper is the thesis "The trade balance of Vietnam in the process of
industrialization and modernization of the country" by Duong Duy Hung. Through
the detailed statistics on turnover, structure and status of trade balance over the
years, the author assessed the impact of factors such as exchange rate, international
trade policy, investment policy on the trade balance of Vietnam.
The third paper is “Lan Huong Hoang (2016) : The role of exchange rate in
supporting trade balance in Vietnam”. In this paper, the author applied a
multivariate Structural Vector Autoregressive (SVAR) and Vector Error correction
model (VECM) to analyze short-term and long-term effects of foreign exchange
rate on trade balance of Vietnam, using monthly data from 2004-2015. Then, author
suggested a number of policy implications to support policy makers in Vietnam.
3. Objectives of the research
Understanding the relationship between Vietnam’s exchange rate policy and
trade balance during the period from 2000 to 2017. Assessing the effectiveness of
exchange rate policy through the adjustments and changes in trade balance.


4

To achieve that objects, the paper should answer the following central research
questions:
• How did Central Bank implement exchange rate policies?
• Do exchange rate policies positively affect imports and exports?
• What is the relationship between exchange rate policy and trade balance in
Vietnam?
• Which exchange rate policy would be consistent with the international trade
practice in Vietnam?
4. Subject and scope of the research
Subject: Exchange rate VND/USD, export and import turnover, trade balance, real
effective exchange rate, the effect of exchange rate policies on trade balance over
the period from 2000Q1 to 2017Q4.
Scope of the research:
Space: Vietnam
Time: The period from 2000 to 2017, especially 2007-2017 period because of
joining the WTO in 2007, Vietnam’s trade relations have been more diversified.
5. Research structure
Besides the introduction, conclusion, the main content of the research is
structured in three chapters as follows:
CHAPTER 1. THEORETICAL FRAMEWORK OF EXCHANGE RATE AND
BALANCE OF TRADE
CHAPTER 2. THE OVERVIEW OF

EXCHANGE RATE AND VIETNAM

TRADE ACTIVITIES
CHAPTER 3. METHODOLOGY AND EMPIRICAL RESULTS
CHAPTER 4. SOME IMPLICATIONS FOR THE EXCHANGE RATE POLICY
AND TRADE ACTIVITIES IN VIETNAM

5

CHAPTER 1. THEORETICAL FRAMEWORK OF EXCHANGE RATE
AND BALANCE OF TRADE
1.1 Theoretical framework of exchange rate
1.1.1 The concept of exchange rate
Each country has its own currency, varying in size, shape, name ... for
example: US uses dollar, European Union countries use EURO, or Vietnam has
VND. Each country's money plays a very important role in boosting the exchange
of goods and merchandise within the country. However, along with the process of
regionalization and globalization, in order to promote trade between countries, it is
imperative to determine the value of one country's currency against another. This is
also a fundamental cause for the formation of exchange rates - as a tool for linking
currencies together, facilitating cross-border trade.
On that basis, the exchange rate (foreign exchange rate) is basically
understood as: “The price of one country’s currency in terms of another country’s
currency”1
Example: Exchange rate of VND vis-à-vis USD
USD 1 = VND 22725 (E = 22725)

1

Paul Krugman and Maurice Obstfeld, International Economics: Theory and Policy, 9 th Edition, Pearson,
2012


6

Table 1.1. Exchange rates between Vietnam Dong and foreign currencies
Exchange rate applied for 26/07/2017 (Unit: Vietnam Dong)
No. Foreign currency

Name of foreign currency

Bid

Ask

1

USD

US Dollar

22,725

23,086

2

EUR

Euro

25,333

26,900

3

JPY

Japanese Yen

194,28

206,29

Source: State Bank of Vietnam
So the bank will buy the dollar with the value of 22.725 VND and sell the
dollar with the value of 23.086 VND respectively.
1.1.2 Quoted and base currencies2
The term quoted currency means the currency that is variable in an exchange
rate quotation; the term base currency means the currency that is fixed. Thus in
GBP 1 = USD 1.7250, sterling (GBP) is base currency, and the US dollar is the
quoted currency. For convenience, the exchange rates are written as base/quoted, in
this case GBP/USD.
Direct quotation takes the form of variable amounts of domestic currency
against a fixed amount of foreign currency. The foreign currency is the base
currency. A Swiss bank quoting “85.5 Swiss francs per 100 Euro” would be quoting
direct – a variable amount of Swiss francs against a fixed euro amount.
Indirect quotation, conversely, takes the form of fixed amounts of domestic
currency against varying amounts of foreign currency. A British bank quoting
“GDP 1 = CHF 2.3575” is quoting indirect.

2

Julian Walmsley, The foreign exchange and money markets guide, 2 rd Eddition, 2000

7

Indirect quotation is usually used for GBP, USD, AUD, while direct quotation
is used for the other currencies. USD is the base currency of the other currencies,
except for EUR, GBP, AUD, NZD. (This thesis use direct quotation).
1.1.3 Exchange rate classification
There are many ways of dividing the exchange rate, however, in the scope of
analyzing the impact of the exchange rate on the trade balance between Vietnam
and the United States and on the basis of the influence of the exchange rate,
exchange rate is divided into nominal exchange rate, nominal effective exchange
rate, real exchange rate, real effective exchange rate.
Nominal exchange rate (NER)
The nominal exchange rate E is defined as the number of units of the domestic
currency that can purchase a unit of a given foreign currency. (The nominal
exchange rate is the exchange rate used daily on the foreign exchange market)
Example:
𝐸USD/€ = 1.3467
𝐸€/USD = 0.7425
Thus, 𝐸USD/€ = 1/𝐸€/USD . An increase in 𝐸USD/€ means a dollar depreciation. If a
currency can buy more (less) of another currency, we say it has been appreciated
(depreciated)
Nominal Effective Exchange Rate (NEER)
The nominal effective exchange rate is a measure of the value of a currency
against a weighted average of several foreign currencies. An increases in NEER
indicates an appreciation of the local currency against the weighted basket of
currencies of its trading partners.
Real exchange rate (RER)

8

The real exchange rate R is defined as the ratio of the price level abroad and
the domestic price level, where the foreign price level is converted into domestic
currency units via the current nominal exchange rate. (Real exchange rate is the
Nominal Exchange rate times the inverse of the relative price levels)
RER = 𝑁𝐸𝑅𝑡

𝑃∗𝑡
𝑃𝑡

Where
RER: Real exchange rate
NER : Nominal exchange rate
𝑃 ∗𝑡 : Foreign price level
𝑃𝑡 : Domestic price level
The real rate tells us how many times more or less goods and services can be
purchased abroad (after conversion into a foreign currency) than in the domestic
market for a given amount.
A decrease in RER is termed appreciation of the real exchange rate, an
increase is termed depreciation.
Real effective exchange rate (REER)
Real effective exchange rate is the nominal effective exchange rate (a measure of
the value of a currency against a weighted average of several foreign currencies)
divided by a price deflator or index of costs. An increase in REER implies that
exports become more expensive and imports become cheaper; therefore, an increase
indicates a loss in trade competitiveness.
𝑛

𝑅𝐸𝐸𝑅𝑡 = ∏(𝑅𝐸𝑅𝑖,𝑡 )𝑤𝑖,𝑡
𝑖=1

Where i=1….,n is trading partner country, 𝑤𝑖 is trade weight of country i in
the domestic country’s total exports, and t is time.


9

Rather than focusing on the nominal exchange rate, it is more sensible to
monitor the real exchange rate when assessing the effect of exchange rates on
international trade or export competitiveness of a country. For simplicity, assume
that the domestic price level rises by 10%, the foreign price level remains
unchanged and the domestic currency depreciates nominally by 10%. Then the real
exchange rate, i.e. the ratio of prices at home and abroad, remains unaffected,
depreciation of the domestic currency notwithstanding. Other things held equal,
there would be no change in the demand for imports in the domestic economy and
in the demand for exports of the domestic economy abroad.
1.1.4 Exchange rate remiges
An exchange rate regime is the system that a country’s monetary authority,
generally the central bank, adopts to establish the exchange rate of its own currency
against other currencies. Each country is free to adopt the exchange-rate regime that
it considers optimal, and will do so using mostly monetary and sometimes
even fiscal policies.
Fixed exchange regime: the government intervenes in the foreign exchange market
in order to keep the exchange rate at a fixed level.
Characteristics of fixed exchange regime:
In a fixed exchange rate regime, the domestic currency is tied to another
foreign currency, mostly more widespread currencies such as the USD, EURO,
GBP or a basket of currencies. In a fixed exchange rate system, the government (or

the central bank acting on the government's behalf) intervenes in the foreign
exchange market to ensure that the exchange rate stays close to a predetermined
target. Under this system, exchange rate stability is achieved but if the exchange
rate is fixed at the wrong rate it may be at the expense of domestic economic
stability.
In a fixed exchange rate system, a rise in the exchange rate of the domestic
currency vis-à-vis another foreign currency is called a devaluation. This means that


10

in order to buy 1 unit of a given foreign currency more of the domestic currency is
needed. On the other hand, when the exchange rate falls it is termed as a
revaluation. These terms imply a deliberate decision on the part of the government
to change the level of the exchange rate. For example a government’s policy
decision to devalue the domestic currency vis-à-vis the US dollar.
Fixed rates provide greater certainty for exporters and importers as there are
no or limited exchange rate risks. As businesses have the perfect knowledge that the
price is fixed and therefore not going to change, it is relatively easier for them to
plan ahead. However, a fixed exchange rate regime may have a high administration
cost and a significant gap between the official rate and that determined by the
market can promote black markets. In a black market the bulk of foreign exchange
transactions are carried out outside the banking system. This may force government
to draw down on reserves to meet its obligations and cause scarcity of foreign
exchange.
Advantages: High stability, be stable for a long time
Disadvantages: The rigidity and subjectivity of the fixed mechanism makes the
exchange rate less flexible and does not accurately reflect the market exchange rate.
Floating Exchange Rate: the government lets the nominal exchange rate be
determined in the foreign exchange market.

Characteristics of floating exchange regime:
In a floating exchange rate remige, the market’s demand and supply of the
currency determine the exchange rate. There is no pre-determined official target for
the exchange rate set by the government. The latter and the central bank indirectly
influence the exchange rate by managing the level of domestic and foreign
currencies in the banking system.
Under a floating exchange rate remige, a rise in the exchange rate of domestic
currency via-à-vis another foreign currency is called a depreciation. This implies


11

that more rupees are required to purchase 1 unit of foreign currency. Vice versa
when less domestic currency is needed it is termed as an appreciation.
Advantages: The floating exchange rate regime ensures the balance of payments,
monetary policy, makes the economy be independent, contributing to economic
stability,stabilizing private investment and the market. . This policy is used by many
capitalist countries with strong currencies such as the US and the UK.
Disadvantages:Because the exchange rate is fully floated, there are potential risks
to the management of capital and import and export. When there are fluctuations in
supply and demand of currencies, currencies will tend to rise or fall automatically.
Semi-fixed exchange rate: Between the two extreme exchange rate regimes there
is the managed float, (semi-fixed exchange rates) the exchange rate is given a
specific target and a central bank keeps the rate from deviating too far from a target
value.Under this remige, the exchange rate is the main target of economic policymaking (interest rates are set to meet the target).
In addition, according to the new classification of the IMF, there are three
exchange rate regimes:
Hard peg exchange rate regime (Currency Board)
Soft peg exchange rate regime
Floating exchange rate regime (Managed floating with no preannounced

path for the exchange rate or Independent floating)
1.2 Balance of Trade
1.2.1 The concept of trade balance
The balance of trade (BOT) is the difference between a country's imports and
its exports for a given time period.
The balance of trade is the largest component of the country's balance of
payments (BOP). Economists use the BOT as a statistical tool to help them


12

understand the relative strength of a country's economy versus other countries'
economies and the flow of trade between nations. The balance of trade is also
referred to as the trade balance or the international trade balance.
The concept of trade balance will be studied, used in analyzes and assessments
conducted on the basis of the general concept of trade balance. Accordingly, the
trade balance is interpreted as a measure of the difference between the value of a
country's exports and imports of goods or an economy over a given period of time,
usually one year.
1.2.2 States of trade balance
With the concept of trade balance as can be seen, depending on the difference
between the value of exports and imports of goods of a country or an economy in
each period, we have the different states in the trade balance of the country or
economy, namely:
• Trade balance when the export and import of a country or an economy are equal in
the given period.
• Trade surplus when the export of a country or an economy exceeds the import
during the given period.
• Trade deficit when the import of a country or an economy exceeds the export
during the given period.

The states of the trade balance clearly interact with other macroeconomic
variables of the economy, as well as partly reflecting the state of the macroeconomy
in general. In general, in principle, every economy is aiming for a long-term goal of
achieving trade balance or trade surplus. However, in different stages of
development, the state of the trade balance fluctuates in accordance with the nature
and level of economic development during that period.


13

1.2.3 Factors affecting Trade balance in Vietnam
The first factor that affecting trade balance is oil price. Oil is the essential
energy resource for production activities in every country, especially in developing
countries like Vietnam. The response of difference economies to an increase in oil
price will depend on the quantities of imports in that country, the strength of current
account, the control of domestic demand management, the ability of that country to
find other energy instead of oil. A country that can response with a high price of oil,
limit the import of oil, that country will have more ability to reduce the balance of
payment deficits or trade deficits.
There is a negative and significant relation between oil prices and the trade balance
in both short – time and long – time. It indicates that with the increase in oil price,
the cost of materials and capital goods increase and then trade deficits (trade
imbalance). Oil price had impact significant especially in poor countries,
developing countries and oil importing countries. Poorer countries are more
vulnerable to the oil price increase because they are relatively more oil intensive.
The second factor affecting trade balance is foreign direct investment (FDI).
Orr (1991) found the result that an increase in FDI of U.S manufacturing will have
positive impact with the trade balance.
The third factor that could impact on the trade balance is government
spending. An increase in government spending produces an expansion in output, an

expansion in consumption, and decrease of the trade balance. An increase in
government spending will lead to an increase in GDP. The trade balance will be
decrease because imports increase and export fall. Thus, the trade balance will be
trade deficits.
The fourth factor affecting trade balance is domestic price. A high price
expectation will cause a decrease in export, an increase in import and a decrease in
competiveness. Thus a high domestic price will lead a decreasing of trade balance
(trade deficits). Trade flows adjusted differently to a change in price.


14

The fifth factor impact on trade balance is manufacturing growth rate.
Mmanufacturing increases the FDI of the country. This caused an increase in the
trade balance. Manufacturing in one of factors which had positive impact on trade
balance. Namely, when the manufacturing growth rate is increasing, it will lead an
increasing on the balance of trade.
The sixth factor impact on trade balance is agricultural growth rate.
Agricultural is one of factor very important in the developing and poor countries.
Namely, agricultural growth rate has a positive impact towards trade balance.
The seventh factor affects trade balance is Exchange Rates, Foreign
Currency Reserves
Exchange rates: A domestic currency that has appreciated significantly may pose
a

challenge

to

the

cost-competitiveness

of

exporters,

who

may

find

themselves priced out of export markets. This may pressure a nation’s trade
balance.
Foreign currency reserves: To compete effectively in extremely competitive
international markets, a nation has to have access to imported machinery that
enhances productivity, which may be difficult if foreign exchange market reserves
are inadequate.
The final factor is trade policies. Barriers to trade also affect the balance of
exports and imports. Policies that restrict imports or subsidize exports change the
relative prices of those goods, making it more or less attractive to import or export.
For example, agricultural subsidies might reduce the cost of agricultural
activities, encouraging more production for export. Import quotas raise the relative
prices of imported goods, which reduces demand.
1.3 The impacts of exchange rate on trade balance
Exchange rates are one of the most important and immediate factor affecting
the trade balance.

15

Accordingly, in principle, when the exchange rate rises, which means that the
domestic currency depreciates against the foreign currency, foreign goods will be
more expensive relative to domestic goods, and so the impact makes import tends to
decrease, export tends to increase, trade balance will tend to be improved.
By contrast, when the exchange rate declines, which means that the domestic
currency appreciates against the foreign currency, foreign goods will be cheaper
than domestic goods, thus import tends to increase, export tends to decrease, trade
balance will tend to decrease.
The J-Curve and the problem of improving the trade balance
One of the issues that macroeconomic policymakers are concerned with is:
Will currency devaluation improve the trade balance? And what is the condition for
a successful devaluation? To answer this question, we will examine the theory of
the J-curve effect.
Because commodity prices are not elastic in the short run, so the devaluation
of the currency makes the real exchange rate rise; An increase in the real exchange
rate stimulates export volume and limits import volume. So improving international
trade competitiveness. Based on this conclusion, many people mistakenly believe
that the trade balance has also improved as the currency devalued. In fact, it’s not
neccessarily like this. To see the impact of dumping on trade balance, we use the
Marshall-Lerner approach as follows:
Domestic currency devaluation will create an effect of increasing export
volume and limiting import volume, but in terms of value, the trade balance will not
necessarily be improved. This happens because currency devaluation produces
effects on price and volume, namely:
- For trade balance in VND: The volume effect is reflected that the devaluation
leads to an increase in export volume and lower import volume, which makes the
trade balance in VND to be improved. The price effect is reflected that the

16

devaluation makes prices of imported goods in domestic currency increase, making
trade balance in VND get worse.
- For trade balance in USD: Volume effect is the same as trade balance in VND.
The price effect is reflected that the devaluation make the export price in foreign
currency decrease, which reduces the trade balance in USD.
The net effect of trade balances (improved or deteriorated), therefore, depends on
the dominance of the volume effect or price effect:
- The first possibility reflects the dominance of the price effect. This means that
although the volume of exports increased and the volume of imports decreased, it
was not enough to offset the decrease in export value in foreign currency and
increase the value of imports in domestic currency. As a result, the trade balance
from equilibrium will become deficit and then the total value (ηx + ηm) <1.
- The second possibility reflects the neutrality of the two effects. This means that
the volume of exports increases and the volume of imports falls short enough to
offset the decrease in the value of exports in foreign currency and the increase in the
value of imports in domestic currency. As a result, the balance of the trade balance
is maintained and then the total value (ηx + ηm) = 1.
- The third ability reflects the superiority of the volume effect. This means that after
the devaluation, export volumes increase and imports fall more than enough to
offset the price effect. As a result, the trade balance improved and then the total
value (ηx + ηm)> 1.
Thus, currency devaluation certainly makes the volume of exports increase
and the volume of imports decrease, but the trade balance is not necessarily so
improved. According to the above analysis, the trade balance is improved or
deteriorated depending on the dominance of volume effect or price effect.
Because price effects are immediately effective after devaluation, while volume
effects only take effect after a certain period of time.This implies that, in the short

run, the price effect is superior to the volume effect, thus worsening trade balance.In


17

contrast, in the long term, the volume effect is superior to the price effect, so the
trade balance improves. This feature of currency devaluations is represented by Jcurve as follows:

Figure 1.1 J-curve
Source: vi.wikipedia.org
The extent and duration of the trade deficit is dependent on many factors. For
industrialized countries, as the economy is characterized primarily by goods that
qualify for international trade (ITG), the devaluation causes a fast increase in the
volume of exports and import volume decreases quickly in short term. Therefore,
the effect of volume has a positive effect in the short term, leading to a temporary
short-term trade deficit, and will be markedly improved in the long run. For
developing countries, as the economy is characterized primarily by goods that do
not qualify for international trade (international non-tradeable goods),

so the

devaluation cause a slow increase in export volume and also a slow in import volume,