NATIONAL ECONOMICS UNIVERSITY ERASMUS UNIVERSITY INSTITUTE OF PUBLIC POLICY AND ROTTERDAM INSTITUTE OF MANAGEMENT SOCIAL STUDIES VIETNAM – NETHERLANDS PROJECT FOR MASTER’S PROGRAM IN DEVELOPMENT ECONOMICS THESIS THE IMPACT OF EXCHANGE RATE POLICY ON TRADE BALANCE AND INFLATION IN VIETNAM Student: Duong Thanh An Class: MDE 12 Supervisor: Nguyen thi Thuy Vinh, PhD Ha noi, 2014 TABLE OF CONTENTS Ha noi, 2014 TABLE OF CONTENTS LIST OF ABBREVIATION LIST OF TABLES LIST OF FIGURES CHAPTER .1 INTRODUCTION .1 1.1The criticality of the study 1.2Research Purpose 1.3Scope of the Study 1.4Research Methodology 1.5Structure of the Thesis CHAPTER .4 THEORETICAL FOUNDATION OF IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION 2.1 Basic concepts of exchange rate 2.2Impacts of exchange rate on trade balance CHAPTER 21 OVERVIEW OF THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM 21 CHAPTER 45 EMPIRICAL STUDY ON THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM .45 LIST OF ABBREVIATION ASEAN Association of Southest Asia CIEM Central Institute for Economic Management CPI Comsumer Price Index EU European Union FDI Foreign Direct Investment IFS International Financial Statistics IMF International Moneytary Fund PPP Purchasing Power Parity WB World Bank WTO World Trade Oranization LIST OF TABLES Ha noi, 2014 Ha noi, 2014 TABLE OF CONTENTS LIST OF ABBREVIATION LIST OF TABLES LIST OF FIGURES CHAPTER .1 INTRODUCTION .1 1.1The criticality of the study 1.2Research Purpose 1.3Scope of the Study 1.4Research Methodology 1.5Structure of the Thesis CHAPTER .4 THEORETICAL FOUNDATION OF IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION 2.1 Basic concepts of exchange rate 2.2Impacts of exchange rate on trade balance CHAPTER 21 OVERVIEW OF THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM 21 CHAPTER 45 EMPIRICAL STUDY ON THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM .45 LIST OF FIGURES Ha noi, 2014 Ha noi, 2014 TABLE OF CONTENTS LIST OF ABBREVIATION LIST OF TABLES LIST OF FIGURES CHAPTER .1 INTRODUCTION .1 1.1The criticality of the study 1.2Research Purpose 1.3Scope of the Study 1.4Research Methodology 1.5Structure of the Thesis CHAPTER .4 THEORETICAL FOUNDATION OF IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION 2.1 Basic concepts of exchange rate 2.2Impacts of exchange rate on trade balance CHAPTER 21 OVERVIEW OF THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM 21 CHAPTER 45 EMPIRICAL STUDY ON THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM .45 ACKNOWLEDGEMENT The thesis is completed under guidelines by Doctor Nguyen Thi ThuyVinh I would like to present my deep gratitude for her attentive and caring instructions During the research period, I have been given with a great deal of cares, encouragement, and precious contributions from my family, colleagues of where I have been working, researchers with similar interests in the topic that I have pursued I am honored to show my great thanks On this occasion, I am much grateful to the Institute of Public Policies and Management National Economics University and particularly to Doctor Giang Thanh Long who have created favorable conditions for me to complete this research program CHAPTER INTRODUCTION 1.1 The criticality of the study As early as the second half of the last century, many countries like Japan and South Korea consider exchange rate policy as an effective tool of their international trade policy to improve trade deficit, increase international reserve, and boost international trade for the ultimate goal of becoming an Asian economic dragons At its early stage of economic reform, China also embraced the “magical stick” of exchange rate to benefit from their export, keeping a consistent trade surplus with the US and becoming the country with biggest foreign exchange reserve Alan Greenspan, former Chairman of US Federal Reserve, also tried to devalue US dollar to promote export and reduce trade deficit On Dec 10, 2003, in order to explain his weak-dollar monetary policy, he said ambiguously on CNN: “Now it is the time American should know the export potential…” Since 2013, the world has merely seen a sharp devaluation of the Japanese yen This phenomenon has also put a lot of controversy whether the Japanese currency devaluations to promote exports In Vietnam, trade deficit, which has been a persistent issue during the last 20 years, not only shows weaknesses of the country’s economy but also implies potential instability in the long run The goal to have a balance in international trade in 2008, which was indicated in International Trade Strategy during 2001-2010, was not met In the past years, inflation in Vietnam pretty high compared to other countries in the world while nominal exchange rate of VND/USD was relatively stable Therefore, there was many researchers suppose that Vietnamese currency was overvalued and then give some suggestions on currency devaluation to boost export as many countries in the world have ever done to improve the trade balance But other experts also noted that the devaluation can cause inflation, a problem that Vieatnam has trying to solve There are many studies on impact of devaluation on trade balance or studies on exchange rate pass-throught on domestic price in some countries in the world including Vietnam (Nguyen Van Tien, 2009; Nguyen Thi Hien, 2011, Nhat Trung, 2011; Nguyen Duc Thanh, 2011; Nguyen Thi Kim Thanh, 2011) However, all of these researches have only focused on either the inflation aspect or trade balance aspect rather than taken the trade-off between them into consideration: a devaluation may improve trade balance but can cause inflation in the economy Therefore, it is very important to study the impact of change in exchange Variance Decomposition of TB 0.071 100.000 0.000 0.000 0.089 97.914 0.183 1.901 0.098 96.671 1.530 1.797 0.102 95.572 2.343 2.084 0.106 94.226 2.502 3.271 0.110 91.824 3.304 4.871 0.112 92.111 3.211 4.676 0.113 92.012 3.195 4.792 0.114 91.408 3.587 5.003 10 0.115 90.351 4.245 5.403 11 0.116 89.462 4.890 5.646 12 0.117 88.378 6.009 5.611 15 0.119 84.944 9.598 5.457 18 0.120 83.116 11.534 5.349 21 0.121 82.559 12.120 5.319 24 0.121 82.511 12.166 5.321 Variance Decomposition of CPI 51 0.004 0.149 99.851 0.000 0.005 4.267 93.506 2.226 0.005 4.846 90.825 4.327 0.006 9.046 87.491 3.461 0.006 10.314 86.381 3.304 0.007 10.701 85.727 3.571 0.007 11.327 85.267 3.404 0.007 11.441 85.227 3.331 0.007 11.707 84.776 3.516 10 0.007 11.770 84.668 3.561 11 0.007 11.728 84.493 3.778 12 0.007 11.726 84.467 3.805 15 0.007 11.969 84.205 3.825 18 0.007 12.389 83.837 3.772 21 0.007 12.617 83.613 3.768 24 0.007 12.659 83.548 3.792 We can find that the change in nominal exchange rate of VND against USD not have much important role in the variances of both trade balance ratio and inflation The predomoniant source of variance in both trade balance index and inflation are the “own shocks”, accounting for more than 80% of the forecast error variance in the medium term 52 However it has more important in the movement of trade balance ratio than in the movement of inflation The exchange rate accounts for more than percent in the variance of trade balance ratio and approximately percent in the variance of inflation Considering period for 2007-2012, Table 4.4 also shows that exchange rate does not have an important role in the variance of trade balance ratio as well as inflation At 18-month horizon the exchange rate accounts for more than % of the variance in inflation and only % of the variance in trade balance ratio However, at horizon of 24- month the role of exchange rate are the same in the variance of trade balance ratio and inflation Table 4.4 Variance Decompositions for 2007-2012 period Period S.E TB CPI Variance Decomposition of TB USD 0.073 100.000 0.000 0.000 0.096 99.217 0.018 0.763 0.112 93.970 5.406 0.623 0.118 89.909 9.528 0.562 0.121 89.119 10.224 0.656 0.124 87.546 9.821 2.631 0.126 87.591 9.566 2.841 0.128 87.267 9.421 3.311 0.130 86.016 10.066 3.917 10 0.134 82.060 13.449 4.490 11 0.137 79.389 15.895 4.714 12 0.138 77.515 17.808 4.676 15 0.148 69.189 26.663 4.147 18 0.153 64.141 31.916 3.941 21 0.154 63.945 32.044 4.010 24 0.155 62.977 32.706 4.316 Variance Decomposition of CPI 0.005060 3.512 96.487 0.000 0.005727 8.777 87.669 3.552 0.006420 8.230 83.164 8.605 53 0.007173 11.794 80.767 7.438 0.007663 14.442 78.999 6.557 0.008194 13.039 80.758 6.201 0.008459 12.928 81.219 5.852 0.008551 13.133 80.900 5.965 0.008726 13.256 81.011 5.731 10 0.008744 13.385 80.689 5.925 11 0.008768 13.670 80.300 6.029 12 0.008977 13.054 80.926 6.018 15 0.009660 12.093 82.688 5.217 18 0.010212 10.916 84.101 4.982 21 0.010370 11.703 83.404 4.892 24 0.010476 12.816 82.273 4.909 In sum, empirical study supposes that: (1) in the short run the movement of exchange rate significantly affects inflation, especially in recent years when Vietnam became WTO’s member; (2) a devaluation can improve trade balance deficit in long run, especially export performance; (3) not only the exchange rate of VND against USD but also others have significant impact on inflation and trade performance in Vietnam CHAPTER SUGGESTION ON IMPROVING THE EFFECTIVENESS OF EXCHANGE RATE POLICY WITHOUT CREATING PRESSURE ON INFLATION 54 5.1 Orientation of exchange rate policies When looking at nominal exchange rates’ changes since 1989, it can be seen that VND/USD official exchange rate tended to follow a cycle with two stages: (i) during economic recession or crisis period, VND remarkably devaluated; (ii) when the recession period ended, the economy got stable, exchange rates were pegged rather flexible to USD This cycle had been repeated over two times since 1989 until present time With above analysis, at an exchange rate mechanism, impacts on inflation in various periods were different There were two reasons for explaining this situation: Firstly, the reason related to inflation’s causes lied in increases of money and credit supply Secondly, the reason related to economic contexts of each period Exchange rate policies alone could not effectively fight against inflation If stabilization of exchange rate was not attached with control of money supply and credit growth rate and macro measure for total demand control, it could not help prevent and monitor inflation, especially in case of free capital mobility On the other hand, if total demand and monetary policies were relevantly controlled, adjustments of exchange rates by the market would not necessarily cause inflation When using maket mechanisms to manage, nominal exchange rates will adjust trade balance automatically Its foundations is that when import surplus is high and maintained over too long time, demands for foreign currencies will increase, which makes domestic currency devalue quite much compared to foreign currencies Foreign currencies’ increases in value will encourage export and make import goods more expensive, therefore reduce trade deficit Nevertheless, exchange rate mechanism in Vietnam has failed to gain this adjustment but also worsened the trade balance deficit over the recent years Over the past years, Vietnam’s development in import-export has made great contributions to the career of national innovation and been recognized as one of the key motivations for economic growth Development strategy based on export promotion is the path for Vietnam to penetrate more deeply into the global value chain and integrate more deeply into the global economy And in the next coming years, export shall still be regarded as the key motivation of Vietnam’s economic growth Therefore, there must have patience to orient industrialization toward export This is the guideline that needs grasping to make policies for Vietnam’s economic development in the next period Following things can be realized: 55 Firstly, Vietnam’s exchange rate mechanism basically is based on pegging mechanism although there were adjustments during the period of economic uncertainties; Secondly, Current exchange rate mechanism does not help Vietnam restrict inflation so much while cannot encourage export or retrict import ; Thirdly, VND, the domestic currency remains under pressures of devaluation in the next coming years Based on laws (Article 10 of the Law on the State Bank) and actual management, the State Bank (SBV) considered exchange rates as one of tools used to realize national monetary policies Whereas Vietnam’s monetary policies were multi-objective and continuously changed within short-term so there often appear disputes between objectives of monetary policies and selected exchange rate mechanisms With such cases, the State Bank prioritized to manage exchange rates for the objective of monetary policies instead of abiding by selected mechanisms (in the direction of flexibility) As a result, flexible exchange rate mechanisms have not met the original commitments Selection of proper exchange rate mechanism is important, however, another issue which is more important is how to treat the selected exchange rate mechanism to assure it strictly abides by disciplines to achieve set objectives Therefore, Vietnam should be more transparent in the process of managing exchange rates to avoid a fall in bipolar situation that creates big gap between the exchange rate mechanism based on laws and the actual exchange rate mechanism due to enforcement failures of announced statements or announcement of undone statements On another hand, due to many priorities for growth objective, Vietnam has sought to strongly attract foreign investment capital while still wished to maintain its monetary policies independent with rigid exchange rate mechanism, which seemed ambitious at the same time to achieve all the three objectives inherently regarded as “impossible trinity” Consequences caused by this policy is that Vietnam had to face several marco uncertainties as realized in 2010 and early 2011 when the monetary policy got less independent as most of the time, it has been falling into passive state, simultaneously, due to a must of adjustments to exchange rates, marco uncertainties even increased This matter shall get simpler if Vietnam accepts to sacrifice perfectness of the objectives: fixed exchange rates, liberalization of capital accounts and independent monetary policies To assure attraction of investment capital for economic growth and in the context of quite high inflation, Vietnam needs to accept the direction of enhancing flexibility of exchange rate mechanisms while continuing openness of capital accounts as now but also accept 56 monetary policies to be less independent to neutralize foreign capital flows’ circulation to better control the inflation Simultaneously, Vietnam should be consistent with selected exchange rate mechanisms and determined not to utilize exchange rates as situational tools to serve for monetary policies Over the past years, Vietnam’s development in import-export has made great contributions to the career of national innovation and been recognized as one of the key motivations for economic growth Development strategy based on export promotion is the path for Vietnam to penetrate more deeply into the global value chain and integrate more deeply into the global economy And in the next coming years, export shall still be regarded as the key motivation of Vietnam’s economic growth Therefore, there must have patience to orient industrialization toward export This is the guideline that needs grasping to make policies for Vietnam’s economic development in the next period Correspondingly, according to the author, in the long tem, Vietnam’s orientation of exchange rates in the next coming time must aim at the objective of supporting export activities to reduce trade deficit 5.2 Suggestions for using exchange rate policies to restrict trade deficit without causing any further pressures on inflation Vietnam now satisfies many conditions, which makes the application of managed floating exchange rate mechanism bring more benefits compared to fixed exchange rate mechanism Firstly, prices of almost all goods ranges and salaries of Vietnam’s enterprise sectors are determined by the market mechanism Floating exchange rates shall help balance changes in prices of local goods with changes in prices of goods in the world, through which helps for better allocation in the economy (Friedman, 1953) Secondly, openness of Vietnam’s economy is wide, but does not depend much on any concrete partner, so floating exchange rates shall not only make Vietnam strongly affected by shocks caused by external currency markets but also help Vietnam well prevent against shocks from the international goods market (Fleming, 1962; Mundell, 1963) As analyzed in the previous parts, exchange rate policies alone not make strong, direct impacts on trade balance or inflation Therefore, to make a floating exchange rate policy and uphold its effects on improvements of trade balance and restrictions of pressures on inflation in Vietnam, the author suggests some following approaches: 5.2.1 Expansion of exchange rate trading bands instead of domestic currency’s 57 devaluation Managed floating mechanism of Vietnam considered as pegged exchange rate within horizontal bands is now applied in a way quite appropriate with the actual context According to this mechanism, one domestic currency which is highly appraised shall be affected by demand - supply rule and traded at the upper band To the next day, transaction level shall increase within the limitations of trading band compared to the previous transaction level Similarly, exchange rates move toward purchansing power parity (longterm balanced real exchange rates) Happenings during the period since 1999 until now, however, show that VND still tends to be highly overvalued, which makes some policies to be effectively annulled For example, exchange rates’ light increase during the period from 1999 until now has occurred completely contrary to expectations of trade balance improvements when exchange rates have increased To make exchange rate policies highly effective without coverage of nominal relations, foreign exchange rates must reflect the level of almost equivalent to purchansing power parity Exchange rate trading band need broadening further to make foreign exchange rates move toward the location of faster purchansing power parity An expansion of fluctuation amplitudes at this time is equivalent to a light devaluation, which occurs in the condition of USD’s devaluation compared to other strong currencies and this is a good chance to enhance competitiveness of Vietnam’s exported goods Domestic currency’s devaluation adjustments through such exchange rate horizontal bands mechanism are more relevant with the policies that aim at marco stabilization, inflation restriction of Vietnam now and will not pose unpredictable threats as the strongest domestic currency devaluation in the conditions of not having tools to prevent against exchange rate risks Expansion of exchange rate trading band makes exchange rates more flexible as well as expanding components in determining exchange rates, exchange rates’ market features will get higher, making contributions to increase effectiveness of constraining inflation in current situations Flexible exchange rates will help restrict increases in money supply which is the agent to cause inflation over the past time Keeping VND weak is a form of price support for exported goods, nevertheless, this policy’s reverse side lies in an increase of 135% money supply of Vietnam since 2005 until now due to spending VND to buy large amounts of foreign currencies This is a very high increase, an important agent of inflation over the last time If exchange rates are flexible, when the market’s exchange 58 rates are relevant, the State shall decide to buy USD and shall enjoy benefits when paying less in VND to buy USD, supplement to the national foreign currency reserves fund 5.2.2 Enforcement of multi-foreign currency policy Over the past time, determining value of VND exchange rates compared to key foreign currencies has been mainly based on the value of USD After determining VND/USD exchange rates, the banks cross-calculate to have the rates of VND against other foreign currency In the other words, Vietnames currency seems fixed to the dollar while relative prices to other currencies fluctuate freely As empirical analysis has shown, the changes of not only the USD but also other currencies agaist VND have a strong impact on inflation and export of Vietnam Then their free fluctuation can cause the risks and affect the economy beyond the control In the coming time, VND should be pegged in a basket of currencies including USD, EUR, JPY, China’s Yuan, and Singpore dollar The exchange rate bands shall be calculated based on average calculation in the currency basket, i.e if VND/USD exchange rate at times exceeds the allowed amplitudes, but VND/EUR exchange rate or other exchange rates are lower than the amplitude, the State Bank shall not necessarily intervene into USD exchange rate EUR, SGD and JPY are selected to be put in the foreign currency basket because Europe is a big market, a crucial partner of Vietnam in trade and investment while Japan and Singapore is the nation with very high import-export turnover with Vietnam Japan and Singapore is always in the list of top investors in Vietnam Japanese government’s credit is one of the highest China shall remain a big competitor of ours in import - export, therefore, Yuan needs considering to be put into the currency basket so that adjustments of exchange rates later can enhance competitiveness of Vietnam’s exported goods compared to those of China At present, Vietnam’s deficit in trade balance with China stands very high and in the short run, it cannot be directly improved through import - export activities, especially when ASEAN - China free trade area is soon established Consideration to put Yuan in the currency basket to calculate exchange rates is one of the preparation measures to utilize exchange rates as tools to improve deficit of trade balance with China in the next coming time Moreover, pegged VND in a basket of currencies also help to reduce dollarization in Vietnam, leading to reduction of independence of Vietnam’s monetary policies Additon to effects of relieving dollarization and increases of monetary policies’ independence, the 59 realization of exchange rate bands based on average calculation of strong currencies, there is another meaning of promoting transactions in other currencies to make exchange rates go in a more favorable way under demand - supply relations in the foreign currency market 5.2.3 Actively transferring structure of exported and import goods in the positive direction In the short time, import remains essential to modernize domestic production, so export shall play as a key motivation to relieve deficit in trade balance Besides orientation to use exchange rate policies to boost up export, there should have collaboration with other different policies like policies of goods ranges, incomes policy, etc., to make export activities gradually experience intensive development Current exported goods now are mainly crude, roughly processed goods with low added values Although such goods are still “sensitive” with exchange rate policies, supply sources of these goods are very hard to increase in a short time so improvements of trade balance through exchange rate policies have long lag Moreover, if export of these goods is maintained at high densities, we have only explored static advantages of natural resources, in the long term, it shall cause bad impacts on improvements of trade balance, which reflects dependent tendency on strategies of crude product export instead of industrialization strategies toward export which step by step replaces import Vietnam export structure mainly agricultural fishery products, resources such as crude oil, rubber… In addition, the composition of exports, imports of raw materials accounted for 70% of the value of exports Vietnam's export sector depends so much on imported materials Besides, caused by acts of excessive spending for imported luxury goods by people Therefore, to improve the trade balance, reducing pressure on inflation should have policies that restrict imports of raw materials, promote domestic resource, improve the efficiency of imported machinery and equipment, development of supporting industries Somehow, government should have campaign program restrict people use imported luxury goods Some other policies that can be mentioned like increasing import tax of petroleum and gasoline, development of supporting downstream industries, supports for industries that need capital and techniques to improve product quality under many forms as training workers, requiring local manufacturers, through industry associations, to produce products with quality for export, even for domestic market, etc., 60 Transformation of exported goods structure shall make exchange rate elasticity of export demand high instead of the fact that this elasticity now is very little A small change in exchange rates now can make positive effects on the trade balance, which is different from the past when only a big change in exchange rates could create impacts, but for trade-off, import prices would increase and cause pressures on inflation 5.2.4 Synchronous collaboration of exchange rate policies with other macroeconomic policies To enhance effectiveness and efficiency of foreign exchange rate policies toward the economy, there must have collaboration with other macroeconomic policies like fiscal and monetary policies Cautious fiscal policies should be preserved and adjustments of tax policies should be made In the context of intergrating to international economic and becoming a WTO member, Vietnam has lifted many non-customs barriers which support commercial activities In the next coming time, to improve trade balance through restrictions of import, Vietnam needs to foster and use the technical barrier more effectively to restrict import surplus The barrier is related to application of such technical measures as: goods quality standards, measures to assure goods production process to be safe, hygienic, and environment protective, issues related to label marking, transportation, goods preservation, etc., Relevant use of these barriers does not only restrict import surplus, make contributions to enforcement of macro policies for socio-economic development, but also protect consumers’ legitimate interests Therefore, they are rational and legal barriers acknowledged and permitted for use by WTO, which are presented in the Agreement on technical barriers to trade (TBT ) There must have relevant priorities for spending policies Unnecessary expenditures should be eliminated but spending on civil construction investment should be increased There must have measures to constrain losses and wastes Budget deficit should be assured within manageable level, which means at the level that can be made up for without causing instability to the macrcoeconomy Nevertheless, fiscal policies should not be too much tightened as this will cause harms to long-term economic growth Besides, we need to switch currently direct tools of monetary policies to indirect ones to manage monetary policies more flexibly, sufficiently and less cause negative impacts on the economy Moreover, when the monetary market develops, prices in the market (interest rates, 61 exchange rates, etc.,) will be formed based on demand - supply relations, capital sources will be effectively allocated When the market is not divided, imbalance in the macrcoeconomy will be avoided, thence effectiveness of monetary policy management will be enhanced The improvement of foreign exchange rate policy needs synchronous collaboration of several measures, not only from the Central Bank Depending on the actual conditions, appropriate tools or measures will be selected to realize the policy of one exchange rate in the common tendency to bring the best effects 5.3 Conclusions The thesis with a topic “The impact of exchange rate policy on trade balance and inflation in Vietnam” focused on theoretical and practical arguments on researches of exchange rate’s impacts on trade balance and inflation in Vietnam through data analysis of the trade balance, inflation and influential factors Concrete contents gained in the thesis are: Systematic presentation of theories on exchange rates to provide theoretical foundations of exchange rates and their impacts on trade balance and inflation Collection of some field researches of exchange rates’ impacts on trade balance and inflation, leading to illustrated conclusions for the research Overview of actual state of Vietnam’s exchange rate management during the period from 1992 to 2011, which analyzed exchange rate policies’ impacts on trade balance and inflation in Vietnam Appyling VAR model to analyse empirically the impact of the change in exchange rate on inflation and trade balance using monthly data from 2000 to 2012 Based on qualitative and quantitative analysises, the author has given some suggestions for the use of exchange rate mechanisms in the next coming time and synchronous measures to make exchange rates become as a tool to improve the trade balance but limit pressures on the inflation in Vietnam Appropriate orientation for foreign exchange rate management mechanism should be based on exchange rates’ roles and features In Vietnam’s current context, enforcement of a managed flexible exchange rate mechanism in synchronous collaboration with some other policies and tools is relevant with economic development strategies and improvement of trade balance without causing pressures on the inflation in the country This mechanism 62 may last for some more time when Vietnam really enjoys a strong economic potentiality and a sufficient foreign currency reserves to intervene into the market when necessary to stabilize the purchasing power of the national currency, stabilize goods – services’ prices in the market An appropriate foreign exchange rate mechanism must be a mechanism that reflects special relations between foreign exchange rates and interest rate, economic growth rate, and currency inflation rate in various periods The thesis has shown that there should be a mechanism for the exchange rate more flexible to bring Vietnamese currency close to the equilibrium as calculated from relevant economic fundamentals These immediate measures are needed to expand margin trading and peg VND to a basket of currencies instead of fixed to the USD In addition, there need the synchronized solutions in structural adjustment of export and import products as well as coordination with other macroeconomic policies 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Introduction Chapter - Theoretical foundation of impact of exchange rate on trade balance and inflation • Chapter - Overview of the impact of exchange rate on trade balance and inflation in Vietnam. .. creating pressure on inflation CHAPTER THEORETICAL FOUNDATION OF IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION 2.1 Basic concepts of exchange rate 2.1.1 Definition of exchange rate Although... EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM 21 CHAPTER 45 EMPIRICAL STUDY ON THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE AND INFLATION IN VIETNAM