Reconsidering Vietnam

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Reconsidering Vietnams Exchange Rate
MechanismA Preliminary Discussion
USD
VND
Kenichi Ohno (VDF GRIPS) Jan. 2004
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Brief History

• Late 1980s multiple rates and high inflation
  under international isolation
• Early 1990s global integration starts, inflation
  stabilization succeeds
• 1991-96 111,000d (nominal anchor)
• 1996-98 stepwise devaluations, coping with the
  Asian crisis
• Feb.1999-now slow depreciation

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Stepwise devaluation
High inflation
Inflation stabilization with 111,000d
Slow depreciation under daily averaging
Asian crisis
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(No Transcript)
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Current System

• The central rate is set daily at the average
  of interbank exchange rates on the previous
  transaction day, with a band of 0.1
• Problems
• --It is merely a technical procedure without
  links to policy goals or economic fundamentals.
• --Policy intention of SBV is not transmitted to
  the market.
• --No criteria to judge the appropriateness of
  VNDs level or system.

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Vietnam (SBV) Should

• Define exchange policy goals
• Adopt a system which can attain these goals
• Within that system, have operational rules for
  daily management
• Discuss exchange rate policy more openly and
  consistently (accountability, dialogue with
  market and investors)

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Issues to be considered

• Which policy goals?
• Use and limits of REER
• Ambiguity of competitiveness
• Menu of exchange rate mechanisms
• Exchange rate smoothing
• Exit policy problem
• China factor

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1. Which Policy Goals?
Possible goals of exchange rate policy

• Competitiveness
• Price stability
• Current-account adjustment
• Financial stability (bal.sheet problem)
• Public debt manage
• -ment (ODA loans)

• Prevention of currency crisis
• Coping with external shocks
• Growth, FDI, industrialization

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Balancing Flexibility Stability

• Competitiveness requires ex.rate flexibility
• Price stability requires ex.rate stability
• But this is not a dilemma in dynamic context
• A developing country receives various shocks.
  Proper policy response sometimes requires
  flexibility, other times stability.

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Goals General Advice --In normal times, the goal
should be balancing exchange rate flexibility and
stability maintain competitiveness under price
stability --Policy judgment should always be
exercised. VND cannot be put on an autopilot. Do
not expect a simple formula. --Adopt a system in
which the degree of flexibility and stability can
be adjusted at any time without causing crisis or
political problem (both free float and rigid fix
are undesirable since they do not satisfy this
condition.)
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2. Real Effective Exchange Rate

• REER should be regularly calculated by SBV as a
  basic indicator of overall competitiveness.
• However, limits of REER should also be
  recognized
• --Base year problem --Choice of
  price index
• --Choice of partner countries --Data
  availability
• --International comparability of commodity
  baskets

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3. Ambiguity of Competitiveness
Apart from REER limits, the concept of
competitiveness faces fundamental problems in
developing countries.

• Vertical trade structure--Major trading partners
  (Japan/EU/US) are not true competitors
  (China/ASEAN/Mexico...)
• Low domestic content of major exports--primary
  commodities, garment, footwear, electronics
• High exchange rate pass-through--As prices
  adjust, any VND/USD rate can be the correct
  rate
• Structural changes under doi moi global
  integration

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SBV Should --Calculate REER regularly for policy
input. --Also systematically monitor a large
number of economic variables including
growth, prices, money, budget, trade BOP,
forex market, FDI investment, banks,
business conditions, asset markets, etc. --Use
judgment and information above to make a policy
decision. --Conduct research on measuring
competitiveness, pass-through, global regional
trends, etc.
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4. Exchange Policy Menu

• Crawl
• Adjustable peg
• Target zone--Soft vs. hard--Real vs.
  nominal--Announced or not--Narrow or wide, etc.
• Soft dollar peg
• Eclectic view

• Free float
• Managed float
• Bipolar view (free float or rigid fix)
• Currency board
• Dollarization
• Currency basket (Dollar/Euro/Yen)

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--Names do not matter much. Actual operation is
the key. --Pick a system which allows a mix of
exchange rate stability and flexibility. As a
general rule, I recommend Short-term stability
against USDLong-term flexibility against
USD Namely, exchange-rate smoothing (filtering
out high-frequency movement)
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5.Exchange Rate Smoothing
WHY SMOOTH?

• Short-term fluctuation contains more noise and
  less fundamentals.
• Prevention of one-way swings such as bubble,
  herding, etc.
• Demand supply do not meet or the rate would be
  too volatile without intervention.
• Official provision of hedging when forward
  markets, options, etc. do not exist.

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Distribution of Exchange Rate Changes
After smoothing
Smoothing with a trend
Before smoothing
0
()
(-)
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Exchange Rate Smoothing An Illustration
Movement driven by market forces without
intervention
Managed float
Adjustable peg with frequent revisions
Crawling peg with variable speed
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6. Exit Policy Problem

• How to transit from a fixed to a more flexible
  exchange rate system without crisis.
• Again, the key is to adopt a system where the mix
  of flexibility and stability can be adjusted.
• Normal operation and crisis response must be
  clearly distinguished.

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Sometimes, the exchange rate comesunder severe
pressure --The critical decision is whether to
resist the pressure or to float. If float, the
timing of floating is important. --If it is
decided to float, prepare measures that minimize
the shock and the period of floatingTemporary
trade capital controls, social protection,
protection of banks firms, etc (Kazakhstan in
1999). Dont accelerate reforms or tighten macro
policies during attack. --In a typical currency
crisis, a 30 depreciation is normal. But shocks
may be heavy or light depending on policies.
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7. China Factor

• Lessons for Vietnam
• China as a risk factor for Vietnam
• --Bursting of the Chinese bubble (consumption and
  housing)
• --Mishandling of RMB policy and regional currency
  repercussions (China now faces a sort of the exit
  policy problem)

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My RecommendationVariable Crawl with Monthly
Evaluation
VND/USD
Crawl speed adjustments
Monthly monitoring
Time
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Variable Crawl for Vietnam

• SBV mainly sets the rate, while market force is
  used as a supplementary input. (VNs financial
  markets are still primitive.)
• SBV monitors the situation monthly and adjusts
  the crawling speed if necessary.
• The actual movement may not be very different
  from today, but SBV assumes more accountability
  based on proper analysis.

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If enough interest exists, VDF will start
research on exchange rate management
The End