Exchange Rate and Trade Balance

Topics: International trade, International economics, Bretton Woods system Pages: 12 (4085 words) Published: April 24, 2013

1. Background of the study
Among various subjects in the field of international trade and monetary policy, the relationship between real exchange rate and trade balance is one of the most popular topics, attracting extensive studies in last couple decades. Although a lot of efforts have been made, international trade economists have yet come up with a convergence point in theory to explain the moving direction of trade balance as the result of currency depreciation or appreciation (Qiao, 2005). Empirical studies also show divergence results of this topic. (Koray and McMillins, 1998). Moreover most of the study has been conduct with economy with higher level of economic development than Vietnam. Vietnam is a developing country whose economy is transformed from center-planned economy into a market-oriented economy. Thanks to the Renovation policies of Vietnamese Government, its economy has been maintaining an impressive rate of growth of GDP in last 20 years. According to the World Development Indicator (WDI) & Global Development Finance (GDF) database of the World Bank, Vietnam’s GDP was $20 billion in 1995, double to $40 billion in 2003 and then archive $100 billion mark for the first time in the history in 2010. The rate of growth of GDP was 9.5%, 7.34% and 6.78% in these years respectively. These terrific numbers and the Vietnam’s great achievement in reducing poverty and improving living condition has invited a lot of international attention (see Turley and Selden (1993), Gates (2010)). Vo (2005) highlighted the four pillars to the successful story of economic development in Vietnam: “1) the acknowledgement of the private business right; (2) the market-oriented reforms; (3) the macroeconomic and social stability; and (4) the opening (mostly in terms of trade and FDI) and the integrating of the economy into the regional and world economy”. Trade policy under Renovation Era has undergone fundamental transformation. Key elements of new trading policy are he key recent reform measures included abandoning system of central government planned import, significantly lowing trade protection barriers such as quotas and tariffs, encourage foreign direct investment (FDI), particularly in export- oriented projects, and lifting restrictions on private-sectors participation in foreign trade and setting up business ventures by private entities (individuals and companies). Along with other policy reform, the acceleration of the process of international economic integration has greatly contributed to the transformation of Vietnam into a dynamic open market oriented economy with high and stable growth rate (Athukorala, 2005) During this period beside unilateral policy to promote trade, the Government of Vietnam has been actively participating in regional, bilateral and multilateral trade liberalization initiatives. Vietnam applied for WTO membership in 1995 and gained full membership status in 2007 (WTO, 2007).

2. Significance of the study
Besides the success achieved, Vietnam economy has been facing many difficulties especially the problem of constantly continuing trade deficit since early 2000, which can threaten the macroeconomic stability (Bui and Ha, 2001). Trinh et al. (2011) pointed out that trade deficit in Vietnam has been monotonically increasing since 2000, averaging between 31 and 36 percent depending on the nominal currency as the Vietnam Dong (VND) or the United State Dollar (USD). Technically trade balance can be manipulated using various kinds of policy tools such as: subsidies, quotas, taxes, and other forms of trade barrier, which can help enhancing export and reducing import. Thus, moving the trade balance along desire direction (Tarasova, 2009). However, as a member of the WTO since 2007, Vietnam is limited from these practices to maintain the fair trading competition. As a result the only viable monetary policy for the...
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