Tài liệu The impact of exchange rate on trade balance between vietnam and china

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA BY TRAN QUOC KHANH CUONG MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, January, 2015 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By TRAN QUOC KHANH CUONG Academic Supervisor: NGUYEN VAN NGAI HO CHI MINH CITY, January, 2015 ACKNOWLEDGEMENT First of all, I would like to show my deepest thanks to my supervisor, Associate Professor, Ph. D Nguyen Van Ngai who gave scientific guidance, useful advice and instruct me to complete this thesis. I would like to thank Professor Chinn M. D., Professor Bahmani-Oskooee, M. and Dr. Pham Khanh Nam who gave many useful comments during the process of doing my thesis. I am very grateful to the lecturers and classmates who help me to much during studying. Finally, I would like to give the special thanks my family who support me moral and financial during the time I study. i ABSTRACTS The goal of this research is to investigate the short term and long term relationship between exchange rate and trade balance. Differing test such as Johansen Cointegraion test, Vector Error Correction, Wald test etc., have been conducted. The data was collected from International Financial Statistics (IFS), Organization for Economic Cooperation and Development (OECD) and Asian Regional Integration Center (ARIC). The conclusion is as follow: • Long run relationship between real exchange rate and trade balance occurs, and • The coefficient of real exchange rate is negative and significant. The results implies that devaluation of currency to cure trade deficit between Vietnam and China may not an appropriate method, for instance, the trade performanceof Vietnam to China could deteriorate. ii Contents CHAPTER 1 ................................................................................................................... 1 INTRODUCTION .......................................................................................................... 1 1.1 Problem statement .............................................................................................. 1 1.2 Research objectives ............................................................................................ 3 1.3 Research methodology ....................................................................................... 3 1.4 Structure of this thesis ........................................................................................ 3 CHAPTER 2 ................................................................................................................... 5 LITERATURE REVIEW .............................................................................................. 5 2.1 Definition of exchange rate, real exchange rate and misalignment ................... 5 2.2 Theoretical model of real exchange rate equilibrium ......................................... 6 2.2.1 Model – based approach .............................................................................. 6 2.2.2 The fundamental equilibrium exchange rate approach................................ 6 2.2.3 The purchasing power parity approach........................................................ 8 2.3 Theory of the impact of exchange rate on trade balance .................................. 10 2.3.1 Marshall – Lerner condition ...................................................................... 10 2.3.2 The J-Curve................................................................................................ 10 iii 2.4 Empirical studies .............................................................................................. 11 2.4.1 Empirical studies for the PPP approach..................................................... 11 2.4.2 Empirical studies for the BEER and the FEER ......................................... 14 2.4.3 Empirical studies of the impact of exchange rate on trade balance........... 15 2.5 Conceptual framework ..................................................................................... 20 CHAPTER 3 ................................................................................................................. 22 THE EXCHANGE RATE AND TRADE .................................................................. 22 BETWEEN VIETNAM AND CHINA ....................................................................... 22 3.1 Tendency of the exchange rate between Vietnam and China .......................... 22 3.2 Trade balance between Vietnam and China ..................................................... 23 3.3 The main commodities of import and export between Vietnam and China in recent years ................................................................................................................. 24 3.3.1 The main commodities of export to China in recent years ........................ 24 3.3.2 Imported commodities from China ............ 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CHAPTER 4 ................................................................................................................. 29 MODEL SPECITICATION AND DATA SOURCE ................................................ 29 4.1 Model for purchasing power parity approach .................................................. 29 4.2 Model for trade balance .................................................................................... 33 iv 4.3 Robustness check for VECM. .......................................................................... 37 4.3.1 Serial Correlation Test ............................................................................... 37 4.3.2 Heteroskedasticity test: .............................................................................. 37 4.3.3 Normality test: ........................................................................................... 38 4.4 Data source ....................................................................................................... 38 4.4.1 Data for PPP approach ............................................................................... 38 4.4.2 Data for trade balance ................................................................................ 39 CHAPTER 5 ................................................................................................................. 41 THE IMPACT OF EXCHANGE RATE ON TRADE BALANCE BETWEEN VIETNAM AND CHINA .............................................................................................. 41 5.1 The estimation of real exchange rate. ............................................................... 41 5.1.1 Unit root test .............................................................................................. 41 5.1.2 Optimal lag for VECM .............................................................................. 42 5.1.3 Johansen (1988) procedure for cointegration test...................................... 45 5.1.4 The estimation of real exchange rate between Vietnam and China .......... 48 5.1.5 Robustness check for PPP model .............................................................. 49 5.2 The exchange rate misalignment between Vietnamese currency (VND) and Chinese currency (RMB) ........................................................................................... 51 v 5.3 The impact of the exchange rate on trade balance ........................................... 53 5.3.1 Unit root test .............................................................................................. 53 5.3.2 Optimal lag for VECM .............................................................................. 55 5.3.3 Diagnostic check for every lag .................................................................. 56 5.3.4 Inverse Roots of AR characteristic polynomial ......................................... 57 5.3.5 Johansen procedure for cointegration test for the impact of exchange rate on trade balance...................................................................................................... 57 5.3.6 The impact of exchange rate on trade balance in long run ........................ 60 5.3.7 The impact of exchange rate on trade balance in short run ....................... 60 5.3.8 Robustness Check ...................................................................................... 61 CHAPTER 6 ................................................................................................................. 66 CONCLUSIONS AND RECOMMENDATIONS ..................................................... 66 6.1 Conclusions ...................................................................................................... 66 6.2 Policy implications ........................................................................................... 67 6.3 Limitations and further researches ................................................................... 67 6.3.1 Limitations ................................................................................................. 67 6.3.2 Further researches ...................................................................................... 67 vi LISTS OF FIGURES Figure 2.1: J curve effect. ............................................................................................... 11 Figure 2.2: Conceptual framework of this study............................................................ 21 Figure 3.1 Nominal exchange rate between Vietnam and China, (VND/RMB) ........... 22 Figure 3.2: Trade balance between Vietnam and China (million US dollar). ............... 23 Figure 5.1: Inverse Roots of AR characteristic polynomial for PPP ............................. 44 Figure 5.2 Real exchange rate between Vietnam and China (VND/RMB) ................... 48 Figure 5.3: Normality test .............................................................................................. 51 Figure 5.3: Misalignment between VND and RMB ...................................................... 52 Figure 5.4: Inverse Roots of AR characteristic polynomial for PPP ............................. 57 Figure 5.5: Normality test for VECM model ................................................................. 63 Figure 5.6: Cumulative sum of recursive ....................................................................... 64 Figure 5.7: Cumulative sum of square of recursive ....................................................... 64 vii LIST OF TABLES Table 3.1: The main commodities of export to China during 2010-2013 (million USD) ........ 24 Table 3.2: The main commodities of import from China during 2010-2013, million USD..... 26 Table 4.1 Data for PPP approach .............................................................................................. 39 Table 4.2: Data for trade balance approach .............................................................................. 39 Table 5.1: Mackinon (1996) critical value. ............................................................................... 41 Table 5.2: Unit root test for PPP approach ............................................................................... 41 Table 5.3: Lag criteria for PPP approach .................................................................................. 43 Table 5.6: Wald test for Horvath – Watson procedure ............................................................. 47 Table 5.9: Unit root test on time series ..................................................................................... 54 Table 5.10: Lag selection of VECM ......................................................................................... 55 Table 5.11: Diagnostic check for every lag .............................................................................. 56 Table 5.12: Johansen cointegration test with 18 lags ............................................................... 58 Table 5.13: Cointegrating equation .......................................................................................... 59 Table 5.13: The speed of adjustment coefficient of long run ................................................... 60 Table 5.14: Wald test for the short run relationship ................................................................. 60 Table 5.16: Heteroskedasticity Test: Breusch-Pagan-Godfrey................................................. 62 viii LISTS OF ABRREVIAION ARDL: Autoregressive Distribution Lag BEER: Behavior Equilibrium Exchange Rate CPI: Consumer Price Index FEER: Fundamental Equilibrium Exchange Rate IIPCN: Index of Industrial Production of China IIPVN: Index of Industrial Production of Vietnam PPP: Purchasing Power Parity RER: Real Exchange Rate STAR: Smooth Transition Autoregressive TB: Trade Balance VECM: Vector Error Correction Model ix CHAPTER 1 INTRODUCTION 1.1 Problem statement Özkan (2013) stated that real exchange rate plays an important role in the macroeconomic such aseconomic development, sustainable growth, especially real exchange rate plays a very important role in trade balance. Trade balance is a component of Gross Domestic Product(GDP). GDP will increase if trade of balance issurplus, and decrease if trade of balance isdeficit. In many recent years, Vietnam (VN) almost has trade deficit with the rest of the world. Trade balance deficit reduces foreign reserve, if it happens in the long term, it will lead to foreign debt. Therefore Vietnam will lend money from abroad and pay interest to compensate for the imbalance. However, this approach is not effective to solve this problem in long term for Vietnam’s economy. Because this process will make budget deficit and not good for the economy of Vietnam. In general, there was a substantial increase in both export and import throughout the period from 2000 to 2013. Nevertheless, this upward trend did not grow constantly. In particular, as a result of global finance crisis, the proportion of import and export witnessed a marginal downward trend between 2008 and 2009. At that time, balance trade plunged into the lowest level for 11 years. However, it recovered and rose considerably more than the previous stage. Although export increased over and over, it was still lower than import that leaded to trade deficit for Vietnam. Until 2012, export already kept up with the import development, comprised nearly 115.5 billion USD that enhanced the effect and advantage of trade balancedue to trade surplus.The most striking feature was that the 1 above surplus continually to rise and reach the highest level in 2013, amounted to 900 million USD and trade balance has the highest trade surplus. According to general statistics office(GSO), from 2000 to 2013, the surplus of trade balanceVietnam, US and Europehas increased since 2000. Admittedly, American and Europe have been truly the potential market for Vietnam’s enterprises to expand export and improve the international business profit.Nevertheless, there is a contrast sharply of trade balance between Vietnam and Asian, especially China compared withUS or EU. In many years, VN always has trade surplus with US and EU; nevertheless, VN takes trade deficit with ASEAN, and especially China. In many years, economists have concerned about the trade deficit between Vietnam and China. And exchange rate between Vietnam and China has been considering as a reason of trade deficit. The question is that should we depreciate our currency? This problem is very important because exchange rate plays an important role in the economy, especially in emergency market such as Vietnam (Stone, M.et al., 2009). It will effect on inflation targeting whichis one of the hottest issue in Vietnam inrecent years. According to Marshall-Learner (ML) condition or J Curve, exchange rate plays an important role in trade balance. Both of them state that if the currency is depreciation, with the condition that adding the elasticity of export and import more than one, the trade balance will increase in the long run. As VND is appreciated, Vietnamese finds imported goods from China cheaper and Chinese finds imported goods from Vietnam more expensive. Therefore, Vietnam has trade deficit. Nevertheless, if VND is depreciated, an opposite effect takes place and Vietnam takes trade surplus with China. 2 Does VND over-valuated compare with China? Does exchange rate effect to trade balance between Vietnam and China? And does depreciation increase trade balance between Vietnam and China? 1.2 Research objectives Based on the problem statement, this study aims to find out: First, estimating of the real exchange rate between Vietnam and China Second,evaluatingof the value of Vietnamese currency against Chinese currency. Third, examiningthe influenceof the exchange rate on trade balance between two countries. 1.3 Research methodology There are three procedures to solve the three objectives of this research. Firstly, Purchasing Power Parity is used to estimate the real exchange rate between Vietnam and China. Secondly, time trend is used to evaluateof the value of Vietnamese currency against Chinese currency. And finally, cointegration and vector error correction is used to estimate the impact of the exchange rate on trade balance between two countries. 1.4 Structure of this thesis The thesis consists of five chapters which are arranged as follows: Chapter 1 provides an overview for the trade balance of Vietnam in recent years, and explains several reasons for choosing this topic and research objectives. Chapter 2 is assigned to literature review. This chapter provides the theories and empirical studies for calculating real exchange rate, the impact of exchange rate on 3 trade balance. Moreover, the conceptual framework will offer a general step to be conducted in this thesis as well. Chapter 3 analyzes the influence of exchange rate on trade balance between Vietnam and China. This chapter provides an overview the bilateral trade between two countries in general and in details. Chapter 4 describes the methodology and data collection for this thesis. This chapter containsempirical models that will apply for the next chapter as well as data sources. Following chapter 4, chapter 5 presents and discusses empirical results. Econometric results are shown and discussed to determine the real exchange rate, misalignments between Vietnam and China. Finally, the role of exchange rate in trade balance between Vietnam and China is covered. Finally, with all results and analyses from previous chapters, the chapter 6 provides recommendations for policy makers. Additionally, the last part contains limitations and further researches as well. 4 CHAPTER 2 LITERATURE REVIEW Before calculating misalignments, the equilibrium real exchange rate should be initially estimated. This chapter provides two approaches for calculating equilibrium exchange rate. The disadvantagesof each approach would be considered, then selects the suitable approach to calculate misalignments. After that, the role of exchange rate in bilateral trade will be examined. 2.1 Definitionof exchange rate, real exchange rate and misalignment GÄrtner (2009) stated that exchange rate is defined either as the price of one unit foreign currency in termsof domestic currencyor the ratio between the price of a bundle of goods foreign and domestic. Definition of real exchange rate (RER) is the ratio price of traded goods to non-traded goods. The equilibrium real exchange rate (ERER) is defined as the rate price of traded goods to non-traded goods that results from the simultaneous achievement of equilibrium in the external sector and internal sector of a country. The misalignment is the differencebetween real exchange rate and equilibrium exchange rate. The misalignment implies the currency overvalued when it is positive, otherwise the currency undervalued. In order to calculate the misalignment, we have to calculate the equilibrium real exchange rate (ERER). There are some methods to calculate ERER such as PPP approach, model – based approach. 5 2.2 Theoretical model of real exchange rate equilibrium 2.2.1 Model – based approach Model – based approach (Clark and McDonald, 1998) measures RER misalignments based on the ERER. This is familiar with “behavior equilibrium exchange rate” (BEER) approach and “fundamental equilibrium exchange rate” (FEER) approach. These approaches are engines to estimate exchange rate. 2.2.2 The fundamental equilibrium exchange rate approach Clark and McDonald (1998) said that the FEER approach was developed by Williamson in 1994. This approach estimates real exchange rate balances with current account (CA) at no unemployment and low inflation with sustainable net capital flow and current account equals (the adverse) of capital account (KA). CA ≡ - KA (2.1) CA = α0 + α1q +α2yd + α3yf (2.2) Where q is the real effective exchange rate, yd and yf are a function of home and foreign output or demand respectively. Substitute equation (2.2) into equation (2.1) we obtain: q ≡ FEER = (- KA - α0 -α2yd - α3yf)/α1 (2.3) The equation (2.3) states the disadvantages of FEER approach. This implies that FEER calculates the equilibrium in the medium term and it ignores the debt shock in estimating the exchange rates. However, this is the principlemodel that can help researchers infurther research about the exchange rate. 6 2.2.2.1 The behavior equilibrium exchange rate approach Clark and McDonald (1998) built this model based on the fundamental macroeconomicssuch as: Real effective exchange rateis the currency of home economy relative to foreign currency. This variable is denoted in natural logs: log(q). Term of trade representsthe domestic export ratio value divide into import value be relative to the equal effective foreign ratio, where the trade weight is calculated trade weighted. This variable is denoted in natural logs: log(tot). Relative price of nontrade to trade goods is defined as the ratio between home country of consumer price index (CPI) and the producer price index (PPI) be relative to the equivalent foreign effective ratio. This variable is denoted in natural logs: log(tnt). Net foreign assetsequals the total foreign assets (minus gold holding) minus total liability to foreigners, express as the ratio to GNP. This variable is denoted in nfa. Relative stock of government debt is defined as the ratio of domestic government net financial liabilities to nominal GDP relative to the effective ratio of partners. Real interest rateis defined as home interest rate (r) minus the foreign interest rate (r*). r is defined as home interest rate.This is calculated inlong term (10 years) government bonds minus the change in the CPI from the previous year. r* is the weighted average partners real interest rate with the same calculate style. Therefore the equation: Xt = [(r - r*), ltntt, ltott, nfat, λt] (2.4) 7 Where: x isa gross vector,q represents real effective exchange rate,tot stands for term of trade, tnt is relative price of nontrade to trade goods, nfa is defined net foreign assets, λ represents relative stock of government debt and real interest rate is r, r* The equation (2.4) includes severalfundamentaleconomics that could affect to the bilateral exchange rate. Therefore, the movement in the real effective exchange rate could be explained by BEER approach. However, the fundamental economicscould explain exchange rate in a variety of variables such as technological process, control over capital flows, etc. (Doroodian, Jung and Yucel, 2010). This reason implies thatthere is no normative formula. Thus, it is difficult to put all variables in the equation with proper data. As a consequence, when variables are limited or exceeded, the coefficient would change certainly. 2.2.3 The purchasing power parity approach 2.2.3.1 The law of one price The Law of One Price proposed by Krugman, Obstfeld and Melitz (2012) expresses that the price of an identical good sold asthesame price in the world when express in termsof the same currencyin the competitive market without transportation cost and official barriers to trade, etc. That means  = st × ∗ (2.5) Where  is theprice of goodsi in term of local currency, st is the nominal exchange rate and ∗ is the price of goodsi in the foreign currency. However, in the reality, there is no evidence that goods and services have the same price in the international market because of transportation cost, tax, etc. 8 2.2.3.2 Purchasing Power Parity The PPP was first expressed by the Salamanca School inSpanishin 16thcentury. At that time, PPP was basically that when we changed to the common currency, the price level of every country should be the same (Rogoff, 1996). Cassel (1918) introduced the term purchasing power parity (PPP). After that, PPP became the benchmark for acenter bank to build up the exchange rate and for scholars study exchange rate determinant. The model of PPP of Cassel became the inspiration for Balassa (1964) and Samuelson (1964) set up their models. They independently worked and gavethe final explanation why absolute PPP become the good theory of exchange rate (Asea, P. and Corden, W. 1994). The reason is that the relative price of each good in different countries should equal to the same price when changinginto the same currency. The PPP has two versions including absolute and relative PPP (Balassa, 1964). According to the first version, Krugman et al., (2012), defined that absolute PPP implies that exchange rate between two currencies of pair countries equal tothe ratio of the price level of these countries. This mean: st = pt/∗ (2.6) Shapiro (1983) stated that the relative PPP implies the ratio of domestic to foreign prices would equalthe ratio change in the equilibrium exchange rate. This states that there is a constant k which has the relationship between price level and equilibrium exchange rate, st = k*pt/∗ (2.7) 9