VIETNAM NATIONAL UNIVERSITY, HANOI

UNIVERSITY OF LANGUAGES AND INTERNATIONAL STUDIES

FACULTY OF ENGLISH LANGUAGE TEACHER EDUCATION

FINAL ASSIGNMENT

Student’s name : Le Thi Minh Trang

Student’s ID : 20041251

Course : International Economics

Lecturer : Do Thuy Linh

HANOI – 2023
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TABLE OF CONTENTS
I. Exchange rate 3
1. Overview of foreign exchange market 3
2. Definition of exchange rate and its importance 5
3. Exchange rates classification 6
4. Exchange rate system 7
II. Determinants of exchange rates 9
1. Balance of payments 9
2. Inflation 10
4. Other factors 11
III. Exchange rate situation in Vietnam 12
1. Exchange rate management of Vietnam through periods 12
2. Suggestions for Vietnam to bring down the high foreign exchange rate 14
IV. References 16
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I. Exchange rate
1. Overview of foreign exchange market
The foreign exchange market, sometimes known as the forex market or FX, is the global
platform on which currencies are actively exchanged. It is the world's largest financial
market, with daily transactions exceeding billions of dollars, making it the most liquid of all
financial markets. Notably, the FX market is an over-the-counter (OTC) market since it
operates without a central marketplace (Kumar, 2014). Unlike traditional stock exchanges,
the forex market is decentralized, so there is no central center for currency trading. Instead,
major banks and financial institutions trade directly with one another in the interbank market.
As a result, this decentralized structure adds to the market's availability 24 hours a day, seven
days a week, enabling for continuous trading across many time zones.

The amounts traded in foreign currency markets are remarkable. According to a Triennial
Central Bank Survey conducted in April 2022 by the Bank for International Settlements
(BIS), an international organization for banks and the financial sector, $7.5 trillion per day
was exchanged on foreign currency markets, making the foreign exchange market the world's
largest market. In comparison, the GDP of the United States in 2022 was $25.46 trillion per
year (Statista, 2023).

Figure 1. Global foreign exchange market turnover

Note. Sourced from BIS Triennial Central Bank Survey (2022)

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The simultaneous purchase and selling of two currencies, known as currency pairs, is a key
feature of forex trading. These pairings consist of a base currency and a quote (or counter)
currency, with the exchange rate reflecting how much of the quote currency is necessary to
acquire one unit of the base currency (Ganti, 2023). In the survey by BIS (2022), it is obvious
that the most liquid trading pairs are USD/EUR, USD/JPY, and USD/GBP.

Figure 2. Foreign exchange market turnover by currency and currency pair

Note. Sourced from BIS Triennial Central Bank Survey (2022)

Bridging the overview of the foreign exchange market with the discussion of exchange rate
and its relevance, it becomes clear that the forex market's vast character sets the stage for the
intricate dynamics of currency valuation. The forex market, being the world's largest and
most liquid financial market, functions effortlessly across time zones, assisted by its
decentralized structure. The astonishing daily transaction volumes highlight the market's
importance in the global economic landscape. Moving on from the complexities of the
market, the definition of exchange rates, and its significance as a key factor determining
international commerce, economic competitiveness, as well as monetary policy will be
demonstrated. Understanding the relationship between the forex market and exchange rates is
critical for understanding the complexity that governments, companies, and investors face in
the global economy.
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2. Definition of exchange rate and its importance

Most nations utilize their own currencies as a medium of exchange, like the Vietnam dong in
Vietnam and the Pounds in the UK, serving as legal tender for all local transactions.
Nonetheless, a few countries, such as El Savaldor, have embraced foreign currencies, like the
US dollar, as their legal tender. Additionally, certain countries, like those in the European
Union, collectively adopt a shared currency, such as the "euro," as their legal tender.

When a country with its unique currency needs to conduct transactions with other nations
using different currencies, it must exchange its currency for others at a specified exchange
rate. Therefore, an exchange rate is the price at which one currency is exchanged for another
and its represent the relative worth of several currencies on the worldwide market. The
number of units of one currency required to purchase one unit of another currency is stated as
a ratio (Chen, 2022). In other words, the exchange rate is the price of one currency stated in
terms of another currency, which also means that it may be expressed in two ways. For
example, since a US Dollar gets us 0.91 Euro, the USD/EUR exchange rate is 0.91. We can
also say that since 1 Euro gets us 1.10 US Dollar, the EUR/USD exchange rate equals 1.10.

Exchange rate plays an important role in the dynamics of international trade because it serves
as the primary mechanism for establishing the value of one currency in reference to another.
This rate reflects the relative strength or weakness of various currencies on a worldwide scale
and is subject to frequent fluctuations caused by a variety of reasons. Economic statistics,
geopolitical events, and market conditions are all aspects that contribute to the complex
network of currency value.

In terms of international trade, exchange rate has a substantial effect on the prices of
products and services traded between nations. According to Nicita (2013), the exchange rate
has a significant impact on a country's trading performance. Currency values and volatility,
whether influenced by external factors or policy, can have significant implications for
international commerce, the balance of payments, and overall economic performance. A
lower currency may improve a country's export competitiveness by making them more
inexpensive to international purchasers. A stronger currency, on the other hand, may boost
the affordability of imports, thus affecting a country's trade balance. The interaction of
exchange rates and international commerce is a dynamic process that alters the economic
landscape of nations. For example, when more US dollars can be bought for €1, or when the
euro appreciates, US goods become less costly for individuals in the Europe area. As a result,
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import prices decline. This has a direct influence on eurozone inflation through the prices of
imported items for consumption, as well as an indirect impact through the prices of imported
raw materials and intermediate goods used in manufacturing (European Central Bank, 2016)

Central to the functioning of monetary systems, exchange rates also serve as a tool for
central banks in implementing monetary policy. By adjusting interest rates and intervening
in the foreign exchange market, central banks aim to achieve economic stability, control
inflation, and safeguard the overall health of their economies (Picardo, 2021). To be more
specific, a weak domestic currency can escalate the inflation rate of a nation that is a
significant importer due to increased pricing for imported imports. This may prompt the
central bank to hike interest rates in order to combat inflation while also supporting the
currency and preventing it from falling quickly. Conversely, a strong currency depresses
inflation and puts a drag on the economy that is akin to restrictive monetary policy.
Consequently, a nation's central bank may seek to maintain interest rates low or decrease
them further so as to restrict the native currency from being too strong.

3. Exchange rates classification

Exchange rates can be classified in a variety of ways. However, when assessing their impact
on the Balance of Trade (BOT) , the exchange rates are divided into two categories based on
their magnitude: real exchange rates (RER) and nominal exchange rates (NER) (Le,
2023). Before explaining the terms RER and NER, this writing will provide a better
understanding of Balance of Trade.

Balance of Trade (BOT), commonly known as the trade balance, is the monetary value
differential between a country's imports and exports during a specific time period. A positive
trade balance represents a trade surplus, whereas a negative trade balance represents a trade
deficit. The BOT is a crucial factor in calculating a country's current account (CFI, n.d.).
According to Kenton (2023), The BOT may be calculated by subtracting the entire value of
its exports from the total amount of its imports. The BOT is used by economists to assess the
relative strength of a country's economy.

A positive trade balance suggests that a country's producers have a thriving international
market. After manufacturing enough products to meet local need, there is enough demand
from international buyers to keep local producers occupied. Meanwhile, a negative trade
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balance indicates that money is flowing out to pay for exports, showing that the country is too
reliant on foreign goods.

The classification of nominal exchange rate and real exchange rate is useful to measure
the effects of exchange rate on the trade balance.
The nominal exchange rate (NER) is the rate used every day in transactions on the foreign
exchange market, it is the price of one currency expressed in terms of another currency
without mentioning the correlation of purchasing power of goods and services between them.
The nominal exchange rate is the currency conversion price, and is expressed as a ratio
(Carbonari, 2009). For if the dollar/euro exchange rate is 1.4, it implies that it takes 1.4
dollars to acquire one unit of the European currency (or NER = 1.4 USD/1 EUR).

The real exchange rate (RER) is the nominal exchange rate adjusted by the correlation of
domestic and foreign price. A decline or increase in nominal exchange rates does not always
imply a rise or fall in international trade competitiveness. The real exchange rate (RER) is the
buying power of one currency unit in relation to anothe based on current currency rates and
costs (Le, 2023). RER is the ratio of the number of currency units required by one country to
buy a basket of goods in another country after converting that country's currency to the
currency of the other country on the foreign exchange market, divided by the number of units
required by that country's currency to directly purchase that basket of goods within that
country.

Real exchange rate fluctuations have a significant influence on import-export dynamics and
balance of trade. The real exchange rate incorporates a currency's true buying power, making
it a critical aspect in determining a country's competitiveness in the worldwide market.
Changes in the actual exchange rate, which reflect changes in the relative worth of currencies,
can have a major impact on the cost of products and services for overseas customers. The
nominal exchange rate, on the other hand, serves as the initial benchmark for measuring
currency values but must be adjusted to generate the actual exchange rate. To account for
factors such as inflation, certain adjustment processes are performed to the nominal exchange
rate, showing the underlying economic significance of currency changes.

4. Exchange rate system

A country's exchange rate system is a set of laws and regulations that define and manage a
country's exchange rate in order to construct an exchange rate mechanism to execute that
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country's general economic development plans and international economic affairs in

particular (Fernández, 2017). The variety of exchange rate regimes is determined by the
involvement of the government and the market in determining exchange rates. Depending on
the amount of government intervention, the government enforces different currency rate
regimes that can be entirely set through the Central Bank (State Bank) the three most
common exchange rate systems can be listed as follows:

Fixed exchange rate system: An exchange rate system which the Central Bank announces
and pledges to act to maintain a predetermined fixed exchange rate known as the Center Rate
within a specified range. The country's central bank is in charge of managing the domestic
currency's exchange rate by buying and selling the local currency in the foreign exchange
market. The Central Bank must have specific foreign exchange reserves accessible in order to
intervene in the foreign exchange market, therefore when a country maintains a fixed
exchange rate system, it confronts various obstacles.

Floating exchange rate system: A system in which exchange rates are established fully
independently in the foreign currency market by the law of supply and demand, with no
intervention by the Central Bank. Exchange rate variations in the floating exchange rate
mechanism always reflect changes in supply and demand linkages in the foreign currency
market. The government participates in the foreign exchange market as a normal member,
which means that it can purchase or sell a specific currency for the purpose of its operations,
rather than intervening to influence or fix exchange rates.

Managed floating exchange system: A system in which the currency rate is permitted to
fluctuate in response to market conditions, but the government occasionally intervenes to
prevent it from moving. beyond a particular point. Some nations have established and
implemented a "currency bloc" in which they strive to maintain fixed exchange rates with the
currencies of the bloc's members while allowing the bloc as a whole to vary in response to
market forces in one direction compared to countries outside the bloc.

According to Fernández (2017), changes in the price of one currency in relation to another
can be defined in many ways depending on the exchange rate system used. For the floating
exchange rate system, currency values in this system are set by market forces. The increase
in the value of one currency in comparison to another is referred to as appreciation. For
example, if the euro appreciates versus the dollar, it implies its value has risen from, say, 1.06
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to 1.07 dollars per euro. Depreciation, on the other hand, denotes the loss of value of one
currency in relation to another. Using the same example, if the euro rises, the dollar falls,
implying that more dollar units are needed to buy a single euro.

In contrast to floating systems, fixed y systems entail central banks making choices to
manage the value of their currency. Devaluation happens when a central bank cuts the
value of its currency on purpose. The move by China's central bank (PBOC) to devalue the
country's currency in August 2015 is an example of this (Boyle, 2023). Meanwhile,
revaluation occurs when a central bank decides to boost the value of its currency.
Switzerland's Central Bank, for example, decided on January 15, 2015, to eliminate the Swiss
Franc's 1.2000 francs per euro ceiling, which was imposed in September 2011 (Delivorias,
2015).

II. Determinants of exchange rates

1. Balance of payments
The Balance of Payments (BOP) is an important economic statistic that gives a detailed
accounting of a country's financial interactions with the rest of the world. While the BOP
does not directly dictate exchange rates, the BOP's many components can have a considerable
impact on currency values (Madura, 2008). The Current Account Balance, which shows a
country's trade balance, is an important component of the BOP. When a country continually
has a trade surplus, meaning that its exports exceed imports, the demand for its currency
rises. This increased demand may lead to the country's currency appreciating. In contrast, a
trade deficit, in which imports exceed exports, may put downward pressure on the currency
(Lioudids, 2022).

The relationship between balance of payments and exchange rates can be presented through
this model (Course Sidekick, 2023):

The = Capital + fxb + Current

Balance of Balance Account
trafe (CI-CO)

X: Export turnover
M: Import turnover
CI: Capital inflow
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CO: Capital outflow

FXB
The balance of paymentsand exchange rate are closely linked. Fluctuations in exchange rates
are closely tied to the international balance of payments. If there's evidence of overspending
in the balance of payments, the demand for foreign currency rises, leading to a decline in the
value of the domestic currency and an increase in the exchange rate. Conversely, when the
balance of payments is in surplus, the demand for the domestic currency rises while the
demand for foreign currency falls, resulting in a decrease in the exchange rate.

2. Inflation
Inflation can have an impact on exchange rate through various channels. In general, when
there is inflation, a currency’s value tends to decline due to the erosion of its purchasing
power. Consequently, countries with high inflation usually witness a relative weaking of their
currencies compared to others. According to Twin & Brock (2023), a country with a
continually decreasing inflation rate typically has an increasing currency value as its buying
power grows in relation to other currencies. Japan, Germany, and Switzerland had low
inflation in the latter part of the twentieth century, but the United States and Canada did not
reach low inflation until much later. Countries with greater inflation often see their currency
depreciate in relation to their trading partners' currencies. Higher interest rates are frequently
associated with this.

3. Interest rates
Every countries want their currency to have the same value as the other countries. In order to
achieve this goal, the inflation rate of the country need to be kept at a moderate level. Interest
rates can affect exchange rate in various ways. Governments and Central Banks can tighten
monetary policy by increasing interest rate or reducing the money supply. Higher interest
rates can attract foreigner. Higher interest rates may entice foreign investors seeking higher
returns, raising demand for the currency of that country (Twin & Brock, 2023). In contrast, if
a nation has high inflation but low interest rates, investors may want to shift their investments
to currencies with lower inflation, causing the currency to fall. All these changes can leave an
impact on the exchange rates as they affects investorpreceptions about the economy’s
stability and attractiveness for investments. Overall, high inflation rates relative to other
countries can erode a currency’s value in the foreign exchange market. However, the link
between inflation and exchange rates is complicated, because it is impacted by a variety of
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other economic factors such as market expectations, monetary policy actions, and global
economic situations (Hacche, 1983).

4. Other factors
Goverment debt: A financially prudent administration will be able to avoid sharp drops in
the national debt, making a country's currency look more appealing and steady in terms of
economic growth. Government debt can affect the exchange rate in numerous ways.
Government debt can have various effects on exchange rates. It can impact interest rates,
which in turn affect currency strength. When a country has high debt, it may lead to increased
interest rates, attracting foreign investors and potentially strengthening the currency.
However, excessive debt can undermine investor confidence, resulting in currency
depreciation as investors sell assets denominated in that currency. Moreover, it can trigger
inflation or crowd out private investment, which can influence the currency's value. The
perception of a country's fiscal health and how it manages its debt are crucial factors in
determining the influence of government debt on exchange rates (Twin & Brock, 2023)

Economic growth: Exchange rates can be impacted by government debt in a number of

ways. An increase in interest rates due to high debt might draw in foreign capital and perhaps
boost the currency. On the other hand, high debt can undermine investor confidence, causing
investors to sell off assets denominated in that currency, which depreciates the currency. It
may also lead to crowding out of private investment or inflationary pressures, which would
affect the value of the currency. Exchange rates are influenced by government debt in a way
that is mostly determined by opinions about fiscal health and debt management.

Politics Situation: Politics Situation is an utmost factor which is going to affect a investor’s
decision. As most foreigners have a tendency to invest in those countries where the political
situation is stable. There won't be any riots or wars because to a solid foundation that values
stability in people, business, and production. On the other hand, they will also prioritize a
number of programs to grow the economy and protect families' investments in order to
uphold the nation's stable political ideals. And when foreign investors come in, they also turn
to large numbers foreign currency, changing the rate differences (Sinha, 2022).
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III. Exchange rate situation in Vietnam

1. Exchange rate management of Vietnam through periods

In a research by Pham & Dinh (2014), exchange rate management of Vietnam from 1989 to
2013 will be displayed through the following table:
Table 1. Exchange rate management of Vietnam from 1989 to 2013

Periods Exchange rate management Exchange rate regime

Before 1989 Multiple exchange rate Three official rate

mechanism Free market price was parallel to the
rates of the state (until the time of the
guarantee)

1989 - 1990 Crawling bands The offical exchange rate (OER)

OER was adjusted by the State Bank
based on news of inflation, interest
rates, payment barriers, and free
market trades.
Commercial banks were allowed to
set the transaction rate within the
range of =/- 5%
The use of exote is strictly controlled

1991 - 1993 Pegged exchange rate within Controlled the use of foreign
horizontal bands currency more strictly, limit carrying
money out of the border.
Established an official foreign
currency reverse fund to stabilize the
exchange rate.
Establisedh two foreign currency
trading assets in HCM City and
Hanoi.
OER was formed based on the bid
rates at two products; The State Bank
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intervened in the transactions on two

products; The exchange rate at
commercial bank is lower than 0,5%
compared to which was stated by
OER

1994 - 1996 Conventional fixed ped The interbank foreign exchange

arrangement market was formed in place of two
low-priced products; The State banks
continued to intervened strongly in
the transactions on this mayor.
OER was successful and
supplemented based on interbank
rates.

1997 - 1998 Crawling bands The exchange rate margin at

commercial banks compared to OBR
was expanded from =/- 1% to +/- 5%
(02/1997) and from +/- 5% to +/-
10% (10/1997) and then
mainstreamed to no more than 7%.
OER was sent to 11,800VND/USD
and 12,998/USD.

1999-2000 Conventional fixed beg OER stated publicly that the

arrangement exchange rates based on the
intermiddle order exchange rate on
the previous working day (Februry
29,1999)
The exchange rate range at
commercial banks decreased to no
more than 0,1%
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2001 - 2007 Crawling peg OER was mainly led from

14,000VND/USDin 2001 to 16,100
VND/USD in 2007.
The exchange rate margin at
commercial banks was adjusted to
+/- 0.25% and +/- 0,5% in 2007

2008 - 2013 Crawling bands OER was regulated from about

16,100VND/USD at the beginning of
2008 to 17,000VND/USD in 2009,
17,940 VND/USD in the early of
2010.
OFR was repeatedly increased and
decreased within minor changes in
2011.
OEK was held at 20,828 VND/USD
during the period from the end of
2011 to June,2013.
The price margin at commercial
cargo compartmentsis regulated
many times up to +/- 0,75%.
The exchange rate fluctuation band
at commercial banks was adjusted
several times to +/-0.75% (from
23/12/2007 to 09/03/2008), +/-1%
(from 10/03/2008 to 25/06/2008),
+/-2% (from 26/05/2008 to
05/11/2008), +/-3% (from
06/11/2008 to 23/03/2009), +/-5%
(from 24/03/2009 to 25/11/2009),
and +/-3% (from 26/11/2009 to
11/02/2011), +/-1% (from
11/02/2011 until the end of 2013).
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2. Suggestions for Vietnam to bring down the high foreign exchange rate
According to Mr. Pham Chi Quang, Deputy Director General in charge of the Monetary
Policy Department of State Bank of Vietnam (SBV), since the beginning of 2022, the
international market has been developing complicatedly, with many unpredictable
movements: political tensions between Russia and Ukraine have negatively affected the
global financial system, with strong impacts on energy and other commodity prices, seriously
affecting and disrupting global supply chains; central banks have accelerated monetary policy
tightening; raised key interest rates to control inflation; In that backdrop, the US Federal
Reserve (FED) has hiked its benchmark interest rate three times in the first six months of
2022, with the 0.75 percentage point rise announced on June 15 being the largest increase
during the previous 28 years. And the FED is projected to tighten its monetary policies more
in the future. The USD has risen considerably (the DXY index has risen by almost 10% since
the beginning of 2022), leading the currencies of several big and emerging nations to fall
sharply. These events have harmed the balance of supply and demand for foreign currencies,
as well as customer psychology in the domestic market, placing pressure on the exchange
rate's and forex market's stability.
In this context, the USD/VND exchange rate reversed its downward trend in 2021 and has
gained by almost 2% since the beginning of 2022 compared to the end of 2021. Despite the
sharp increases in energy and commodity prices, the domestic forex market remains stable,
market liquidity has been smooth, and legitimate demands for foreign currency have been
fully and promptly met, particularly the demand for foreign currency to import essential
commodities for serving production and business operations. However, in the case that
fluctuation in exchange rate increases dramatically, which is not compatible with the
worldwide and local market circumstances and shifts, as well as the general objective of
monetary policy management, I suggest several measures for the State Bank of Vietnam as
follows:
One approach is direct involvement in the foreign exchange market, in which the SBV
can buy and sell currency reserves in order to impact the domestic currency's value,
which aims to stabilize or alter the exchange rate to a more acceptable level. Secondly,
adjusting interest rates is another way for SBV as the central bank may attract foreign
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money by boosting interest rates, stimulating demand for the home currency and potentially
strengthening it. This strategy, however, should be carefully studied because it has
ramifications for domestic borrowing and economic activity. Furthermore, the SBV may
propose adopting or revising capital regulations. During times of economic instability,
these restrictions restrict the movement of cash into and out of the country, avoiding
excessive speculative trading and capital flight. This method contributes to the stability of the
foreign currency market. Finally, the SBV is also responsible for regulating foreign
exchange operations. Therefore, the state bank can regulate currency supply and demand by
enacting particular laws, such as prohibitions on certain sorts of transactions or limits on the
amount of currency that can be bought or sold.

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