INTRODUCTION
1. The urgency of research
Since exchange rate is one of basic tools to help governments operate their macroeconomies and
especially to guarantee the balance of external economy, exchange rate and mechanism operating
exchange rate policies until now have been sensitive and decisive issues to every country.
Exports’competitiveness, trade balance and international payments, national reserves, changes of
manufacturing framework and trust in the national currency, the goverrnment and future, etc, are
inextricably linked and dependent on exchange rate.
In the high-speed inflationary economy, Vietnam has implemented raising the value of national
currency to curb inflation. As a result, the value of real exchange rate USD/VND (RER) and real
effective exchange rate (REER) in recent years have decreased, partly restricting exports and
promoting imports, which in turn leads to the deficit of trade balance. In addition, signs of
Vietnam’s unstable economy and impacts from the global financial crisis have lessened investment
flows towards Vietnam and reduced foreign exchange reserves which can be lower to the
international standard. This fact leads Vietnam’s economy to the new context in which the scarcity
of foreign exchange and the pressure from exchange rate became worrying problems while the gap
between rates in the free market has widened. Exchange rate is not only a result of the imbalance
between supply and demand of foreign currencies. Has the recent deficit of trade balance resulted
from many reasons one of which is exchange rate and pressure from changes of exchange rate
attributed to the deficit of current balance account and the decrease in capital balance account?
With hope of clarifying the foundation and reality to complete the orientation and solutions to
improve the positive relationship between exchange rate and the Vietnamese balance of payments,
especially when Vietnam has become an official member of the World Trade Organization (WTO) and
integrated into the global economy, the author chooses the thesis topic “The relation between exchange
rate and the balance of payments – Theory and reality in Vietnam” to analyse and research. In
addition, this thesis evaluates the influence of exchange rate USD/VND on the balance of payments and
vice versa, the impacts of partial balances on the pressure of exchange rate. From all analysis and
assessment, the project figures out achievements and limitations to propose a few solutions in order to
improve the positive relation in the future.

2. Domestic and international research situations

views that the improvement in the Vietnamese trade balance means more attention to operate
policies of exchange rate and foreign exchange (Nguyen Thi Mui 2009, Le Xuan Nghia 2009,
Nguyen Minh Phong 2009). Research on “Using ECM model in evaluation of the real exchange
rate’ imfluences on export in Vietnam” written by Nguyen Chien Thang 2003. By using Error
Correction Model (ECM), he investigates impacts of the real bilateral exchange rate USD/VND on
Vietnam’s export in the period 1986-2000 and results show that long-term elasticity coefficients for
Vietnam’s export is 1.13 while that of Lord’s research in Vietnam’s leather shoes export is 1.97 and
of Nguyen Van Cong (2002) is 1.33. Research on exchange rate’s impacts on the trade balance
written by Nguyen Van Cong is based on Marshall Lerner condition to examine the real exchange
rate’s impacts on the amount of exports and imports in the short and long term. The result is
Marshall Lerner is not satisfactory when the sum of export and import elasticity coefficients is
smaller than 1 (1.33 + (-1.28) = 0.05<1), recent research of Nguyen Van Tien and Dinh Thi Thanh
Long (Banking Academy-2009) on analyzing and calculating the elasticity of export and import
demand for exchange rate is based on examining 3 levels of exchange rate on the elasticity of
import and export. The result is with official exchange rate and its levels of ask/bid rates, the
Marshall Lerner condition is not satisfactory but with ask/bid rates of commercial banks and income
variable, it is.
2.2 International research overview
There are some particular research works on examination of the relation between exchange rate
and the balance of payments. Research on International Monetary and Financial Economics
written by Joseph P.Danields and David D. VanHoose (2005) clarifies the relation between
exchange rate and the balance of payments according to elasticity theory, expenditure theory,
monetary theory and investment portfolio theory. Research on Multinational Business Finance
of David K.Eiteman 2001 provides an overview of exchange rate’ influential factors, then
examining impacts of the balance and payments on exchange rate. Two research works are
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beneficially theoretical factual foundations for the author to continue doing research the reality of
this relation in Vietnam.
Research of Mohsen Bahmani-Oskooee and Gour Goswami 2003 “A Disaggregated
Approach to Test the J-Curve Phenomenon: Japan versus Her Major Trading Partners”

and simultaneously study developments and policies of foreign exchange rate in Vietnam from
1999 to 2009.
- Focus on the depth of bilateral impacts between the real bilateral and real effective
exchange rate and the balance of payments in Vietnam through analyzing specifically the causal
relation between exchange rate and partial balances of the balance of payments, and forming
quantitative models to measure these relations in Vietnam.
Based on international experiences and the reality of Vietnamese economy, exchange rate
policies and the balance of payments, the thesis also figures out lessons for Vietnam, then offering
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solutions to improve the positive relation between exchange rate and the balance of payments.
5. Subjects and scope of research
5.1 Research Subjects
The thesis’s subjects are exchange rate, balance of payments and their relationship.
5.2 Scope of research
The thesis focuses on the following issues:
- First, the thesis examines overall theories on the relationbetween exchange rate and the
balance of payments.
- Second, the thesis investigates the reality of the balance of payments, policies of exchange
rate and the relation between exchange rate USD/VND and the balance of payments in Vietnam
during the period from 1999 to 2009. Since trade balance is a significant part of the balance of
payments, the thesis centers deeply on the causal relation between real exchange rate and trade
balance.
- The thesis also analyses experiences of managing rate policies in some particular nations
such as China, Korea and the United States in order to improve the balance of payments.
5. Research methodology
Research methods used in the thesis include:
- Methods of Marxism dialectial and historical materialism based on applying the
Government and Party’s views and policies upon the economic development and integration stated at
the 9
th

1999-2009.
- Analyse the reality of the balance of payments in Vietnam can conclude that the pressure from
the deficit of overall balance stems from the deficit of trade balance in current account. This
situation will last in the long term as long as the manufacturing capacity and the competitiveness of
Vietnam’s goods and services are enhanced.
- Through studying the causal relation between exchange rate and the balance of payments, the
thesis shows that there is a bilateral relation between the real exchange rate and trade balance with a
certain lags. The sum of export and import elasticity coefficients larger than 1 permits Vietnam to
think about domestic currency devaluation in the future in order to improve trade balance with all
necessary conditions.
- In order to provide specific solutions to improve the relation between exchange rate and the
balance of payments, the author bases on evidence to predict the trend of the changes of exchange
rate of VND and other currencies to USD. The results are in the future the nominal exchange rate of
VND is likely to decrease compared to USD and Vietnam still has to encounter inflation issues.
Based on internal analysis of Vietnam’s economy, the Vietnamese balance of payments is foreseen
to be under the pressure of the deficit in trade balance.
- The thesis also forms a system of orientation and solutions to improve this relation. Proposed
solutions are based on two main groups: (i) The group of completing policies of exchange rate
based on benefits to international trade. In the short term, the thesis proposes scenarios for inflation,
the development of Vietnam and America to adjust exchange rate to support export and improve
trade balance. (ii) The group of improving the balance of payments in order to contribute to the
stabilization of exchange rate, increase the efficiency of operationg exchange rate based on two
main solutions, including a solution to improve current balance account and another to improve
capital balance account. The root to improve the balance of payments is to increase economic
competitiveness, good manufacturing capacity, replace imports, improve investment environment,
conduct tough fiscal policy in the current context and accept lower economic growth.
- In addition, the thesis provides conditional petitions to carry out solutions. Then, the long-
term stabilization of low inflation and improve environment for economic competitions will be key
answers to better the relation between exchange rate and the balance of payments in Vietnam.
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1.2.4.3 Overall balance (changes in official reserves)
1.3 The relation between exchange rate and the balance of payments
1.3.1 Exchange rate’ effects on the balance of payments
- Theory of elasticity: The main content of this theory is to analyse two factors which have
direct impacts on current balance account in the context of devaluation. Through analyzing export
and import elasticity coefficients in comparison with relative prices (exchange rate). The Marshall-
Lerner condition shows the successful devaluation of national currencies (the improvement in trade
balance) means the sum of export and import elasticity coefficients higher than 1.
- Theory of Absorption approach: This theory proves that the devaluation can improve trade
balance while savings from income increase more than the rise in expenditure.
- Theory of Monetary approach: In the system of fixed exchange rate, the increase in
domestic credit supply will lead to the deficit of the balance of payments and vice versa, the
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decrease in domestic creadit supply will lead to the surplus of the balance of payments. On the other
hand, in the system of flexible exchange rate, the increase in domestic credit supply will decrease
the value of national currency and vice versa, the fall in the domestic credit supply means the
increase in the value of national currency.
- Theory of porfolio approach: Exchange rate of a specific country is identified by the
demand-supply relation of financial assets (money, bonds).
1.3.2 Effects of the balance of payments on exchange rate
- In the system of fixed rate: The government takes responsibility for guarateeing the balance
of the balance of payments. If the sum of current balance account and capital balance account is not
approximatedly 0, the government can get invloved in the foreign exchange market by selling or
buying foreign exchange reserves.
- In the system of floating rate: The government does not get involved in operating exchange
rate. The fact shows that when the balance of payments is not in the state of balance, it will impacts
exchange rate to make the balance of payments return to the state of balance (David K.Eiteman
2001, Page.62).
- In the system of managed floating rate: The government can interfere to ensure to have an
expect exchange rate according to the context, the market’s conditions. The government often

- Reasons for the fluctuation of exchange rate USD/VND in time include: the increasing far
difference between inflation and income in Vietnam compared to America and other nations;
continuous deficit of current balance account; the weakening of USD
2.1.2 Policies of exchange rate
- Since 2/1999, the mechanism of operating exchange rate has been changed (Dicision
64/1999 and 65/1999). Since then, the State Bank announced only the average exchange rate
USD/VND of in the market of interbanks. Exchange rate of commercial banks are calculated
according to the average exchange rate of interbanks in the range of fluctuation decided by the State
Bank (from ±0.1% to ±5%).
- Exchange rate of VND is linked inextricably to USD during research period
- Sometimes, the State Bank is late to adjust exchange rate to keep up with the current context
of market and has not fulfilled tasks and responsibilities of the management agency in predicting
and orienting the trend of market, which certainly causes many negative effects.
2.2 The reality of the balance of payments in Vietnam from 1999 to 2009
2.2.1 The context of Vietnam’s economy
- The economy has grown at high speed.
- Being a member of WTO offers the balance of payments, especially trade balance, many
chances and a few important challenges.
- The deficit of the balance of payments and budget balance is still large.
- The global financial crisis’s negative effects on the deficit of the balance of payments as
investment flows towards Vietnam are cushioned dramatically.
2.2.2 Current account
2.2.2.1 Developments of current account:
The balance state of current account of Vietnam is directly affected by the state of trade
balance because transactions of goods make up a large proportion of the total income and
expenditure in current account (approximately 70%-85%)
2.2.2.2 Reasons for the deficit of current account
Since the weak manufacturing capacity lessen the competitiveness of Vietnamese goods even
in the domestic market, the deficit of income balance and investment policies for growth and an
unsuitable policy of exchange rate encourage import.

2.3 The reality of the relation between exchange rate and the balance of payments of Vietnam
in the period 1999-2009
2.3.1 Exchange rate’s effects on the balance of payments
2.3.1.1 Exchange rate’s effects on trade balance
- From 1999 to 2002, the real bilateral and effective exchange rate are likely to increase,
contributing to the improvement in the competitiveness of international trade.
The real bilateral and effective exchange rate and rate of export compared to import (X/M) in
Vietnam from 1999 to 2009
Source: Collected and calculated from statistics of CEIC Database
- The real exchange rate (RER) and real effective exchange rate (REER) affect trade balance
with certain lags
- Under the pressure of high inflation, RER and REER which are going to be smaller than 1
encourage import and lower export’s competitiveness. As a result, growth speed of import is
higher than that of export in recent years, leading to the serious deficit of trade balance.
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USD/VND
RER USD/VND
2.3.1.2 Exchange rate’s effects on Vietnam capital account
- Policies of stablizing exchange rate in the long term and allowing the fluctuation of VND with
the trend of devaluation in the short term has attracted foreign investment flows towards Vietnam.
- Devaluing VND by 1% compared to foreign currency will increase the amount of FDI towards
Vietnam by 0.92% (Thi Hong Hanh Pham, Duc Thinh Nguyen 2010).
- The VND devaluation seems to put a positive effect on FDI flows, thus improving capital
balance to finance the deficit of Vietnam’s current balance account recently.
2.3.2 Effects of the balance of payments on exchange rate
2.3.2.1 Current account’s effects on exchange rate
- The deficit of current account is likely to increase and is one of reasons for VND devaluation
in recent years with increasing pressure.
- Pressure of increasing exchange rate because of current account is reflected through the
difference between exchange rate in the free market and official exchange rate.

1 1
m n
t i t i i t i t t
i i
REER TB REER
α χ λ φν υ
− − −
= =
∆ = + ∆ + ∆ + +
∑ ∑

2.3.3.1.2 Examine Marshall Lerner condition
Model in the long term:
dNX X dy
M
dE E dE
α β χ γ
 
= + + +
 ÷
 
Model in the short term:
1
0 0 0
X
p p p
i
i i i i
i i i
dNX dy

+
χ
>0 (0.989354+-0.772639 = 0.216715>0).
- Elasticity coefficient of export demand to the real exchange rate has its statistical value at
1% with lag 0, 1 and 4. Elasticity of coefficient of import demand, lag 0, 1 and 2 also has its
statistical value at 1% and 5%.
2.4 General conclusions on the reality of the relation between exchange rate and the balance
of payments
2.4.1 Positive impacts
- VND regularly adjusted to be devalued and flexible recently puts positive impacts on
Vietnam’s export.
- Developments of REER and trade balance is cointergrated and has a causal relation.
- Effects of the real bilateral and effective exchange rate USD/VND on trade balance with a
certain lags.
- Together with consequences, the fixed exchange rate (USD/VND) policy also brings
Vietnam’s export encouraging and positive signs contributing to improve trade balance.
- Both exchange rate and domestic income affect trade balance in the long term and short
term.
- Stable exchange rate policy in the long term with VND devaluation trend appears to
encourage foreign capital flows to Vietnam .
- The State Bank’s exchange rate policy with the gradual VND devaluation helps businesses
foresee the trend of exchange rate fluctuation and feel secure to carry out their business strategies
without concerning about the fluctuation of nominal exchange rate USD/VND.
- Capital account, the main part of the balance of payments, contributes to improve
exchange rate supply source in the foreign exchange, thus lowering the pressure on exchange rate
over years.
2.4.2 Negative effects and reasons
- Policy of exchange rate USD/VND has many consequences.
- Vietnam exchange rate policy is likely to overestimate the real value of VND to USD and
other currencies of main commercial partners.

payments
3.2.1 Adjust exchange rate for the improvement in the balance of payments
- Exchange rate adjustment in near future requires the factor of “stability” in the long term and
“flexibility” in the short term to encourage foreign investment flows for the improvement in the
capital balance.
- Besides exchange rate, Vietnam needs to adjust the macroeconomy to gain stable and
sustainable development.
- Exchange rate needs to be adjusted to heighten goods and services’’ competitiveness in
international trade. By doing this, the minimum of the target real exchange rate must be higher or
equivalent to 1.
- Policy of exchange rate adjustment needs to be flexible and acute before domestic and
foreign macroeconomic variables
- The State Bank can be independent on using tools of monetary policies.
3.2.2 The contribution of exchange rate to the balance between internal and external economy
- Exchange rate is adjusted to balance internal economy, stabilize inflation and gain
sustainable economic growth.
- Vietnam in hope of improving the economy to balance internally and externally is required
to cut out expenditure and adjust to devalue VND.
3.2.3 The balance of payments is adjusted to stabilize exchange rate
- Adjustment in the balance of payments contributes to decrease the budget deficit, restrain
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inflation and lessen the pressure on exchange rate.
- In the long term, the issue on macro stability considers restructuring economy as the
prerequisite to decrease excess of imports over exports, thus alleviate long term pressure on
exchange rate.
- Changes in the manufacturing framework increase additional value of domestic factors in
exports, raise investment effectiveness (decrease ICOR, excessive capital in the economy).
3.2.4. Co-ordinate synchronically macro-policies
- Find solutions to the target of internal balance which are stabilizing inflation, interest and
need to result from monetary and spending policies.

essential to consider and adjust monthly.
3.3.1.4 Vietnam should adjust exchange rate to improve trade balance
Vietnam need carry out “exchange rate adjustment” and in far future, Vietnam can think
about “national currency devaluation” to improve trade balance.
3.3.1.4 .1 Conditions to devalue
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- Inflation needs to be maintained at relatively low level in the long time, for example 4-5%/
year and minimum time for stability must be 3 to 5 years.
- Export and import elasticity coefficients are big enough (to have the total sum higher than 1) or
at least J effect can perform with moderate lags (from 3 to 6 months).
- Foreign exchange reserve is large enough to maintain the fluctuation of national currency
value with the range established daily
- Exchange rate policy is necessary to combine with foreign trade policy and industrial
policy and other tools of monetary policies.
3.3.1.4 .2 Scenarios of exchange rate adjustment in the future
- Identify the target real exchange rate:
To improve trade balance, the real exchange rate is proposed to be 1; 1.02 and 1.045
equivalent to the real exchange rate from the original year Quarter 1/1999 (the current balance
account) for scenarios of exchange rate adjustment.
- Estimated inflation:
After analyzing scenarios of exchange rate, in the author’s personal view, the State Bank
needs to adjust the nominal exchange rate so that the real bilateral exchange rate RER is at least 1
and according to inflation conditions in 2011 and 2012, the State Bank can adjust the correlative
nominal exchange rate.
3.3.2 Solutions to improve the balance of payments to stabilize exchange rate
3.3.2.1 Solutions to improve current account
3.3.2.1.1 Foster the manufacturing capacity and competitiveness of Vietnam’s exports to improve
trade balance
- Invest in depth and innovate technology actively.
- Develop support industries, prioritize main export industries.

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CONCLUSION
Through the thesis “The relation between exchange rate and the balance of payments-
Theory and reality in Vietnam”, the author drawa out following conclusions:
First, improving current balance account in the balance of payments and putting this balance
to the state of balance are macroeconomic targets of any nations.
Second, there is a relation between exchange rate and the balance of payments. Exchange
rate is not only one of influential factors on the balance of payments but also the result of the
balance between foreign currency supply-demand stemming from the state of the balance of
payments, especially, exchange rate affects directly trade balance and indirectly others partial
balances. Although national curreny devaluation policy will encourage exports and restrain imports,
it doesn’t mean that every nation can devalue its currency without Marshall Lerner condition and J
effect satisfied. In fact, many research on elasticity theory examination based on Marshall Lerner
condition in countries in the world show that exchange rate has a certain effect on trade balance in
the balance of payments
Third, studying experiences from many countries proves that exchange rate policy is a great
contributor to current success on economy and society of China and Korea when these nations
implement domestic currency devaluation policy after preparing all necessary conditions for
boosting exports to the global market. Lessons for Vietnam from other countries’ experiences
include: exchange rate system should be flexible, suitable for each period of Vietnam’s
development, coherent and synchronic in operating exchange rate policy; and the implementation of
exchange rate policy needs synchronic co-ordination with other macroeconomic policies.
Fourth, studying the reality of the relation between exchange rate USD/VND and the Vietnam
balance of payments figures out some following points:
+ Even though the real nominal bilateral exchange rate USD/VND is likely to increase over
time, in recent years, under the pressure of inflation, the real value of VND tends to rise compared
to USD and other currencies of main commercial partners. This fact lowers the competitiveness of
price of Vietnam goods in the world market, worsens trade balance and heightens the pressure on
the balance of payments.
+ In the long term, developments of the real effective exchange rate REER and trade balance