The exchange rate misalignment and its relationship with trade balance: the case of Vietnam

Abstract

It is said that the exchange rate policy plays an important role in an economy. It links the domestic economy to other foreign ones. And exchange rate misalignment is often the most interested topic of economists. Hence, the aim of this research is to (i) estimate the exchange rate misalignment and (ii) investigate its relationship with trade balance, in case of Vietnam. The equilibrium exchange rates are obtained by two methods: the relative PPP approach and the Behavioral Equilibrium Exchange Rate (BEER) model. The misalignment of exchange rate is defined as the difference between the actual and the equilibrium exchange rate. In the BEER approach, the co-integration is used to test the long run relationship between the real effective exchange rate (REER) and several macroeconomics variables. In the PPP approach, the misalignment of exchange rate is calculated simply based on the domestic and foreign CPIs. The result from the PPP approach suggests that: (i) the VND was undervalued and slightly overvalued from 2000 to the middle of 2007; (ii) the overvaluation of VND has sharply increased from the last half of 2007 up to now. The exchange rate misalignment from PPP approach is chosen to examine the impacts on the Vietnam’s trade balance. The conclusion is that the exchange rate misalignment does not have strong relationship with trade balance.