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Foreign Direct Investment, Exports and Real Exchang e Rate Linkages:

Vietnam Evidence from a Cointegration Approach

Thi Hong Hanh PHAM

Centre for Analysis and Research in Economics (CARE-EA 2260), University of Rouen

3, avenue Pasteur F-76186 Rouen Cedex 1 (FRANCE)

E-mail: hanh.phamhong@gmail.com

Thinh Duc NGUYEN

Crawford School of Economics and Government, College of Asia and The Pacific

The Australian National University, Canberra ACT 0200, Australia

E-mail: thinh.nguyen@anu.edu.au

Abstract:

The abundance of theoretical models and empirical studies have analysed the possible links between

foreign direct investment (FDI) and real exchange rate (RER), and between Exports and RER. It is,

however, surprising that there was little empirical work investigating the relationships among exports,

FDI and RER at once. The aim of this paper, therefore, attempts to fill the gap by econometrically

testing for the linkages among these three in a co-integration framework, which is based on Vietnam

panel data for the period 1990 – 2007. FDI into Vietnam and Vietnam exports are significantly

affected by bilateral RER. Also, exports from Vietnam to its trade partners are significantly affected

by FDI. These sets of relationships support two channels through which the RER affects exports: a

direct effect on the relative price of goods and an indirect effect through FDI.

Key words: Foreign Direct Investment; Exports; Real Exchange Rate; Co-integration; Vietnam

JEL Classification: F13, F21, F31, O24

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1. Introduction

Most of the economic theory focused on the question whether FDI is a substitute for, or a complement

to international trade. The traditional Heckscher - Ohlin - Samuelson (HOS) model suggests that

international trade can substitute FDI by moving freely factors of production (labour and capital)

between countries. Based on the assumptions of the neoclassical HOS framework, where the flows of

FDI depend on the differences in factor prices and factor endowments between countries, Mundell

(1957) investigated the relationship between FDI and exports. He found that international mobility of

factors of production including FDI constitutes a perfect substitute for exports. According to Kojima

(1975), FDI may have a positive impact on trade in the case that the mobility of factors moves towards

a country with a shortage.

Other theoretical contributions seek to explain the complementary relationship between FDI and trade.

These theories are valid for vertical FDI in which a multinational firm has headquarters located in the

home country and several branches located in the host country with cheaper costs of production and

input resources. In Helpman (1984), the headquarters tend to export capital equipment and factors

services, such as R&D, to the host country, and in return, the host country exports input resources to

the home country. Therefore, in the case of vertical FDI, there are complementarities between trade

flows of final goods and intra-firm transfers of intermediate goods. Markusen and Venables (1995,

1999) expand the nature of the relationship between trade and foreign direct investment concerning the

differences between countries such as factor endowments and technological capabilities. Trade and

FDI between North - North countries, therefore, could be considered as substitutes while FDI and

trade between developed and developing countries are likely to be complements.

In addition to these direct linkages, there is an indirect linkage between trade flows and FDI since each

share the common determinant of the real exchange rate. In this paper, we work toward disentangling

the scale of the direct and indirect linkages between trade flows, in detail exports flow, and direct

investment in order to completely trace the role of the real exchange rate on each of these activities.

The data we examine are for the Vietnam exports, FDI and bilateral RER between Vietnam and ten

partner countries. These ten countries are not only the most important trade partners of Vietnam but

also the most important FDI source into Vietnam. We decide to address our empirical work in the

context of Vietnam because Vietnam has been successful example of transitional economies after its

“Doi Moi” reform in 1986. The remarkable economic progress of Vietnam has been also a significant

result of the open up of the economy to foreign trade and efficient reforms in investment, monetary

and financial policies.

Our test for the relationships among Exports, FDI and RER will be performed in three steps. First, we

test for the order of integration or the presence of unit root of our sector panel. Second, having

established the order of integration, we use heterogeneous panel co-integration technique developed

by Pedroni (1999) to test for the long run co-integrated relationships between the variables in question.

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In the last step, the Fixed-effects model will be used to assess explicitly the channels through which

the variables studied can affect each other. As with much other empirical research, we find that the

bilateral RER significantly affects both Vietnam exports and FDI flows into Vietnam.

The remainder of our paper is organised as follows. Section 2 discusses the literature background of

the exchange rate regimes. Section 3 briefly reviews exports development, FDI inflows and exchange

rates policies in Vietnam from 1990 to 2007. The data and the methodology employed in our study

will be specified in Section 4 and Section 5, respectively. Basing on major econometrical findings,

Section 6 presents briefly some ideas which may be relevant to the evaluation and reform of

Vietnam’s exchange rate policy. Section 7 concludes the paper.

2. Literature reviews

In this section, basing on exchange rate regimes literature, we will discuss how exchange rate regimes

can influence macroeconomics. First, we explain why the choice of exchange rate regime can directly

have consequences for economic growth of a country via its effects on adjustment to macroeconomic

shocks. Second, we analyse the indirect impact of exchange rate regime on economic growth through

its impact on two of the most important determinants of economic growth – investment and

international trade.

The exchange rate regime can be considered as a control variable in a growth function because of its

potential role in influencing growth through its effects on the adjustment to economic shocks. The

exchange rate regimes literature has emphasized how an economy’s adjustment process following a

shock can differ based on the nature of the exchange rate regime. Mundell (1968) showed that even

though the long-run equilibrium is the same in fixed and flexible exchange rate regimes, the

adjustment process towards the equilibrium will be different. Moreover, responses to a negative terms-

of-trade shock differed significantly across exchange rate regimes in a sample of 75 developing

countries over the period 1973–1996 in Broda (2002). Broda found that countries with fixed exchange

rate regimes experienced large and significant declines in real GDP, while the real exchange rate

depreciated slowly by means of a fall in prices. Countries with more flexible regimes tended to

experience small real GDP declines and large real depreciations.

A more flexible exchange rate regime is also less likely to generate persistent misalignments in

exchange markets, which may result in an economic crisis. Indeed, Berg et al. (1999) and Goldstein et

al. (2000) showed that an overvalued real exchange rate is one of the most relevant advance indicators

of an impending currency crisis. Thus, an important reason explaining why fixed exchange rate

regimes may have negative effects on growth is that they tend to break down. The possible linkage

between pegged regimes and currency crashes, however, is not clear. An IMF survey (1997), basing

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on the 116 currency crashes1 over the period 1975-1996, found that close to half of these crashes were

under flexible regimes.

Moreover, a flexible exchange rate regime has not always a positive effect on the adjustment to

economic shocks. Since a flexible regime is more prone to exchange rate shocks. The appearance of

this additional source of shocks might exacerbate the business cycle and dampen growth compared

with an economy under a fixed exchange rate regime. This problem could be especially pronounced

for countries with underdeveloped or weak financial systems. Thus, choice of a flexible regime to

facilitate the adjustment to shocks is valid only for economies with developed financial systems and

monetary policy credibility. Indeed, for developing countries, fixing the exchange rate to a hard

currency might result in a smoother business cycle than if they attempted to make a flexible exchange

rate regime. This issue was confirmed in a research of Hausmann et al. (1995). They argue that

flexible exchange rate regimes in Latin America have not permitted a more stabilizing monetary

policy, tending instead to be more pro-cyclical.

The choice of exchange rate regimes could also affect economic growth indirectly through its

influences on other determinants of economic growth, such as investment and openness to

international trade and capital flows.

First, the endogenous-growth literature (see Edwards, 1993 and Barro and Sala-i-Martin, 1995) has

established a positive link between openness to international trade and economic growth. In the light

of this theory, more a country is open to international trade more rapidly it will grow, because this

country has developed a greater ability to absorb technological advances and can take advantage of

larger markets. Thus, the nature of the exchange rate regime, which influences the volume of

international trade, could translate into an effect on growth. In line of the trade literature, international

trade is influenced by the type of exchange rate regime. The literature, however, does not clearly

predict which exchange rate regime is more likely to promote international trade. Frankel and Rose

(2002) found evidence that currency unions exert a positive effect on international trade, and hence on

income per capita. That means that international trade should be higher under fixed regimes, since a

low level of exchange rate volatility and uncertainty will tend to reduce the cost of trade and, hence,

increase its volume. While Nilsson and Nilsson (2000) find an evidence suggesting that more flexible

regimes can favour export growth, because they are less likely to create conditions for persistent

misalignments.

Second, similarly to international trade, openness to international capital flows, such as FDI inflows, is

also considered as an important engine of economic growth. Bailliu (2000) suggests that international

capital flows can promote growth by increasing the domestic investment rate, by leading to

investments associated with positive spillovers, and/or by improving domestic financial sector. The

exchange rate regime can, therefore, influence economic growth indirectly via its effects on the

1 These currency crashes were defined as a depreciation of at least 25% and a 10% increase in the rate of depreciation over the previous year.

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volume or composition of international capital flows. Dooley (1994) argued that a fixed or quasi-fixed

exchange rate regime can be associated with an increase in speculative capital flows, such as in the

case of some emerging markets in the 1990s.

Thirdly, exchange rate regimes can also influence economic growth through physical capital

accumulation channel. In reality, the empirical literature on the relationship between exchange rate

regimes and investment has generated mixed results. On the one hand, investment will tend to be

higher under a fixed exchange rate regime due to a reduction in political uncertainty, real interest rates,

and exchange rate variability, as Aizenman (1994) argues. On the other hand, by eliminating an

important adjustment mechanism, a fixed regime can exacerbate protectionist pressures and reduce the

efficiency of a given stock of capital. In addition, Bohm and Funke (2001) showed that currency

volatility may exert only a small influence upon the investment level.

In sum, the choice of exchange rate regime has become a subject of international trade debate. The

debate focusing on fixed versus flexible exchange rate regimes has been renewed in recent year as a

result of a series of economic crises, such as the Asian financial crisis in 1997 and the recent global

crisis, in which unsustainable exchange rate regimes were widely perceived to have been a cause. As a

result, the adequacy of exchange rate regimes becomes one of the key issues of economic policies. The

following sections will first examine the possible indirect between RER and FDI and exports, and

hence indicate various ideas which may be relevant to the evaluation and reform of Vietnam’s

exchange rate management.

3. Exports, FDI and Exchange Rates: Vietnam backgro und

3.1. FDI flows into Vietnam

In the case of developing countries, insufficient domestic capital investment and outdated technologies

greatly encumber economic growth. FDI is considered as a short cut to solve this problem. In order to

attract FDI, at the beginning of the “Doi Moi” reform, the Vietnamese government passed the Foreign

Investment Law in 1987, which has formed the legal basis for foreign investment in Vietnam. The

Foreign Investment Law has been revised a few times so as to incorporate national industrial policies,

such as promoting investment in resource and labour intensive industries, encouraging export-oriented

FDI, emphasizing technology transfer, and so forth. With a stabilised economy, abundant cheap

labour, rich natural resources and potential market, together with an improved legal system, Vietnam

have been transformed to become a popular destination of FDI. For instance, in the first Law on

Foreign Investment (1987), a private organisation alone was not allowed to enter a joint venture with a

foreign partner. It had to have joint capital with a state-owned organisation to be acceptable, but since

1992, private organisations are entitled to set up a joint venture with a foreign partner. In terms of

regulation of investment mode, from 2000, enterprises with foreign-owned capital, and parties to

BCCs (Business Cooperation Contract), have been also allowed to change the mode of investment and

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to split, merge and consolidate enterprises. Figure 1 depicts officially registered FDI and actually

implemented FDI in Vietnam over the period 1990 - 2007.

Since 1990, Vietnam has observed a huge inflow of FDI. The officially registered FDI inflows rose

from US$ 189.7 million in 1990 to their peek of US$ 8.6 billion in 1996. The actually implemented

FDI also grew rapidly from US$ 180 million in 1990 to US$ 2.5 million in 1996. A number of reasons

backed this robust increase. Foreign investors were attracted by the potentiality of a transitional

economy with a great market remaining untapped. They were also attracted by a series of other

positive factors such as the abundant labour force, cheap labour cost and high literacy rate. In addition

to these internal factors, there were external ones contributing to the increase of inward FDI into

Vietnam (Freeman, 2002). The first factor was the capital flow into the emerging markets in the 1980s

and early 1990s, of which South East Asia was a key FDI recipient. In 1990, South East Asian

countries attracted 36 per cent the total FDI invested in developing countries. Secondly, there was the

foreign capital flow into the transitional economies of former socialist sector where new business

opportunities and great profits were expected. Thirdly, such regional countries with stronger

economies as Malaysia, Singapore, Thailand, and so forth have begun to export capital. Being a

transitional economy in the South East Asia, Viet Nam has benefited from these factors.

<Insert Figure 1>

From 1997 to 1999, Viet Nam experienced a downfall of registered FDI source, particularly 49 per

cent in 1997, 16 per cent in 1998 and 59 per cent in 1999 (MPI), which was partly due to the Asian

financial crisis. The five major investors into Vietnam were all from Asia and they themselves had to

face difficulties in their own countries. To maintain the business operations in their local countries,

these investors had to postpone or cancel overseas expansion plans, in particularly FDI projects. The

financial crisis also made investors lower their expansion criteria into Asian market, which led to the

devaluation of the currencies of South East Asian countries. Moreover, foreign investors also realised

the exaggeration in the market demand projections as well as the barriers to business which then

turned apparent. Vietnam, therefore, became less attractive for export-oriented projects.

From 2000 to 2002, the value of registered FDI increased again with 25.8 per cent in 2000, and 22.6

per cent in 2001, but that was still less than two thirds of 1996 (MPI). There were many reasons

leading to this reduction of FDI with the first being the downfall of the global economy after the

break-up of the high-tech bubble in the USA. In addition, together with the prolonged crisis in Japan

these seriously affected Asian countries, including Vietnam. In this period, a bilateral trade agreement

(BTA) between Vietnam and the United States came into effect. Parker et al. (2002) indicate that the

BTA has not had a positive effect on new registered U.S. FDI to Vietnam, since registered U.S. FDI

fell substantially from US $ 159.5 million in 2002 to US$ 47.1 million in 2004. Implemented U.S.

FDI, however, presents a more positive result, growing solidly from US$ 61.3 million in 2002 to US$

162.4 million in 2004.

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In the most current period from 2006 to 2007, Vietnam has witnessed the strong comeback of FDI. In

2006, the whole country attracted over 10.2 billion USD of newly registered capital, rising by 57 per

cent compared with previous years, which exceeded the highest record level of 8.6 billion US dollar

attained in 1997. In 2007, FDI flow into Vietnam amounted to 2130 million US dollar distributed in

1445 licensed projects (MPI). Until 2007, 100 per cent foreign owned investment accounts for 77.65

per cent of the licensed projects and 59.84 per cent of the registered capital while the form of Joint

Venture (JV) corresponds to only 19 per cent of the total projects and 25.9 per cent of the total

registered capital, and the rest includes Business Corporate Contract (BCC), Joint Stock Company,

Mother-Subsidiary Company and BOT/BT/BTO2 projects.

In terms of the home country, investors from over 80 different countries and economies have invested

in Vietnam. Until 2007, Asian countries accounted for 66 per cent, Europe 22 per cent and North

America 4.5 per cent. Table 1 lists the top ten FDI source countries for Vietnam measured by

cumulatively registered FDI from 1988 to 2007. Among the top ten, South Korea is the biggest foreign

investor with 1857 projects and US$ 14.398 million of registered capital, followed by Singapore,

Taiwan, Japan and British Virgin Islands. The following next big five investors are Hong Kong,

Malaysia, the US, Netherlands and France. In general, these top ten investors account for about 80 per

cent of the total licensed projects and registered FDI flow in Vietnam.

<Insert Table 1>

In terms of economic structure, in 2007, foreign investors have focused on such industries as oil and

gas, light industry, heavy industry, corresponding to 60 per cent of licensed projects and 68 per cent of

registered capital. Agriculture, fishing and forestry share only 6 per cent of the total projects and 4 per

cent of committed capital. The service sector (construction, hotels, restaurants, transportation and

communication and other service industries like insurance, banking …and so forth) accounts for 28

per cent of the total projects and 40 per cent of the total registered capital.

3.2. Vietnam’s trade openness

Since the “Doi Moi” reform in 1986, international trade had become an increasingly important part of

the Vietnamese economy. Vietnam aggressively promotes trade with various policy instruments such

as implementing trade liberalisation, including tariff reductions and other measures designed to relax

import and export restrictions. Trade liberalisation of Vietnam results from bilateral and multilateral

commitments. Actually, Vietnam had signed bilateral trade agreements (BTA) with more than 60

countries, including the BTA with the U.S. that came into force in December 2001. Vietnam is also

implementing reforms to integrate into the ASEAN Free Trade Area (AFTA), with detailed plans for

reducing tariff rates and removing other non-tariff barriers. Vietnam expects to completely comply

with AFTA by 2010. Moreover, in order to fulfil Vietnam’s commitments to the IMF, the quantitative

restrictions on steel and edible oil were completely removed by the end of 2004. As a result of 2 BOT: Build – Operate – Transfer; BT: Build – Transfer; BTO: Build – Transfer – Operate

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liberalisation, international trade of Vietnam had been expanding rapidly since 1990 and transferred

Vietnam from a closed economy to an open economy.

In particularly, the export-led economic growth strategy has been very successful. This strategy

aggressively promotes exports with various policy instruments, such as setting up export processing

zones and devaluating the overvalued currency. The export promotion policies have been very

successful. The Vietnamese exports rose from $1018.5 million in 1990 to $52400 million in 2007. The

annual growth rate of exports averaged 20 per cent during this period, results in the ratio of exports to

GPD to be increased from 10 per cent to 75 per cent. The exports growth has been a critical driving

force for rapid economic growth, employment creation, and poverty reduction. Simultaneously,

Vietnamese imports rose from 1374.7 million US$ in 1990 to 67200 million US$ in 2007. In other

words, we can consider that with a remarkable economic progress, the economy of Vietnam has also

undergone important structural changes. The ratio of merchandise trade (exports plus imports) to

nominal GDP was only 15 percent as late as 1988, but it increased markedly to 66 percent in 1995 and

133 percent in 2005. Although imports exceeded exports by an average of about 7.5 percent of GDP in

1986-2005, trends in the ratios of trade to GDP and exports to GDP have been similar.

On January 11, 2007 Vietnam became the 150th member of the World Trade Organization (WTO).

Vietnam had made great strides toward integration with the global economy well ahead of its WTO

accession. Between 1993 and 2006, Vietnam’s trade openness (the sum of exports and imports in

relation to GDP) more than doubled, while its export market share more than quadrupled (see Figure

2). With exports as the leading engine of growth, real GDP has increased on average by 7.5 percent a

year during that period and poverty has fallen sharply. Given this impressive record, it is worthwhile

to assess how WTO accession will influence the process of Vietnam’s global integration in the future

and how this process may, in turn, affect both the regional and world economies.

<Insert Figure 2>

The rapid exports growth of Vietnam has also relied on foreign invested firms (FIF). Table 2 outlines

the exports and of Vietnam and FDI distribution in export sectors from 1990 to 2007.

The FIF sector is considered as an important exporter of Vietnam. Its share in total exports increased

from 18.24 per cent in 1990 to 53.01 per cent in 2007. This trend is in accordance with a boom in

export-led FDI projects.

<Insert Table 2>

In term of economic sector, by 2007, Light industry became the number one exporting sector. It

accounted for 44 percent of the total exports, 18 percentage points higher than in 1990. The share of

FDI in Light industry increased from 4 per cent in 1990 to 38 percent in 2003, and after decreased to

14 per cent in 2007, making it the second largest sector with cumulative FDI. The largest amount of

FDI was attracted in Oil and Heavy industry. FDI into Oil and Heavy industry increased from US$

166.1 million in 1990 to US$ 4295.1 million in 2007, about 54 per cent of FDI into Vietnam. As a

result, the exports of Oil and Heavy industry accounted for US$ 17267.7 million in 2007, making the

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second largest exporting sector after light industry. The FDI distribution in export sector suggests that

FDI was concentrated in the sectors relatively more exports and the exports of the sectors with more

FDI grew faster than the average. We may, therefore, consider that there exists a causal relationship

between exports and FDI.

3.3. Exchange rates management of Vietnam

Before the “Doi Moi” Reform, Vietnam had triple-digit inflation (774 percent per annum in 1986),

multiple exchange rates, and a rapidly depreciating currency in the parallel market. In the early 1990s,

however, Vietnam began to overcome these problems by containing inflation and stabilizing its

currency. International integration with the West began in earnest around 1993. Since then, Vietnam’s

exchange rate management has evolved significantly as capital liberalization proceeded and new

external circumstances arose.

In the final stage of disinflation, the State Bank of Vietnam (SBV) kept the VND/USD exchange rate

at around 11,000 from late 1991 to early 1997. The exchange rate was, moreover, virtually fixed at

that level from early 1994 to late 1996. This “11,000 VND policy” can be interpreted as an attempt to

secure lasting price stability by the discipline of a dollar peg. This reform in the exchange rate finally

succeeded in reducing inflation to a very low level. However, the side effect of this policy was gradual

overvaluation. From the summer of 1996, the SBV began to effectively depreciate VND by

broadening the bandwidth around the official central rate. The actual rate always stayed near the

highest (most depreciated) end of the band. Figure 3 depicts movement of exchange rate in Vietnam

from 1990 to 2007.

<Insert Figure 3>

From 1997 to 1998, Vietnam had to cope with the impact of the Asian financial crisis. While Vietnam

was not directly attacked by speculators, VND became overvalued relative to the regional currencies

which fell sharply. The exchange rate band was further broadened to ±5% in February 1997 and to

±10% in October 1997. In February 1998, the official central rate itself was devalued from 11,175 to

11,800 VND/USD. These adjustments brought the actual exchange rate to 12,980, at the most

depreciated end of the revised band.

In February 1999, the SBV introduced a new exchange rate mechanism. The central rate was now set

daily at the average of interbank exchange rates on the previous transaction day with a very narrow

band of ±0.1%. With this mechanism, VND started to crawl (depreciate) very slowly towards the

present level of around 15,600 (December 2003). From 2004 to late 2007, the State Bank of Vietnam

(SBV) kept the VND/USD exchange rate at around from 15,664 to 16,073.

The current exchange rate mechanism of Vietnam based on averaging of the previous day’s interbank

exchange rates is imperfect since it is merely a technical procedure without analytical linkage with

economic fundamentals. Therefore, Vietnam needs to re-formulate its exchange rate policy in a way

that clarifies its economic objectives. Despite of this default, we cannot deny success of Vietnam in

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improving the efficiency of exchange rate regime in a way that contributes to significant or consistent

exports and FDI inward growth.

There are several channels through which real exchange rates may affect FID inflows. In Vietnam’s

context, the most important channel may be that a depreciation of the real exchange rate reduces the

cost of domestic labor (and other productive inputs) relative to foreign production costs. The

depreciation increases labor demand and employment, thereby raising the return on capital. Thus,

green-field FDI increases in response to a depreciation.

Real exchange rates can directly affect on the relative prices of Vietnam’s exports, and also explore

the indirect real exchange rate linkage via FDI. Exports may also increase in the wake of direct

investment as the producers in the home country use the host country as a platform for selling to third-

country markets. From Figure 4, we observe that exports and FDI into Vietnam increase following a

depreciation of the real exchange rate.

<Insert Figure 4>

4. Data

Our analysis is based on panel annual data from 1990 to 2007 covering FDI flows into Vietnam,

exports flows and bilateral real exchange rate between Vietnam and ten partner countries. The

countries in our panel are Japan, The U.S., France, Thailand, Singapore, Australia, Malaysia, Hong

Kong SA, Taiwan and Korea. The variables studied are identified as follows:

• itEX : Exports from Vietnam to country i at year t in million constant US dollars 1995 (source:

Vietnam Ministry of Industry and Trade);

• itFDI : Foreign direct investment flows into Vietnam from country i at year t in million

constant US dollars 1995 (source: Vietnam Ministry of Planning and Investment). In this

work, we use the implemented FDI inflows data. The reason is that many foreign investors

that invested in Vietnam during the period failed to register their projects with the Ministry of

Planning and Investment in advance. They registered their investment projects in the

following years after they started the projects. This reason explains why the officially

registered FDI cannot be used as a consistent and accurate measurement for FDI activities in

Vietnam for our work and also for other rigorous researches.

• itRER : Bilateral real exchange rate between Vietnam and country i at year t, which is

calculated as the product of the nominal exchange rate and relative price levels in each

country. The real exchange rate between foreign country i and Vietnam at time t is thus:

VNt

tii

p

peRER ti

t

*

,,×= (1)

where VNtp is the price level of Vietnam, *,tip is the price level in foreign country i, and ie is the

nominal exchange rate (IMF, International Financial Statistics, line 00rf) between the VN dong

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and the currency of foreign country i. ie is expressed as the number of VN dong units per foreign

currency unit, so that ie rises with an depreciation of Vietnam currency. Equation 1 suggests that

we should expect to find a positive coefficient on the real exchange rate in all estimated

regressions, where an increase in the bilateral real exchange rate represents a real depreciation of

the VN dong. To construct bilateral RER between Vietnam and foreign country, we use the most

commonly used price series that are consumer price indices (CPI) (IMF, International Financial

Statistics, line 64, base year 1995). These have the advantage of being timely, similarly

constructed across countries and available for a wide range of countries over a long time span.

• itGDP : the GDP of country i at year t in million constant US dollars (source: United Nations

Division Statistics).

All of variables are transformed into logarithms so that estimated regression coefficients are

interpreted as elasticities.

5. Methodology and empirical results

To investigate the possible linkages between FDI into Vietnam, Vietnam exports and bilateral RER we

apply the Pedroni panel co-integration methodology (1999). Our test will be performed in three steps.

First, we test for the order of integration or the presence of unit root of our panel. Second, having

established the order of integration, we use heterogeneous panel co-integration technique developed

by Pedroni (1999) to test for the long run co-integrated relationships among the variables studied in

question. In the last step, the Fixed – effects model will be applied.

5.1. Panel unit root test

Unit root tests are traditionally used to test for the order of integration of the variables or to verify the

stationarity3 of the variables. The traditional Augmented Dickey-Fuller (ADF) technique has become

well-known to test for unit root of the time series. To test for the panel unit root, a number of such

recent developments has also appeared in the literature, including: Levin, Lin and Chu (LLC test)

(2002); Im, Pesaran and Shin (IPS test) (1997); Maddala and Wu (1999); Choi (2001); and Hadri

(2000). From among these different panel unit root tests, LLC test and IPS test are the most popular.

Both of these tests are based on the ADF principle.

LLC test assumes homogeneity in the dynamics of the autoregressive (AR) coefficients for all panel

members. Concretely, LLC test assumes that each individual unit in the panel shares the same AR(1)

coefficient, but allows for individual effects, time effects and possibly a time trend. Lags of the

dependent variable may be introduced to allow for serial correlation in the errors. The test may be

viewed as a pooled Dickey-Fuller test, or an Augmented Dickey-Fuller (ADF) test when lags are

3 If a time series is found to be nonstationary or integrated of order d, denoted by I(d), it can be made stationary by differencing the series d times. If d = 0, the resulting I(0) process represents a stationary time series.

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included, with the null hypothesis that of non-stationarity (I(1) behavior). After transformation, the t-

star statistic is distributed standard normal under the null hypothesis of non-stationarity.

The IPS test is more general than the LLC test because of allowing for heterogeneity in dynamic

panel. Therefore, it is described as a “Heterogeneous Panel Unit Root Test”. It is particularly

reasonable to allow for such heterogeneity in choosing the lag length in ADF tests when imposing

uniform lag length is not appropriate. In addition, IPS test allows for individual effects, time trends,

and common time effects. Based on the mean of the individual Dickey-Fuller t-statistics of each unit

in the panel, the IPS test assumes that all series are non-stationary under the null hypothesis. Lags of

the dependent variable may be introduced to allow for serial correlation in the errors. The exact critical

values of the t-bar statistic are given in IPS test. IPS test has thus considered a technique, which has

higher power than other tests, including LLC test. Statistic results of LLC test and IPS test are reported

in Table 3.

In the LLC test for the levels of FDI flow and exports, the small negative statistics values for each

variable do not exceed the critical values (in absolute terms). However, when we take the first

difference of each variable, the large negative LLC statistics indicate rejection of the null of non-

stationarity at the 1% level and 5% level for all models.

<Insert Table 3>

The IPS results indicate, in general, that the null of a unit root for the individual series is not rejected

for all of the series tested at their levels. Given the short span of the individual series, we are more

confident to accept the more powerful IPS panel test results, which undoubtedly do not reject the null

of unit roots for the panel with 180 observations. On the other hand, the null of unit root is strongly

rejected at the least 5% level of significance for all series at their first difference. The results strongly

support the conclusion that the series are stationary only after being differenced once. Hence, the IPS

test indicates that the series are integrated of order one, i.e., I(1) at least 5% significance level.

Therefore, we conclude that all variables are non-stationary and integrated of order one in level but

integrated in order zero in their first difference at least 5% level of significance.

Having established that FDI, GDP, RER and Exports series are integrated of the first order, the panel

co-integration approach is applicable to determine the nature of the long-run relationship among the

variables studied.

5.2. Panel co-integration

The traditional co-integration analysis presented by Engle and Granger (1987) permits to identify the

relationship between the variables by eliminating the risk of spurious regression. However, the Engle

and Granger approach cannot identify the number of co-integration vectors and cannot adequately

estimate the parameters if the number of variables is more than two. Hence, Johansen (1988) use

maximum likelihood method within a vector autoregressive (VAR) framework to test for the presence

of co-integration relationship between the economic variables. The Johansen’s procedure is useful in

conducting individual co-integration tests, but does not deal with panel co-integration test.

13

Therefore, most of the recent researches utilized the two types of the heterogeneous panel co-

integration test developed by Pedroni (1999). Pedroni’s test allows different individual cross-section

effects by allowing for heterogeneity in the intercepts and slopes of the co-integrating equation.

The Pedroni panel co-integration technique makes use of a residual-based ADF test. Pedroni test for

the co-integrated relationship, for example between FDI, bilateral RER and Vietnam exports in our

panel, is based on the estimated residuals from the following long-run model:

itit

it

itii

i RERGDPEXFDIt 110 εββ ++++= (2)

where 10,...,1=i countries and 18,...,1=t period observations. The term ittiiit 1)1(11 ξερε += − is the

deviations from the modeled long-run relationship. If the series are co-integrated, it1ε should be a

stationary variable. The null hypothesis in Pedroni’s test procedure is whetheriρ is unity. In addition,

Pedroni technique permits to test for the co-integrated relationship between FDI and exports in four

different models: Model with heterogeneous intercepts and ignoring common time effect (M1); Model

with heterogeneous intercepts and heterogeneous trend ignoring common time effect (M2); Model

with heterogeneous intercepts allowing common time effect (M3); Model with heterogeneous

intercepts and heterogeneous trend allowing common time effect (M4). All of the Pedroni’s statistics

under different model specifications are reported in Table 4.

<Insert Table 4>

Pedroni test’s results include seven different statistics for the test of the null hypothesis of no co-

integration in heterogeneous panels. The first group of tests is termed “within dimension”. This group

includes: The “panel v-stat” and the “panel rho-stat” are similar to the Phillips and Perron (1988) test;

the panel pp-stat (panel non-parametric) and the “panel adf-stat” (panel parametric) are analogous to

the single-equation ADF-test. The second group of tests calling “between dimensions” is comparable

to the group mean panel tests of Im et al. (1997). The “between dimensions” tests include three tests:

group rho-stat; group pp-stat; and group adf-stat.

The calculated test statistics reject the null hypothesis of absence of co-integration at 1 percent for the

FDI regression and also for the Exports regression. We can, therefore, point out the co-integrated

relationship among the variables studied in the long-run. Moreover, we notice substantially larger

panel co-integration statistics in the FDI regression, providing support to the proposition that more

perceptible and strong correlation between FDI flows into Vietnam and bilateral RER.

5.3. Fixed – effects estimations

The previous section concluded the presence of a co-integrating relationship among the variables, but

did not indicate the channels through which the variables studied may affect each other. Applying the

Fixed – effects model, this section presents our empirical findings on the linkages among bilateral

RER, FDI into Vietnam and Vietnam exports.

14

The Fixed – effects technique is applied in two regressions: FDI regression and exports regression. In

the FDI regression, the dependent variable is value of FDI flows into Vietnam. The independent

variables include GDP and lagged GDP of the FDI home country, exports and lagged exports from

Vietnam to the FDI home country, bilateral RER and lagged bilateral RER between Vietnam and the

FDI source country. In the exports regression, the dependent variable is exports from Vietnam to its

FDI source countries. The independent variables include both contemporaneous and lagged values of

bilateral RER, FDI flows into Vietnam and GDP of the FDI source country. In each of two

regressions, we add a dummy variable DU accounting for the appearance of Asia financial crisis,

which obviously affected Vietnamese economy and its trade partners. This dummy takes the value of 1

from 1997 to 1999, and 0 in all other period. The Fixed – effects estimations over the full panel is

presented in Table 5.

<Insert Table 5>

We begin with discussion on our empirical findings for the FDI regression. According to the results,

we observe that when Vietnam currency depreciate with respect to the foreign currency (i.e. when

itRER 1− increases), there is a corresponding increase in foreign direct investment. In detail, 1 percent

depreciation in the VN dong causes an increase in foreign direct investment into Vietnam of 0.92

percent. Besides, 1 percent increases in GDP ( itGDP 1− ) of the FDI home country increases FDI flows

into Vietnam of 2.48%. The result also point out that during the period of Asian financial crisis, FDI

flows into Vietnam and Vietnam exports decrease 15% and 29%, respectively.

There are several possible channels through which bilateral real exchange rates may affect FDI. In the

case of Vietnam, the most important channel is that a depreciation of the bilateral real exchange rate

reduces the cost of domestic labour (and other productive inputs) relative to foreign production costs.

The depreciation increases labour demand and employment, thereby raising the return on capital.

Thus, green-field FDI increases in response to a depreciation. This channel supports the finding on a

positive coefficient on the bilateral RER in the FDI regression, where an increase in the bilateral RER

represents a real depreciation of the VN dong. Moreover, the bilateral RER may also affect FDI into

Vietnam through an imperfect capital markets channel of Vietnam. In this case, a real depreciation of

Vietnam currency raises the wealth of foreign investors relative to that of domestic investors and

thereby increases FDI. This channel also has the prediction that a real depreciation increases FDI. The

imperfect capital markets channel for real exchange rate effects may be more relevant in merger and

acquisition bids than in the green-field investments which prevail in Vietnam.

The fixed – effects estimations for the Exports regression also indicate that the bilateral RER

depreciation has the positive expected effect on Vietnam exports. We observe that 1 percent

depreciation of lagged RER ( itRER 1− ) or contemporaneous RER ( i

tRER ) with respect to the foreign

currency causes an increase in exports from Vietnam of 0.58% or 0.27%, respectively. Moreover, 1%

15

increase in lagged GDP of the FDI home country may cause 2.48% increase in exports from Vietnam

to the partner country.

From Table 5, we can also observe a weakly causal linkage between FDI flows into Vietnam and

exports from Vietnam to the FDI home country. This result suggests an open question, which concerns

the role of the performance of FDI flows into Vietnam from a specific country in promoting the

exports from Vietnam to other countries. In order to solve this question, we will explore the possibility

of spillovers across countries by performing an additional Fixed – effects test. This test is based on the

following pair of data series: on one side there are FDI into Vietnam from country i ( itFDI ), and on

other side there are total Exports from Vietnam to all other countries ( *tEX ) in our panel. The results

of cross-country spillovers are reported in Table 6.

<Insert Table 6>

From Table 6, we find out an evidence of bidirectional causal linkage between FDI into Vietnam from

country i and Vietnam exports to other countries in our panel at 5% significance level. This suggests

that Vietnam exports to a specific country have not only been promoted by FDI from this country but

also by FDI into Vietnam from other source countries through cross – country spillovers channel. In

other words, motivation of foreign investors may be explained by their strategy, which is to use

Vietnam as a platform for selling their products to the third country markets.

6. Vietnam Exchange rate management: Current Proble ms

Although success in improving the efficiency of exchange rate regime, the current exchange rate

mechanism of Vietnam based on averaging of the previous day’s inter-bank exchange rates is

imperfect since it is merely a technical procedure without analytical linkage with economic

fundamentals. Since exchange rate policy is not defined in terms of economic fundamentals, it is hard

to evaluate whether or not the current level of VN Dong is appropriate. Vietnam, therefore, needs to

reformulate its exchange rate policy in a way that clarifies its economics objectives.

In the case of developing countries as Vietnam, the macroeconomic policymakers have been faced

with a difficult task. On the one hand, the global economy is unstable with frequent shocks, crises and

instabilities. On the other hand, domestic markets of developing countries are weak, hence local

enterprises lack competitiveness. Under such circumstances, avoiding unnecessary shocks to the

national economy and providing a stable environment for economic development have become the

most important objective in the exchange rate management. Some possible goals of exchange rate

policy may include the following: (1) Competitiveness; (2) Price Stability; (3) Domestic financial

stability; (4) Minimizing the impact of various external shocks; (5) Stimulating growth, capital

accumulation, in particularly FDI.

Basing a set of economic objectives, Vietnam must adapt its policy goals to initial conditions and

changing circumstances but cannot pursue all these goals simultaneously. In the context of becoming

16

150th member of WTO, mixing the two most fundamental goals of competitiveness and price stability

should actually the most basic strategy for Vietnam. Hence, these two goals are achieved, Vietnam

may orient to the fifth goal of stimulating growth and FDI. However, competitiveness and price

stability goals are conflicting requirement. Because competitiveness requires flexible adjustment of the

exchange rate to eliminate overvaluation, but price stability requires using the nominal exchange rate.

In order to achieve simultaneously competitiveness and price stability, the budget and money must be

under control, the domestic economy is healthy, and no serious external shocks exist.

The issue for Vietnam is which exchange rate mechanism Vietnam should adopt to achieve the best

mix of exchange rate flexibility and stability. In developing countries, some exchange rate mechanism

examples may include the following:

<Insert Table 7>

Some of the above propositions are not suitable for Vietnam. Especially the “bipolar view”

mechanism is highly inappropriate. The principal of this mechanism is that each country must choose

a rigid fix or free float, but not in between. On the one hand, free float regime is not an ideal option for

Vietnam, a low-income country with undeveloped markets, especially with a weak financial market.

On the other hand, a rigid dollar peg, such as Argentina case during 1991-2001, usually ends up in

currency crisis and severe recession. Generally, an optimal exchange rate regime is always one of the

most important objectives of the macroeconomic authorities in developing countries. Thus, we will

deepen this issue in our future research.

7. Closing remarks

This paper has considered the possible linkages among bilateral RER, FDI flows into Vietnam and

Vietnam exports, using annual panel data for the period 1990 - 2007 by means of panel co-integration

techniques. We have also extended this analysis to detail the channels via which the variables studied

can affect each other by employing the Fixed – effects model.

Our major finding provides evidence of a number of statistically significant linkages. First, a real

depreciation of Vietnam dong with respect to the foreign currency increases both FDI into Vietnam

and exports from Vietnam. Second, FDI into Vietnam is associated with an increase in exports from

Vietnam to the FDI source countries. Further, Vietnam exports to a specific country have not only

been promoted by FDI from this country but also by FDI into Vietnam from other source countries

through cross – country spillovers channel. These linkages put evidence on the export-oriented FDI

policy of the Vietnamese government. Third, Vietnam exports growth is also shown to play a role for

attracting FDI in Vietnam.

Our second major finding is that the sets of relationships, between the bilateral RER and FDI, and

between FDI and exports, support two ways through which the RER affects exports flows: a direct

effect on the relative price of goods and an indirect effect through FDI.

17

In sum, our paper can be seen as a complement to the recent empirical studies as it investigates the

relationships among exports, FDI and bilateral RER at once.

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19

Figure 1: FDI into Vietnam from 1990 to 2007

0

5000

10000

15000

20000

25000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Mill

ions

dol

lars

Registered FDI Implemented FDI

Source: Vietnam Ministry of Planning and Investment (MPI)

Figure 2: Vietnam’s trade Openness

Source: Direction of trade, IMF 1/ Vietnam's exports as a percentage of world imports

Figure 3: VND/USD Exchange Rate

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Year

VN

Don

g

Source: United Nations Statistics Division database

20

Figure 4: Exchange rate, FDI and Exports movements in Vietnam

Source: UNSD database; Vietnam Ministry of Industry and Trade; Vietnam Ministry of Planning and Investment

Table 1: Top ten FDI Countries and Territories updated to 31/12/ 2007 (US$ millions)

No Country, Territory Registered capital Implemented capital

1 Korea 5 168 2 738 2 Singapore 3 894 3 858 3 Taiwan 4 599 3 079 4 Japan 3 963 4 987 5 British Virgin Islands 2 612 1 376 6 Hong Kong 2 167 2 161 7 Malaysia 1 797 1 083 8 The USA 1 450 746 9 Netherlands 1 482 2 031 10 France 1 441 1 085

Source: Foreign Investment Agency (FIA) – MPI

0

5000

10000

15000

20000

25000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Year

$US

mill

ion

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

Exports Registered FDI Exchange rate

VN

Don

g

21

Table 2: Exports and FDI distribution by sectors (in US$ million)

EXPORT SECTORS Total Exports and Exports by FIFs1

Oil and Heavy industry

Light industry Agriculture - Fishery - Forestry

FDI Exports FDI Exports FDI Exports

Value % Value % Value % Value % Value % Value %

Total exports of Vietnam

Exports by FIFs

Share of FIFs (%)

1990 166.1 60 261.5 26 11.1 4 269.5 26 9.8 3 487.0 48 1018 185.6 18.24 1991 869.0 44 697.1 17 58.3 3 300.1 14 76.5 4 1089 53 2086.2 300.3 14.40 1992 1848.0 56 954.8 26 149.6 5 349.5 14 35.4 1 1276.1 50 2580.4 546.7 21.19 1993 783.3 28 1014 33 384.2 14 526.5 18 212.4 7 1444.4 48 2984.9 610.5 20.45 1994 617.2 17 1167.6 37 520.8 14 938.2 23 326.3 9 1948.1 48 4053.9 1136.4 28.03 1995 537.8 24 1377.7 34 240.7 11 1549.8 28 187.2 8 2521.1 45 5448.6 1473.1 27.04 1996 392.5 16 2085 29 236.6 10 2101 29 92.6 4 3067.5 43 7253.5 2155 29.71 1997 550.9 21 2574 25 234.6 9 3372.4 37 266.5 10 3238.6 36 9185 3213 34.98 1998 927.5 49 2609 29 95.2 5 3427.5 37 78.5 4 3314.7 35 9351.2 3215 34.38 1999 573.9 29 3609.5 28 180.0 9 4243.2 37 149.3 8 3688.7 32 11541.4 4682 40.57 2000 1493.3 66 5382.1 28 311.0 14 4903.1 34 181.4 8 4197.6 29 14482.8 6810.3 47.02 2001 931.1 46 5274.3 31 483.1 24 5368.3 36 158.1 8 4413.7 29 15056.3 6798.3 45.15 2002 803.6 31 5304.3 37 681.2 26 6785.7 41 232.4 9 4616 28 16706 7871.8 47.12 2003 719.4 27 6485.2 35 984.0 38 8597.4 43 246.4 12 5066.9 25 20149.5 10161.2 50.43 2004 902.9 35 8633 32 533.5 21 10920 41 303.8 6 6951.2 26 26504.2 14487.7 54.66 2005 1203.9 42 11701.4 36 530.7 19 13293.4 41 162.3 4 7452.4 23 32447.2 18553.7 57.18 2006 3047.6 53 14428.6 36 775.2 14 16389.6 41 202.5 4 9008 23 39826.2 23061.3 57.90 2007 4295.1 54 17264.7 33 1093 14 23305.2 44 756.9 4 11830.0 23 52399.9 27775.7 53.01

Source: Ministry of Industry and Trade and Ministry of Planning and Investment 1 Foreign Invested Firm

22

Table 3: Panel unit root tests

Panel A: LLC unit root test

Variables Model Level First difference

EX FDI GDP RER EX FDI GDP RER 1 -1.57 -1.02 -1.24 -2.18 -5.45** -5.53** -4.33** -5.88** 2 -1.77 -1.15 -1.44 -2.26 -4.84*** -5.62** -4.71** -5.42** 3 -2.03 -2.31 -1.29 2.32 -6.65*** -5.71*** -4.96*** -5.62***

(1): Model with heterogeneous intercepts and heterogeneous trend. (2): Model with heterogeneous intercepts. (3): Model without heterogeneous intercepts. (**): Rejection of the null hypothesis at the 5% significance level. (***): Rejection of the null hypothesis at the 1% significance level.

Panel B: IPS unit root test

Variables Model Level First difference

With common time effect EX FDI GDP RER EX FDI GDP RER (1)a -2.08 -1.77 -2.06 -1.52 -2.95*** -3.55*** -2.91*** -2.75** (2)b -0.81 -0.99 -0.73 0.01 -2.45*** -2.47*** -2.04** -2.24***

Without common time effect EX FDI GDP RER EX FDI GDP RER (1)a -2.27 -2.41 -2.19 -1.72 -2.83** -2.92*** -2.91*** -2.81** (2)b -1.16 -1.25 -1.75 -1.88 -2.41*** -2.31*** -2.17** -2.08**

a: The critical value at 1%, 5% and 10% is -2.84, -2.63 and -2.52 respectively. b: The critical value at 1%, 5% and 10% is -1.89, -1.99 and -2.21 respectively. (1): Model with heterogeneous intercepts and heterogeneous trend. (2): Model with heterogeneous intercepts only. *** (**): Rejection of the null hypothesis at the 1% and 5% significance level respectively.

23

Table 4: Pedroni panel co-integration tests

FDI regression Exports regression Test statistics M1 M2 M3 M4 M1 M2 M3 M4

panel v-stat -0.34 -2.21 0.29 -1.69 -0.98 -2.83 -0.72 -2.19 panel rho-stat -4.84 -6.74 -5.79 -4.28 -3.24 -3.21 -3.78 -3.04 panel pp-stat -11.57 -12.85 -14.19 -18.69 -6.70 -7.88 -6.47 -6.43 panel adf-stat -6.60 -5.65 -5.22 -11.53 -4.96 -3.91 -4.48 -4.84 group rho-stat -5.57 -5.29 -4.26 -4.83 -4.14 -3.50 -4.39 -5.20 group pp-stat -14.94 -14.32 -17.73 -18.88 -7.36 -8.04 -8.21 -8.69 group adf-stat -9.01 -5.97 -5.19 -6.60 -4.54 -3.32 -5.33 -5.71

Table 5: Fixed – effects Model Estimations

FDI regression Exports regression Dependent variables Coefficient

estimated Standard error Coefficient

estimated Standard error

itRER 1.28 0.89 0.27** 0.24

itRER 1− 0.92** 0.42 0.58*** 0.44

itFDI - - -0.05 0.02

itFDI 1− - - 0.001** 0.02

itEX -0.49 0.31 - -

itEX 1− 0.003** 0.32 - -

itGDP -3.13 2.30 1.38** 0.63

itGDP 1− 2.48*** 2.31 1.22** 1.62

DU -0.15*** 0.22 -0.29** 0.59 constant 0.09** 0.17 0.03*** 0.04

The adjusted R-squared of FDI regression is 0.953. The adjusted R-squared of Exports regression is 0.961. *** (**): Significance at the 1% and 5% level, respectively.

Table 6: Spillovers results

FDI regression Exports regression Dependent variables Coefficient

estimated Standard error Coefficient

estimated Standard error

itFDI - - 0.04** 0.03

itFDI 1− - - 0.02** 0.03

*tEX 0.24** 0.24 - -

*1−tEX 0.21** 0.24 - -

DU 0.03** 0.22 -0.06** 0.08 constant -0.06 0.10 0.08** 0.03

The adjusted R-squared of FDI regression is 0.94. The adjusted R-squared of Exports regression is 0.97. **: Significance at the 5% level.

24

Table 7: Some current exchange rate mechanisms in developing countries

Mechanism Explanation Advocates & countries Managed float

Artificial pegs invite currency crisis. Dollar peg should be avoided by any means. Countries with dollar pegs should not receive international support.

Meltzer Report (US, March 2000)

Bipolar view

In the global finance of the 21st century, no country can choose a middle position between rigidity and flexibility. The only options are rigid fix or free float.

Barry Eichengreen, Stanley Fischer. Once popular, but now attracts less attention.

Currency board

Fix the exchange rate and abolish the central bank. The monetary agency passively supplies base money in exchange for the same amount of foreign assets. Merits: greater confidence in price and currency stabilization. Demerits: absence of monetary policy and the lender of last resort at the time of banking crisis.

Hong Kong, Brunei. Estonia, Lithuania. People are more skeptical about applicability to larger countries (Argentina, Indonesia, etc.)

Dollarization

More extreme than currency board. Abolish domestic currency and circulate USD. The merits and demerits are the same as in the case of currency board but magnified.

Panama, Ecuador.

Multiple currency basket (in East Asia)

Dollar peg was a cause of the Asian crisis. Developing countries in East Asia should have more flexibility by pegging to a weighted average of USD, Euro and Yen (this is also supposed to promote the yen’s internationalization).

Takatoshi Ito, Eiji Ogawa, Kwan Chi Hung, Japanese MOF, John Williamson.

Target zone

Intervene as necessary to keep the exchange rate within a prescribed band. There are many types including (i) with or without the use of a currency basket as the central rate; (ii) with or without inflation slide (real versus nominal); (iii) soft versus hard band (or double target zone with both hard and soft bands); (iv) announced versus unannounced; (v) wide versus narrow band; (vi) Band-Basket-Crawl; and so on.

John Williamson, Rudiger Dornbusch.

Return to soft dollar zone (in East Asia)

USD plays the dominant role in trade, investment and finance. It is proper and desirable for East Asian developing countries to return to the mild dollar peg.

Ronald McKinnon.

Eclectic pragmatism

No single formula fits all countries; conditions are different from country to country. Each country should select the most suitable system among crawl, adjustable peg, managed float, etc. in response to changing circumstances. In any system, improve actual operation to avoid crisis.

Jeffrey Frankel, some IMF economists (Paul Masson).

Source: Ohno (2003)