<Issue Paper for Possible Future Research>

Exchange Rate Management of Vietnam
Re-examination of Policy Goals and Modality
December 25, 2003
Kenichi Ohno
Vietnam Development Forum
This paper presents various ideas which may be relevant to the evaluation and reform ofVietnam’s exchange rate management. While many theoretical and empirical studies on
exchange rates exist, they do not directly address the questions that Vietnam currently faces.
Based on such existing studies, this paper analyzes Vietnam’s exchange rate problems
concretely and realistically. The list of issues below are not meant to be complete or final; ourpurpose is to stimulate preliminary discussions. If sufficient interest is aroused, the VDF may
launch a research project to deepen the analyses.

I. Overview
Brief history
In the late 1980s, Vietnam had triple-digit inflation, multiple exchange rates, and a rapidly
depreciating currency in the parallel market. In the early 1990s, however, Vietnam began toovercome 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.
Inflation was brought down to a single digit by 1993. But price stability was fragile anddomestic inflation still remained high relative to the international level. In the final stage ofdisinflation, the State Bank of Vietnam (SBV) kept the VND/USD exchange rate at around
11,000 for more than five years, from late 1991 to early 1997 (moreover, the rate was 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 nominal

anchor use of 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
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central rate. The actual rate always stayed near the highest (most depreciated) end of theband.
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 theregional 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 wasnow set daily at the average of interbank exchange rates on the previous transaction day witha 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).

VND/ USD Ex c h a n g e Ra t e
16000
14000
12000
10000
8000
6000

Dec- 03

Dec- 02

Dec- 01

Dec- 00

Dec- 99

Dec- 98

Dec- 97

Dec- 96Dec- 95

Dec- 94

Dec- 93

Dec- 92

Dec- 91

Dec- 90

Dec- 89

4000

The issue
The current exchange rate mechanism 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. Since exchange rate policy and operational rules are not definedin terms of economic fundamentals, it is hard to know the policy intention of the SBV. Without
an effective criterion, it is also difficult to evaluate whether or not the current level of VND isappropriate. Vietnam needs to re-formulate its exchange rate policy in a way that clarifies its
economic objectives.

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To do so, three levels of discussion must be made.
(1) Policy goals: what should be achieved by exchange rate policy?
(2) Choice of system: what kind of exchange rate management is suitable for Vietnam?
(3) Choice of level: what level of VND is appropriate?
These questions are mutually related but can be discussed separately. For policy formulation,(1) and (2) are the most important. If they are answered clearly, the third question will bemuch easier to answer. The first question identifies the policy purpose while the second asks
the modality by which that purpose can be achieved.
Moreover, the normal mode and the crisis mode of exchange rate management should be
distinguished. The questions posed above are for the normal time when there is no seriouspressure in the currency market. But sometimes (every several years or hopefully less often),a crisis may occur in which the home currency or the entire region is subjected to unstable
market sentiment. If a crisis occurs, normal policy operation should be suspended andappropriate crisis response must be installed. The key decisions in a crisis are (i) whether
and/or when to float; and (ii) what additional measures need to be introduced at the time offloating.
Since neither market nor government is perfect, the two must be combined appropriately in
exchange rate management. The market should be the basis of exchange rate determination,
but it sometimes exhibits volatility, misalignment and bubbles. The government should
correct such irregularities, but too much intervention damages the proper functioning of themarket. In Vietnam where the currency market in particular and financial markets in general
are very shallow and undeveloped, we cannot expect the market to operate smoothly or findthe correct exchange rate by itself. Therefore, the SBV is obliged to “make” the market and set
its direction relatively more strongly than in more developed countries. In this sense, the SBV
carries a heavy responsibility in managing the exchange rate.
The SBV must select policy goals and operational modality which are suitable for Vietnam’s
reality. The current exchange rate mechanism fails to define policy goals. Without policy goals,
the operational rule cannot be evaluated adequately.

II. Policy Goals
Multiplicity of goals

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The macroeconomic authorities of developing countries are faced with a difficult task. On the
one hand, the global economy is unstable with frequent shocks, crises and instabilities. It isalso a very tough place where big firms from EU, US, Japan, Korea, China, etc. compete
fiercely. On the other hand, domestic capability is weak. Markets are underdeveloped andlocal enterprises lack competitiveness. The government is also without sufficient knowledge
and resources. Under such circumstances, the central banker is required to manage theexchange rate in order to avoid unnecessary shocks to the national economy and provide astable environment for economic development.
There are many possible goals of exchange rate policy. The candidates may include thefollowing.
(1) Competitiveness(2) Price stability(3) Current account adjustment(4) Domestic financial stability (balance-sheet problem)(5) Public debt management (exchange risks and debt sustainability)(6) Prevention of currency crisis(7) Minimizing the impact of various external shocks(8) Promoting growth, FDI and industrialization
Among these, (1) and (2) are the most fundamental. (3) is often advocated as important, but
its desirability and feasibility can be questioned. (4) and (5) aim to avoid exchange risks. (6)and (7) are related to crisis prevention and response. Finally, (8) pursues supply-side goals,
but whether that is the correct policy assignment is an open question. It is generally better toassign the exchange rate to macroeconomic or financial tasks. A stable macroeconomy in turn(indirectly) provides the best background for robust growth.
Since there is only one exchange rate, the central bank cannot pursue all these goals
simultaneously; it has to choose. Furthermore, these goals are not equally valid for all cases,
so each country must adapt its policy goals to initial conditions and changing circumstances.
It is not right to ask for a simple and unchanging rule. Exchange rate management is a
dynamic and complicated task which cannot be put on an autopilot controlled by a computer.
Rules must be supplemented by human wisdom and judgment.
Balancing flexibility and stability
For Vietnam, we propose eclectic and pragmatic policy goals in exchange rate management.
This view is not derived from theoretical models or econometrics but from observing
4Vietnam’s reality and the experiences of many other developing countries.
In normal times, we propose the basic strategy of mixing the two most fundamental goals ofcompetitiveness and price stability. This is not easy, since competitiveness requires flexible
adjustment of the exchange rate to eliminate overvaluation, but price stability requires using
the nominal exchange rate as a nominal anchor (not fully accommodating domestic inflation).
Flexibility and stability are conflicting requirements. However, this difficulty should not betaken negatively as a hopeless dilemma but positively as a challenge for continuously
attentive policy management.
Competitiveness and price stability are mutually consistent and easy to achieve if the budget
and money are under control, the domestic economy is healthy, and no serious external shocks
exist. However, if any of these conditions is missing, the central bank has to reassess theweight of exchange rate flexibility relative to its stability. For example, the nominal anchor
use of the exchange rate is quite appropriate if domestic inflation is on the rise or in the final
stage of disinflation. But devaluation may be an option if competitiveness is lost due toexternal shocks under relatively sound macroeconomic management. As each circumstance isdifferent, it is impossible to write down a simple formula. The central bank must exercise agood policy judgment in combining exchange rate flexibility and stability.
A developing country should adopt an exchange rate system which allows it to mix exchange
rate flexibility and stability. The relative weight between flexibility and stability should be
adjusted over time. In addition, revision of the system should be possible without the sense ofpolicy failure or crisis. (Alternative exchange rate mechanisms will be discussed below.)
While the proper mix of competitiveness and price stability should be the main policy concern,other goals listed above, namely (3)-(7), should occasionally supplement it. At times, some ofthem may become a very serious policy issue. However, the last goal (8) should not be directly
targeted for the reason noted earlier.
Utility and limits of REER
The real effective exchange rate (REER) is an inflation-adjusted, trading partner-weighted
exchange rate. It is an overall indicator of a nation’s price competitiveness and can signal an
overvaluation or undervaluation of the home currency. This indicator is a useful guide forachieving the proper mix of exchange rate flexibility and stability. It should be regarded as abasic input to policy making in the same way as the doctor checks the body temperature of apatient.
5However, REER also have certain technical limitations. There is no definite number for REER
as its calculation depends very much on the following factors:--Choice of the base year--Type of the price index used (CPI is often used because of it is most commonly available)--Weighting of partner countries--International comparability of commodity baskets--Data availability
Calculation of REER alone cannot show with certainty whether the home currency isovervalued or not. Because of the technical problems noted above, each researcher andorganization tends to come up with different REER levels. Uncertainty is reduced somewhat
if REER is calculated by direct sampling of prices rather than by the use of published priceindices (which is, however, impractical for developing countries). Even in that case, ambiguity
cannot be entirely eliminated.
Vietnam's Competitiveness(Real effective exchange rate, Dec.1989 = 100)
120

110

UPDATE CALCULATION TO
MOST RECENT PERIOD

100

90

80

70

Gain
60

50

Loss
Dec-98

Jun-98Dec-97

Jun-97

Dec-96

Jun-96

Dec-95

Jun-95

Dec-94Jun-94

Dec-93Jun-93Dec-92Jun-92

Dec-91

Jun-91

Dec-90Jun-90Dec-8940

The ambiguity of competitivenessBesides these technical problems associated with REER, Vietnam also faces fundamental
problems in evaluating the appropriateness of its exchange rate level. These problems arecaused by Vietnam’s status as a low-income developing and transition country.
First, there is ambiguity arising from vertical trade structure. Vietnam’s exports areconcentrated in primary commodities and processed manufacturing (garment, footwear,
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electronic parts, etc) whose main markets are Japan, US and EU. Bilateral trade weights
used in REER calculation are dominated by these developed economies, but they are notdirect competitors of Vietnam. If Vietnam wishes to measure its competitive position properly,comparison should be made with China, ASEAN, Mexico, etc. But these true rivals are notrepresented by bilateral trade weights due to the absence of intra-industry trade.
Second, there is an issue related to low domestic labor content and high exchange ratepass-through. Vietnam’s main exports noted above are dominated by natural or foreign inputs,
both of which are denominated in USD. Domestic labor accounts for a very small part of total
production cost (typically 10% or less). As a result, when VND depreciates, many costs andprices (including export prices) adjust very quickly with little real effect. Some domestic
prices are quoted in USD even though payments may be made in VND or gold. If theVietnamese economy could adjust to any exchange rate level, it would not be very meaningful
to ask, “what is the correct VND/USD rate?” Any exchange rate would be the correct one oncethe economy had adjusted to that level. The equilibrium exchange rate is indeterminate whenpass-through is very high (it is worthwhile to estimate Vietnam’s pass-through coefficient). In
such a case, depreciation will not improve competitiveness or the current account.
Competitiveness must be improved through enterprise effort and institutional reforms rather
than exchange rate adjustment.
Third, comparison of REER across time is invalid if structural change is significant. The
Vietnamese economy has changed greatly with the systemic reforms under doi moi and global
integration under the open door policy. Vietnam’s guiding economic principle has also shifted
dramatically. REER between 1993 and 2003 cannot be compared directly because theunderlying economic structures are very different.
For all these reasons, REER is a convenient but imperfect index of competitiveness. The userof REER should always be reminded of these limitations and problems.
Monitoring the need for adjustment
In addition to REER, the SBV should constantly monitor a broad range of macroeconomic
indicators to see if any adjustment in VND is warranted or not. For example:--Competitiveness (using the REER index as discussed above)--Inflation at home and abroad--Monetary and fiscal indicators--Trends in exports and imports--International reserves and market pressure
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--Trends in FDI and domestic investment--Domestic business conditions (production, sales, employment, etc)--Banking sector indicators (domestic credit, deposits, NPL, interest rates, etc)--Asset market conditions (land, housing, gold, stock market)
There is no simple formula for summarizing all these indicators. Experience and analysis
must be used to make a judgment. Meanwhile, the literature on the early warning system ofcurrency crisis may provide a more complete checklist of economic variables for the central
bank.

III. Exchange Rate Mechanism
Alternative options
Which exchange rate mechanism should Vietnam adopt to achieve the best mix of exchange
rate flexibility and stability? Today, the exchange rate policy menu for developing countries isquite long. Here are some examples.

ProposalManaged float

Bipolar view

Currency board

Dollarization

Multiple currency
basket (in East
Asia)
Target zone

Explanation

Advocates & countries

Artificial pegs invite currency crisis. Dollar peg should
be avoided by any means. Countries with dollar pegs
should not receive international support.
In the global finance of the 21st century, no country
can choose a middle position between rigidity andflexibility. The only options are rigid fix or free float.
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.
More extreme thancurrency board. Abolish domestic
currency and circulate USD. The merits and demerits
are the same as in the case of currency board but
magnified.
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).
Intervene as necessary to keep the exchange rate

Meltzer Report (US, March
2000)

8

Barry Eichengreen, Stanley
Fischer. Once popular, but
now attracts less attention.
Hong Kong, Brunei. Estonia,
Lithuania. People are more
skeptical about applicability
to larger countries (Argentina,
Indonesia, etc.)

Panama, Ecuador.

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

John

Williamson,

Rudiger

Return to soft
dollar zone (in East
Asia)

Eclectic
pragmatism

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.
USD plays the dominant role in trade, investment andfinance. It is proper and desirable for East Asiandeveloping countries to return to the mild dollar peg.
No single formula fits all countries; conditions aredifferent from country to country. Each country should
select the most suitable system among crawl,
adjustable peg, managed float, etc. in response tochanging circumstances. In any system, improveactual operation to avoid crisis.

Dornbusch.

Ronald McKinnon.

Jeffrey Frankel, some IMF
economists (Paul Masson).

The author’s view is close to the last (eclectic pragmatism). In order to balance flexibility andstability, not only the exchange rate level but also the exchange rate system should be revised
from time to time in response to changing domestic and external developments. There are
more than one system that can combine flexibility and stability (if well managed) including
adjustable peg, variable crawl, currency basket with a band, managed float, and so on. Whatis important is not the name of the system but how well it is managed operationally.
Some of the options above are not suitable for Vietnam. Especially the bipolar view (eachcountry must choose a rigid fix or free float, but not in between) is highly inappropriate. Free
float is not a meaningful or feasible option for low-income countries with undeveloped
markets. On the other hand, a rigid dollar peg, as in Argentina during 1991-2001, usuallyends up in currency crisis and severe recession. A currency board and dollarization should not
be adopted in Vietnam because they are too rigid.
Exchange rate smoothing
In mixing exchange rate flexibility and stability, our general advice is to attain:--Short-term stability against USD--Long-term flexibility against USD
VND should be stable against USD on a day-to-day or even month-to-month basis, but overthe longer run (a few to several years) it should adjust its level. The SBV should normally set
the direction or intervene (if necessary) in the foreign exchange market. At the same time, it
should also be equipped with a mechanism to adjust the level (if necessary) without inviting acrisis. Statistically, this is equivalent to smoothing the VND/USD exchange rate, or
suppressing short-term fluctuation but realizing long-term trends (filtering out high9

frequencies).
But why should the central bank wish to smooth the exchange rate? Four reasons can bepresented.
(i)

Short-term fluctuation contains more noise and less information on fundamentals
compared with long-term movements (low signal-to-noise ratio).

(ii) Prevention of unwarranted one-way movements such as bubbles, herding,information-cascade, etc.
(iii) Lack of stabilizing currency traders; without official intervention, demand andsupply would not meet or the exchange rate would be too volatile.
(iv) Official provision of “hedging” (ensuring short-term exchange rate stability) for
exporters and importers in countries without forward, swap or futures markets.
In smoothing exchange rates, countries with more developed financial markets (Singapore,
Taiwan, Korea) often prefer managed float, with the market mainly determining theexchange rate while the central bank plays a supplementary role. By contrast, countries withprimitive financial markets and capital control (China, Vietnam) often adopt an adjustablepeg where the central bank mainly sets the exchange rate. Other countries may adopt
systems in between. The relative weights of market and official intervention should be chosen
in a way most comfortable for each country.

Exchange Rate Smoothing: An Illustration

Movement driven by market forces
without intervention

Managed float

Crawling peg with variable speed

Adjustable peg with frequent revisions

Exit policy problem and the timing of floating

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In addition to improving the normal operation, Vietnam must also prepare for emergency
situations. The exit policy problem addresses the question of how to end a fixed (or very
stable) exchange rate without a big crisis. This is a particularly serious issue for countries
with dollarization, a currency board, or an adjustable peg with infrequent adjustments. There
are different occasions from which the exit policy problem arises.
(i)

After a successful disinflation: high-inflation countries often adopt a fixed exchange
rate as a nominal anchor to stop inflation. After successful disinflation, however, thegovernment cannot end the fixed exchange rate system since the success is closely
associated with it. The home currency is pegged too long and becomes overvalued
until it is finally attacked by speculators.

(ii) In the process of financial liberalization: countries with rigid capital control or
multiple exchange rates face the problem of currency unification and one-timedepreciation in transition to a more liberal economic system.
(iii) Responding to various shocks: whether or not macroeconomic management is sound,various domestic or external shocks will occur. The home currency may come understrong pressure and the authority must decide whether to yield to it.
The last possibility is most relevant to Vietnam. VND may be attacked due to, for example,
regional currency crisis or other instability in the region. Proper response must be preparedin advance against such a circumstance.
As argued above, the exchange rate system should permit an easy exit to another system
without crisis. In this regard, dollarization and a currency board, which fix the exchange rateby law or even by the constitution, are too risky and therefore unacceptable. (If East Asian
economic integration proceeds greatly, a common regional currency may become feasible. But
it is too early to discuss this possibility.)
If the home currency is already under attack, the central bank must decide whether to float
and, if so, when. Again there is no general formula. Some countries do well to resist themarket pressure but others float with relatively little damage. Some countries float
immediately while others delay the decision for some time. In a typical crisis, a depreciationof 30% is normal and expectable. If the currency falls more than this, it can be considered avery severe crisis indeed (Indonesia and Russia suffered a 80% depreciation).
Once the crisis is over, the exchange rate usually stabilizes quickly and the central bank can
restore the normal mode of exchange rate management. If this does not happen and thecurrency continues to fall for several months, wrong policy response should be suspected (thiswas the case with the Asian financial crisis in 1997-98; IMF-led policy packages may have11

contributed to the worsening of the crisis).
If the decision is to float the currency, a set of supplementary policy measures should be
simultaneously introduced to minimize the shock to the national economy and end thefloating as soon as possible. Kazakhstan provides an excellent example of how to do this. Afterthe Russian ruble collapsed in August 1998, the Kazakh currency (tenge) came under a strong
downward pressure. When it finally floated in April 1999, the following measures were also
taken:--Temporary adoption of trade barriers and capital control--Special forward exchange arrangement to curb deposit withdrawals--Temporary freeze of public utility charges and other poverty alleviation measures--Temporary easing of prudential regulation on commercial banks--No fiscal or monetary tightening--No acceleration of structural reforms during the crisis
Kazakhstan was a market-oriented economy, but it temporarily deviated from the market
principle to protect its consumers, depositors, firms and banks during the height of the crisis.
After falling 33%, the tenge quickly stabilized within a few weeks. This was a very different
policy response compared with the East Asian countries.
The China factor
In conducting exchange rate policy, Vietnam must carefully watch the Chinese situation
because (i) China provides valuable lessons for Vietnam; and (ii) developments of the Chinese
economy and RMB may pose potential problems for the Vietnamese economy.
China currently shows the sign of overheating. There is a large and persistentcurrent-account surplus and FDI inflows are strong. Real growth is high, consumption isbooming, and urban land prices are rising. International reserves are ballooning and money
expands rapidly. For Vietnam, there are two macroeconomic risks.
The first risk is the bursting of the Chinese bubble which leads to deflation and economic
confusion. If that happens, there will be a serious impact on the regional economy (including
Vietnam) through weak demand, capital outflows and possible currency attacks. The second
risk is the mishandling of RMB’s exit policy problem. At present, the Chinese government
refuses to revalue RMB despite international pressure. But sooner or later, China will have to
move to a more flexible currency system. If the transition is smooth, there should be no great
difficulty for Vietnam. But if it is a catastrophic transition, it will damage the regional
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economy. The soft landing of the Chinese economy as well as RMB is the key.
The currency basket?
The argument for multiple currency baskets is popular among Japanese economists andofficials. They propose that East Asian developing countries should stop using USD as thebenchmark and adopt currency baskets composed of USD, Euro and Yen. However, the author
does not support such an idea.
The reason is that currency baskets do not facilitate exchange rate management very much.
Currency baskets solve only a small part of the adjustment problem arising from thefluctuations of the major currencies, while other adjustments (inflation gap, real shocks,
currency crisis) are left to the judgment of the monetary authority. Currency baskets are evenharmful if they give the false sense of security and automaticity. Exchange rate movement
driven by the major currencies does not coincide with the adjustment needed from a broader
perspective. With or without currency baskets, insight and experience are crucial for good
macroeconomic management. What is required is intelligent and experienced central bankstaff and not the installment of a partially automatic adjustment mechanism.

Adjustment
to:

Inflation

Currency

Basket +slidebasketinflation slide

ManualManualAuto

Auto

ManualAuto

ManualAuto

ManualManualManualManualManualManualManualManualDollar peg

Fluctuationsof USD, yen,
euroInternational
inflation gap
Real shocks
Currency
crisisConcrete suggestions
Finally, let us summarize our conclusions with concrete proposals.
As to the system, Vietnam’s reality as an economy with underdeveloped markets calls for asystem in which the SBV mainly sets the daily exchange rate while market signals are used13

as supplementary inputs. Free float is impractical and rigid fixes are dangerous. Specifically,
the author proposes a variable crawl with monthly monitoring and speed adjustment (if there
is no reason to change the speed, no adjustment is made that month). On the surface, thissystem may operate much like the current system; VND will slowly depreciate. But thepattern of crawling will no longer be left to the will of the market. It will be analyzed,
determined and announced by the SBV with proper reasoning. Formalization of the crawlingmechanism strengthens the analytical capability as well as the policy accountability of the
SBV.
Even when the need for adjustment is slim, it is recommended that VND is allowed to moveslightly against USD (not kept at a certain level for too long). This is to give the impressionthat the exchange rate is not pegged at all and change is possible at any time. In this regard, avariable crawl (which adjusts the sliding speed) is superior to an adjustable peg (which
adjusts the level). Realigning the peg is big news and stirs much political debate while
modifying the speed of sliding attracts much less attention and can be done quietly.
A variable crawl has been adopted by many developing and transition countries includingIndonesia and Kazakhstan. It is a suitable system for a developing country whose financial
markets are not yet fully developed. On the other hand, pegs with infrequent adjustments
tend to cause the exit policy problem as seen in Mexico, Argentina, Hong Kong and China.

Variable Crawl with Monthly Evaluation
VND/USD
Crawl speed adjustments

Monthly monitoringTime
As to the current level of VND/USD, the author does not see any need for a major revision. A
new exchange rate mechanism can be started smoothly without a big initial one-time jump.
But this issue should be more carefully evaluated by the SBV before coming to a final
conclusion. At any rate, it is not wise to realign the exchange rate level without clear reason;that will confuse the market.
14

As to the band around the central rate, I suggest a relatively narrow band of ±1% or even less.
This is because the SBV must play the role of a market maker in a thin market with a small
number of participants (dominated by a few state-owned commercial banks). In such a market,
currency movements within the band do not contain much economic information. The factthat the actual rate is usually stuck to the upper end of the band should not be construed as
the evidence of VND’s overvaluation. The current bandwidth of ±0.1% is a little too narrow
but, in the author’s view, still within the acceptable range.
In order to manage a variable crawl effectively, the SBV must conduct additional studies tosupport its operation. They include:--Analyses on policy objectives and operation mechanism (along the line of this paper)--Reliable calculation of REER--Monthly monitoring mechanism of a broad range of relevant economic variables--Survey of relevant literature (including currency crisis early warning systems)--Statistically estimate Vietnam’s exchange rate pass-through coefficients--Prepare procedure for switching from the normal mode to the crisis mode
[END]

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