One Small Weight in the AEC Asian Currency Unit
By JC Collins
It’s been a long time since we visited our good friend and little currency that could – the Vietnamese dong, otherwise known as the VND. After numerous posts in the first few years or so of POM I’ve allowed the attention given to this topic to wane somewhat. The amount of factual and reliable information regarding the VND is extremely limited and such a vacuum is filled with rumor and conjecture.
There are plenty of sites which promote this misleading information and I do not intend to have POM be one of them. This is why I have focused past posts regarding this topic on factual information which has been made available.
Such information includes statements by the State Bank of Vietnam regarding the need to improve the exchange rate mechanism of the VND by pegging to a basket of currencies or to the currency of its largest trading partner, which happens to be China.
It also includes the implementation of a test exchange rate arrangement where the Chinese renminbi and the dong are directly convertible. This is happening through the Pan-Asian FX Trading Center which is located on a border location between Vietnam and China. Additional information on this center has been difficult to obtain.
Vietnamese monetary authorities have openly expressed the financial need to strengthen the dong and stabilize its exchange rate. One of the missing components for this strategy has been a large surplus or foreign exchange reserves.
As most POM readers know one of the staples of the monetary theory presented here is that nations with large trade surpluses will experience currency appreciation in order to affect a more stable balance of payments framework. The idea is that large trade surpluses develop because a currency is undervalued making exports cheaper. Once a currency begins to appreciate those exports become more expensive which forces trade to shift.
Nations with overvalued currencies will experience a devaluation which will make their exports more affordable. America is an example of the latter while China is an example of the former.
As stated, Vietnam has not, to date, accumulated a large foreign exchange reserve. But this is set to change with the implementation of the Trans-Pacific Partnership, otherwise known as the TPP.
With the TPP Vietnam will become the biggest winner of the 12 nation trade agreement. The effects of this have not been openly expressed, and the financial and macroeconomic impacts on Vietnam are unknown. This would include impacts on the exchange rate arrangement which the VND has maintained with the USD for decades.
It took seven years, but the US and Japan led TPP was finally signed in February. Most analysts and framers of the TPP agree that Vietnam will benefit the most with higher exports, larger foreign direct investment flows, and an overall rise in economic growth.
The largest and most substantial increases will be realized in the exporting of textiles, garments, and consumer electronics. All of this will contribute to an overall increase in Vietnams monetary and financial positioning, which will lead to an increase in foreign reserves.
Larger flows of foreign exchange reserves will grow Vietnam’s current account surplus, which will in turn create a larger demand for the VND to appreciate. The exclusion of exchange rate controls in the TPP has been one of the biggest criticisms of the trade agreement.
In 2010 Vietnam had an account deficit of $4.3 billion USD. A trade surplus of $1.3 billion had grown by 2015. Though Vietnam is expected to have a deficit again this year, the implementation of the TPP can quickly turn this around once again and large trade surpluses will develop.
As a natural progression, as the current account surplus develops, investors will gain more confidence in the VND which will in turn create appreciation pressures. This makes currency stabilization and appreciation one of the benefits of the TPP for Vietnam.
The wildcard in this equation is the creation of a regional currency unit for the ASEAN +3 AEC Trade Agreement. In the post TPP and the AEC – Parallel Trade Agreements, we reviewed the mandates of both agreements and how Vietnam will be the biggest winner from both.
The AEC will require the creation of an Asian Currency Unit (ACU) to function in the same manner which the European Currency Unit was the predecessor to the euro as the common economic zone developed. The AEC and the ACU will serve the same function.
The State Bank of Vietnam has already expressed its willingness to de-peg the VND from the USD and peg to a currency basket. This is likely a reference to a forthcoming ACU for use in the AEC. Considering the connection and hinge between east and west characteristic of both the TPP and AEC, we can only speculate on timeframes and fully implementation of the strategy discussed above.
The mandates of the multilateral monetary framework are to rebalance and prevent the accumulation of large foreign exchange reserves and trade surpluses. This positions the VND well for a future appreciation. It is still the small currency that can, and I still believe in its potential as an important part of an overall and diversified FX investment strategy. – JC