What Type of Exchange Rate Regime Is Present in Vietnam?
Uncover the methods and rationale behind Vietnam's approach to currency management and its economic implications.
Exchange rates play a significant role in a country’s economic landscape. A country’s choice of how to manage its currency’s value relative to others is known as its exchange rate regime. This framework dictates the degree of government intervention in the foreign exchange market. The selected regime aims to balance various economic objectives, such as promoting exports, controlling inflation, and attracting foreign investment.
Common Exchange Rate Regimes
Exchange rate regimes generally exist along a spectrum, ranging from systems with minimal government involvement to those with strict controls. At one end of this spectrum is a fixed exchange rate, where a country’s currency is pegged to another currency, a basket of currencies, or a commodity like gold. Under this system, the central bank commits to maintaining the set parity, often requiring direct intervention in the foreign exchange market to buy or sell its currency.
Conversely, a floating exchange rate system allows the currency’s value to be determined primarily by market forces, namely supply and demand, with little to no official intervention. This regime offers flexibility, as the exchange rate can adjust automatically to economic shocks. However, it can also lead to greater volatility, which might create uncertainty for businesses involved in international trade.
Between these two extremes lies the managed float, sometimes referred to as a dirty float. In this hybrid system, market forces largely determine the exchange rate, but the central bank retains the option to intervene periodically. The purpose of such intervention is typically to smooth out excessive fluctuations, prevent rapid appreciation or depreciation, or guide the exchange rate in a desired direction without maintaining a rigid peg. This approach seeks to combine the flexibility of a floating system with a degree of stability and control.
Vietnam’s Exchange Rate Regime Today
Vietnam currently operates a managed floating exchange rate system. Under this regime, the State Bank of Vietnam (SBV) oversees and manages the Vietnamese Dong (VND) against foreign currencies, particularly the US Dollar. This approach balances market dynamics with maintaining control to ensure economic stability.
The SBV’s exchange rate policy aims to promote macroeconomic stability, control inflation, and support export growth. A stable exchange rate also fosters a predictable business environment and attracts foreign direct investment. The SBV’s active management prevents excessive volatility and achieves these broader economic goals.
Vietnam’s current managed float system represents an evolution from earlier, more rigid exchange rate arrangements. The controlled floating regime, implemented since January 2016, allows for greater flexibility and enables the SBV to intervene as needed.
Mechanisms of Exchange Rate Management in Vietnam
The State Bank of Vietnam employs specific mechanisms to manage the Vietnamese Dong within its managed floating regime. A core tool is the daily interbank reference exchange rate for the VND against the US Dollar, which serves as a benchmark for commercial banks.
Commercial banks can trade the US Dollar against the VND within a specified trading band around this daily reference rate. This band currently allows for fluctuations of plus or minus 5% from the announced reference rate. This trading band was widened from 3% to 5% in October 2022.
The SBV actively intervenes in the foreign exchange market to maintain the exchange rate within this band or to influence its direction. This often involves buying or selling foreign currency reserves, predominantly US Dollars, to strengthen or weaken the VND. These interventions smooth out sharp fluctuations and ensure an orderly market.
Beyond direct market intervention, the SBV also utilizes monetary policy tools to indirectly influence the exchange rate. This includes adjusting interest rates and conducting open market operations, such as issuing Vietnamese Dong bonds, to manage liquidity in the banking system. By influencing domestic interest rates and liquidity, the SBV can impact capital flows and the exchange rate. The SBV considers global market movements, domestic inflation, the trade balance, foreign direct investment, and the monetary policies of major trading partners like the United States when setting the daily reference rate and intervening.