Article

Are Devaluations Expansionary Global Business Review

20(1) 72–83, 2019
in Laos? © 2018 IMI
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DOI: 10.1177/0972150918803996
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Phouphet Kyophilavong1
Muhammad Shahbaz2
Thongphet Lamphayphan3
Byoungki Kim4
Michael C. S. Wong5

Abstract
This study investigates whether currency devaluation is expansionary for Laos. We combine cointegra-
tion and vector error correction method (VECM) Granger causality analysis to examine long-run and
causal relationships among selected macroeconomic variables. Our results confirm the presence of
cointegration among the variables and support expansionary effects of currency devaluation on eco-
nomic growth of Laos. Government spending increases economic growth but money supply decreases
the growth. World income is inversely linked with Laos’ economic growth. Our evidence supports the
devaluation-led growth hypothesis.

Keywords
Devaluation, VECM Granger causality, Laos

Introduction
Policies targeting exchange rate can have fundamental effects on an economy. Managing exchange
rate is considered to be a major policy objective in both developed and developing countries to achieve
sustainable economic growth, competitiveness and containment of inflation. To adopt an appropriate
policy, there are ongoing theoretical debates on how much an exchange rate should fluctuate.

1
Faculty of Economics and Business Management, National University of Laos, Vientiane, Laos.
2
Department of Energy and Sustainable Development, Montpelier Business School, Montpelier, France.
3
Graduate School of Economic Sciences, Hiroshima Shudo University, Hiroshima, Hiroshima Prefecture, Japan.
4
Faculty of Economics, Shiga University, Hikone, Shiga Prefecture, Japan.
5
Department of Economics and Finance, City University of Hong Kong, Kowloon Tong, Hong Kong.

Corresponding author:
Phouphet Kyophilavong, Faculty of Economics and Business Management, National University of Laos, P.O. Box 7322, FEB, NUoL,
Dongdok, Vientiane, Laos.
E-mail: Phouphetkyophilavong@gmail.com
Kyophilavong et al. 73

Many argue that currency devaluations of domestic decrease economic growth because a rise in import
prices hinders a country’s domestic production. Some argue that it stimulates economic activities because
of increase in relative prices. Currency devaluation can increase international competitiveness of domestic
industries, diverting domestic expenditures on foreign goods to expenditures on home goods.
There are a number of studies on the relationship between exchange rate devaluation and economic
growth. There is overwhelming evidence that a depreciated exchange rate promotes economic growth
(Asif, Shah, Zaman, & Rashid, 2011; Bleaney & Vargas, 2009; Khondker, Bidisha, & Razzaque, 2012;
Mpofu, 2013; Nunnenkamp & Schweickert, 1990; Rodrik, 2008; Vieira & MacDonald, 2010). Some recent
studies find that devaluation of local currency is contractionary, harmful to aggregate output (Bahmani-
Oskooee & Miteza, 2011; Karadam & Ozmen, 2013). These previous studies provide mixed results.
Impacts of exchange rate on economic growth can vary across countries.
So far, there is no documented study on how exchange rate affects economic growth of Laos. Before
its economic reform in 1986, Laos had adopted multiple exchange rates under a fixed exchange rate
regime. Laos began to apply floating exchange rate policy in 1989 (Kyophilavong, 2010). Under this
regime, Bank of Lao PDR (BOL) determines a daily reference rate of Kip against US dollar. This reference
rate is calculated by a weighted average of foreign exchange transactions of commercial banks and selected
market exchange rates.1 To stabilize the exchange rate, BOL intervenes the foreign exchange market and
adjusts the exchange rate of Kip by selling or buying foreign currencies. Under this regime, the exchange
rate demonstrates remarkable stability. Deviation of market exchange rate from its official rate becomes-
more narrow. However, due to lack of foreign reserves, such intervention is less effective. The problem
is complicated by inefficient decision-making process of BOL in implementing its original policies on
exchange rate. It is also criticized that some market exchange rates used by local commercial banks are
less movable, leading to an inactive interbank market for them.
As currency devaluation attracts enormous attention in many countries, we find a limited number
of related studies on Laos.2 This article is aimed at analysing the effect of currency devaluation on the
Laos economy. A key objective of this study is to investigate whether devaluation is expansionary or
contractionary in the case of Laos.
The remaining article is organized as follows: the second section provides a literature review on the
effect of devaluation on economic growth. The third and fourth sections present the objective of the
rationale of the study. Estimation results are reported in the fifth section. Finally, conclusions and policy
recommendations are shown in the sixth section.

Literature Review
There are ongoing debates on effective exchange rate policies in developing countries. Currency devalu-
ation can have both contractionary and expansionary effects on economic growth. Currency devaluation
may reduce aggregate supply by raising cost of imports but it may increase aggregate demand by increas-
ing net exports.
Some studies strongly argue that currency devaluation imposes contractionary effects on economic
growth (Diaz-Alejandro, 1963; Hirschman, 1949). Meade (1951) argues that currency devaluation leads
to contraction if the Marshall–Lerner condition is not satisfied. Both Guittian (1976) and Dornbusch
(1988) argue that success of currency depreciation depends on how much demand and supply curves
shift. On emerging and small economies, many studies find that currency devaluation results in faster
economic growth (see, e.g., Asif et al., 2011; Bahmani-Oskooee & Abera Gelan, 2013; Bleaney & Vargas,
2009; Galebotswe & Andrias, 2011; Haddad & Pancaro, 2010; Hsing, 2010; Immolei & Enoma, 2011;
74 Global Business Review 20(1)

Khondker et al., 2012; Kim & Ying, 2007; Mpofu, 2013; Nunnenkamp & Schweicker, 1990; Yilanci &
Hepsag 2011).
With annual time-series data in 1985–2004 from 13 developed countries and 20 emerging countries,
Bleaney and Vargas (2009) show a consistently positive relationship between currency devaluation and
economic growth in developed countries but its currency devaluation harms economic growth in emerg-
ing countries. Evidence on a positive relationship between currency devaluation and economic growth is
reported by Gylfason and Radetzki (1991) and G. Kim and Kim (2008) on underdeveloped, developing
and developed countries, Bahmani-Oskooee and Miteza (2003) for both OECD and non-OECD coun-
tries and Munthali, Simwaka, and Mwale (2010) on Malawi. Applying a pooled time-series cross-country
regression on 48 developing countries with time-series data in 1982–1987, Nunnenkamp and Schweickert
(1990) find that devaluation of local currency boosts economic growth. It claims that currency devalua-
tion cannot be blamed for declining economic growth experienced by developing countries with high
foreign debts in the 1980s. It argues that both restricted monetary and fiscal policies, rather than currency
devaluation, adversely affect those economies.
By employing panel unit root and panel cointegration techniques to study annual data from 42 countries
in 1988–1997, Bahmani-Oskooee and Miteza (2011) find contractionary effect of currency devaluation
in non-OECD countries in the long run. Based on the panel data model applied by Bahmani-Oskooee
and Miteza (2006, 2011) show some contradicting results. Edwards shows that contractionary effects of
currency devaluation happen in the first year and currency devaluation turns expansionary in subsequent
years. Bleaney and Vargas (2009) also find evidence that, in emerging markets, currency devaluation
depresses economic growth. Similar results are reported by Munthali et al. (2010), Ehinomen et al.
(2012), Gylfason and Radetzki (1991), Choudhary and Chaudhry (2007), Blecker and Razmi (2008),
Munthali et al. (2010), Ehinomen et al. (2012), Shahbaz, Islam, and Aamir (2012), Bahmani-Oskooee
and Abera Gelan (2013) and Ilir (2006). These studies generally find that devaluations result in contrac-
tionary effects on economic growth in developing countries. In general, the above empirical results
are inconclusive and are mixed which depend on characteristics of countries and methodologies.
How currency devaluation will affect Laos’ economy is unclear because of limited research on Laos.

Objectives
A key objective of this study is to investigate the relationship between exchange rate and economic
growth in Laos. Specifically, we investigate whether currency devaluation is expansionary or contrac-
tionary in the case of Laos. We apply the Bayer–Hanck test, a cointegration test proposed by Bayer and
Hanck (2013). In addition, we apply the Granger causality test with vector error correction method
(VECM) framework to investigate causal relationships among our selected variables.

Rationale of the Study

This study contributes to existing economic literature in three ways. First, there are many studies to
investigate the relationship between currency devaluation and economic growth but their findings are
inconclusive. So far, there is no related study on Laos. Thus, this study will add value to existing litera-
ture. Second, the results on Laos may provide insights to other less developed economies like Laos.
Third, we apply unit root test with structural break to the study time-series data (same as Zivot and
Andrews, 1992) and Bayer–Hanck test, a new cointegration test developed by Bayer and Hanck (2013).
Kyophilavong et al. 75

Methodology
Our model is based on Edward (1986), Bahmani-Oskooee, Chomsisenphet, and Kandi (2002), P. K.
Narayan and Narayan (2007) and Shahbaz et al. (2012) and written as follows:

Y = (M, G, D, YW) (1)

Y is domestic income defined as real GDP. M is real money supply. G is real government spending.
D is real nominal effective exchange rate (Kip/US dollar).3 YW is foreign income defined as real foreign
direct investment (FDI). We use quarterly data in 1992Q1–2013Q4 due to data availability.
M and G represent the monetary and fiscal policies, respectively. The coefficients of M and G are
expected to be positive. YD and D represent the external sector of economy. YD is expected to have
positive impacts on growth. If YD increases, it will increase domestic production and export which lead
to higher economic growth. The effect of D on growth is unclear. It could be either expansionary or
contractionary. The coefficient of D is positive if D has expansionary effects on growth. The coefficient
of D is negative if D has contractionary effects on growth.
According to standard econometric analysis, time series is said to be cointegrated if two or more
series are individually integrated and some linear combinations of them show a lower order of integra-
tion. Engle and Granger (1987) develop the first generation of cointegration test and set a necessary
condition of stationarity among non-stationary variables. This approach has powerful tools when data
sets are of limited length. Later, another cointegration test known as Johansen maximum eigenvalue test
is developed by Johansen (1991). Since it permits more than one cointegrating relationship, the test can
be more applicable than the Engle–Granger test. Another approach of cointegration test is Phillips–
Ouliaris cointegration test developed by Phillips and Ouliaris (1990). Other important approaches can
include error correction model (ECM) based on F-test of Peter Boswijk (1994) and the ECM based on
the t-test of Banerjee, Dolado, and Mestre (1998).
However, different tests might suggest inconsistent conclusions. Bayer and Hanck (2013) propose
Bayer–Hanck test that considers a joint test statistic for the null of no cointegration based on Engle and
Granger, Johansen, Peter Boswijk and Banerjee tests. This new testing approach allows us to combine
various individual cointegration test results for a conclusive result. This article applies the Bayer–Hanck
test to evaluate cointegrating relationship between currency devaluation and economic growth of Laos.
Following Bayer and Hanck (2013), we combine a computed significance level ( p-value) of individual
cointegration tests in the Fisher’s equations as follows:

EG - JOH = - 2 7ln (p EG) + (p JOH )A(2)

EG - JOH - BO - BDM = - 2 7ln (p EG) + (p JOH ) + (p BO) + (p BDM )A(3)

where p EG, p JOH , p BO and p BDM are the p-values of various individual cointegration tests, respectively.4
It is assumed that if the estimated Fisher statistics exceed the critical values provided by Bayer and
Hanck (2013), the null hypothesis of no cointegration is rejected.
As long as the variables are cointegrated for the long run, we evaluate both their long-run and short-
run relationships. A long-run relationship between currency devaluation and economic growth requires
us to detect their direction of causality. This will be done with VECM Granger causality framework.
The VECM is shown as follows:
76 Global Business Review 20(1)

R V
SRSln Yt WWV RS{ 1VW RSa a a a a VW SRln Y
S WVW SSp 1WW SRSln Yt - 1 WVW
SS S
W S W W S
SS
11, i 12, i 13, i 14, i 15, iW
WW SS
t-1
W SS WW S W
SSln D t WWW SS{ 2WW p S b 21, i b 22, i b 23, i b 24, i b 25, i W SSln D t - 1 WWW SSp 2WW SSSln D t - 1 WWW
S S
W S W W S
S W
W S S
W S W S W W
(1 - L) SSln G t WW = SS{ 3WW + | (1 - L) SSc 31, i c 32, i c 33, i c 34, i c 35, i WW # SSln G t - 1 WW + SSp 3WW # SSln G t - 1 WW
SS WW S W i = 1 S W SS WW S W SS W
SSln M t WW SS{ 4WW SSd d d d d WW Sln M
S t-1 W
W SSp 4WW SSln M t - 1 WWW
SS S
W S WW S
SS
41, i 42, i 43, i 44, i 45, i W
W S S
W S W S W W
Sln YW tWW S{ 5W e 51, i e 52, i e 53, i e 54, i e 55, i W SSln YW t - 1WW SSp 5WW SSln YW t - 1WW
T X T X T X T X T X T X(4)
SSRn 1tWVW
SS WW
SSn 2tWW
S W
# [ECM t - 1] + SSn 3tWW
SS WW
SSn 4tWW
SS WW
Sn 5tW
T X
In the above equation, (1 - L) is a difference operator and ECM t - 1 is generated from the long-run
relationship. A long-run causality is indicated by the coefficient for the ECM t - 1 with significant t-test
statistic. A short-run causality is shown by statistically significant F-statistic of a Wald test that incorpo-
rates differences and lagged differences of independent variables in the model. A joint significance of the
lagged error term with differences and lagged differences of independent variables will support the
presence of joint long-run and short-run causality. For example, a 12, i ! 06 i implies that currency devalu-
ation Granger-causes economic growth and economic growth Granger-causes currency devaluation
indicated by b 21, i ! 06 i.

Analysis
We apply the unit root test of Zivot and Andrews (1992), which accommodates a single unknown struc-
tural break stemming in time series. This approach utilizes a full sample and a different dummy variable
for each possible break date. This approach is unique that critical values in Zivot and Andrews are
different from the critical values in, for example, Perron (1989) because selection of break dates is
treated as a part of its estimation procedure. The results of Zivot–Andrews unit root test (reported in
Table 1) show that Yt, YW t and D t are stationary with intercept and trend, while G t and M t are integrated
at I(1). This implies that our variables have a mixed order of integration. The break in 1997Q4 refers to

Table 1.  Zivot–Andrews Unit Root Test

At Level At 1st Difference

Variable T-Statistic Time Break T-Statistic Time Break
Yt −2.211 (4) 1997Q4 −7.443(0)* 2008Q1
Gt −3.133(1) 2004Q3 −5.433(3)* 1996Q4
YW t −3.711(4) 2006Q2 −6.663 (4)* 1998Q1
Dt −4.233(4) 1997Q4 −7.531(0)* 1988Q4
Mt −4.390 (3) 2006Q3 −8.195 (2)* 1996Q1
Source: The authors.
Note: * Represents significant at 1% level of significance. Lag order is shown in parenthesis.
Kyophilavong et al. 77

the Asian financial crisis, in which Thailand first had its crisis and imposed contagion effects on Laos
and the rest of other Asian countries.
Table 1 shows that, at 10 per cent level of significance, the t-statistics of YW t and D t reject the null
hypothesis of a unit root where the t-statistics of Yt reject the null hypothesis at 5 per cent level of signifi-
cance. Hence, the results suggest that these variables are stationary. Nonetheless, when these variables
are transformed into first difference, the t-statistics of all variables, including Yt, G t, YW t, D t and M t,
reject the null hypothesis of non-stationarity at 10 per cent level of significance. This means that all these
variables are stationary.
As the unit root test shows that all variables follow I(1), the combined cointegration tests are further
conducted. Table 2 illustrates the combined cointegration tests, including the EG-JOH and EG-JOH-BO-
BDM tests. The results reveal that Fisher statistics of EG-JOH and EG-JOH-BO-BDM tests on Yt, Dt, Gt
and Mt are higher than the critical value at 5 per cent significance level. This indicates that both EG-JOH
and EG-JOH-BO-BDM tests statistically reject the null hypothesis of no cointegration between varia-
bles. However, the result of combined cointegration tests on YWt fails to reject the null hypothesis of no
cointegration. Our findings support that there is a cointegration among Yt, Dt, Gt, Mt and their determinants
except YWt. This implies that the long-run relationship exists among currency devaluation, government
spending, money supply, world income and economic growth in 1992Q1–2013Q4.
The results depicted in Table 3 support the findings of Rodrik (2008) that devaluation promotes
economic growth. In other words, devaluation of local currency is expansionary in Laos. Given other
factors unchanged, a 1 per cent increase in currency devaluation results in economic growth by 1.22 per cent.
The impact of government spending on economic growth is significantly positive. A 1 per cent increase
in government spending results in economic growth by 0.9935 per cent. The relationship between money
supply and economic growth is significantly negative. It implies that a 1 per cent increase in money
supply decreases economic growth by 0.6968 per cent Foreign income has a significantly inverse impact
on the economy. By keeping other economic agents constant, 0.2663 per cent economic growth is
decreased by a 1 per cent increase in foreign income. Table 3 also reveals that the long-run model is
passed on the diagnostic tests. For example, it has no statistical issue relating to normality of error term
or autoregressive conditional heteroskedasticity. The long-run model is well confirmed by the Ramsey
RESET test. The CUSUM and CUSUMsq diagrams show stability of those long-run estimates.

Table 2.  The Results of Bayer and Hanck Cointegration Analysis

Estimated Models EG-JOH EG-JOH-BO-BDM Cointegration

Yt = f (D t, G t, M t, YW t) 18.170 47.536 Yes
D t = f (Yt, G t, M t, YW t) 16.986 24.727 Yes
G t = f (Yt, D t, M t, YW t) 15.265 25.265 Yes
M t = f (Yt, D t, G t, YW t) 16.720 37.816 Yes
YW t = f (Yt, D t, G t, M t) 5.785 5.716 No
Significance level Critical values Critical values
1% level 16.259 31.169
5% level 10.637 20.486
10% level 8.363 16.097
Source: The authors.
Note: ** Represents significant at 5% level. Critical values at 5% level are 10.576 (EG-JOH) and 20.143 (EG-JOH-BO-
BDM), respectively.
78 Global Business Review 20(1)

Table 3.  Long-Run Analysis

Dependent Variable = ln Yt
Variables Coefficient Std. Error T-Statistic Prob.
Constant 5.1425** 1.9825 2.5939 0.0115
ln D t 1.2220** 0.5348 2.2847 0.0252
ln G t 0.9935* 0.2705 3.6728 0.0005
ln M t −0.6968* 0.2351 −2.9630 0.0041
ln YW t −0.2663* 0.0459 −5.7915 0.0000
R2 0.8677
Adj. R2 0.8587
F-statistic 95.8161*
Diagnostic Checks
Test F-Statistic Prob.
| NORMAL
2 4.3562 0.1132
| 2 ARCH 1.0015 0.7823
| 2 REMSAY 0.4151 0.5214
CUSUM Stable At 5%
CUSUMsq Stable At 5%
Source: The authors.
Note: * and ** show significance at 1% and 5% levels, respectively.

The short-run causality results are reported in Table 4. We find that the impact of currency devaluation
is positive, but it is statistically insignificant. Government spending and economic growth are positively
correlated at 1 per cent level of significance. Money supply affects economic growth positively, but this
effect is insignificant. The relationship between foreign income and domestic economic growth is nega-
tive, but it is insignificant. The impact of the dummy is positive and it is statistically significant at the 5
per cent confidence level. The negative sign of coefficient of ECM t - 1 is −0.0623 and it is significant at
1 per cent confidence level. This confirms our established long-run relationship between the variables.
The coefficient of the lagged error term indicates the speed of adjustment from short-run towards the
long-run equilibrium path. We find that short-run deviations in the previous period are corrected by 6.23
per cent in future in case of Laos. It may take almost 4 years to reach the long-run equilibrium path using
growth function. The short-run model shows that the error term is normally distributed with zero mean
and constant variance. There is no problem of autoregressive conditional heteroskedasticity and the
model is well constructed.
The existence of a long-run relationship (i.e., cointegration) among the variables, including currency
devaluation, government spending, money supply, foreign income and economic growth, motivates us
to examine directions of their causality with the VECM Granger causality approach. Results of the
causality test are reported in Table 5. A long-run causality is indicated by a significant coefficient of the
one-period-lagged error correction term ECTt - 1 in Equation (4). A short-run causality can be detected by
the joint significance of the LR test of the lagged explanatory variables in the equation. Our empirical
results suggest that ECTt - 1 is significant in three of the five VECM equations. Both currency devalua-
tion and foreign income have insignificant coefficient on ECTt−1.
The long-run causality results reveal that currency devaluation Granger-causes economic growth, but its
inverse causality effect is absent. There is a feedback effect between government spending and economic
growth. Money supply Granger-causes economic growth, while economic growth Granger-causes
Kyophilavong et al. 79

Table 4.  Short-Run Analysis

Dependent Variable = D ln Yt
Variables Coefficient Std. Error T-Statistic Prob.
Constant −0.0439* 0.0088 −4.9674 0.0000
D ln D t 0.0668 0.1284 0.5204 0.6044
D ln G t 0.3893* 0.1269 3.0683 0.0030
D ln M t 0.0466 0.0723 0.6451 0.5209
D ln YW t −0.0191 0.0260 −0.7348 0.4648
ECM t - 1 −0.0623* 0.0220 −2.8319 0.0060
R2 0.3159
Adj. R2 0.2589
F-statistic 5.5424*
Diagnostic Checks
Test F-statistic Prob.
| 2 NORMAL 0.8871 0.7981
| 2 ARCH 0.6800 0.5123
| 2 REMSAY 1.9053 0.2312
CUSUM Stable At 5%
CUSUMsq Unstable At 5%
Source: The authors.
Note: * Shows significance at 1% level.

Table 5.  The VECM Granger Causality Analysis

Direction of Causality
Short Run Long Run
Dependent
Variable D ln Yt - 1 D ln D t - 1 D ln G t - 1 D ln M t - 1 D ln YW t - 1 ECTt - 1
D ln Yt 0.5983 3.4268** 0.8908 0.3686 −0.0697*
…. [0.5526] [0.0382] [0.4510] [0.6930] [−2.9838]
D ln D t 4.4838** 0.5218 5.0410* 1.1612
[0.0154] …. [0.5958] [0.0091] [0.3180] ….
D ln G t 0.9070 7.2728* 3.8809** 2.5849*** −0.1993*
[0.4082] [0.0014] …. [0.0254] [0.0829] [−4.4321]
D ln M t 10.2502* 0.2065 1.8902 0.6261 −0.1756**
[0.0001] [0.8139] [0.1590] …. [0.5377] [−2.4338]
D ln YM t 0.6077 0.5255 1.5739 0.6609
[0.5014] [0.5936] [0.2147] [0.5197] …. ….
Source: The authors.
Note: *, ** and *** show significance at 1%, 5% and 10% levels, respectively.

money supply. The relationship between money supply and government spending is bidirectional. Both
money supply and government spending Granger-cause currency devaluation. Foreign income also
Granger-causes domestic economic growth, money supply and government spending. In the short run,
we find that economic growth Granger-causes currency devaluation. This suggests a growth-led
80 Global Business Review 20(1)

devaluation. Economic growth Granger-causes government spending. Money supply Granger-causes

devaluation, while economic growth Granger-causes money supply. Money supply and foreign income
Granger-cause government spending.
Our findings support that currency devaluation promotes faster economic growth in Laos. It is consistent
with many similar studies on emerging economies (see, e.g., Asif et al., 2011 on Pakistan; Immolei &
Enoma, 2011 on Nigeria; Khondker et al., 2012 on Bangladesh; Bahmani-Oskooee & Abera Gelan, 2013
on eight African countries; and Galebotswe & Andrias, 2011 on Botswana).
Many developing countries experience financial crisis, such as Asian financial crisis in 1997. They tend
to fear that currency devaluation would cause negative impact on their economy growth and intervene in
their exchange rate markets. The BOL is one example that it intervenes aggressively in the Kip market
to stabilize its movements. Findings from this study may give BOL and other central banks of develop-
ing countries new insights that currency devaluation can lead to economic growth. The BOL should have
appropriate policies to manage exchange rate for achieving economic growth. The BOL should increase
foreign reserves and improve the capacity of human resources to monitor and evaluate policies on
exchange rate (Kyophilavong, 2010). Finally, BOL should consider depreciation of Kip in order to
promote exports.

Conclusion and Policy Implications

The objective of this article is to investigate the impact of devaluation on the Laos economy. We employed
Bayer and Hanck cointegration analysis and error correction method (ECM) for analysing short-run
dynamics. Our results confirm the presence of cointegration among macroeconomic variables in Laos.
Moreover, the results support that currency devaluation is expansionary. This means currency devalua-
tion promotes economic growth. Government spending increases economic growth but money supply
reduces it. World income is inversely linked with Laos’s economic growth. Causality analysis indicates
a unidirectional causality running from currency devaluation to economic growth. This suggests the
expansionary effects of currency devaluation on Laos’ economic growth.
Our findings show that currency devaluation promotes economic growth of Laos. The BOL currently
adopts a managed floating exchange rate policy in order to make Kip stable against US dollar. This policy
cannot improve trade balance in the long run, weakening exports in the long run. Moreover, BOL faces
various challenges on managing effective exchange rate policy.
From the findings of this article, we have the following policy recommendations. First, Laos should
increase foreign reserves for effectively managing exchange rate. Second, BOL should improve its
human resource capacity and decision process for exchange rate management. Third, devaluation of
Lao currency (Kip) helps improve competitiveness of Laos in exports. Finally, BOL should consider a
flexible exchange rate policy.

Acknowledgement
The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve
the quality of the article. Usual disclaimers apply.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of
this article.
Kyophilavong et al. 81

Funding
The authors received no financial support for the research, authorship and/or publication of this article.

Notes
1. This reference rate is amended in order to respond to market conditions. For example, in 2006, commercial banks
were required to adjust their daily selling exchange rate for the dollar by ± 0.30 per cent from its reference rate
and required to set margins between the buying and selling rates that did not exceed ± 1.5 per cent.
2. There are empirical studies on how exchange rate affects trade balance and some selected macroeconomic
variables (Chansomphou & Ichihashi, 2010; Kyophilavong, Shahbaz, & Uddin, 2013, 2015, 2016; Kyophilavong
& Toyoda, 2007).
3. Increasing in exchange rate indicates a devaluation of the local currency.
4. Note that EG: Engle and Granger’s test (Engle & Granger, 1987); JOH: Johansen’s tests (Johansen, 1991);
Boswijk’s test (Peter Boswijk, 1994) and Banerjee et al.’s tests (Banerjee et al., 1998).

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