Table of Contents

Introduction..........................................................................................................................1

Main contents.......................................................................................................................2

1. What is the exchange rate?............................................................................................2

1.1. Definition of exchange rate....................................................................................2

1.2. Significance of exchange rate.................................................................................2

2. How is the exchange rate determined in the foreign exchange market?.......................3

3. Identify the balance of trade, nominal and real exchange rate......................................4

3.1. Balance of Trade.....................................................................................................4

3.2. Nominal Exchange Rate.........................................................................................5

3.3. Real Exchange Rate................................................................................................6

4. Distinguish between devaluation and depreciation of domestic currency....................6

4.1 Devaluation of Currency..........................................................................................6

4.2 Depreciation of Currency........................................................................................7

5. How can the State Bank of Vietnam help in bringing down the foreign exchange rate
which is very high?...........................................................................................................8

5.1. Tightening Monetary Policy...................................................................................8

5.2. Selling Foreign Currency Reserves........................................................................8

5.3. Widening the Trading Band....................................................................................9

5.4. Signaling Future Policy Intentions.........................................................................9

Conclusion..........................................................................................................................10

References..........................................................................................................................11
 Introduction

Exchange rates between currencies have profound implications for any country
integrated into global trade and financial systems, including Vietnam. Currency
valuations impact international competitiveness, foreign investment flows, inflation,
living standards, and monetary policy options. For developing export-driven economies
like Vietnam reliant on overseas trade, managing exchange rate levels and volatility is
crucial for macroeconomic stability and sustained growth. This essay will explore
foundational concepts around exchange rates, what determines currency values on forex
markets, how rates influence wider economies, and the complex dynamics facing
policymakers seeking to steer rates.
Vietnam’s heavy reliance on exports such as electronics, textiles and agricultural
products means the value of its currency, the dong, strongly impacts the affordability and
demand for these goods abroad. Meanwhile, Vietnam depends heavily on imported inputs
for its manufacturing exporters. The dong's value also shapes flows of remittances,
foreign investments and tourism receipts contributing to economic growth. Therefore,
both depreciation and appreciation of the dong can disrupt key sectors. Recent inflation
and US Federal Reserve tightening have sparked dong depreciation, hurting living costs
but benefiting export competitiveness. This exemplifies the tradeoffs policymakers face
regarding exchange rates.
This essay will define exchange rates and analyze the significance of currency
valuations for macroeconomic performance, trade, investment and inflation in Vietnam. It
will examine how the complex dynamics of global foreign exchange markets determine
floating exchange rates via factors like interest and inflation rate differences and
speculative capital flows. The essay will distinguish critical concepts like nominal versus
real exchange rates and depreciation versus devaluation of currencies. Lastly, it will
assess policy options and limitations facing the State Bank of Vietnam in responding to
excessive dong appreciation or depreciation pressures. Grasping these exchange rate
economics foundations is essential for Vietnam navigating an increasingly globalized
world.
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2
 Main contents
1. What is the exchange rate?
1.1. Definition of exchange rate
The exchange rate is the price of one country's currency expressed in terms of
another country's currency (Kenton, 2023). More specifically, the exchange rate is the
amount that one unit of a currency can be exchanged for another currency. For example,
the current VND/USD exchange rate is about 23,000, meaning one US dollar can be
exchanged for around 23,000 Vietnamese dong.
The exchange rate is important because it impacts international trade, investments,
tourism, and the competitiveness of a country's exports (Kenton, 2023). It reflects the
purchasing power between currencies and the relative strength between different
economies. For Vietnam, the exchange rate influences how affordable its exports are to
other countries and determines how far money from tourism, remittances and foreign
investments can go domestically to spur economic growth (Nguyen, 2022).
An exchange rate can be determined by supply and demand dynamics in the
foreign exchange market and can shift based on macroeconomic factors like inflation,
interest rates, speculation, and political stability (Kramer & Nguyen, 2022). Central banks
may also intervene to prevent sharp currency fluctuations or to boost exports. Recently,
the VND/USD rate has depreciated as the US Federal Reserve has hiked interest rates,
boosting demand for dollars globally (Nguyen, 2022). Vietnam's central bank has sold
dollars from state currency reserves to curb the dong's decline.
1.2. Significance of exchange rate
The exchange rate holds major significance for any country participating in
international trade and global financial markets. Most importantly, the exchange rate
impacts the international competitiveness of a country’s exports (Le & Nguyen, 2018).
For example, Vietnam is a major exporter of goods like textiles, electronics, and
agricultural products. If the VND depreciates against the USD, Vietnamese exports
become cheaper for American importers. This makes Vietnamese products more
affordable and competitive in the large US consumer market, potentially expanding

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Vietnam’s exports and economic growth. On the other hand, an appreciating dong makes
exports more expensive.
Exchange rates also significantly influence other macroeconomic metrics like
inflation, interest rates, employment, and gross domestic product (GDP) (Le & Nguyen,
2018). For instance, the recent depreciation of the dong against the dollar has contributed
to higher inflation in Vietnam through more expensive imports from the US and other
countries pricing goods in dollars. This harms standards of living in Vietnam. Meanwhile,
the low dong supports Vietnamese export industries and associated jobs. Therefore,
exchange rate shifts can involve complicated trade-offs for policymakers.
Additionally, exchange rates impact foreign investment, remittances, and tourism
inflows which are all major contributors to Vietnam’s economy (Nguyen, 2022). A
weaker dong means foreign capital goes further for investors, providing incentives for
foreign direct investment. It also means higher value remittances and tourism receipts for
Vietnamese recipients and businesses catering to tourists. Therefore, maintaining a stable
and appropriately valued currency is important for Vietnam’s ongoing development.
Aggressive exchange rate fluctuations can deter foreign businesses, migrant workers, and
travelers.
Careful exchange rate management by Vietnam’s central bank and government is
essential given these implications for jobs, prices, investment, living standards, and
overall macroeconomic performance. Policymakers face complex decisions balancing
multiple stakeholders and goals related to the dong’s value.

2. How is the exchange rate determined in the foreign exchange market?

The exchange rate between two currencies is ultimately determined by the
dynamics of supply and demand in the global foreign exchange (Forex) market. This
enormous decentralized market consists of a diverse array of buyers and sellers
negotiating trades that set relative prices between currencies (Madura, 2018). Major
participants include large banks, multinational corporations, hedge funds, central banks,
retail currency brokers and speculators.

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 In free floating exchange rate regimes, currency valuations fluctuate based on
market forces without government pegging or fixing of rates. The key driver is the interest
rate differential between two economies. Higher interest rates in a country will attract
foreign capital flows seeking to earn higher yields, boosting demand for and value of that
country’s currency (Madura, 2018). This also connects to relative inflation rates between
currencies. Higher inflation erodes purchasing power, decreasing currency demand.
Additionally, the overall balance of international trade in goods and services
impacts currency markets. If one country runs consistent large trade surpluses with
another, it will accumulate growing payments denominated in the other’s currency over
time (Madura, 2018). This can increase supply and depreciate that foreign currency, all
else equal. Current account deficits and surpluses driven by trade can have similar effects.
Speculative trading and betting on currency shifts also impacts exchange rates,
sometimes disconnected from economic fundamentals (Das et al., 2022, 2022). Large
capital flows from major players in currency markets can move rates significantly, at least
in the short run. Such speculative trading exacerbates volatility.
Finally, the foreign exchange interventions and monetary policies enacted by
central banks substantially sway exchange rates (Das et al., 2022, 2022). Direct buying
and selling of foreign currencies to support or suppress valuations is impactful. And
interest rate adjustments that attract or discourage foreign capital flows can be impactful
as well.
In summary, exchange rates emerge from the constantly fluctuating supply and
demand for currencies across global Forex spot, forward, futures and options markets.
Myriad players interact creating shifts based on trade flows, macroeconomics,
speculation, and central bank policies. This complex price discovery aligns exchange rates
with their latest perceived market value.
3. Identify the balance of trade, nominal and real exchange rate.
3.1. Balance of Trade
The balance of trade refers to the difference in monetary value between a country’s
annual imports and exports of physical goods and services. Sometimes also called the
trade balance or net exports, a positive balance of trade signifies a country exports more
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than it imports, resulting in a trade surplus during that period (Amadeo, 2023). It earns
more foreign currency from abroad through overseas sales than it spends purchasing
foreign products. The opposite scenario of importing more than exporting creates a trade
deficit.
The balance of trade varies substantially between countries and shifts year to year
based on macroeconomic conditions and consumer demand both domestically and in
export markets. Monitoring the trade balance provides insight into international
competitiveness, reliance on foreign imports versus domestic production, and overall
economic openness (Nopiana et al., 2022). For advanced export-driven economies,
maintaining a positive balance is often a priority to drive foreign income and gross
domestic product (GDP) growth.
Trade balances also influence other key areas of the economy like employment
levels in export industries, currency exchange rates and interest rates. For example,
consistent large trade surpluses leading to accumulating foreign currency reserves can
strengthen and appreciate the local currency relative to foreign currencies. On the other
hand, prolonged deficits may depreciate currency over time (Nopiana et al., 2022).
Deficits can also prompt policy shifts like trade protectionism.
Both trade flows and exchange rates respond to consumer behavior, macro
conditions like inflation and growth rates, and structural factors like labor costs and
productivity (Amadeo, 2023). Ultimately a nation’s balance of trade underscores
competitiveness, points to growing or declining economic sectors, impacts multiple facets
of the economy, and informs policymaking. Tracking imports and exports reveals
economic strengths, weaknesses and interconnections across global trade.
3.2. Nominal Exchange Rate
The nominal exchange rate refers to the rate at which one currency can be
exchanged for another currency at the current market price, absent accounting for
inflation or price differences between countries (Buffie et al., 2022). Also called the
bilateral exchange rate, it denotes the amount of units of one currency required to
purchase a single unit of another currency based purely on the currencies' relative market
values.
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 For example, the current nominal VND/USD exchange rate is about 23,000
Vietnamese dong per 1 US dollar. This rate fluctuates regularly based on macroeconomic
factors impacting currency markets like trade balances, interest and inflation rate
differences, speculation, and central bank intervention. It contrasts with real exchange
rates that factor in price level contrasts between countries over time (Buffie et al., 2022).
Monitoring nominal exchange rates is essential for governments and businesses
involved in global trade and finance to understand import/export competitiveness, impacts
on domestic inflation, and risks related to currency volatility. Comparing shifts in nominal
rates versus real rates also sheds light on how much inflation differentials are impacting
currency moves rather than true economic strength factors. This helps inform sound
exchange rate management policies.

3.3. Real Exchange Rate

The real exchange rate accounts for differences in price levels and inflation when
comparing the relative value of currencies over time (Madura, 2018). Unlike nominal
exchange rates denoting strict currency market conversion rates, real exchange rates
adjust for price level contrasts across countries.
For example, if over one year Vietnam experiences much higher inflation than the
United States, that diminishes the true purchasing power of the Vietnamese dong relative
to the dollar by increasing prices for imported US goods and services. This erosion in the
dong's real value would be reflected in a higher real VND/USD exchange rate compared
to the nominal rate. The real rate provides a more accurate picture of the currencies'
comparative worth for trading purposes adjusted for inflation (Madura, 2018).
Monitoring real exchange rates alongside nominal rates helps governments and
businesses understand how much shifts are being driven by true demand, trade balances
and productivity changes versus domestic or foreign inflation differentials. For export-
focused countries especially, tracking real exchange rate trends provides insight into
underlying competitiveness and growth factors while accounting for often volatile price

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dynamics. This informs sound policymaking around trade, currency markets, and
macroeconomic performance overall.
4. Distinguish between devaluation and depreciation of domestic currency.
4.1 Devaluation of Currency
Currency devaluation refers to a deliberate downward adjustment to the official
exchange rate of a currency relative to major foreign currencies by the domestic
government or monetary authority (Callen et al., 2022). Typically countries officially peg
their currency’s value to another dominant currency like the US dollar. Devaluation
occurs when policymakers make a decisive intervention to lower the fixed exchange rate
at which their currency converts.
For example, Vietnam could opt to devalue the dong by 5% against the dollar,
adjusting the official rate from 23,000 dong per dollar to over 24,000. Devaluations intend
to boost export competitiveness in foreign trade by making exports cheaper for
international importers, as well as to address balance of payment issues or unsustainable
deficits (Callen et al., 2022). However, devaluations also risk spurring inflation through
currency depreciation passed to consumers. There are complex policy tradeoffs.
Overall currency devaluation signifies an active and deliberate downward
exchange rate adjustment by a government compared to market-driven floating exchange
rate changes. It attempts to reset at a more favorable level to gain trade and
macroeconomic advantages.
4.2 Depreciation of Currency
Unlike overt exchange rate shifting through devaluation policy decisions, currency
depreciation refers to a more gradual market-driven decline in a currency’s value relative
to other foreign currencies (Callen et al., 2022). Under floating exchange rate regimes, a
currency can naturally depreciate over time without official decrees based on supply and
demand, loss of value from high inflation, or reduced confidence and investment appeal.
For instance, the dong could depreciate 10% against the USD over 6 months due to
rising US interest rates attracting capital flows into dollars combined with investor
uncertainty around Vietnamese political factors. Depreciation makes a country’s exports

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more competitive internationally much like devaluation, but arises from decentralized
currency markets and macro conditions rather than authoritative rate shifts.
Both devaluation and depreciation result in a currency declining in value compared
to foreign currencies. But devaluation stems from proactive government policy changes
while depreciation aligns with market valuation changes. Different causes, mechanisms
and policy implications apply to each despite some similar outcomes.
5. How can the State Bank of Vietnam help in bringing down the foreign exchange
rate which is very high?
The State Bank of Vietnam (SBV) has several monetary policy tools and foreign
exchange mechanisms available to attempt exerting downward pressure on the
Vietnamese dong (VND) exchange rate if it becomes extremely overvalued relative to
currencies like the US dollar (USD). However, influencing currency markets to align with
policy goals faces challenges and tradeoffs.
5.1. Tightening Monetary Policy
With high domestic inflation often boosting import demand and currency
appreciation pressure, the SBV could tighten monetary policy by raising interest rates (Le
& Nguyen, 2018). Higher interest rates aim to cool an overheating economy and reduce
price inflation. This can curb rising demand for imported goods and services which might
ease upward pressure on the exchange rate.
However, considerable risks exist of slowdown across indebted domestic sectors
sensitive to borrowing costs like construction and manufacturing (Le & Nguyen, 2018).
Tighter credit policy can directly and indirectly harm output and employment growth. The
SBV must balance these impacts against currency overvaluation concerns when setting
interest rates. Aggressive rate hikes may undermine broader economic objectives like
sustainable GDP growth.
5.2. Selling Foreign Currency Reserves
Direct foreign exchange market intervention via selling USD reserves offers the
most direct mechanism for the SBV pull down the VND/USD rate (Le & Nguyen, 2018).
Flooding supply of dollars to meet Vietnam’s demand needs would bid down the

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exchange rate without wider economic disruption. This intervention proved successful in
stabilizing the dong recently.
However, reserve sales cannot defend overextended currency valuations
indefinitely (Uyen et al., 2022). Vietnam’s dollar reserves declined markedly shoring up
the dong in 2022 before the SBV apparently withdrew intervention amid further
depreciation pressure. Reserves safeguard import needs so cannot be depleted excessively.
And heavy-handed intervention discourages market efficiency.
5.3. Widening the Trading Band
Vietnam could consider marginally widening the allowable VND trading range
around its central parity rate with the USD, enabling greater volatility to shake out
overvaluation (Uyen et al., 2022). Letting the dong depreciate more significantly shows
authorities will not infinitely defend higher valuations. This may partly realign currency
markets without drastic intervention.
Of course, increased volatility also elevates risks, market uncertainty and
adjustment costs across exposed sectors (Le & Nguyen, 2018). Volatility must be
contained to avoid capital flight or severe inflationary consequences. There are no easy
options available to the SBV for tackling currency overvaluation trends in currency
markets ultimately driven by macroeconomic fundamentals.
5.4. Signaling Future Policy Intentions
Finally, verbal signaling and forward guidance on intended future interest rates
shifts or foreign exchange policy adjustments may shape currency market expectations
(Le & Nguyen, 2018). Strong indications from the SBV leadership around not supporting
further VND appreciation could slow speculative demand and ease upward rate
momentum.
However, the credibility of authorities in actually following through on rate or
policy pronouncements remains vital for influencing markets (Le & Nguyen, 2018). And
signaling cannot distract from fundamental economic realities driving exchange rates like
trade balances, inflation and interest rate differentials. Rhetoric alone has limited impact
on currency valuations.

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 In conclusion, while the SBV retains some monetary policy tools to address
excessive VND exchange rate appreciation versus the USD, all policy options face
significant constraints and tradeoffs. Market efficiency considerations and negative
impacts on other economic goals inherently limit currency intervention effectiveness.

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 Conclusion

In conclusion, exchange rates are vital economic parameters connecting global

trade and financial flows across borders and currencies. The exchange rate denotes the
price of one currency in terms of another. Rates impact international competitiveness,
investment incentives, inflation, living standards and overall macroeconomic
performance.
Exchange rates fluctuate based on the complex dynamics between currency
demand and supply in decentralized global foreign exchange markets. Key drivers include
trade and current account balances, interest and inflation rate differences between
economies, speculative capital flows, and central bank policies. Movements in rates
significantly influence trade, employment, growth, prices and production across countries.
For developing export-reliant economies like Vietnam, managing exchange rate
levels and stability is crucial amid global integration. Currency shifts affect exports,
foreign investments, tourism receipts and macro goals. Recently, dong depreciation has
lifted export affordability but also domestic inflation. This exemplifies the complex
tradeoffs policymakers face regarding exchange rates. Tools to counter excessive
currency appreciation offer imperfect solutions.
In summary, this essay has explored foundational exchange rate concepts including
definitions, drivers, wider economic implications and policy responses. As the world
becomes more financially interconnected, understanding the profound role exchange rates
play in linking trade and capital flows remains essential. For open economies like
Vietnam, fostering currency stability alongside trade competitiveness and sustainable
growth requires nuanced exchange rate analysis and calibrated policy actions from central
banks and governments. Managing exchange rates will only grow in complexity and
importance as globalization accelerates.

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(2023). Implications of Central Bank Digital Currencies for Monetary Policy
Transmission. IMF Fintech Note, 2023/010, International Monetary Fund,
Washington, DC.

Buffie, E., Adam, C., O'Connell, S., & Pattillo, C. (2022). Macroeconomic management:
Stabilization, recovery, and growth. Oxford University Press.
https://doi.org/10.1093/oso/9780198866350.003.0004

Callen, T., Debrun, X., Hoek, J., Klyuev, V., & Tapsoba, R. (2022). Inflation and
exchange rate pass-through. IMF Economic Review, 70(4), 799-859.
https://www.researchgate.net/publication/339889870_Inflation_and_Exchange_Rat
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Nopiana, E., Habibah, Z., & Putri, W. A. (2022). The impact of exports and imports on
economic growth in Indonesia. Marginal, 1(3).
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Kenton, W. (2023). Exchange rate. Investopedia.

https://www.investopedia.com/terms/e/exchangerate.asp

Kramer, A., & Nguyen, G. (2022, October 25). SBV starts to buy US dollars, pump
Vietnamese dong into market. https://en.sggp.org.vn/sbv-starts-to-buy-us-dollars-
pump-vietnamese-dong-into-market-post99201.html.

Le, D. T., & Nguyen, V. H. (2018). Exchange rate policy in Vietnam: Evolution, changes,
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Luong, T. (2022). Why Manufacturing is Driving Vietnam’s Growth.
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Nguyen, L. (2022). Explained: Implications of the Latest Fed Rate Hike on the
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Uyen, N. D. T., Giang, N. K., & Yap, K. L. M (2022). Vietnam Central Bank Widens
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