This year Vietnam is the host APEC country, convening a series of official meetings that will culminate in the APEC leaders’ forum in November.

Vietnam’s economy has performed remarkably since economic and political reforms started under the so-called Doi Moi liberalisation program launched in 1986. Due to its rapid economic growth which averaged around 6.5 per cent in the 2000s, one of the fastest in the world, Vietnam has progressed from one of the world’s poorest nations to attain lower middle-income status.

A recently published paper “Is Vietnam’s Exchange Rate Overvalued?” by Hung Bui, Tony Makin and Shyama Ratnasiri published in the Journal of the Asia Pacific Economy focuses on Vietnam’s exchange rate, whose official rate has been pegged by the State Bank against the U.S dollar since 1989, despite wider market liberalisation throughout the Vietnamese economy over this time.

As we say in the abstract of the paper “Whether Vietnam’s official exchange rate is appropriately valued has important implications for the economy’s international competitiveness, trade balance and GDP. The main aim of the paper is to assess whether the official exchange rate has been valued appropriately with reference to macroeconomic fundamentals, as proposed by the Purchasing Power Parity (PPP) and the Behavioural Equilibrium Exchange Rate (BEER) approaches to evaluating equilibrium exchange rates. Our main empirical finding based on co-integration analysis using quarterly data from 1995 to 2014 is that according to both these approaches the Vietnamese Dong was significantly overvalued for extended times, most notably due to Vietnam’s relatively high inflation rate.”

This suggests Vietnam’s competitiveness is worse than it should be, and adds to the risk that despite its stellar economic performance over recent decades Vietnam could fall into the “middle income trap”. A more flexible exchange rate for Vietnam could lead to improved competitiveness and is also advisable given the economy’s susceptibility to terms of trade shocks that stem from its exposure through commodity exports to world price fluctuations. High exposure to fluctuating world commodity prices is a characteristic Vietnam’s economy has in common with Australia’s.

Yet a gradual approach to adopting a more flexible, or free floating, exchange rate regime for Vietnam would be appropriate in light of its relatively shallow foreign exchange market, and the capacity of its financial sector to manage currency risk.

Article by Griffith Asia Institute APEC Study Centre Director, Professor Tony Makin.