Myanmar has much to learn from Viet Nam’s exchange rate reforms

Myanmar’s exchange rate reform is a fundamental change, but it is not unique. A striking parallel can be found in Viet Nam’s move in the late 1980s to unify its multiple exchange rates into a single rate and its corresponding announcement of exchange rate management through a managed float, just as Myanmar is doing now. The experience of Viet Nam in reforming its exchange rate system—both good and bad—offers valuable lessons for Myanmar. The aim of this piece is to try to draw out some of these lessons. The objective is not to recommend that Myanmar should uncritically follow the lessons from the Viet Nam experience, but that the country should adopt these lessons to its own circumstances.

Myanmar’s Exchange Rate Reform in a Nutshell

The first salvo in a series of bold macroeconomic reforms is underway in Myanmar. On 1 April, the country began unifying official and “unofficial” exchange rates to produce a unique and realistic exchange rate for the nation’s currency, the kyat. The Central Bank of Myanmar (CBM) has declared that it will adopt a managed floating exchange rate for the kyat, which will allow the market to determine its value, and, at the same time, give CBM flexibility in influencing the kyat–dollar exchange rate. In line with the float, CBM also oversees a daily currency auction involving up to 11 dealer banks to determine the reference rate for that day’s trading. Once the rate has been set, banks are allowed to trade at plus or minus 0.8% of the reference rate.

The move abandons a 35-year-old regime in which the official exchange rate was pegged to special drawing rights (SDR) at 8.5 kyats per unit of SDR, or about 6 kyats per US dollar, making the official exchange rate more than 100 times the many unofficial exchange rates of around 800 kyats per dollar. These unofficial exchange rates allowed the private sector to circumvent strict exchange controls, such as the requirement of a license and foreign-exchange export earnings for private importers. Under the previous system, the official exchange rate was applied only to transactions in the public sector, which created substantial rents to people with access to official foreign exchange and to state-owned enterprises (SOEs) engaged in importing (such entities are allocated foreign exchange from a central fund at the overvalued official rate).

Key Lessons from Viet Nam

There are four key lessons that Myanmar can learn from Viet Nam’s exchange rate reform experience.

First, no developing country, and particularly not an economy in the early stage of economic transition, has ever adopted a “clean” float on its way to revamping its exchange rate system. In that regard, Myanmar’s small, commodity-export-based economy will be buffeted by fluctuations in commodity prices. CBM’s exchange rate strategy of intervening in order to achieve a more stable kyat exchange rate during the unification process is therefore understandable. But Viet Nam’s experience suggests that this strategy can also have an unintended consequence.

Viet Nam also made a statement that there would be a more market-oriented determination of its exchange rate, but in practice its central bank has played a dominant role in the foreign exchange market, to the extent that market participants have come to perceive the monetary authority’s preference for stability in the nominal exchange rate, and thereby the corresponding absence of foreign exchange risk. As a result, Viet Nam’s foreign exchange market is shallow and underdeveloped (Nguyen and Nguyen 2009). Thus, an obvious and crucial lesson in the process of developing a formal foreign exchange market for Myanmar is the recognition of an apparent trade-off between stability and the development of the market. It is then essential to allow some flexibility in the exchange rate, even if this is quite small. This will produce among market participants a sense of the existence of currency risk and, over time, once an adequate technical capacity to manage risk is achieved, a reasonable degree of forward market activity in the foreign exchange can then develop.

Second, Viet Nam’s experience suggests that, early in exchange rate reform, shoring up the public’s confidence in the domestic currency is crucial. Specifically, the implementation of positive real interest rates, which effectively raise household savings (Irvin 1995), and the use of government bonds to finance fiscal deficits, rather than printing money, have been critical steps (Nguyen 1999). In Myanmar, the low rate of savings due to caps on interest rates on deposits and loans that were lower than the inflation rate effectively meant that many savings were not intermediated by the banking system, and were probably tucked away in foreign currencies or gold. Furthermore, the government’s control of the central bank has meant that printing kyat to support a budget deficit has become the norm, which leads to high and fluctuating inflation in Myanmar. This last point underlines the importance in Myanmar of at least an operationally independent and accountable CBM in order for it to establish monetary control early in the unification process.

Third, Myanmar’s economic circumstances resemble those of Viet Nam at the time it reformed its exchange rate system. Just like Viet Nam, which had a petroleum boom and rapid inflows of foreign direct investment (FDI), Myanmar is experiencing a bonanza in natural gas development and exports. FDI inflows will accelerate with the resumption of international aid as well as an expected relaxation of foreign investment rules. Ironically, the strengthening of the kyat in both nominal and real terms perhaps represents the most serious threat to the macroeconomic wellbeing of Myanmar. The damage it is causing to Myanmar’s few private export successes such as rice, beans, pulses, marine products, and garments—goods that employ many people—threatens Myanmar’s opportunities to catch up with the export successes of its Southeast Asian peers.

How can this problem be solved? Easing import restrictions, which will stimulate demand for foreign exchange, can lift some of the pressure on the kyat’s strength. In Viet Nam, current account transactions, particularly consumer goods imports, were greatly liberalized following the decision to unify, while capital controls continue to be in force. Apart from official transfers, only FDI and remittances from Vietnamese living abroad have not been restricted. As a result, short-term capital inflows in Viet Nam have been successfully restricted (Camen 2006).

Fourth, a potential pitfall for Myanmar’s exchange rate reform, recently highlighted by ADB in its forecast for Myanmar in Asian Development Outlook (ADO) 2012, is the exposure of the true economic viability of importing SOEs once a more competitive exchange rate replaces the old and dissolved official rate. ADO argues that loss-making and inefficient SOEs may need to make lay-offs and to raise prices to stave off closure and bankruptcies (ADB 2012). There is also a risk that they may also saddle banks in Myanmar with massive non-performing loans. Viet Nam’s handling of inefficient SOEs provides an encouraging example of a policy of privatization. By transferring SOE ownership to the private sector via a program of “equitization,” the government can remove the burden of subsidizing inefficient SOEs, and allow it to focus its limited resources on the provision of social safety nets for the poor (Soe 2004).

Final thoughts

Myanmar has not undergone serious economic reforms before and its weak technical capacity and lack of experience in building market infrastructure to support the overhaul of its exchange rate system are formidable, yet surmountable challenges. Myanmar’s economic authorities, particularly the finance ministry and central bank, should establish a framework of monetary policy—including its objectives, intermediate targets and policy tools—and clarify the role of exchange rate policy in relation to this framework. A coherent monetary policy framework will thereby allow these bodies to take full advantage of the positive effects of its exchange rate reform. They and many other ministries need all the technical assistance and training that the international community can provide to help them build and strengthen their capacity and ensure that the reforms ultimately succeed.

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References:

Asian Development Bank. 2012. Asian Development Outlook: Part 3 – Economic trends and prospects in Myanmar. Retrieved www.adb.org/documents/books/ado/2012/ado2012.pdf.

Camen, U. 2006. Monetary Policy in Vietnam: the case of a transition country. BIS Papers, No. 31: 232–252.

Irvin, G. 1995. Vietnam: Assessing the achievements of Doi Moi. The Journal of Development Studies, 31(5): 725–731.

Nguyen, T. H. 1999. The Inflation of Vietnam in Transition. CAS Discussion Paper No. 22. Centre for International Management and Development Antwerp, Centre for ASEAN Studies.

Nguyen, T. P. and Nguyen, D. T. 2009. Exchange Rate Policy in Vietnam, 1985–2008. ASEAN Economic Bulletin, 26, 2: 137–63.

Soe, T. 2004. Myanmar in Economic Transition: Constraints and Related Issues Affecting the Agriculture Sector. Asian Journal of Agriculture and Development, 1, 2, 57–68.