GMSARN International Conference on Sustainable Development: Issues and Prospects for the GMS 12-14 Nov.

2008

The Prospect of GMS as a Common Currency Area

Chawin Leenabanchong and Chotima Pornsawang

Abstract— This paper examines the effect of a common currency on international trade in GMS area. By using Thailand
as a centre of cross-border trade with the GMS countries, we try to estimate the effect of exchange rate volatility on
Thailand’s bilateral cross-border trade. In the testing model, the bilateral cross-border trade is assumed to be a linear
function with exchange rate volatility, number of border crossing points and custom checkpoints, contiguity, among other
factors. The empirical result shows that exchange rate volatility depresses Thailand’s cross-border trade whereas the other
factors specified by Gravity model such as the advantage on sharing the same border line is found to have a positive
influence on bilateral trade between Thailand and GMS’s border trade.

Keywords— Exchange rate policy, trade creation effects.

natural resources, and a long history (Poncet, 2006).

INTRODUCTION
The 1997 Asian Currency Crisis has brought the idea
related to region financial cooperation in order to prevent
against future crisis. This idea is not new. Former
Malaysian Prime Minister Mahathir Mohammad went on
record as saying this region should ultimately thinking
about using its own currency. A common currency area as
a form of financial cooperation among ASEAN + 3
(China, Japan and Republic of Korea) was initiated since
ASEAN summit in Manila in November 1999 and
materialized at Chiang Mai as Chiang Mai Initiative was
introduced. As a matter of fact, East Asia is the only
remaining area without a regional financial cooperation
as in EU or NAFTA area.
This paper is concerned with the needs for monetary
and exchange rate policy cooperation and the prospects of
cooperation for the GMS economies. The progress in
financial cooperation such as Chiang Mai Initiative and
the Asian Bond Initiative, were preliminary and not cover
all of GMS economies needs. Some countries among
GMS have border trade as a main life line and sometimes
greater than international trade. Geographically, Thailand
shares the most border connections among these
countries, only Yunan and Vietnam with trans-border
trade. Therefore, as a matter of fact, the settlement of
these trades naturally have to do in local currency.
The Greater Mekong Sub-region (GMS) is composed
of six member countries: Thailand, Cambodia, Myanmar,
the Lao People’s Democratic Republic (Lao PDR), Viet
Nam and Yunnan Province of China. Since 1992, the
GMS cooperation supported by the Asian Development
Bank (ADB) aims at encouraging economic cooperation
in terms of trade, foreign direct investment and tourism,
linking countries that already share common border,
Chawin Leenabanchong is with Faculty of Economics, Thammasat
University, 2 Prachan Road, Bangkok 1020, Thailand. Email:
perrly_ja@hotmail.com.
Chotima Pornsawang is with Faculty of Economics, Prince of
Songkla University, Songkla, Thailand.
In this region, the GMS economies have expanded
rapidly over the past four years either in size of economy
or in degree of openness. According to the table 1, the
higher domestic demand as shown by GDP growth of all
four countries were all above 4 percent, ranging from 5.2
percent in Thailand to 11.1 percent in Cambodia, and
their international trade which measured as a percentage
of GDP were also exceeding 100 percent in 2007 (with
the exception of Lao PDR). Amongst six countries,
Thailand can be considered as a regional economic hub
with the largest and most developed market, and as the
center of transportation in the sub-region due to
geographic advantage and the developed transport
facilities.
As a regional economic hub, Thailand is a major
trading partner of neighboring countries. Although
Thailand’s relative share of intra-GMS regional trade is
small about 4% of its total trade with the rest of the
world, but bilateral trade share with some GMS members
is high. For example, share of bilateral trade with
Vietnam is approximately 42 percent and 35 percent with
Myanmar (table 2). Furthermore, bilateral intra-GMS
trading trend seems to increase due to more sub-regional
economic cooperation within GMS countries. According
to the composition of trade, the main Thailand’s export
products are machines and equipment, chemical product
and textiles and clothing. While its import commodities
are primary products; for example fuels, agricultural raw
material and food items.
As a center of sub-region transportation, Thailand is
the gateway to this sub-region because it shares common
border with most of GMS countries such as; Lao PDR
and Union of Myanmar to the north, Cambodia and the
Gulf of Thailand to the east and Union of Myanmar and
the Indian Ocean to the west (figure 1). Consequently, the
share border creates trade opportunities between people
on both sides of the border line. Bilateral cross-border
trade with Thailand accounted for nearly 50% of total
regional trade over 2004-2007 period and shown an
increasing trend among the GMS members (table 3).

1
 Source: Poncet, 2006
Fig. 1: Greater Mekong Sub-region

Table 1: Selected Economic Indicators for the GMS Countries, 2004-2007

Indicators Cambodia Laos Thailand Vietnam

Population growth (% per year) 1.9 2.1 0.8 1.3
GDP growth (% per year) 11.1 7.5 5.2 8.2
*
Openness Ratio
1998 62.9 69.2 86.9 76.7
2007 110.1 48.6 119.3 157.3
*
Notes: is measured by Trade in goods as a percent of GDP
Source: adapted from Key Indicators for Asia and the Pacific, ADB1 (2008)

Table 2: Share of bilateral trade between Thailand and GMS countries (%)

Country 2004 2005 2006 2007

Myanmar 36.3 35.2 36.1 32.3
Cambodia 10.6 10.4 10.8 11.9
Loa PDR 12.6 12.1 12.9 12.6
Vietnam 40.4 42.3 40.2 43.2
1/
Ratio (GMS’s trade/total trade) 3.1 3.5 4.0 4.0
1/
Notes: Ratio of total trade of Thailand with GMS countries to total trade of Thailand with the world.
Source: Department of Foreign Trade, Ministry of Commerce Thailand.

1
www.adb.org/statistics

2
 Table 3: Thailand's cross border trade value with the GMS Countries, 2004-2007
unit: Million baht
Country 2004
Myanmar 67,992.6
Cambodia 23,570.8
Loa PDR 29,130.1
Yunnan 4,720.1
Total Cross-Border Trade 125,413.5
**
Total GMS trade 230,100.5
Ratio (cross-border trade/ GMS's
54.5
trade) %
Notes: **Total trade-GMS excludes the People’s Republic of China
Source: Department of Foreign Trade, Ministry of Commerce Thailand.
Presently, Thailand has opened many international
crossing points along the border lines with its neighbors.
On the highway, there are for example; Mae Sai-
Tachilek, connecting Thai-Myanmar, Arayaprathet-
Poipet, connecting Thai-Cambodia and Mukdahan-
Savannakhet, connecting Thai-Lao PDR. On the
waterway along Mekong river, the border trade from
Yunnan takes place at Chiang Saen port, Thailand, as a
main port. However, the major obstacle on the border
trade is the payment systems. Transactions for cross
border payments appear to be done mainly in both baht
and GMS national currencies. Without an establishing
common currency area, you may expect high transaction
costs due to the volatility in exchange rate.
Against these backgrounds, the prospect of
establishing common currency in this area may be in
different conditions to ASEAN + 3. This paper aims to
capture the necessary conditions as suggested by the
OCA theory to evaluate the prospect of either US dollar
or Thai baht as a common currency in GMS area.
Therefore, this paper attempts to estimate the effect of
exchange rate volatility on Thailand’s cross-border trade
with its GMS trading partners using a gravity model. The
paper proceeds as follows. Section II reviews the
literature. We next present our data and methodology in
section III. Section IV conveys estimation results of the
effect of exchange rate volatility on trade. The final
section provides concluding remarks.
1. LITERATURE REVIEW
The earlier papers use only cross-section or time-
series data to examine the impact of exchange rate
volatility and trade. Recent works on this topic employ
the gravity model in explaining trade flows by using
panel data because it can be accounted for either fixed
effects or random effects. Moreover, many studies found
some significant evidence of a negative relationship
between exchange rate volatility and trade. We review the
relevant papers briefly as follows:
Dell’ Ariccia (1998) estimates the impact of exchange
rate volatility on the bilateral trade of 15 EU member
states plus Switzerland over the 20 years, from 1975 to
1994, using the gravity model. The result finds that
exchange rate volatility has a small but significant
2005 2006 2007
84,273.0 99,295.9 97,267.6
29,473.9 34,597.0 34,761.3
36,610.4 46,431.8 51,310.4
7,433.3 6,086.0 6,523.8
157,790.5 186,410.7 189,863.2
309,169.6 376,428.8 392,329.3
51.0 49.5 48.4
negative impact on trade; eliminating exchange rate
volatility to zero in 1994 would have increased trade by 3
to 4 percent.
Rose (2000) also employs the gravity approach and
uses a very large data set involving 186 countries for the
five years 1970, 1975, 1980, 1985 and 1990. The result
which is similar to the finding of Dell’ Ariccia shows that
a small but significant negative effect: reducing volatility
by one standard deviation (7 percent) around the mean (5
percent) would increase bilateral trade by about 13
percent. Likewise, the evidence’s Clark et al. (2004) find
a negative and significant impact of exchange rate
uncertainty on trade; variability of exchange rate;
approximately one standard deviation would depress
trade by 7 percent.
Baak (2004) investigates the impact of exchange rate
volatility on exports among 14 Asia Pacific countries.
The empirical tests using annual data for the period from
1980 to 2002 detect a significant negative impact of
exchange rate volatility on the volume of exports. Also,
the results show that the GDP’s importing country, the
depreciation of the exporting country’s currency value,
the use of the same language and the membership of
APEC have positive impacts on exports, while the
distance between trading countries have negative impacts.
Chit et al. (2008) use a panel comprising 25 years of
quarterly data and perform unit- root and co-integration
tests to verify the long-run exchange rate relationship
among the regression variables. The results provide
strong evidence that exchange rate volatility has a
negative impact on the exports of emerging East Asian
countries.
2. DATA AND METHODOLOGY
The scope of this study is limited to bilateral trade
flows of Thailand with 4 GMS countries, namely,
Cambodia, Myanmar, Lao PDR, and Yunnan. Vietnam is
excluded from the study owing to the unavailability of
cross-border trade data. We obtained the monthly cross-
border trade data, measured in millions of current Baht,
from Department of Foreign Trade, Ministry of
Commerce Thailand (www.dft.moc.go.th). The monthly
exchange rates were collected from
www.exchangerate.com.
3
The Gravity Model
The gravity model is applied to analyze the impact of
exchange rate volatility on trade using annual data from
2004 to 2008. The measure of volatility in exchange rate
is the same as employed by Rose (2000). However, the
dependent variable in equation is average value of
bilateral cross-border trade. The proposed gravity model
is shown below:
LnTradeijt = β 0 + β 1VOLijt + β 2 ln NBijt + β 3 Cont ijt
+ β 4 Lang ijt + β 5 FTAijt + β 6 ASEAN ijt + ε ijt (1)
The subscripts, i and j, stands for countries involved
in border trade, and the subscript, t, stands for time.
Tradeijt represents average value of bilateral cross-border
trade between country i (Thailand) and j (4 GMS
countries) at time t. VOLijt is the exchange rate volatility
that is defined as the standard deviation of the first-
difference of the monthly natural logarithm of the
bilateral nominal exchange rate at time t. For comparison,
we provide 2 different measures of exchange rate
volatility using national GMS currencies per Baht in
model 1 and national GMS currencies per US dollar in
model 2. NBijt is sum of crossing points and custom
checkpoints along the border line which are as follows:
one for Thai-Yunnan at Chiang Saen, 14 for Thai-
Myanmar, 15 for Thai-Cambodia and 36 for Thai-Lao
PDR crossing points and custom checkpoints.
Additionally, Contijt is the dummy for the share of
border line. If the two trading partner countries share a
border line, the value of this variable is one, and it is zero,
otherwise. Langijt is the dummy for the use of the same
language. FTAijt is the dummy for the use of the same
regional trade agreement. Finally, ASEANijt is the
dummy for the ASEAN membership. If both countries (i
and j) are members, the value of this variable is one, and
it is zero, otherwise.
Expected signs of the coefficients
Most empirical works treat exchange rate volatility as
a risk discouraging international trade. On the one hand,
higher risk means higher cost for risk-averse traders,
which leads to less international trade. On the other hand,
if changes in exchange rates become more unpredictable,
this generates more uncertainty about the profits to be
made, discouraging economic agents involved in
international trade (Baak, 2004). In this sense, the
exchange rate volatility coefficient (β1) is expected to be
negative.
In the gravity model, distance between the capital
cities of the two countries is a determinant factor, which
is used as a proxy to consider the impact of transport
costs and other transaction costs. However, this paper
concerns merely cross-border trade, so that the variable is
not suitable in this case. Hence, we choose NBijt as a
barrier to trade proxy. If there are many crossing points
and custom checkpoints, it helps less transport costs and
other transaction costs. So β2 is expected to be positive.
As the countries sharing a border line and using the
same language may have more trade opportunities.
Introducing, FTAijt and ASEANijt represent the trade-
boosting efforts among member countries; thus, FTA and
ASEAN membership may have a positive impact on
cross-border trade. Accordingly, coefficient of these
dummies (β3, β4, β5, β6) are expected to be positive.
3. ESTIMATION RESULTS
According to gravity model regression in table 4, the
results show that the estimated coefficient values for
exchange rate volatility and common border dummy have
expected signs and are significant. Whereas language,
FTA cooperation and ASEAN membership generate a
near singular matrix in the regression equation because
GMS countries use no common language. Moreover, all
these countries are members of the Association of South
East Asian Nations (ASEAN) as shown in table 5, then
dummies for language, FTA cooperation and ASEAN
membership are all excluded from estimation.
The results shown in table 4 are also robust across the
different measures of exchange rate uncertainty. In the
model 1, estimation of the coefficient on the exchange
rate volatility (β1) of national GMS currencies per Baht is
-5.87 and statistically significant at the 5% level. This
implies that exchange rate volatility depresses Thailand’s
bilateral cross-border trade in a huge volume.
Hypothetically, reducing exchange rate volatility by one
standard deviation around 5% from its mean, would
enhance the log of bilateral cross-border trade by (-
5.87)(-5) = 29.35 or [exp(29.35)]%.
Consistently, the coefficient on the exchange rate
volatility in the model 2, national GMS currencies per US
dollar, is -7.11 and statistically significant at the 5% level.
Indeed, increasing exchange rate volatility by one
standard deviation around 2% from its mean, would
decrease the log of bilateral cross-border trade by (-
7.11)(2) = -14.22 or [exp(14.22)]% with small relatively
difference in adjusted R2 between model 1 and model 2.
Likewise, two countries sharing the same border line
will be shorter and lower in distance and transport cost.
Hence, they are expected to trade more products. The
significant coefficient for contiguity variable is of 2.1 in
both models. This implies that, other things being equal,
bilateral cross-border trade between Thailand and GMS
members are 8.16 times greater than the normal level
[exp(2.1)] predicted by the gravity model.
4. CONCLUSIONS
In this paper we tested the relationship between
exchange rate volatility and cross-border trade among
Thailand with GMS countries. Applying the gravity
model, the result shows that the contiguity variable has a
statistically positive significant effect on the bilateral
trade volume. Similarly, we found evidence of a strongly
significant negative effect of exchange rate volatility on
trade, according to the reviewed empirical studies.
In addition, we suggest the policy implications from
the study. First, improvement in infrastructure promotes
successful trade flows and tourisms within membership
owing to the advantage of sharing common border.
Second, greater stability in the exchange system would
help boost potential to trade for GMS countries.
According to this study, suggest that cross-border trade
volume between Thailand and four GSM members may
be considerably increasing, if reducing exchange rate
uncertainty. Finally, reducing border-trade obstacles such
as increasing border crossing or improving custom
checkpoints processes which is now complex and opaque,
regardless of statistical significance.
4
 Table 4: Gravity Model Estimation Results

Variable Pooled Panel Regression

Model 1 Model 2
Exchange rate volatility (VOLijt) -5.8707 -7.1141
*
(2.9030) (2.7758)*
Contiguity (Contij) 2.1057 2.1057
**
(0.0627) (0.0674)**
Constant 6.1963 6.1963
**
(0.0451) (0.0518)**
Number of observations 220 220
Adjusted R2 0.7625 0.7584
Notes: All variables marked ** are significant at 1% level and these marked * are significant at 5% level,
respectively. The figures in parentheses are standard errors.

Table 5: GMS’s membership and Free Trade Agreement

ASEAN member WTO/APEC

Country FTA/RTA concluded
(associated year) member
Cambodia Yes (1999) Yes / No ASEAN Free Trade Agreement (AFTA)
Lao PDR Yes (1997) No / No ASEAN Free Trade Agreement (AFTA)
Myanmar Yes (1997) Yes / No ASEAN Free Trade Agreement (AFTA)
Thailand Yes (1967) Yes / Yes ASEAN Free Trade Agreement (AFTA)
Australia
New Zealand
Bahrain
China (Preferential Trade Agreement on Agriculture)
India
Japan
Vietnam Yes (1995) No / Yes ASEAN Free Trade Agreement (AFTA)
Notes: RTA refers regional Trade Agreement.
Source: www.aseansec.org.

Fluctuations and Trade Flows: Evidence from the

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Rate