Financial markets

Financial markets help corporation and governmental units to raise capital through the mobilization of public and private saving, in channeling those savings into productive and technological investments, and in showing the potential earning capacity of corporations.

Chapter 1 Introduction

1.1 Background

Financial markets help corporation and governmental units to raise capital through the mobilization of public and private saving, in channeling those savings into productive and technological investments, and in showing the potential earning capacity of corporations

Financial markets are categorized in different ways, one of them is based on the maturity of financial claim traded Under this way, financial markets encompass two components: capital market and money market These markets cater to the financial requirements of the real sectors of the economy The money market trades short-term debt instruments with maturity of one year or less The capital markets, are those for longer-term debt instruments and stocks A capital market can further be classified into non-securities and securities markets The non-securities market provides non-negotiable medium and long-term debt through the involvement of development financial institutions (DFIs), banks, and contractual savings institutions that mobilize savings, later lending them directly to the users of these funds The securities market provides medium and long-term equity and debt in negotiable from that are issued by government, companies, and corporations

The non-securities market in most developing countries, generally, is developed and well-organized However, the securities market has lagged behind and developed rather late, even though in some developing countries, like Vietnam, it has not existed yet Thus, this research study, therefore, emphasize on external and internal factors that influence establishing capital market, especially securities market in Vietnam

1.2 Rationale

Vietnam, now, needs huge capital from different resources for its industrialization and modernization stage Besides, business environment in Vietnam has, recently, been changing fast Along with opening the economy to the world, international relationship has improved Government’s policies and regulations related to business operations also are being improved

to facilitate doing business of enterprises and attract foreign investment As result, many private companies and foreign companies in form of Joint-venture or full foreign owned enterprises have been set up in Vietnam But now, Vietnam has encountered difficulties that how to raise capital for its industrializing and modernizing in generally, for expanding business operation of investment of domestic and foreign investors, especially Due to the lack of development of a capital market is probably the most serious obstacle to a continued marketlization of Vietnamese economy Vietnam’s present financial system is poorly equipped

to meet these challenges It is almost entirely credit-based, with the state banks playing the major role The post-1989 Vietnamese market economy has shown, like others, that resources are created by the process of expansion of markets and rise in business confidence Also, the drastic increase in mobilization issues may partly reflect the erosion of social safety nets that has taken place in recent years Therefore, with a view to attract foreign investors and

mobilize saving efficiently, the government of Vietnam has taken few bold steps in making law relating to establishment of capital market in coming years.

1.3 Objectives

Securities market is quite a new issue in Vietnamese business environment For Vietnamese businessmen, they still have not an insight into the market mechanism In order to provide them an overview of this market, the main objectives of the study is to explore legal issues, legislative framework and analyze advantages and disadvantages in carrying out securities market Several specific objectives are as follows:

• Assess the fundamental concepts, terminology about stock markets and investment as they relate to Vietnam;

• To determine the well known of the market and the constraints to development;

• To determine the impact of the banks’ role in the embryonic stage of sock market;

• To determine from potential investors and listed companies what they expect;

• To determine the organizational structure of this market;

• To look into the future prospects of the markets and give recommendations

1.4 Scope of the study

This study is focused on analysis of obstacles that result from capital market which has not been established yet It also analyzes opportunities and advantages in establishing and operating of this market The study will concentrate on following areas:

• Investment entities and participants in the market;

• The regulatory and institutional framework;

• The role of the stock market and the condition necessary for business operations in Vietnam;

• The role of banks in embryonic stage;

• Introduce the fundamental structure and the stages of the securities market development

1.5 Research methodology

1.5.1 Information requirement

In order to conduct the research, the following information are needed:

• Socio-economic conditions analysis of investments, savings, and income

• Infrastructure in terms of banking system and information system

• Laws and regulations to guide participants in the market

• Changing financial system

• Policies that encourage foreign investors in the market

• Major players identification

• Investors’ attitude toward the market

• The instruments which will be traded in the initial period.

• Organizations which can help to establish stock market in term of equipment, training, an insight market mechanism

• The companies which have privatized and issued shares within corporation

• The organizational structure of the market

1.5.2 Collection of data

* Secondary data

General information were collected from published materials These materials were obtained from various sources such as Statistical Bureau of Vietnam, State Bank of Vietnam and Ministry of Finance Apart from the mentioned sources, secondary data were collected from published information in both Vietnamese and English which were taken from Libraries, State Departments and Research Institutions

* Primary data

Along with the secondary data, primary resources are also required To obtain the primary data, interviews, and surveys were conducted Guidelines were designed for conducting interviews with managers and officials working in the State Bank of Vietnam, Ministry of Finance

Besides, four State-owned Commercial Banks, nine banks (including foreign banks and branches of foreign banks), ten Jointstock Banks, forty investors (in which twenty domestic investors and twenty foreign investors) were selected for purpose of the research Interviews and discussions with the managers in selected interviewees were conducted to get their opinions on the securities market

Internal factors in Securities Market

Conclusions and Recommendations

Figure 1.1: Research Framework

Chapter 2 Literature Review

2.1 Definitions

2.1.1 Capital markets

There are various definitions on capital markets According to Kidwell [1984], financial markets can be classified on the basis of maturity of the financial claims that are traded Therefore, in this context, money markets trade in short-term debt instruments having maturity

of one year or less Capital markets, on the other hand, describes the market that deals with any long-term debt instrument or equity obligations having maturity greater than one year

Kitchen [1986] has used the term “capital market” to include both securities market and the money market According to him securities market is the market dealing with government bonds and debt and equity issued by corporations Another researcher, Robbins, makes no distinction between the securities and non-securities market and from the understanding of his definition, capital market is the securities market

M.B.Abbasi [1994] define capital market is as a set of institutions, processes and individuals which facilitate the flow of society’s saving into productive investments

Wijewardene [1993] also divides financial markets into the money market and the capital market The former deals with maturity of one year or less, while the later consists of transactions with maturity of more than one year In the capital market, he detailedly divides into medium- and long-term, transactions with maturity between one and five years are medium term, while those with maturity of more than five years fall into long-term The capital market can therefore be divided into submarkets:

• Loan market or the no-securities market, where the money is made available to the users

in the form of loan from financial intermediaries without creating a tradable security in the process

• Securities market, where money is acquired by the users by selling debt or equity instruments to savers which may be tradable or non-tradable in the market

According to view of Asian Development Bank (ADB), capital market as typically defined include the portion of the financial system that provide medium- and long-term funds for creating fixed assets (such as plant and machinery) used in the production of other goods

In contrast, money markets provides short-term finance generally for working capital needs on

a loan basis for period of less than one year Thus, money markets provide shot-term funds for meeting fluctuating needs and must be paid relatively quick, and capital markets provide long-term funds which can be used to make “capital investments”

For the purpose of this research study, the definition given by the ADB will be used is clear and precise

2.1.2 Efficient capital market

The purpose of capital market is to transfer funds between lenders (savers) and borrowers (producers) efficiently In an efficient capital market, prices fully and instantaneously reflect all available relevant information This means that when assets are traded, prices are accurate signals for capital allocation.

Drake, P.S [1977] has done a great deal to operationalize the notion of capital market efficiency He defines three types of efficiency, each of which is based on a different notion of exactly what type of information is understood to be relevant in the phrase “all prices fully reflect all relevant information”

1 Weak-form efficiency: no investor can earn excess returns by developing trading rules based on historical price or return information In other words, the information in past prices or returns is not useful or relevant in achieving excess returns

2 Semistrong-form efficiency: no investor can earn returns form trading rules based on any publicly available information

3 Strong-form efficiency: no investor can earn returns using any information whether publicly available or not

Allen, M [1991] has extended the definition of market efficiency The market is said to

be efficient with regard to an information event if the information causes no portfolio changes The definition requires not only that there be no price change but also that there be no transactions

2.2 Structure capital market

According to ADB, the capital market consists of two segments: the non-securities markets and the securities market The non-securities markets provide non-negotiable medium- and long-term debt funds through financial institutions such as development finance institutions, commercial banks, and contractual savings institutions which mobilize savings and then lend these mobilized funds directly to business, industry, and users of funds Securities markets provide medium- and long-term equity and debt funds in negotiable form which are issued by corporations and governments, or through financial institutions such as investment or merchant banks and venture capital firms, directly to individual and institutional investors are then traded among different holders Thus , investors in the securities markets can sell their securities whenever they need funds, through equities they can participate in the financial risk of the enterprise

Table 2.1: Organization of capital market [1]

Non-securities markets Securities marketsInstruments Loans

MortgagesLeasesSales and lease-back

Equity (shares and stocks)Equity equivalents (convertible bonds or debentures)

Debt securities (bonds or debentures)Primary market Secondary marketInstitutions Development banks

Specialized banksCommercial banksSaving banksInsurance companiesPension and employeeProvident funds

Leasing companies

Corporate government issuersInvestment, merchant banks

Brokers, dealersSecurities regulatory bodies

Debenture trusteesVenture capital firms

Over the counter marketsStock exchanges

Brokers, dealersClearance and settlement agencies

Transfer agents and mutual funds

Generally, the institutions and individuals that constitute the capital market may be divided into two categories:

1 Participants: who are the ultimate savers and users of capital, as well as the financial institutions and intermediaries that channel capital from savers to users

2 Supporting and supervisory entities: Which are typically government bodies that facilities and regulate the activities of the participants

The main features of capital market are three fold:

• Collection and provision of capital for real investment, i.e to fulfill the investment needs of the company

• Provide an opportunities to gain higher return through financial investment for investors, i.e provide a medium of investment

• Provide higher liquidity, i.e readily encashable and transactable investment instruments for investors in the market

2.3 Significance of capital market

2.3.1 Economic development and capital market

* Demand-following approach: The role of financial markets, largely comprising of

the capital market, in economic development has been an area of increasing interest for development economics This sector was initially through of as playing more or less a passive role in economic development - “where enterprise leads finance follows” The view that growth in the financial sector is an outcome of the development in the real sector has been explained that this approach places emphasis the demand side for financial services; as the economy grows it generates additional and new demands for these services, which bring about a supply response in the growth of the financial system In this view, the lack of financial

institutions in undeveloped countries is simply an indication of the lack of demand for their services.

The more rapid the growth rate of real national income, the greater will be the demand

by enterprises for external funds and therefore financial intermediation, since under most circumstances firms will be less able to finance expansion from internally generated depreciation allowances and retained profits The financial system can thus support and sustain the leading sectors in the process of growth

The nature of the pace of growth of financial sector depends on factors such as growth rate real output and the commercialization and monetization of agriculture and other subsistence sectors The demand-following-supply response of the growing financial system is presumed to come about more or less automatically i.e the supply of entrepreneurs is highly elastic and no constraint on the provision of favorable legal, institutional and economic environment is envisaged

* Supply-leading approach: This approach suggests the creation of financial

institutions and the supply of their assets, liabilities and other financial services in advance of the demand for them, especially the demand of entrepreneurs in the modern growth - inducing sectors The supply-leading strategy has to simultaneously deal with the issue of transferring resources from traditional sectors to modern sectors, and to promote and stimulate an entrepreneurial response in these modern sectors This strategy is considered to be most

suited to the countries where entrepreneuship is a major constraint on development In the

process the top management of the financial institutions may ply the role of entrepreneurs in industrial enterprises

The supply-leading strategy is more effective during the initial phases of development and induces growth in the real sector by financial means The more backward the economy relative to others, the greater the emphasis on the strategy of supply-leading finance The use

of this strategy, however, should ensure that the use of resources, especially entrepreneurial talents and managerial skills, and the costs of implicit or explicit subsidies should produce sufficient benefits in the form of stimulating real economic development for this approach to be justified

Irrespective of which of the two strategies is practiced, the thrust of recent times is focus on financial liberalization and encouragement of efficient markets through financial deepening and elimination of fragmentation of markets to improve the process of mobilization

of financial savings as well as the efficiency of investment This would help eliminate the conditions of what M.B Abbasi [1994] calls “financial repression” resulting from credit rationing, subsidized credit and other factors responsible for distortions in the financial markets

2.3.2 Mobilization of savings

Mobilization of domestic savings - private and public is one of the three essential steps involved in the process of capital formation; the two other steps being the channeling of savings through a finance and credit mechanism and the act of investment itself In Vietnam, the level of domestic savings is still low Sustained high growth rates will be critically dependent on a significant increase in the level of domestic savings, both from the public and the private sector The savings rate is projected to increase from 17.0 to over 20.0 percent of GDP during the projection period

The government is expected to contribute significantly to this increase with its own savings; its efforts have already produced encouraging results in 1994 The scope for further increase in public savings through increase in revenues may be limited in the future since the share of revenue in GDP is already large Further public savings will need to come from expenditure restraints which can only be implemented through careful setting of priorities in public spending.

Progress in the mobilization of savings will however depend on the maintenance of a stable macroeconomic environment and the development of an appropriate incentive regime for investment - including the strengthening of the legal framework, the financial system, and the framework for the trade and investment

2.3.3 Determinants of savings

* Financial repression: One of the major impediments to saving in developing

countries, according to M.B Abbasi [1994], is the persistence of financial repression in these economies The intensity of financial repression in an economy is measured by the existence

of negative real rates of interest The role of various factors leading to financial repression can

be judged from their contribution to widening the gap between real and normal interest rates while interacting with ongoing inflation The factors that contribute to financial repression include taxation, usual restrictions on interest rates, heavy reserve requirements on bank deposits, compulsory credit allocations etc as they reduce the attractiveness of investment in financial assets and holding claims on the domestic banking system

* Income: Income, occupies the central place in determination of savings in the

economy The amount of savings is determined by the absolute level of income as well as the proportions of income saved out of each additional unit of income i.e., the marginal propensity

to save (MPS) The MPS should, according to the theory, increase with the increase in income over time and across various income sections in the economy

* Interest rates: The rates of interest is a major determinant of the demand of money

whereas the saving rate is only indirectly affected A rise in the rate of interest reduces the level of investment which result in the fall of the level of income and hence savings in the economy This indirect interaction implies a negative relationship between these two variables

* Taxation: Most studies of the effects of taxation on saving show that government

savings increase with increased revenue taxation However, several other studies [Please, S., 1970] indicate that the increase in government savings is more than offset by a decrease in the rate of private saving, while studies by Landan L.[1980] found the reserve to be the case

* Foreign aid: Studies conducted on the impact of foreign aid on savings have found

that foreign capital is a substitute for domestic savings In other words, an increase in foreign aid usually result in a decline in domestic savings or more accurately a part of the capital inflow finances increased consumption

* Export: Several studies have shown a positive relationship between savings and

exports However, it is not clear whether this implies that the export sector has a higher propensity to save than other sectors, or if it is the growth engendered by exports which is responsible for the higher savings rates

2.3.4 The role of financial intermediaries

Financial intermediaries are defined as the “economic units whose principal function is managing financial assets of other economic units - business concerns and individuals Thus they bring savers and borrowers together by selling securities to savers from money and lending that money to borrowers” [Benton E Gup, 1976].

UNIDO [21], has stressed the essential role that financial institutions have to play as intermediaries and promoters of industrialization process The following statements support this claim

• Financial institutions in less developed countries have to play an important role in the process of economic development and they should be properly organized and oriented towards the specific objectives they are expected to fulfill [Zolates, Xenophan, 1963]

• In order to ensure efficient and rational mobilization of savings and channeling of these funds for the financing of the investment programs consistent with the development objectives, financial institutions play a very important role, because they act as intermediaries between surplus and deficit sectors in the country [Kivanc, Tarik, 1984]

• Economic development of any country depend on the contribution to growth of the financial sector [World Bank, 1985]

Edwards [1987], has listed characteristics of successful economies and all successful cases of economic resurgence which highlight the importance of finance and financial institutions in industrial investment They are:

1) Political acceptance of the importance of industry in the national economy;

2) The political will to act to create favorable financial circumstances and appropriate

institutions to help industry flourish;

3) An organization which acts as a financial ombudsman which, from a deep knowledge of

the circumstances of a particular industrial situation, can approve a company’s investment plans (and frequently improving them in the process);

4) A financial system committed to the national success of its manufacturing industries;

5) Relatively cheap long-term loans for industry from the financial system;

6) The absence of any nonsensical theories about the ‘proper relation’ of debt to equity; and7) A co-operative and practical approach by government, industry and banks to solve the

national economic problem

It is widely recognized that during prosperous economic times there is always a rapid increase in overall indebtedness, and during economic recessions there is always a slowdown

in the rate of growth of outstanding debt The implication for financial intermediation is that the greater the amount of spending financed externally through debt on equity issues, the greater will be the role played by financial institutions The term of financial institutions can be applied

as the central bank (State bank of Vietnam), commercial banks, investment and development banks, finance companies, insurance corporation

2.4 What is the securities market

2.4.1 Concept of securities market

The concept of a securities market arises from three distinguishing principles One is the type of funds attracted to it Funds moving through the securities market may include risk averters, but the unique characteristic of this market is that it draws from investors who are risk assumers and are therefore willing to provide capital to new growing ventures where the chances of loss are marked by equal or greater opportunities for eventual gain The second principle of securities market is that the mechanism for moving its money flows involves specialized institutions such as stock exchanges and securities dealers that have their own procedures, technique of control and applicable legislation The third principle refers to the instruments used which are securities including stocks and bonds not ordinarily available in other markets The development of any capital market must give consideration to these three aspects Since its growth depends on the incentive embodied in the potential gains available

to risk assuming investors, uncertainty is an essential characteristic of the securities market [Robbins, 1985]

2.4.2 Functions of securities market

As securities market has two closely interrelated parts: a new issue market where corporations sell securities for the first time to the public which is termed as the primary market and the secondary market or trading market where the securities, after they have been initially issued, may be bought and sold among investors each of these segments plays a part

in the overall contribution that the capital markets to a nation’s economy [Robbins, 1985]

The establishment of an efficient trading market is an essential precondition for a thriving new issue market and any factor real or artificial, which tends to reduce the marketability of securities or the investors confidence in the price making mechanism, adversely affects the new issue market This degree of efficiency, both of the trading and the new issue market has a direct influence on the economic climate and potential of the country

By providing a secondary market in securities the stock exchange not only epitomizes the free enterprise system but acts a prerequisite for its survival and operation

The primary market implies the very beginning stage of the securities market where securities are issued by the issuers and sold to the investors and then the money flows to the issuers from investors (buyers of the securities) This market characterized by the followings:

1 Secutalization process of the needed capital;

2 Process of the direct finance transforming money into the long-term capital

The secondary market can be referred to as all types of markets where existing securities are being traded between investors The features of this market are as follows:

1 To get holding securities cashed;

2 Fair price determination of securities, free auction (perfect competition)

3 The fair price in the secondary market affects the issuing price in the primary market, two markets are interdependent

Securities Securities

Primary market Secondary market

Figure 2.1: Structure of the securities market [2]

An important aspect of the primary and secondary market is that they expose a company seeking funds to the test of outside judgment, which is particularly important in developing countries to ensure that the funds more along economic channels Without capital markets, ventures are ineligible for bank funds cannot be launched or must obtain their financing from private sources Therefore, due to bank bias a venture which has merit is killed and economy suffers If the reserve takes place where a potentially more useful outlets, and economy suffers In many developed capital markets, the judgment of investors, reflected in the pricing mechanism of the market, has provided an effective means of discriminating the values of different enterprises and of assessing their future worth to the national economy

In addition to the financing, allocating and testing role, the securities market serve other purposes Once functioning properly, they are a significant source of savings, through institutions such as mutual funds: this function has increased prominence due to inflationary tendencies where individuals have being able to protect the capital value of at least a portion

of savings from being eroded by rising price levels From the company’s point of view, the market enables equity financing thereby reducing the risk of overly extended borrowing and permitting the company’s to attain a better balanced capital structure between bonds and stocks Finally, by creating a objective basis for establishing prices, the securities market facilitates the determination of valuation for taxation and mergers [Robbins, 1985]

2.4.3 Advantages of securities market

◊ A stock market enables companies to raise fresh capital both initially, by going public (primary issues) and subsequently through secondary issues (rights or placements of stocks) thus a stock exchange can provide additional capital for companies Therefore, company expansion takes place more readily

◊ A stock market provides governments with an alternative means of selling bonds and raising capital The virtue of this depends on the ability of the government to use the funds efficiently for the national economy

◊ A stock market provides savers and financial institutions with a further outlet for their funds Investment in equities (and government stock unless held to maturity)is of course investment in risky instruments However investors have different risk taking capacities and like to be offered a range of risks and a corresponding range of expected return A stock market enables investors to select a portfolio which gives a risk return combination according to their liking It enables them to diversify their investment and reduce risk A stock market by offering various returns, may be important to investors whose only alternative is to place deposits and receive low repressed rates of interest It can therefore encourage savings and mobilization of funds If the secondary market is active investors have a market which is more liquid

◊ A stock market provides a hierarchy of rates of return (and therefore of cost of capital) between equities, corporate bonds and government stocks Therefore firms and

government rising new capital have to pay a rate of return which reflects both of rate of return and alternative investors and risk associated with the undertaking Therefore allocation of capital is improved exante This is important in capital markets which otherwise repressed and when the cost of borrowing is not related either to the demand for capital or risk of the investment.

◊ The stock market provides a vehicle for government corporations to go to public especially with the privatization program worldwide

◊ Stock market can bring foreign capital into a country from foreign portfolio investors wishing to diversify internationally

2.4.4 Disadvantages of securities market

The criticisms of stock markets are essentially the following:

◊ The encourage unequal distribution of wealth, by enabling those who are wealthy to invest with a view to increasing their wealth, without working for it

◊ Stock markets can encourage rash speculation both by individuals and institutions when followed by collapse can lead to the ruin of both with consequent destabilizing effects on the national economy Wall street in late 1920’s, Hongkong in 1973

◊ Stock markets can provide an opportunity for dishonest activity, such as conflict of interest, market rigging insider dealing, issuing false or misleading prospectus, pushing and selling overpriced or worthless stock

◊ Although stock markets may allocate funds to the activities which are expected to show the greatest financial profit, may not be the most profitable from a national point of view because markets and prices are seriously distorted in many developing countries

2.4.5 The supply of securities

Investors need a reasonable choice of both government securities and company so that they can set up the type of portfolio they wish, and change it readily This implies that there must be a reasonable number of fairly large companies willing to make their shares available to the public (Kitchen 1986)

Supply of securities could come from the state enterprises when they want to raise

debt by issues of bond s or debentures, also another source of supply is from the

privatization of state enterprises, where enterprises capital is raised by a public issue in the primary securities market Other sources of supply are the formation of new companies, increases of capital of companies already public, private companies going public and also in some instances joint ventures and wholly owned subsidiaries and companies

approved by Board of Investment in different countries (Robbins)

However, it must be stressed that in developing countries family owned companies may be reluctant to dilute ownership and control Also some private companies have found ample opportunity for tax evasion which may not be available if they go to public One way of inducing private companies to go to public is for the broad of investment to offer additional benefits such as tax reduction etc for quoted companies

2.4.6 The demand for securities

The demand for shares depends on savings A well functioning market requires a mix

of long term investors such as Insurance Companies, Pension funds, Investment trusts, Unit trusts, dealers and short term investors (often individuals) which keep the market fluid There must therefore be substantial number of institutions which hold the savings of individuals and individual investors [Kitchen 1986] This in turn implies a reasonably widespread distribution of wealth and income within a country, and a sizable middle class Countries which have highly skewed income and wealth distributions are unlikely to have the right mix of investors to keep the market active and fluid The success of the Malaysian and Singaporean stock exchanges may be attribute partly to the large number of middle and lower middle class shareholders [Darke 1977]

In addition to having and adequate level and distribution of wealth a country must possess individuals willing to buy share Investors need to be made aware of the stock exchanges, of possible risks as well as of possible returns This requires active, but responsible, promotion on the part of the stock exchange authorities, investment trusts and unit trusts and shareholders’ representative bodies

At the same financial institutions need to be willing and able to buy shares As Darke (1977) has pointed out, institutions may need to be persuaded of the desirability of equity investments; they may need to be freed from requirements to invest very heavily or even entirely in government stocks

The most important factor determining the willingness to buy and hold securities is the elusive “investor confidence” Investors need have confidence in the macroeconomics

performance of the economy (Market risk) Doubtful growth prospects and fears of inflation

are bad for stock markets, which perform badly under either worry Investors need also to

have confidence in the firm whose shares they buy (specific risk) They need confidence in

the firm’s products and markets, its management and in its in integrity in disclosing information Finally they need to have confidence in the operation of the stock market and of its members Malpractice deter investor They also need confidence in the accounting standards required of the firm and in the auditing of the accountancy profession [Kitchen 1986]

Hopefully a direct interest in stocks would also be created by offering tax inducements through the treatment of capital gains and dividend income [Robbins, 1985]

2.5 The instruments in the securities market

The generic term of for a wide variety of stocks and shares and bonds offered by developed stock markets today is “securities” They present what is known as capital of the company However when looking at the types of stocks and shares offered, it is usual to divide the market into two: the bond market and equity market and other forms of a company’s risk capital (Allen 1991)

2.5.1 Stocks

Common stocks:

Stocks could also be termed the equity They represent the true risk of the company They can be referred to as ordinary or common stocks they are the true owners of the company and they are entitled to the company profits once the fixed interest stocks are paid These are called earnings When a company is doing well it will raise the earnings or dividends to the ordinary shareholders get what is left after all debts are paid Like all other shares they have a par value, but in their case it is market value that counts and is quoted every day on stock exchange

Preference stocks:

Preference stocks are part of the true share capital of the company, but are a special category, which carries less risk than equities They carry a fixed annual dividend and follow after debentures and loan stock in a share out of the company’s assets Dividends may not fluctuate with company profits, though is a company badly they may not be paid Preference shares may be cumulative in that interest not paid in a particular year has to be paid in subsequent years If interest rates rise sharply the price of preference stock could rise sharply, so timing is important for anyone buying this stock In some markets preference stocks may be convertible into common stocks (Allens 1991)

2.5.2 The bond market

When you buy bonds you own a debt and become a creditor because you have loaned money to the company or government Individuals lend money to institutions, governments, agencies, corporations etc in exchange for bonds issued by the institutions as proof of the loan agreement, plus regular interest payments Interest payments are usually fixed Bonds may seems less glamorous than stocks because for years their prices fluctuated less dramatically And unlike dividends, the interest payments, don not increase when a company

is profiting Perceptions may change and recently bond prices have fluctuated as much if not more than stock prices

As in stock trading there is an active group of investors looking to buy previously issued bonds The market for these bonds, where their selling prices fluctuate, is called secondary market Mostly, already issued bonds are traded over the counter Dealers of bonds across the country are connected via electronic display terminals that give them the latest information in bond prices A broker buying a bond consults a terminal to find out which dealer is currently offering the best price, then calls that dealer to negotiate Changes in interest rates affect the price of a bond Issuers of bonds offer to pay investors a rate of interest which is competitive with other bond rates at the time This rate is similar to other rates as the prime rates, mortgage and personal loan rates After a bond issued, however interest rates in the economy may change - making the rate of the issued bond more or less attractive to investors If the bond is paying more interest than elsewhere investors will be willing to pay more to own it If the bond is paying less, the reserve is true In general the interest rate and the bond price fluctuate like two sides of a see saw When interest rates drop, the value of existing bonds usually goes up since the prevailing rate on the bond is higher than the prevailing interest rates When the interest rate goes up the value of bonds comes down since the return on the bond is less attractive than the prevailing rate The term

yield describes what you will earn from a bond Investors determine bond values largely by comparing yield The yield is the interest divided by the price of the bond.

Chapter 3 External factors influencing the establishment of securities market

3.1 Review of macroeconomic performance

As Vietnam’s leaders turn their attention to the next Five-Year plan for 1996-2000, they

do so with a fast growing economy and a good track record of macroeconomic management During the past five years, the economy has grown at an average of eight percent per year, inflation has been reduced to single digit levels, and the exchange rate is stable Rapid growth

as also resulted in the recent widening of the trade and current account deficits, which need to

be controlled in order to ensure that growth is sustainable The most remarkable achievement

of this period has been the steady rise of savings This increase in savings, combined with large inflows of foreign direct investment (FDI) and disbursements of official development assistance (ODA), as fueled a significant increase in investment, which in turn has provided the primary impetus to economic growth These impressive results have been achieved through a combination of stabilization, liberalization and structural reform, including a progressive integration of Vietnam into the world economy Price, trade and business liberalization resulted in foreign trade advancing at double-digit rates and a steady increase in the number of exported goods as well as trading partners

This strong macroeconomic performance has been achieved in spite of limited policy instruments and many remaining structural weaknesses Budgetary management still relies

on crude expenditure classification and accounting which complicates expenditure management Similarly, monetary policy is conducted with direct instruments bank by bank credit ceilings, maximum lending rates and ceilings on spreads between lending and deposit rates which discourage intermediation and competition Finally, institutional weaknesses ranging from the legal framework to the payments system limit the ability of policy makers to influence the behavior of markets Therefore, sustaining recent economic achievements will not be easy

GDP growth: In 1996, the economic is expected to grow at 9.0-9.5 percent This

growth rate mirrors the economic performance in 1995 when GDP growth reached an estimated 9.5 percent, the highest recorded since the adjustment and reform program accelerated in 1989 (see Table 4.1) All sectors grew rapidly in 1995 Growth in agriculture at 4.7 percent, was impressive, given that yields for most products are already high and that limited expansion of cultivated areas could take place Industry continued to grow at a double-digit rate (13.9 percent in 1995) for the fourth consecutive year, with export-oriented consumer goods and light industries showing the most rapid growth The services sector also grew rapidly, led by banking, finance, and retail trade, where the private sector now accounts for three quarters of total sales

Table 3.1: Macroeconomic indicators during period 1991-1996 [18]

-Inflation: Despite its reform, the monetary system has failed to catch up with the

development of the national economy Over past five years, inflation rate was controlled and fallen In the first half of the year 1996 the inflation rate was not high Prices of consumer goods and services rose by 3.3 percent and 4.6 percent compared with December and June last year, respectively That was the lowest rate of increase in comparing with the period since 1991

Investment and savings: On expenditure side, growth continues to be driven by

investment, confirming that Vietnam has the potential to embark on the same high investment, high growth path as its East Asian neighbors In 1995 investment grew by 22 percent, reaching an estimated for 5.7 percent of GDP (25.5 percent in 1994, see Table 4.2) Government investment accounted for 5.7 percent of GDP, while investment by private and state-owned enterprises amounted to 21.4 percent of GDP The large increase in investment was fueled by USD$ 1.8 billion in FDI inflows, as foreign investors accelerated the pace of implementation of earlier commitments In fact, FDI financed nearly 25 percent of total investment in 1995, compared to 16 percent in 1994 Substantial inflows are continuing in

1996, as inflows for the first quarter were estimated at $400 million by the State Bank of Vietnam (SBVN), compared with $300 million for the same period in 1995

Table 3.2: Savings and investment, 1991-1995 (percent of GDP) [27]

as private savings have remained at about 12 percent of GDP since 1991 (except for 1993) Sustaining high growth in the future will require a steady increase in private savings, as further

improvements in Government savings will be difficult in the near term Higher private savings will require a stable macroeconomic climate, as improved financial system and further structural reforms.

Foreign investment has provided the primary impetus to growth and has drastically increased since 1990 In total, foreign direct investment approvals are estimated at more than USD$ 20 billion by September 1996 (excluding USD$ 1.7 billion of canceled projects)

Table 3.3: Foreign direct investment (million USD$) [18]

of a modern central bank

Two additional State-owned Commercial Banks (SOCBs) were created: the Industrial and Commercial Bank (Incombank), from the Industrial and Commercial loan Department of the SBVN, and Vietnam Bank for Agriculture (Agribank), from the agricultural credit department With enabling legislation to include those of shareholding (Jointstock) banks, Joint-Venture banks, branches/offices of foreign banks, and credit cooperatives, and some housing banks

In early 1994 regulations were introduced for establishing savings and loans institutions known as Popular Credit (or People’s) funds By the end 1994, in addition to the four SOCBs, there were in operation 36 Shareholding Banks (30 in urban areas), 69 Credit Cooperatives, 3 Joint-venture Banks, 9 Foreign Banks (and 32 Foreign Bank Representative Offices), and about 153 Popular Credit Funds There were also two Finance Companies, and one Government Insurance Company [Vietnam Financial Sector Review, 1995]

With fast growing number of banks, its operation is also expanding and diversifying step by step These include credit service, discount valued paper, leasing credit, buying shares, services of collateral, bidding for Treasury bill and sell of goods on installment Loan structure has changed positively The proportion of medium- and long-term loan and loan to private-economic sector are still low but trend is upwards

State economic sector loan Private economic sector loan

Figure 3.1: The proportion of loan between State- and private-economic sector [27]

Short te rm loan Medium term loan Long term loan

Figure 3.2: The changes in loan proportion [27]

However, at present operations of the banks and financial companies have many shortcomings This affects on establishment and development of financial market in general and securities market in particular

Based on selected banks which were interviewed, some findings are below:

First, the average capital of each bank is quite low The State-owned banks with rather large capital of VND 1000-3000 billion, some Jointstock Banks with over legal capital of VND

100 billion, the rest of them only VND 10-20 billion The banks can not diversify its transactions and can not invest in safely credit with too small legal capital

Second, in most of the banks credit is carried out by collateral (including the owned banks) There are no close relationship between banks and companies in doing business.

State-Third, in the financial field is still lack of the management skills and professional qualifications of managers Managers have not gotten an efficient experience into banking operation in the open market situation In fact, the capacity for legal capital in Joint-stock banks are higher than State-owned banks This capacity, however, has not yet implemented due to lack of development of securities and securities market The Bank Association and interbank market were established but they have not yet improved interbank transaction links

For Foreign Banks, up to the mid-year 1996, there are forty-one in operation, including twenty branches and twenty-one representative offices but their activities now are restricted

In fact, these banks' activities have not yet integrated into the economy in Vietnam It plays a dim role in the economy Its major customers are Joint-venture Companies, 100% foreign investment companies, they avoid lending domestic investors

The reason is lack of legal standards in the financial market First of all, is the accounting and auditing standards Vietnam has recently adopted International Accounting Standard (1996) A Vietnam auditing system has been set up Domestic business is used to this auditing system Another reason is their inherent capital is very low, average capital of VND 7 billion in a State-owned enterprise and VND 91 million in a private enterprise

♦ Taxation system:

Besides the banking reform, the taxation reform has been the main step of the whole financial reform Economically, one of its most important tasks is to eliminate the administrative supply-withdrawal system of state enterprise finances and to build a new tax system applicable to every business The new tax laws promulgated included the following kinds of taxes: [Vu Tuan Anh, 1994]

• Agricultural tax collected only in agricultural cultivation (there is ongoing discussion

in the National Assembly on a new draft of the law on agricultural tax into land tax and agricultural turnover tax);

• turnover tax;

• profit tax;

• special commodity tax (on cigarettes, alcoholic products);

• import-export tax;

• tax on use and exploitation of natural resources;

• tax on housing and the use of land;

• personal income tax

Despite a slight increase in the past years, the tax revenue remains extremely low (only a little more than 4.5 percent of gross domestic product) compared with other countries

in the world) There are still a number of flaws in the current tax system that have to be continuously improved

Firstly, the theoretical basis of taxation including the major principles of equity (horizontal and vertical), incidence, structure, effects on the output of production, on consumption and savings, on people’s lives, and so forth has not been clearly defined

Different requests are made of the taxation system by different groups of people responsible for taxation policy and financial policy-making, such as members of National Assembly, governmental financial specialists, and local administrators As yet there is no common criterion.

Secondly, the lack of a theoretical basis means that the current tax system does not take in all possible categories and sources of taxation; and some kinds of taxation do not seem to have a rational basis A typical case of this is the turnover tax, which is based on the repeated taxation of product value The feasibility of implementing value-added tax is also being discussed

Thirdly, the effects of the current tax system on economic output and its social consequences have not been sufficiently investigated, so frequent readjustments and fine-tuning continue to be required This created an unfavorable environment for businesses, and

on saving and consumption

♦ The accounting, auditing and statistical system:

From January, 1996, Vietnam officially shifted statistic-accounting system from the socialist

system to the capitalist system and implemented accounting system under instruction of International Monetary Fund (IMF) and World Bank (WB) as well develop auditing system The State General Auditing (belongs to the government) was established in mid-year 1995 Two domestic auditing companies were also established and four branches of foreign auditing companies in Vietnam Vietnamese companies (State and private) start to implement an annual and semi-annual auditing regime

♦ Issuing and trading stock:

Up to now, 160 Jointstock Companies are set up, including forty-eight banks, two financial Companies and five SOEs completed equitisation program total value of stock of these companies estimate VND 960 billion Besides, about VND 5,200 billion of government medium-term bonds and VND 150 billion of corporate long-term bonds Thus, total value of securities in the market is now about VND 6,400 billion (equivalent USD$ 600 million) [Financial Magazine, 1996]

In reality, the Vietnam Bank for Private Enterprises (VP Bank) is the only option since it

is the only one bank that the State Bank has allowed to sell shares to foreigners Direct investment in other Private Companies, Joint-stock Companies, or Joint-stock Banks is not allowed

These securities are not traded in the secondary market because majority of Jointstock Companies are private, they manage shares and shareholders Government bonds

do not bear completed market elements: low interest rate, high denomination Issuing bond has suffered by administrative, forced factors Buyers of government bond are mainly companies, buyers of corporate bond are mainly workers, staff with in company

3.3 The start up of the securities market

It is not difficult to establish securities market but it is difficult to maintain its operation regularly, efficiently and maintain its growth A securities market will operate efficiently in an adequate socio-economic environment This means it has to have an infrastructure in accordance with subjective and objective factors of this market That is: economic factors, legal situation, and awareness of the stock market How are these factors in Vietnam?

3.3.1 The economic factors

Economic factors are influence by government policies From 1986, Vietnam carried out policies to develop the multi-sector economy, moving according to the market economy with Government's management With the policies, Vietnam has drastically changed in structure of economic sectors and forms of business organization

♦ The State-owned economic sector:

The State entrusts companies with capital management, but the companies must produce themselves and make a certain profit

Vietnam rearranged the organization of SOEs, dissolution or annexation of making and undeveloped enterprises Simultaneously, Vietnam also carried out equitisation program The number of SOEs reduced from 12,297 units in 1990 to 6,480 units in 1994 with total capital of VND 48,000 billion, average VND 7 billion of each Most of them were dismissed, some were annexed, and some were equitised.[Vietnam’s socio-economic development, 1996]

loss-The result of economic policies in the State-owned sector in recent years overcame elementarily compensatory status of the State budget Many enterprises shifted from loss-making to a profit-loss break-even point and to a profitability and contribute to the State budget

♦ The private-economic sector:

According to the current law, Vietnam has three main organizational forms:

The proportion of capital in the private-economic sector is quite low comparing with the State-economic sector, average capital is only VND 6 billion (equivalent USD$ 600,000) while its capacity for mobilizing capital is potential

♦ The economic sector with foreign participation:

According to the investment law, Vietnam has three forms:

- Business-cooperate contract

- Joint-venture

- 100% foreign investment

3.3.2 The legal situation

The legal system on economic matter in Vietnam is considered weak The National Assembly has been concerned with this matter in recent years The constitution in 1992 set up the government’s economic regulation Based on this, other laws were promulgated in economic mechanism such as: civil law, labor law, law on enterprise bankruptcy, on encouragement of domestic investment, and the on economic court

However, in order to have a good legal environment in establishing and developing financial market in generally, securities market in especially, Vietnam has to readjust some laws that were enacted before 1992, for example, law on Jointstock Company, on limited Company, on foreign investment and two ordinances on banks

3.3.3 Awareness of the stock market

The Vietnamese perception of the securities and securities market now is at a low level The fundamental concepts of stocks, bonds, securities market, underwriting etc are not yet well-known, and the legal fundamentals are not yet established In reality, the financial investment is completely dependent on each persons limited experience and knowledge

Businessmen only know to mobilize capital through internal sources and borrowing Joint-stock companies issuing stock, a method of borrowing without interest payment, is still not used efficiently

3.4 A prerequisite for the emergence of a stock market in Vietnam

3.4.1 Development of the bid market

Following a switch to the market economy mechanism and the two-tier banking model, the SBVN has set up and brought into operation the Local Currency Interbanking market In order to create the conditions for capital intra-trading among Commercial Banks (CBs) with the State Bank acting as the ultimate trader In 1995, the Bid market on treasury bills and the Bills trading market came into being, the participants which are the CBs, the Joint-Stock Banks, the branches of foreign banks, as also the Financial Companies, the Insurance Companies the Fund for Insurance and the Investment Fund (collectively referred to as Financial intermediary organizations) The latter as the buyers, while the seller is the Ministry of Finance (Bank Treasury) and the regulatory body is the State Bank; the rate of interest rate obtained through bids constitutes the purchasing price, and purchases take the form of specific entries in books

or bill certificates

After preparing the legal conditions and holding a trial bid, the first bid on treasury bills was organized on June 8,1995 Thirty out of a total of thirty-four participants took part in the bid, but only twenty-three were lawful ones The predicted total issuance amount was VND 60 billion, registered purchases amounted to VND 395.2 billion, the lowest registered interest rate

and the highest registered interest rate were 16.66% and 24% respectively As a result of bid opening, eight banks were successful bidders, with bid interest rate amounting to 18% per annum and total face value of successful bid amounting to VND 83.6 billion [Vietnam Economic Review, 1996]

Thereafter, the second bid was held on June 21, 1995 the third bid on July 20, 1995 and the fourth bid on August 10, 1995

These four bids were organized in keeping with legal stipulations and did achieve, on

an initial basis, the objectives, although some units applying for bids did not provide deposit money

With bids carried out through the State Bank, the State Treasury could, within a short period of time, save nearly VND 250 billion, a substantial reduction in state budget expenditures as compared with the direct sale of Treasury bills by Treasury units The interest rate of Treasury bills could be gradually lowered and now stands, on an average, at 17.5% per annum (that is 1.47% per month), much lower than 21% annual interest rate (that is 1.75% per month) as was the case when the bills were directly issued by the State Treasury All this has resulted in saving about VND 10 billion per year for the state budget Indeed, because of a difference in interest rate of 0.28% per month, and the total value in all these four bids, one could save each month VND 682 million for the state budget, that is VND 4.1 billion in six months The state bank has been able, on an initial basis, to achieve unified management of the interest rate in the national economy, thereby creating the conditions for reducing the interest rate relating to the mobilization of funds by the banking system and the State Treasury

The primary market has come into being following the first issuance and bid of Treasury bills through the State Bank The American City Bank’s branch in Hanoi bought VND

29 billion worth of Treasury bills from Vietcombank with an interest rate of 17.5% Many CBs have sold the Treasury bills to their customers and the population In the future, if the bid market of Treasury bills is well organized, leading to the development of that market and other organizations and individuals, the secondary market would become buoyant, would be able to meet more adequately the demands in circulation of the treasury bills and other securities as investment funds and would create the material conditions for a stock market to emerge soon

in Vietnam In other words, this is one of the prerequisites for the birth of a securities market

in this country in the foreseeable future

The process of equitisation has been implemented very slowly The main reason for the delay was the ultimately instructions by functional ministries relating the above-mention Decision Equitisation concept and content were not fully recognized and there was no close co-ordination with the arrangement of the enterprise Therefore, on March 4, 1993, the Prime Minister continued to issue an instruction No.84/TTG regarding “the expedition of the pilot equitisation of SOEs and solutions to diversify the forms of ownership for SOEs” In comparison with Decision No.202/CT, this instruction had many new items and was more concrete It was to instruct the implementation process and encourage SOEs to equitise As a result, in March 1993, seven SOEs sent their application for equitisation to Ministry of Finance.

After a period of evaluation and selection, three SOEs was selected to be equitised for the first time They were the Hiep An Shoe - making enterprise, the Union of Transport Agents and Legamex In the initial stage of equitisation, the issue was quite new to these SOEs, regulations were not comprehensive and the conditions to boost up equitisation were not well prepared Therefore, the process of equitisation was implemented very slowly

On May 7, 1996, Decree No 28/CP of the State on “the change of some SOEs to be equitised companies” showed the State’s determination to implement equitisation All the provisions in the Decree were new and they were made on the basis of settlement of issues arose during the pilot program such as the decisions on the time to fulfill the procedures to shift from a State-owned into an equitised company, on the rights and interests of the enterprise and the staff and workers in the enterprise, on preference of the shareholders, on the principles to identify the enterprise’s value

Until early 1996, a total of five SOEs have officially equitised and operated under the Law on Company (a quite small number in comparison with three years of implementing equitisation) They are the Company of Transport Agents’ Union, the Company of Refrigeratory Electric Engineering, the Hiep An Shoe-making Factory, the Animal Food Processing Enterprise and the Goods Processing for Export Enterprise Two enterprises which first changed the form of ownership which operates under the law on company were the Company of Transport Agents’ Union and the Company of Refrigerator Electric Engineering in September 1993 In the equitised enterprises, the State shared 15-30% of the capital, enterprises’ staff and workers shared 40-50% and the remaining 20% was sold to Vietnamese people who were not working in the enterprises There were no shares sold to foreign legal individual and organizations [Vietnam socio-economic development, 1996]

On August 13, 1996, the Prime minister issued decision No.548/TTG on the central instruction to decide the number of SOEs to be equitised in each ministry, each locality and major corporations And the State assigned the central department for equitisation to fulfill the equitisation of 150 SOEs by the end of 1997

Vietnam identified the targets of equitisation They are:

1 To transfer part of the State ownership to shareholder ownership in order to improve the business efficiency;

2 To mobilize a certain amount of capital at home and abroad to invest in business;

production-3 To create conditions for laborers to become the real master of the enterprise.Equitised enterprises have started to develop better performance Their operation became more effective Their revenue, tax to the State, profit and workers’ wages have

increased considerably In addition, the State has a new source of income, the company’s business is developing, and as result, the shareholders not only enjoy the higher interest rate than the bank interest rate but the price of the share is higher than its face value as well and the workers work harder for the company and for their own interests.

With these outcomes, some suspicion over the effectiveness of the equitisation has been cleared Almost all economic norms and economic efficiency have been increasing during the operation period of the equitised enterprises The number of workers enrolled in these enterprises was not decreased as some people thought previously but increased

In the second quarter of 1996, some other SOEs were equitised including the Ship Engineering Company in Quy Nhon - Binh Dinh (the first SOE in the sea product sector which was equitised), the Hai Van Nam hotel (of the Saigon Railway Service Company), the Honey Company and the Furniture Enterprise (of the Hanoi construction Material Company)

However, all the test-run equitised enterprises were of small scale and had small amount of capital The highest amount was over VND 16 billion and the lowest was less than VND 2 billion Their business was in unimportant fields: three enterprises involving in service sectors, the two other involving in industrial production Moreover, the number of equitised enterprises was very small and they could not represent other sector, other management level and other areas (most of them are in HoChiMinh city and Long An province)

Regarding the equitisation method, in the initial stage of experimental equitisation, Vietnam mainly applied the method to sell the shares to staff and workers in the enterprise and Vietnamese individuals and organizations Under this method, there was no participation

of foreign legal organizations and individuals (according to the regulations of the State) Equitised enterprises still have some shares held by the State with the proportion varied from different enterprises The State also applies preferential polices to encourage shareholders Thus, it is necessary on equitisation and establishment of Jointstock Companies because these organizations will create “typical goods’ in the stock market

3.5 The role of the securities market for the economic development

Securities market has its role in two markets (primary and secondary markets) and in three aspects: (1) mobilization of capital; (2) transfer and allocation of capital; and (3) use of capital Under these conditions and opinions of interviewees, the role of the securities market are as follows:

Besides, estimated capital investment for the economy in the 1990s is nearly tripled from 1980s All business activities to achieve targets and strategies always require to capital