The impacts of capital flows on vietnam stock market luận văn thạc sĩ

ACRONYMS AND ABBREVIATIONS Foreign Direct Investment Foreign Portfolio Investment Foreign Indirect Investment World Trade Organization Vietnam Stock Market Hochiminhcity Stock Exchange H

VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACTS OF CAPITAL FLOWS ON

VIETNAM STOCK MARKET

BY

TRAN TUYET HANH

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, NOVEMBER 2012

VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACTS OF CAPITAL FLOWS ON

VIETNAM STOCK MARKET

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

of research for writing this thesis

I am also very grateful to all lecturers of the Vietnam-Netherlands Programme for giving

me knowledge and guidance to fulfill the M.A Programme

I would like to thank all the members of the Vietnam-Netherlands Program, especially, VNP Library for helping me to have necessary documents and research papers during my completion of the thesis

Finally, I am indebted to my parents whose love, sympathy and encouragement enabled me

to complete this thesis I am also thankful to my classmates for their warm encouragement

ACRONYMS AND ABBREVIATIONS

Foreign Direct Investment Foreign Portfolio Investment Foreign Indirect Investment World Trade Organization

Vietnam Stock Market Hochiminhcity Stock Exchange Hanoi Stock Exchange

Price-earning Vietnam Index Initial Public Offering

Over The Counter Market Less Developed Countries Index of Industrial Production Vector Auto regression

Augmented Dickey Fuller Phillips Peron

Error Correction Model State Bank of Vietnam

State Securities Commission of Vietnam Consumer Price Index

ABSTRACT

This thesis investigates the impacts of FPI flows on Vietnam stock market (VSM)

In other words, we aim to examine whether a long-run or short-run impact of FPI flows on VSM exists or not And, if any, how long does it take for changes to be fully effective? We use the mol!thly time series data of VN-Index and FPI flows from July 2000 to June 2012 to analysis In order to calculate the growth rate of VN-Index, we take logarithm ofVN-Index series and denote it as Delta-VN Then,

we adopt various techniques on time series regression such as unit root test using both Augmented Dickey Fuller (ADF) test and Phillips Peron (PP) test for stationary, co-integration test using Engle &Granger approach and Johansen approach for examining the existence of a long-run relationship between two variables, Granger Causality test for checking the existence and direction of causality relationship between them, error correction models for investigating the existence of short-term relationship Moreover, we also apply Serial Correlation LM test, Heteroskedasticity ARCH test, Histogram Normality test to check the appropriateness of the estimated model The research findings show that there is an unilateral effect from FPI flows on Vietnam stock returns The thesis also illustrates

an existence of a long-run impact between them when an increase in FPI flows can lead to 86% of increase in Vietnam equity returns On the other hand, there is also a short-run impact from FPI on VSM which would be decreasing gradually since the third month

-TABLE OF CONTENTS CHAPTER 1 INTRODUCTION !

1.1 Problem statement 1

1.2 Research objectives 4

1.3 Research questions 4

1.4 Research scope 4

1.5 Structure of the thesis 5

CHAPTER 2 LITERATURE REVIEW 6

2.1 The role ofFPI on economic development 6

2.2 The role of Vietnam Stock Market 7

2.3 Theoretical framework 8

2.3.1Foreign Portfolio Investment and stock market 9

2.3.2 Conceptual framework 11

2.4 Empirical studies 13

2.5 Suggested research model 15

2.6 Chapter remark 16

CHAPTER3 RESEARCH METHODOLOGY&DATA COLLECTION 17

3 1 Econometric techniques 1 7 3 1.1 Stationary and unit root tests 1 7 3 1.2 Co integration 18

3 1.3 Granger Causality tests 18

3.1.4Error correction mechanism 19

• 3.2 Data collection 20

3 3 Data analysis 22

3.3.1 Dependent variable: Delta-VN 22

3.3.2 Independent variable: FPI 23

3.3.3 Interaction between FPI flows and VN-Index 23

13.3 Chapter remark 33

CHAPTER 4 EMPIRICAL ANALYSIS 35

4.1 Structural Break Point test 35

4.2 Unit root test 35

4.3 Co-integration test 36

4.4 Granger Causality test 38

4.5 Error Correction Model 39

4.6 Chapter remark 38

CHAPTER 5 CONCLUSION AND POLICY RECOMMENDATIONS 43

5.1 Main findings 4 3 5.2 Policy recommendation 44

5.3 Research limitation and suggestion for further study 45

REFERENCES 46

APPENDIX A DESCRIPTIVE STATISTIC 49

-LIST OF GRAPHS

Graph 3.3-1: Delta-VN=log(VN-IndexJVN-Index(-1)) 22

I Graph 3.3-2: Foreign portfolio investment flows (FPI) to Vietnam from July 2000 to June 2012 23

Graph 3.3-3: FPI&VN-Index from July 2000 to June 2012 24

LIST OF TABLES Table 4.1-1: Summary of structural breakpoint test 35

'fable 4.2-1: Summary of unit root test results 36

Table 4.3-1: Summary of unit root test results for residuals using ADF&PP test: Engle &Granger test 36

Table 4.3-2: Summary of Johansen cointegration tes~··· 37

Table 4.3-3: Summary of Trace Statistic value 38

Table 4.4-1: Summary of Granger Causality test 38

Table 4.5-1: Summary of testing Vector Error Correction Model 39

Table 4.5-2: Summary of the tests for approriateness of the estimated model 41

LIST OF FIGURES

Figure A-1: Structural Breakpoint Test for Delta-VN variable 49

I figure A-2: Structural Breakpoint Test for fPI variable 49

figure A-3: Unit root test for Delta-VN variable 50

figure A-4: Unit root test for FPI variable 52

figure A-5: Cointegration test (Engle &Granger method) for residuals from the linear regression for two variables 54

figure A-6: Results of the Johansen Cointegration test for model2 55

figure A-7: Results of the Johansen Cointegration test for model3 57

Figure A-8: Results of the Johansen Cointegration test for model4 58

Figure A-9: Results of the Granger Causality test 59

figure A-1 0: Results of the Vector Error Correction Model 60

Figure A-ll: Results of the Wald test 61

Figure A-12: Results of the Serial Correlation test 61

Figure A-13: Results of the Heteroscedastiscity test 63

Figure A-14: Results of the Histogram Normality test 64

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1.1 Problem statement

After the official joint to the World Trade Organization (WTO) in 2007, Vietnam has been opening the financial market, economy and trade With the competitive advantages of lower production cost and investment risk than in other Southeast Asian countries, Vietnam has become an attractive destination of foreign capitals Vietnam is making a good impression on international investors because it is expanding rapidly in emerging market and obtaining dramatic growth after the global financial crises in 2008 Due to government's gradual relaxing macro policies on foreign investment restrictions in the stock market, Vietnam has further enhanced attraction to international equity investors

About the regulations on foreign share holding rate, Vietnam has raised the percentage of foreign holding rate from 30% up to 49% These regulations are rather suitable for Vietnam Stock Market (VSM) in this developing period

About the regulations on profit transferring outflows, in order to encourage foreign investors we have offered duty-free on this kind of outflows since 2004 for Vietnamese foreigners and foreign residents

On July 28, 2012 Vietnam stock market (VSM) was 12 years old with some notable achievements when it reached more than 1.2 million transaction accounts, 1,690 public companies, 105 securities companies, 4 7 fund management companies and 23 stock investment funds Market capitalization accounted for

27% of GDP Till May 31, total loans for securities of whole banking systems were about 12 trillion VND, bad debt at 485 billion VND

On HNX, foreign players also posted net purchase of nearly 60 billion VND (See Economic Financial report Jul 20 12)

In fact, FPI flows into Vietnam have been increasing rapidly in recent years Especially, since Vietnam officially joined WTO in 2007, FPI flows have increased strongly, accounting for more than 50% of total foreign investment capitals In the 2008 global financial crisis, the FPI flowed out; the stock market fell 66%, from 921 points to 316 points and caused bad effects on macro economy Then, along with the economic recovery, the stock market witnessed a net inflow

of FPI capitals but the stock market rarely crossed 500 points, with mini-recoveries inevitably followed by lengthy slumps On theory, FPI flows can benefit an economy in three broad ways First, FPI inflows can provide a non-debt capital source of foreign investment for a developing country and supplement domestic savings for improving the investment rate Moreover, FPI also reduces the pressure

of foreign exchange gap for the less-developing countries Second, rises in foreign capital inflows can increase the allocated efficiency of capital in a country Therefore, FPI can induce financial resources to flow from capital-abundant countries to capital-scarce ones Consequently, resource flows into the capital-scarce countries reduce their capital cost, increase investment and raise output Third, through its various linkage effects via the domestic capital market, FPI

affects the economy by giving an upward thrust to the domestic stock market prices, impacting on the price-earning (PIE) ratios of the firms and making these ratios become higher which lead to a lower cost of finance and in tum attract a higher amount of investment Consequently, the lower cost of capitals can encourage new equity issues with higher premium On the other hand, FPI flows also stimulate the domestic stock market's development when it opens the entry for foreign investors

In Resolution No.01/NQ-CP dated March 01, 2012 on key solutions to realize the socio-economic development plan and state budgeting for 2012, the main targets for economic development in 2012 have been set up such as about 6% to 6.5 %in the GDP growth rate, 13% in total export growth , import surplus accounted for 11% -12% of total export turnover , controlling trade deficit under 10%, the overspending in state budget controlled less than 4.8% of GDP, total capitals invested in social development accounting for 33.5% of GDP, the expansion in the consumer price index less than 10%, 1.6 million employed workers, the urban unemployment rate remaining at 4%

So, they aim to these objectives: prioritizing curbing inflation by applying tight, cautious and flexible monetary policy in accordance with the tight and effective fiscal policy, stabilizing the macro-economy, maintaining growth rate at a reasonable level by reinforcing the inspection of market and prices, well-organizing the domestic market, encouraging exports, controlling imports and reducing trade deficit On the other hand, they also object to growth model renovation, the national economy restructure and improvement in the quality performance and competitiveness of the national economy and enhancement in the performance of external relations and international integration by these solutions: restructuring investments focused on public investments, restructuring the financial and banking system, especially on commercial banks, restructuring enterprises focused on SOEs

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Despite a huge amount of empirical researches on stock market behaviors, most

factors' influences on stock markets Thus, an increased knowledge of how foreign portfolio investments influence on Vietnam stock market (VSM) is a practical interest to investors and financial researchers

Therefore, finding the impacts of FPI flows on Vietnam Stock Market, especially

in the long-run, will help policy makers improve policies to attract more FPI flows and achieve national economic objectives

1.2 Research objectives

The thesis' objectives include:

• To examine the impacts ofFPI on Vietnam Stock Market (VSM)

• To recommend general policies for sustainable development in VSM to encourage more FPI flows into Vietnam

1.3 Research questions

The thesis aims to answer the following questions:

• Is there a long-run or short-run impact ofFPI flows on VSM?

• Is it correct to say that VSM takes time to be fully adjusted after any changes in FPI flows? So how long does it take for the change to take effect?

1.4 Research scope

The research focuses on finding the impacts of FPI flows on Vietnam Stock Market

So we only investigate monthly time series data of net FPI flows and VN-Index from July 2000 to June 2012

1.5 Structure of the thesis

• Chapter 2 provides an overview on theoretical background of FPI impacts on VSM which are expressed in general through the conceptual framework

• Chapter 3 presents the research methodology Based on the other empirical researches, we draw out the study framework This chapter also describes the general econometric models, variables, data collection which are explained the reasons for choosing variables included and reliable sources to collect data

• Chapter 4 shows the statistic results from adopting the econometric model above Findings are analyzed to answer the research questions in the chapter

1

• Chapter 5 obtains the main findings and recommends sustainable policies to improve VSM in order to encourage FPI flows

CHAPTER 2: LITERATURE REVIEW

the main purpose of this chapter is to review theoretical and empirical literature for the links among FPI & VSM This chapter is divided into five main parts The first and second parts contain the concepts and the roles of FPI & VSM to economic growth The third part, theoretical frameworks include some theories about the relationship between FPI and stock market, conceptual framework The fourth part presents empirical studies about the impacts from FPI flows on stock market in detail The final part suggests the research model

2.1 The role of FPI on economic development

~apital flows including short-term portfolio flows and long-term investments have related to economic development and even to infrastructure development To boost

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economic growth and expand resources for development finance, governments usually promote international capital inflows, strengthen capital markets in order to encourage efficient financial markets According to Bakardzhieva et al (2000), capital flows were clarified into several types "Three distinctive flows appear in the financial account of balance of payments, namely foreign direct investments (FDI), portfolio investments and other investments" In this paper, we just focus on portfolio investments into the Vietnam stock market These flows are referred as the foreign portfolio flows (FPI) in Vietnam

Foreign Portfolio Investment (FPI) represents passive holdings of securities such as foreign stocks, bonds or other financial assets, none of which entails active management or control of the securities' issuers by the foreign investors However, they can sell off easily the securities and pull out the portfolio investment Therefore, FPI is much more volatile than FDI For developing countries, FPI can bring rapid development, helping an emerging economic opportunity, job creations,

and significant wealth When an economic takes a downturn, or fails to meet the expectations of international investors, the huge capital inflows can be withdrawn grammatically According to World Bank (2001), the external problem of excessive capital outflows were as follows: the capital outflows above critical threshold levels might impact adversely on the domestic economy by draining foreign exchange reserves, reducing the resources available for domestic investment, and slowing the developing of the financial sector However, the World Bank (2001) report also found that there was an existence of a strong relationship between FPI with domestic investment In the other word, in a research on some East Asia economies during 1990s of Henry (2000), stock market liberalization on trading might lead to investment booms But, capital inflows might not lead to economic growth because

it occurs in conjunction with a set of domestic complementarities for capital absorption, retentive capabilities, and consequent impact on production and consumption In fact, global financial integration only allows greater ease in the entry and exit of capital _

2.2 The role of Vietnam stock market (VSM)

The State Securities Commission, part of the Ministry of Finance, has been managing the Vietnam stock market They have issued a Law on Securities in June

2006 to facilitate the development of the securities market speedily and sustainably

by covering the regulation of listing and trading securities, the State's roles in administering and inspecting the securities market There are two stock exchanges

in Vietnam, one in Hanoi and one in Ho Chi Minh City The Ho Chi Minh stock exchange was inaugurated in July 2000 and became a main Vietnam stock exchange with approximately 280 companies listed We use the measure of VSM expressed

as VN-Index quoted in the Ho Chi Minh stock exchange It is a weighted index of all the companies listed on the Ho Chi Minh Stock Exchange The index was created with a base index value of 100 as of July 2000 In order to

capitalization-estimate the growth rate of VN-Index, we take the logarithm of VN-Index over lag one ofVN-Index and named this variable as Delta-VN

Stock markets bring benefits to corporations, individual investors and governments '

For corporations, by making an Initial Public Offering (IPO) on the stock exchange,

a corporation can gain access to a huge amount of investors, raise capitals by attracting abundant capital resources for their business Moreover, access to the stock markets also facilitates growth by merger or acquisition through share purchases For investors, stock markets are able to help them improve returns by diversifYing their choices of different corporations and industries to invest Equities cannot ensure a fixed rate of return Thus, they become a riskier investment than money markets or bonds What equities provide is the prospect of a combination of income and capital gains, plus a superior rate of return For the economy, stock markets can put people's savings to work, the economy cannot get benefits or just a little from individual cash savings or bank accounts Stock investment is a direct method in the success of businesses and helps promote stronger economic growth

In the other word, stock markets are also a measure of the economy's performance

In general, the performance of share prices is a good indicator of its current condition and of the confidence of individuals within that economy So, in some extent, the performance of the stock market is correlated with the health of the economy Moreover, the strict regulations and requirements for corporation's stock

to be listed on the stock exchange and maintained on trading are a good way for investors to ensure corporate governance because management standards and standards of record keeping within that corporation are maintained at a high level For governments, stock markets can give access to funds because the stock exchange allows individuals to lend money to their government when government may issue bonds quoted on the stock market to raise money for infrastructure or major projects

2.3 Theoretical frameworks

7here are many researches on the role of FPI flows through the stock market into emerging market economies

2.3.1 Foreign Portfolio and stock market

Theoretically, many economists and researchers have the different viewpoints about the relationship between FPI and stock returns in domestic economies

The first theory is to support the unilaterally impacts from FPI flows on stock returns According to Clark and Berko (1997) who investigated the economically and statistically significant positive correlation between monthly foreign purchases

of Mexican stocks and Mexican stock returns, a percent increase in foreign inflows led to 13 percent increase in Mexican stock prices Additionally, Choe et al (1999), who examined foreign investors' impacts on the Korean stock index from November 1996 to the end of 1997, found evidences of foreign investors' positive trading and herding before the Korea economic crisis However, there was no evidence that the foreign investors· transactions had a destabilizing impact on the Korean stock market during their sample period The Korean stock market was adjusted quickly and efficiently by large sales of foreign investors On the other hand, Bose and Condoo (2004), who studied the impact ofthe FII policy reforms on FII portfolio flows to the Indian stock market through a multivariate GARCH regression model, strongly suggested that liberalization policies had had the desired expansionary effect and obtained a sensitive impact of FII inflows to a change in BSE returns

The second theory is to illustrate the viewpoint that there is no correlation between FPI flows and stock returns According to Singh and Weisse (1998) who examined two major components of financial liberalization : stock market development and portfolio capital flows in the scenarios of less developed countries (LDC), LDCs should pay attention on strengthening their banking systems rather than stock

markets because their banks could promote long-term economic growth and

1industrialization Moreover, they were able to suffer the burden of globalization 1without speculative portfolio inflows In addition, Pal (2006), who aimed to 1

examine the impact of Foreign Portfolio Investment on Indian economy through the

I

stock market, showed that the perceived benefits of foreign portfolio investment had not been utilized in India The prediction that the foreign portfolio investors would boost economy through a country's stock market did not work in India

The third theory is to demonstrate the impacts from stock returns on FPI flows According to Ko et al (2005) who investigated the characteristics of the stock ownership by institutional and foreign investors in both Japan and Korea, foreign investors had more advantages in preferences to large capitalization and low book-to-market ratio stocks than institutional investors in both stock markets Furthermore, foreign investors prefered high-return stocks, especially in Korea Moreover, the preferred stocks of both institutional and foreign investors had statistically significant positive abnormal profits in both markets while favored ones

by either institutional or foreign investors had statistically significant positive abnormal only in Korea In other word, Liljeblom, E and Loflund, A (2005), who investigated determinants of foreign equity investment flows after the deregulation

of Finnish stock market, indicated that the Finish stocks owned by foreigners were found to deviate clearly from the Finnish stock market Portfolios of foreign investors were significantly titled to additional withholding tax on low dividend-yield Moreover, large- capitalization and liquidity stocks were preferred with a record of strong profitability (measured by past ROI) Additionally, Thapa and Poshakwale (2012), who found the answer for the question whether national equity market characteristics explained specific differentiation in distribution of foreign equity portfolios by using panel data of comprehensive foreign portfolio holdings and different measures of national stock market factors for 36 host countries, showed that foreign investors prefered larger and more visible developed markets with higher liquidity, higher efficiency and lower transaction costs

However, only a few studies like Froot et al (200 1) found a bilateral impact ,between FPI flows and stock returns They studied the behavior of international

I portfolio flows and their relationship with equity returns by employing panel data of 1

44 countries and found that international portfolio flows were strongly influenced

by past returns while foreign portfolio inflows had positive impact for future equity returns Moreover, the sensitivity of local stock prices to foreign inflows was positive and large

Based on the reality scenario in Vietnam, we support the theory about the unilateral impacts from FPI flows on the VSM

Test the impacts of FPI flows on Vietnam stock market

(Delta-VN) in the long-run and short-run

There has been the growing role of foreign portfolio investment in international financial markets over the last decade The increased flows to securities investment from industrialized countries to emerging markets are able to lead to possibility for development in all involved countries The percentage of FPI holding in a stock is

an important factor to analyze When this rate increases, the stock price goes up and when it drops, the share price comes down If foreign investors invest in a company,

to cause severe price fluctuations resulting in risky volatility Second, increased holding rate from overseas may lead to loss of control in domestic firms Third, when FPI flows into stock market in huge amounts, they can create great influence

on the way the stock market behaves, going up or down Fourth, the effect ofFPI on the currency appreciation may lead to the un-competitiveness in the export industries

In this thesis, we aim to investigate the impacts of FPI flows on Vietnam Stock Market (VSM) in the long run and the short run Then, we make some recommendations on policies for sustainable development in VSM to attract more FPI flows

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2.4 Empirical studies

Recently, there have been a lot of researches about the relationship between FPI flows and stock returns By applying various methods, most recent studies demonstrated the complementary impact of FPI on stock returns

Chakrabarti, R (200 1) analyzed FII flows in India and their relationship with other economic variables including stock returns by applying Granger Causality test on monthly data from January 1993 to December 1999 of FII flows to India, market capitalization data and other financial data like the exchange rate, short term interest rate in India, return on the MSCI world index, S&P 500, BSE national index and country credit rating data He arrived the conclusions related to stock returns that while the flows were closely related to Idian equity returns, they were effected by these returns rather than the cause of that Moreover, the Asian crisis marked a regime change in the determinants of FII flows to Indian equity returns becoming the sole driver of flows since the crisis Moreover, when Fils were compared to the local investors, they did not face an informational disadvantage in India

On the other hand, Mukherjee et al (2002) used two types of variables to explore the relationship of foreign institutional investment (FII) flows to the Indian equity market with its possible covariates for the period January 1999 to May 2002 The first included variables reflecting daily market return and its volatility in domestic

· and international equity markets The second were macro variables affecting foreign investors' expectation about return in Indian equity market like exchange rate, short-term interest rate and index of industrial production (liP) The data-set was combined with day-to-day variations, thus, it was suitable to test various correlations, including Granger causality for equity market operations After relating daily FII flows, they modified the model specification to include the variables' short-term past history over different time frames, like a week or fortnight Later, they tried to relate FII flows to Indian macroeconomic indicators Therefore, their results indicated that FII flows in the Indian equity market had

I

tendency to be caused by stock market returns but not vice versa It meant that Indian equity return was the most important factor affecting the FII flows into India Moreover, while FII sale and FII net inflows were strongly affected by Indian stock market's performance, this market performance did not cause FII purchase In other words, FII investors did not diversify their investments by Indian stock market Also, returns from exchange rate differentiation and the Indian economic performance might have affected on FII inflows , but such effects did not seem to

be strong Finally, FII flows were automatically daily correlated and this correlation could not be calculated for the all

In addition to the international evidences of the role of FPI on stock returns, there are numerous evidences in a group of specific countries Syriopoulos (20 1 0) employed weekly stock index closing prices in the Balkan countries such as the BET -C of Romania, SO FIX of Bulgaria, CROBEX of Croatia, ISE-1 00 of Turkey, GR-GI of Greece, CYP-GI of Cyprus, S&P500 of the US and DAX of Germany expanding from April 27, 1998 to September 10, 2007 to examine the risk and :return of international portfolios allocated by investors to major Balkan equity markets They applied linear method like error-correction vector autoregressive model and non-linear method like switching regime error correction model to test for the potential linkages between Balkans and developed stock markets The results illustrated the presence of co-integration vectors indicating a stationary long-run relationship among the Balkan equity markets On the other hand, the Balkan equity markets were affected by both domestic and external forces and shaped their long-run equilibrium path However, inflows of international portfolio investments and trading activity in the Balkan equity markets were growing rapidly

Saxena and Bhadauriya (20 11) collected daily data series on Fils inflows and S&P CNX NIFTY computed by logarithmic returns on daily closing prices for 7 financial years from April 2003 to March 2010 to explore the causal relationship between FII inflows and volatility in indices of NSE by adopting unit root test, Granger Causality test in a hi-variable VAR framework and vector auto regression

For applying the test, they had to convert all variables into a stationary process before including them into a V AR system In order to test the variables' stationary, they used Augmented Dickey Fuller test and Phillip Peron test They aimed to find the answer for the question that whether movements in Fil inflows had an effect on stock market returns or movements in stock market returns had an effect on direction of Fil inflows in India and got the results that there was no bidirectional causal relationship between stock market volatility and Fil inflows They found that stock market volatility was a cause to foreign institutional investment inflows and the trends of foreign institutional investment inflows did not have that much impact

on stock market volatility Also, they found that the past data of stock market returns could forecast the present and future trend of foreign institutional investment inflows to India

The most recent research is Kumar et al (2012) who studied empirically dynamic interaction between Foreign Institutional Investor (Fil) flows and Indian stock market returns through aggregate daily Fil data comprising three components purchases, sales and net purchases along with the S&P CNX Nifty market index taken by the log difference from 7th January 2000 to 61h August 2009 using ordinary least square regression , vector auto regression and impulse response function along with Granger Causality test to illustrate a sharp and significant impacts between Fil flows and Indian equity market returns The results showed strong evidence of positive feedback trading of Fils with an adjusted R square of eleven percent Also the Granger Causality test led to rejection of both null hypothesis lending strong support to a bidirectional relation between Fils and equity market returns in India But, the overall response function of institutional investors to a one standard error shock revealed a sharp and significant impacts dying out in four to five days

2.5 Suggested research model

Theoretical framework shows that there are strong impacts from FPI flows on stock returns As a paper of Saxena and Bhadauriya (20 11) and Syriopoulos (20 1 0), we

adopt unit root test, co-integration test, Granger Causality test and vector error

6ur support to the theory of unilateral impacts from FPI flows on stock returns, we

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prefer Delta-VN as dependent variable and FPI as independent variable in our

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model in order to estimate the role of FPI flows on the VSM

Therefore, our suggested general model for this thesis is as follow:

Delta-VN = f (FPI)

~.6 Chapter remark

In summary, most studies employ daily data to investigate the relationship between FPI flows and stock market returns However, we shall expand the data into monthly data like the study of Chakrabarti (200 1) to get a general view about the 'impacts from FPI flows on stock returns in month by month Moreover, we shall learn the methods of Saxena and Bhadauriya (20 11) in testing time series data such ,as unit root test using both Augmented Dickey Fuller (ADF) test and Phillip Peron (PP) test, Granger Causality test in a hi-variable VAR framework Additionally, we also extend to co-integration test on these monthly data to examine a long-term relationship between them In other words, we shall adopt a lesson from Syriopoulos (20 1 0) in using error correction model to investigate a short-run relationship between two variables Finally, we infer a general model for this thesis

CHAPTER 3: RESEARCH METHODOLOGY AND

DATA COLLECTION

The beginning of this chapter is to discuss and justify the methods to analyze: stationary & unit root test, co-integration, Granger Causality, error correction model Then, we describe our data collection and go ahead to data analysis Finally,

we summarize this chapter into the chapter remark

3.1.1 Stationary and unit-root tests

According to Gujarati and Porter (2009) a time series is stationary when its mean and variance are constant over time and the value of the covariance between the two time periods depends only on the distance or gap or lag between the two time periods and not the actual time at which the covariance is computed Our thesis uses

a set of time series data to generalize the behavior of foreign portfolio investment (FPI) and VNindex (adjusted as Delta-VN to obtain the growth rate of VNindex) Thus the measurement of stationary time series becomes an important issue Because if a time series is non-stationary, we can study its behavior only for the time period under-consideration As a consequence, it is not possible to generalize it

to other time periods So the regression becomes spurious and lead to incorrect conclusions

By applying the augmented Dickey-Fuller (ADF) test for stationary (see Dickey and Fuller 1979, 1981) we obtain the estimated equation for the ADF test as follows:

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m AYt= ao + ~~Yt-I+Ot: + IeiAYt-I +Et (1)

i=1

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Where A is the first different operator, Yt is Delta-VN or FPI, t is the time trend, E is

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the stationary random error and m is the maximum lag length The null hypothesis

is that the series contains a unit root which implies that ~ =0 The null hypothesis is rejected if~ is negative and statistically significant

3.1.2 Co-integration

When we regress two non-stationary time senes, we may produce a spunous regression Suppose we consider two time series data X &Y and subject these time series individually to unit root analysis, we find that they contain a stochastic trend

It is possible that the two series have the same common trend so that the regression

of one on the other will not be spurious We say that two variables are co integrated 'It means that two variables will be co-integrated if they have a long term relationship between them, on equilibrium (Gujarati and Porter, 2009)

Among various approaches to test co-integration, Engle and Granger approach is the most conventional technique But it is very restrictive because it can be applied only on a single co-integrating relation Thus, we should employ additionally the , most commonly used method, say, Johansen approach based on the autoregressive

I representation which provides two different likelihood ratio tests: the trace statistic

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, and the maximum eigenvalue (see Johansen 1988, Johansen and Juselius 1990)

· 3.1.3 Granger causality tests

In our thesis, we use the Granger Causality Test to check the existence of causal relationship between two variables: FPI and Delta-VN According to Gujarati and Porter (2009), the Granger causality test assumes that the information relevant to the prediction of the respective variables is contained solely in the time series data

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Qn these variables A Granger causality test involves regressing a variable X on lagged values of itself and on lagged values of the other variable of interest Z, as specific as the following model:

In this thesis, X may be Delta- VN and Z may be FPI By interchanging the roles of Delta-VN and FPI, reverse causality as well as the existence of feedback between the two variables can be examined

3.1.4 Error correction mechanism

In the short-run, the variables may be disequilibrium, after confirming that the variables are co-integrated and have Granger causality relationship, we conduct the ECM test to treat the error term as the "equilibrium error" We use this error term to tie the short-run behavior of the variables to its long-run value (see Gujarati and Porter, 2009) as the ECM below:

k-1

~ Yt = 9o + Iei~ Yt-1 + a~·yt-k +Et (3)

i=l Where ~ is the difference operator, Yt is (Delta-VN, FPI), 90 represents the intercept, and Et represents the vector of white noise process The matrix ~ consists

of r (r ~ n-1) co-integrating vectors Similarly, the matrix a contains the error correction parameters In equation (3), the null hypothesis is that the matrix (rr =

a~) has a reduced rank of r ~ n-1 The alternative hypothesis, on the other hand, is

that the matrix (n =a~) has full rank

Table 3.2-1: Variables summary

pependent variable

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Delta-VN The growth rate of VN- Author's calculation

Index equals logarithm

of Index(-1)

(VN-Index/VN-,Independent variable

Investment (Net FPI inflows)

·The main objective of the thesis is to explore the impacts of FPI flows on VSM The study is carried out by using monthly data series of FPI flows into VSM and 'Vietnam market returns (expressed through VN-Index) from July 2000 to June

· variable in this thesis

On the other hand, we take the last indices of the month as monthly indices for Index variable, then, we compute the growth rate of VN-Index by taking logarithm

VN-· the VN-Index using the following formula:

VNindext Delta-VN=logVNI de n

Xt-J

hot and how long it takes for the change to take effect

•

' has been fluctuating around its mean which suggests that these series are stationary They seem to be I (0) so they have stationary stochastic process This can be

1 confirmed by unit root analysis as shown in Table 4.2-1

+-~~.,J: : C,~~: : c, :'-"-.: :.: -'+;.,-:-"' -".,J: ~ : L.f-.: >: : ,7 ''-" '¥ FPI (biiiion dongs )

~o June 2012 Source: Hose & IFS

]n this thesis, FPI variable denotes the net inflows of foreign portfolio investment over the sample period As can be seen in the graph, the series have been fluctuating around its mean Before the late of 2006, there seems to have no investment from tbreigners into VSM After that, thanks to the opening in the equity market, foreign portfolio capitals started to flow rapidly into VSM

3.3.3 Interaction between FPI flows and VN-Index

~raph 3.3-3: FPI & VN!ndexfrom July 2000-June 2012 Source: IFS & Hose

f'.fter signing the Bilateral Trade Agreement with United State in July 2000 and officially joining World Trade Organizations (WTO) in 2007, Vietnam had committed to reform and opened the economy for foreign investors Then, we have got some achievements in development, especially in private sector and trade liberalization The VSM officially traded on July 28th 2000 starting with the start at

100 points and the first two trading shares were REE (Refrigeration Electrical Ip:ngineering Joint Stock Company) and SAM (Cable and Telecommunication Materials Joint Stock Company) Then, the VN-Index had been continuously

I

increasing during the following 12 months and peaked at 570 points on June 25th

lOO 1 Due to the scarcity of trading goods in this period, the fact that demand was greater than supply many times led to investors competing to buy at the ceiling prices and boosted the VN-Index increase continuously After peaking the mark of

5170 points, VN-Index had gone down quickly during the next 3.5 months, Ipdex lost 64% of its value, and got 203 points on October 5th 2001 Before 2001,

VN-I

there was nearly no portfolio inflows from foreigners into VSM Only some

investors paid interest in the stock market The net inflows were always lower than

5 billion dongs because just a little bit foreign capital flows ran into Vietnam The

• difficulties that foreign investors had to face in Vietnam were unstable economic

I environment, the out-of-date legal framework which did not catch up with the

be listed and traded, officially operated with less strict listing conditions to encourage small joint stock companies to list shares on the stock market So, it helped increasing the share supply and diversified options for investors to trade Market boomed from the mark of 300 points in the earlier 2006 The period from the end of 2003 to 2006 was the recovery term and booming in FPI inflows when the government issued the opening and transparency policies for FPI investors livforeover, the government aimed to promote privatization, loosen the foreign investors' stock holding ratio.Since 2004, foreigners had some positive reactions to VSM, the flows fluctuated around 10 billion dongs and reached the peak in this period at 189.96 billion dongs on March 2004 In 2006, the interest of foreigners to VSM was increasing dramatically The net inflows had risen to over 500 billion dongs and hit the peak of2006 at 2,323.67 billion dongs on December

Before 2007, Vietnam economy performed regularly the low growth rate of CPI which fluctuated around 0.5% and kept the CPI over these years under two digits Since 2007, as committed with WTO members, the government had allowed the

•

privatization in some sensitive fields such as banking, insurance, petroleum, telecommunication sectors and relaxed many restrictions for foreigner investors As a consequence of the openness in the economy, the story of inflation started in

I 2007 and boomed in 2008 While the economy was gradually absorbing huge cash

I inflows from overseas, State Bank of Vietnam (SBV) had some intervention in stabilizing the exchange rate by injecting 112 billion dongs equivalent to 7 billion USD Associated with the excessive solution of the government in controlling inflation, the inflation rate in 2007 reached 12.6% In 2007, the VN-Index started at

7 51.77 points and continued increasing The VN-Index had surpassed the mark of LOOO points on 19th January at 1,023.5 points and peaked at 1,170.67 points on 03th December During the first three months of 2007, the VN-Index increased with the average growth rate of 16.41% per month and the average transaction value of LOOO billions per session In which, only on January 2007, the grm\:1h rate was '38.25% However, since mid-March the VN-Index began to decline and fluctuated 'regularly with large amplitudes and soared to a peak of 1,174 points on March 12th '2007 During the rest of the year 2007, the VN-Index went around 900-1,100 points On 24th April, the VN-lndex bottomed at 905.53 points, down 22.65% compared to the highest level From the end of April to the first half of May the VN-Index rebounded strongly but still not escape the downward trend in the market In the second quarter, the index as well as the volume and value of transactions of VN-Index again bottomed 890.02 points on 20th August Then the market began to recover on 09th May, the VN-Index peaked at 1,106.06 points on 03th October After that, due to the coming IPO deluge and the date of Implementation of the Directive No 03 regulated to control the rate of loans in Securities lending investment not exceed 3% of the total outstanding loans of aommercial banks, the market started coming down with transaction value decline and the VN-Index plummeted on 28th December at 927.02 points, closed the year 2007with the 174.25 point gains and 23% increase of the VN-Index In 2007, a part

of FPI flows invested nearly US$7 billions in official listed market, the rest was in

the OTC market Foreign investors hold 25% to 30% of the listed companies' shares, the trading value accounted for 18% of the market FPI flows increased , sharply in 2007 and accounted for 50% of total foreign investment in Vietnam as lthe heat development in the VSM The foreigner investors'trading had become more vibrant because foreign investors were paying more attention on the VSM since we joined the WTO Whole the year 2007, the trading volume and value

!accounted for 36.09% and 41.72% of the total market trading respectively

Starting in 2008, VN-Index had faced many adverse information from the state bank on monetary policy to control inflation under two digits The fact that the

!central bank had withdrawed cash from circulation by many strong methods forced commerical banks to push up interest rates to raise capitals due to cash scarcity While the stock market was being on a downtrend, high interest rates caused investors to exit the market because savings became more profitable and safer On March 25, the VN-Index closed at 496.64 points, officially broke the bottom at- 500 points Then, VN-Index had fallen continuously from 1,100 points to 496 points (down to 50%), the State Securities Commsion of Vietnam (SSC) decided to reduce trading amplitude to calm down investors in trading As a result, speculative psychology came back the market However, the macro-economy stage was still so bad that this short-term uptrend was ended soon on April 091h 2008 after the VN-Index increased continuously in 11 sessions reached 552 points (up by 11% compared with the bottom at 496 points) The stock market returned to long-term downtrend From May to the mid-June, associated with the consecutive bad news, the stock market also received a big sales-off shares which were the large capitalized blue chips from the Repo contracts of securities companies and commercial banks Combination of these factors had pulled VN-Index decline exceeded easily 400 points and touched the bottom at 367 points on June 11th 2008 Since the macro policies had come to effectiness in the middle June, the trade deficit decreased significantly, credit growth slowed down selectively After the market fell to the bottom at 367 points, speculators came back to collect the cheap