The role of credit and monetary transmission in vietnam, a var approach , luận văn thạc sĩ

Andthey introduced CC commodities and credit curve that had shape like IS/LM curve totest the role of credit channel through bank lending channel when shock happening.They divided two su

•

VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE ROLE OF CREDIT AND MONETARY TRANSMISSION IN VIETNAM: A VAR

Dr NGUYEN VAN NGAI

HO CHI MINH CITY, May 2012

2

• I have deeply grateful to many people who support and advise me during the writing

this thesis The thesis will not be complete without their assistance and encouragement

My first thanks to my supervisor- Dr Nguyen Van Ngai, who gave me valuable ideas,comments, suggestions, and motivation during the preparation of this thesis Thanks tohis friendly attitude and enthusiasm has given me more self-confident to complete thisstudy

I sincerely thank Tutor- Mr Phung Thanh Binh who provided me materials, alsoeconomic techniques relevant to my thesis I am grateful to all lecturers and tutors ofVietnam-Netherlands Master Program in Development Economic, who have madeinvaluable contributions

I wish my express my special thanks to my friends Nguyen Van Dung, Le Anh Khang,

Vo Thi Ngoc Trinh They have spent a lot of time and effort in helping me during mywriting

Last but not least, I thankful to my lover, parents and brother who were always beside

me and gave me spiritual support

•

Among different channels (namely: interest rate, asset price, credit, exchange ratechannel) are affected by monetary policy, which one plays as a key channel in thismechanism In this study, I investigate the role of credit channel in monetarytransmission mechanism in the case of Vietnam Two different specifications of loanmarkets are conducted: classical market (without domestic credit) and augmentedmarket (with domestic credit) to look for the evidences of the role of credit Vectorautoregression model which focuses on the reduced form will be employed as maineconometric techniques in this thesis The empirical results support that credit channelplays important role in monetary transmission in Vietnam case The correlation betweenlending channel and monetary policy is somewhat weak The policy implication thatcredit sector should be carefully controlled when implements new monetary policy

model

Table 4.4: Optimal lap-Classical marketTable 4.5: Optimal lap- Augmented marketTable 4.6: V AR Regression Statistic- Classical marketTable 4.7: V AR Regression Statistic- Augmented marketTable 4.8: Variance Decompositions for vector autoregression for Classical and Augmented Market

LIST OF FIGURES

Figure 3.1: Analytical FrameworkFigure 4.1: The impulse response functions for classical marketFigure 4.2: The impulse response functions for augmented market

• IFS-IMF: International Financial Statistic- International Monetary FundsLIST OF ABBREVIATIONS

SBV: State Bank ofVietnamOMOs: Open Market OperationSOCBs: State Owned Commercial BankJSBs: Join Stock Bank

ADF: Augmented Dickey FullerPP: Philips-Perron

LR: sequential modified LR test statisticFPE: Final prediction error

AIC: Akaike information criterionSC: Schawarz information criterionHQ: Hannan-Quinn information criterion

U.S: United States

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 9

1.1 RELEVANCE AND BACKGROUND OF STUDY 9

1.2 PROBLEM STATEMENT 10

1.4.RESEARCH QUESTION 11

1.6 STRUCTURE OF THESIS 12

CHAPTER 2: LITERATURE REVIEW 14

2.1 CREDIT CHANNEL THEORY 14

2.2 MONETARY POLICY FRAMEWORK OF VIETNAM 16

2.2.1 LEGAL FRAMEWORK 16

2.2.2 MONETARY POLICY STRATEGY AND INSTRUMENTS 17

2.2.3 VIETNAM'S FINANCIAL MARKET OVERVIEW 19

2.3 EMPIRICAL LITERATURE 21

3.1 ANALYTICAL FRAMEWORK 27

3.2 MODEL SPECIFICATION 28

3.3 DATA SOURCES 30

3.4 STEPS OF ESTIMATION 32

CHAPTER 4: FINDING AND DISCUSSION 34

4.1 DESCRIPTIVE STATISTIC 34

4.2 UNIT ROOT TESTS 35

4.3 VARREGRESSION STATISTICS FOR CLASSICAL AND AUGMENTED MARKET 37

4.4 IMPULSE RESPONES AND VARIANCE DECOMPOSITIONS 40

4.5 RESULTS COMPARISON 47

CHAPTER 5: CONCLUSION AND POLICY IMPLICATION 49

5.1 CONCLUSIONS 49

5.2 POLICY IMPLICATION50

5.3 LIMITATION AND FURTHER STUDIES 53

5.3.1 LIMITATION 53

5.3.2 FURTHER STUDIES 53

REFERENCES 55

APPENDIX 58

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CHAPTER 1: INTRODUCTION

This chapter will present how important of this study is, its objectives and researchquestions In addition, a brief of methodology is also mentioned in this chapter Finally,the scope and structure of thesis are deal with in this part

1.1 RELEVANCE AND BACKGROUND OF STUDY

The restructuring of state owned commercial banks (SOCBs) and the establishment ofjoin stock banks (JSBs), had appeared since Vietnam financial reform in the first haft of1990s Consequently, the finance system of Vietnam has deepened when monetizationincreased continuously (in 2004, the ratio M2 to GDP was above estimated 70%compare to 25% in mid-1990) Seventy-three percentage of total credit is provided bySOCBs in 2004 The credit market and other parts of financial system to be segmentedproceeding JSBs and others small banks supplied credit primarily to private sector,whereas SOCBs almost loaned both sectors equivalently (Camen, 2006)

When Vietnam took part in the World Trade Organization (WTO), lead to the surge ofnew foreign direct investment and portfolio inflows Globalization, it's synonymous withVietnam has posed significant challenges to their economy Unfavorable balance ofpayments is also the major concern Vietnam's financial sector has been explosion since

2000 year only, noticeable in 2007-2008 periods Consequently, Vietnam's credit marketgrew too hot, the number was estimated about 50 percentage in January 2008, thatcontributed a positive element to inflation rising, got 14 percentage at this time (Ishii,2008) And at early months of year 2011, Vietnam's inflation rate accelerated to 13.89percent in March, peak out at highest in 25 months Moreover, the trade gap increased to

$1.15 billion that month after look over $1.11 billion in February (S&P Reporting,

2011 )

1.2 PROBLEM STATEMENT

For facileness, most of economic models usually assume that the changes of economywhich affect by financial conditions have just relatively bounded by set of severalfinancial variables They could be risk-free interest rates in short term or governmentbond rates in long term (Hall, 2001 )

However, once the system of financial develops with high degree, especially in recentyears, its impact on the economy becomes wider and deeper Hence, it's quite hard tofind the root of problem when the economy is developed, because of some variables maynot be indicated For example, the world financial crisis in 2008 had a root from creditsector, typically, mortgage assets crisis in the U.S or the refugee capital of Vietnamsecurity market in 2008 due to the easing monetary policy in previous years In the past,many economists such as Pintinkin, Gurley, Shaw, etc., emphasized the important role offinancial intermediaries and credit markets Modigliani and Papademos (1977) alsoadmitted that the traditional theory of monetary mechanism ignored the functions offinancial intermediaries and bank credits Financial intermediaries were strong influence

on credit supply than money supply (Gurley and Shaw, 1956) Evidently, credit channelcontributes a significant factor and affects directly to decisions of policy makers

Hence, understanding the position of credit channel in financial market is crucial topolicy makers In detail, understanding the transmitted mechanism of monetary policythrough credit channel is very important As a result, indentify the role of credit channel

in monetary transmission is essential for enhancement current policies By that way, itcontributes to the achievement of national economic objective

1.3 RESEARCH OBJECTIVE

This study aims to identify the role of credit channel in Vietnam's monetarytransmission mechanism, specify 1996-2010 period Following the main objective, thethesis:

To analyze whether past value of credit helps predict the money supply;

Toexamine the impact of credit shocks on money supply, also other macro

Does the past value of credit help predict money supply?

How does money supply reaction to credit shock?

Whether credit shocks plays important role in forecasting money supply's error?

1.5 METHODOLOGY

To carry out above objectives, this study uses quarterly data from 1996:Ql to 2010: Q3.Econometric techniques and descriptive statistic will be employed as primaryquantitative in this research

Descriptive statistic analysis gives an overview of all variables that are used in thisthesis Those are including: the distribution, variation, central tendency of all originalalso changed data Since then, we can a cursory evaluate the quality of employed data.Concerning to the econometric techniques of time series data, vector autoregression (VAR) will be employed to answer key questions Due to the data is time series, unit roottest is used to examine for stationary of all variables to ensure the validation oft-test andF-test in firstly Next, optimal lag lengths for VAR model is chosen by different criteria

to have the best model Granger causality test will help us answer first sub questionwhether past value of credit is useful to forecast money supply Then, impulse responsesand variance decompositions are two popular techniques of VAR model to answer twolast sub questions respectively Collecting from those empirical results, we can concludethe role of credit channel in monetary transmission in Vietnam case

1.6STRUCTURE OF THESIS

The study is organized as following:

Chapter 1 introduces the importance of thesis, relevance and back ground of study, theobjectives and research questions And the methodology is presented as briefly in thispart

Chapter 2 demonstrates the literature review Firstly, credit channel theory ismentioned as a core of study Secondly, empirical studies about the role of creditchannel in monetary policy transmission are presented In addition, the chapter givesoverview the Vietnam's monetary policy framework, in which focuses on the creditmarket

Chapter 3 presents analytical framework, then develop the model which helps usanswer key question Finally, data description as well as steps of economic techniqueswill be mentioned in this chapter.

Chapter 4 shows the empirical results and discussion Finally, results comparison isalso presented in this part

Chapter 5 give conclusion, suggests some practical policy implications, and discussesthe limitations and direction for further studies

CHAPTER 2: LITERATURE REVIEW

In this part will be described theories applied in thesis as briefly Next, the framework ofmonetary policy in Vietnam is presented in this part Besides that, some remarkableempirical studies regarding to the role of credit in monetary transmission in othercountries, also in Vietnam will be introduced

2.1 CREDIT CHANNEL THEORY

Credit channel theory is based on the existing of external finance premium, reflectedtypically by principal agent problem between lender and borrower Bernanke andGertler (1995) had discussed in some details through two possible linkages, these arethe bank lending channel and the balance-sheet channel This thesis will mention twolinkages which are relevant to credit channel theory

The bank lending channel: concentrates the variability of loan supply through deposit

institutions caused by the effect of monetary policy actions

Banks, that remain dominant information sources in the economy, so that, canovercoming asymmetric information problems and other fictions in credit markets That

is a reason why many borrowers depend on bank credit, specially small and mediumsize enterprises Once this function still remains, the influence of bank lending channel

in monetary policy transmission continues its role

In case, the government does expansionary monetary policy, bring to increases the bankdeposits from customers or bank reserves; the quantity of bank loans available would beincreased, then investment increases, lead to output increases

Conversely, tightening monetary policy is synonymous with reducing bank reserves orcustomer deposits, which leads to a decreased of quantity of bank loans available Next,reduce investment spending and output decrease as consequently

Another side of credit view, when we mention to the impact of monetary policy toenterprises, small firms suffer bad effects on expenditure than large firms (Mishkin,1996) The reason is because of more dependent on bank loan with small companies,whereas big companies can access huge capital through stock and bond markets, notnecessary via bank channel.

Balance sheet channels: focuses influence of monetary policy changing on borrower's

balance sheets and income statement

In balance sheet aspect, the changing in company's worth due to the variability ofmonetary policy tends to raise the adverse selection and moral hazard problems whengrant loans to those companies The borrowers have less collateral in case, theprobability moral hazard problem happen will high if those firms want to access theloan More details, the company with lower equity prices has tendency to accept riskyprojects Then, the more risky the firms take, the more probability the firms could notpaid back their loans, which leads to bank collapsed and decreased in lending, and alsoinvestment spending Meanwhile, the banks request the lenders provide more collateralfor their crediting due to net worth declining, hence have an increase the adverseselection problems, and reduce fund for investment as consequences

Here is several ways which monetary policy acts upon on firm's balance sheet:

Expansionary monetary policy, as already dealt with earlier, is the reason of rising in equity stake In this circumstance, adverse selection and moral hazard problems were decreased as well Next, firm's valuation will increase and the sources of capital, which provide for investment, are also higher and lead to increasing in aggregate demand

In other way, lower interest rates by the reason of expansionary monetary policy alsocause the firm's balance sheet reformation because of the effect of cash flow Therefore,adverse selection and moral hazard problems can be lessened As a result,

capital available for loan will increase, investment spending growth, aggregate outputincrement finally.

Monetary expansion is the reason which brings to the unforeseen increase in the pricelevel, hence raises the net worth of companies and lower adverse selection and moralhazard problems It implicates a rise in investment spending and aggregate output

On the other hand, contractionary monetary policy causes a decline in equity price orreducing in cash flow Therefore, a lower net worth of business firms because of theincrease of adverse selection and moral hazard problems, in tum decrease leading tofinancing investment and consumption

2.2 MONETARY POLICY FRAMEWORK OF VIETNAM

2.2.1 LEGAL FRAMEWORK

According to "Law on the State Bank of Vietnam", the SBV is a body of governmentand the central bank of the Socialist Republic of Vietnam The Law also stated thatNational Assembly and the government are responsible to give decisions, also itssupervisor relevance to monetary policy The government has function to prepare a plan,including projection annual inflation rate for monetary policy It determines the amount

of liquidity which to be injected in the economy The government has to report theprogress on implementation of monetary policy to National Assembly The role of SBVincludes exercise monetary policy, as designed by government In addition, the SBV willconduct the state's management through monetary and bank activities and act ascurrency issuing bank, bank of credit institutions, and bank of government Thoseactivities have goal to stabilizing the currency value, preserve banking activities andbanking system, and adapting with state budget and economy growth within the contextofthe country's socialist orientation (State Bank of Vietnam, 2003)

Base on SBV Law, SBV operates as a part of Vietnamese government, while theNational Assembly plays an important role in monetary decision A strong intervened ofgovernment; also National Assembly in the implementation money policy exhibits thatthe limited ofSBV's independence instruments (Camen, 2006).

2.2.2 MONETARY POLICY STRATEGY AND INSTRUMENTS

The Vietnam's monetary policy strategy is extracted from five years plan of Social andEconomic Develop Strategy And the government has duty to formulate the action planfor implementation Not only the targets for injection of liquidity into the economy areset, but also M2, credits, deposit and other target related will be determinate asimportant part of government's action plan (Camen, 2006)

The SBV, as a part of government, bases on macroeconomic and monetary objectives,announces annual targets for total liquidity and credit to the economy Each year, theSBV arranges a report the implementation monetary policy of that year and monetaryoutlook for next year Then, the SBV submits it for the government consideration andapproval Finally, government will submit this report to National Assembly forapproval, after consulting with National Monetary Policy Advisory Board1 (Hung andPfau, 2008)

Regarding to monetary instruments, a number of indirect tools have been introducedinclude reserve requirement, refinancing, discount financing facilities, open marketoperation and foreign exchange interventions

Reserve Requirements

SBV has applied reserve requirement in various forms since 1990s This instrumentproves its important role on money market regulating in past Currently, required

Minister of Finance, and other experts.

reserves are distributed into classes depend on deposit maturity, the sectoral focus ofbank, and the kind of currency deposits (domestic or foreign currency) Deposits of lessthan a year are higher than those for more than a year and interest subsidized for bankswhen credit for agriculture sectors or People Credit's Fund (Camen, 2006).

In 2008 year, reserve requirement was used as an effective tool in order to constraininflation due to strong economic and monetary movements both domestically andinternationally On February 2008, the SBV raised the reserve requirement ratio by 1percentage point applicable to both local and foreign currency deposits in most of creditinstitutions (SBV, 2008) In recent years, with goal to prevent economic down tum, theSBV decreased required reserve applicable to VND deposit for below 12 months twice

in 2009 from 6% to 5% and to 3%, exception for Vietnam Bank for Agriculture andDevelopment reduced this rate from 3% to 2% and 1% (SBV, 2009) In 2010 year, SBVcontinued to keep reserve requirement ratio at low level; in specific; 3%, 1% for VNDdeposit below and more than 12 months respectively For foreign currency, SBV alsoadjusted down to help credit institution increase foreign currency funding (SBV, 201 0)

Open Market Operations (OMOs)

OMOs have been used by State bank since July 2000 Over those years, this instrumentproves its importance and becomes a single most significant monetary instrument forcontrolling liquidity OMOs were flexibly managed in line with other monetary policyinstruments, thus helping to stabilize the money market SBV conducted by issuingSBV's compulsory bills, higher base interest rate, in particular, increasing 182-day and364-day bills with the annual rates of7.5% and 7.75% respectively for sake of inflationcontrol at first 7 months of 2008 (SBV, 2008) The first half of 2009, SBV had offered

to purchase valuable papers for maturity 14-days, that supplied short-term capital andfacilitated credit institutions to meet capital need for economic stimulus programs

(SBV, 2009) However, this action of SBV was unsuccessful because of low demand offund and surplus financial resources at that timing Continuity, OMOs were conducted tosupport credit institutions in first 9-months of 2010 by purchasing valuable papers, butincreased interest rate for those papers due to high inflation pressure at 3-months endof2010 (SBV, 2010).

Discount Policy

Besides changing reserved requirement, a refinancing and a discount facility are anothertool ofSBV's discount policy The form of refinancing rate and rediscount rate are fairlysimilarly However, rediscount rate is set by SBV that base on collateral valuable paperssuch as draft, promissory note, bond etc Commercial banks use those valuable papers

as collateral to access funds form SBV While refinancing rate is given rely oncommercial bank's loan by SBV Commercial banks use those loans as collateral fortheir loan from SBV Because of this difference, refinancing rate is usually higher thanrediscount rate in practical Recently, the SBV has used refinancing rate as a mean ofsupplementing ensure short term lending and liquidity to credit institution in 2010 SBVprovided mainly 1 to 2 months refinancing to guarantee liquidity of economy And atlate 2010 year, the SBV conducted refinancing in order to promptly adapting the highdemand for deposit withdrawals of economic organizations and individuals during LunarNew Year (SBV, 2010)

2.2.3 VIETNAM'S FINANCIAL MARKET OVERVIEW

Historically, only the SBV and two SOCBs provided almost all financial services forVietnam's financial system In 1988, two years after Doi moi, the SBV was separatedand operated as the central bank in which specializes in the monetary policy andfinancial supervision Next step of financial reform is appearance of join stock of

commercial banks and foreign banks in 1991, 1992 respectively To fulfill policyfinance, Development Assistance Fund was established in 2000 year Vietnam'sfinancial market connects closely in non-commercial lending in past, in whichagriculture sector dominance (World Bank report, 2006)

In the World Bank's report related to the state of Vietnam's capital market in 2006commented that Vietnam's banking sector had expanded rapidly, mostly by supplyingloans to private sector SOCBs still remain dominant for credit to economy Despite ofsector reform, the banking sector remains financially weak and requires reinforcement toenhance its stability and lending capacity (World Bank report, 2006)

Table 2.1: One decade and Vietnam's credit

-2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Credit to

Economy (tril.) Credit to Economy

(growth rate) GDP (tril.)

Credit to Economy(%

GDP)

Source: Calculated from IMF-IFS and GSO data

In the banking sector credit, credit to the economy rose from VND 155 trillion in 2000(35 percent GDP) to VND 2,690 trillion (136 percent GDP) in 2010 (as shown table2.1 ) Only one decade, the supplied credit increased seventeen times Noticeable,Vietnam's credit growth was too fast since late 2007 (50 percent credit's growth) Thisphenomenon could be explained by a massive capital inflows and real estate price

• bubbles as collateral loan (Vietnam Plus News, 2009)

Vietnam's credit growth 2011 and orientation in 2012

According to Reuters Article, total outstanding loans in Vietnam's banking system grew10.9 percent last year from 2010 That is a lowest rate of credit growth in one decaderecently This number was well smaller than a target 15-17 percent, which had been cutunder 20 percent initially in 2011 year Meanwhile, deposit growths 8.89 percent from

2010 and money supply expanded an estimated 9.27 percent in monthly report ofSBV

Vietnam is targeting credit growth at 15-17 percent this year and a 14-16 percentincrease in money supply (Reuters News, 2012) Monetary policy will be used byCentral Bank to meet a credit growth Nguyen Van Binh, the Governor ofSBV, quoted

in December lending growth could stay below 15 percent SBV continues to focus ondevelopment of agriculture and rural sectors, production of goods for export, auxiliaryindustries and to support small and medium-sized enterprises (Baomoi News, 2011).Agribank, Vietnam's top lender by assets, is still chosen in fund disbursement, accountfor 75-89 percent of its loans for agriculture and rural development Further, centralbank has allocated various annual credit growth targets for domestic banks For rankingbetween zero and 17 percent, SBV divided banks into four groups, which havemaximum loan growth rate of 17 percent, 15 percent, 8 percent and zero percentrespectively (Reuters New, 2012)

2.3 EMPIRICAL LITERATURE

In recent years, many empirical studies related to the role of credit in monetary policytransmission have been done At beginning, Bemanke and Blinder (1988) were raisedthis problem in famous paper "Credit, Money and Aggregate Demand" IS/LM model

as simple tool which they employed to measure variance of money demand shock Andthey introduced CC (commodities and credit) curve that had shape like IS/LM curve totest the role of credit channel through bank lending channel when shock happening.They divided two sub-samples (1974:1-1979:3 and 1979:4-1985:4) and concluded thatthe variance of money-demand shocks was much smaller than that of credit-demandshocks during the first sub-period but more important relative in 1980's.

A question about the role of credit channel and monetary transmission was raised afterthat And Ramey (1993), had been conducted this topic in his study since Ben Bemankewrote his paper He used monthly sample size of American from 1954:1 to 1991:12 toanswer the question whether had the relative importance of money and credit channel inmonetary transmission mechanism With purpose analyze this mechanism in detail theauthor employed dynamic stochastic general equilibrium model and eight variables(including: industrial product, Ml, M2, bank loans, Federal rate, 6-month commercialrate, 3-month Treasury rate, inflation rate) As the result, he denied the role of creditchannel when concluded money channel is much more important than credit channel indirect transmission policy shock during that time

After that, Bemarke and Gertler (1995) postulated credit channel was importantcomponent in "black box"2• Two linkages of credit channel are bank lending andbalance sheet channel were presented very details Most of studies afterwards take thisidea as main orient when want to examine credit role In order to view the responses topolicy shocks, vector autoregression method operated as efficiently tool in study Theyrecognized credit channel could indentify significant cost due to the capital effects of thepure neoclassical type

In his investigation following Korea's financial crisis, Kim (1999) explored the role ofcredit channel in monetary policy transmission He based on monthly data from 1993:1

to 1998:5 and combined three methodologies: a narrative approach, disaggregated bank

data, disequilibrium model to test for bank lending channel For econometricspecification, standard vector autoregression was employed to identify whether loansupply are really important The result provided persuadable proofs of the important role

of credit channel afterward consequence of the financial crisis

Following years, many researchers, did the study nearly the same that topic However,many countries which had various characteristics, so those results also were diverse.Unlike empirical working previous, Warner and Georges (2001) offered novel test ofcredit view of monetary transmission by using stock market return They estimated theabnormal return for daily stock market return of common shares ofU.S manufacturingfirms Research's finding showed that there was no consistent relationship betweenabnormal stock returns and credit constraint both two periods (recessionary: 1990-1991and expansionary: 1993-1994) Similarly effect with Warner and Georges, in hisempirical study, Suzuki (2004) had study whether lending vie~ was correct in the case ofAustralia during 1985:Q1-2000:Q2 The author found that lending channel is lessdominant in Australia, because of some features of Australia bank's behavior In anotherview, Lown and Morgan (2002), Disyatat and Vongsinsirikul (2003) shed light on crediteffects in U.S and Thailand economy respectively For Lown and Morgan paper, theauthors looked for evidence of both type of credit effects by using information on bank'scommercial credit standards as proxy for bank credit availability The applied vectorautoregression (VAR) model extended to resolve "mystery"4 • One remarkable of thisstudy, loan market was classified by two forms; those are classical market andaugmented market By market discrimination, the author could find out the role of creditstandard in U.S economy The empirical concluded that the dynamic of commercialcredit standards matter a lot both loans and output Take on typical econometricmethodology, VAR model, Disyatat and Vongsinsirikul engaged

three main variables of Thailand economy (real output, the CPI, and 14-day repurchaserate) through 1993-Ql to 2001-Q4 to measure the intensity of money markettransmission to private areas The study realized that investment was significance tomonetary shocks and bank played as essential adhesive for monetary policyimplementation in reality.

While explored the variation financial environment after inflation targeting in Thailand,Charoenseang and Manakit (2006) realized that transmission of monetary policythrough the credit channel was dominant than interest rate channel during June-2000 toJuly-2006 Typically, that is dependent capital sources of economic activities on banklending in Thai financial market Once again, the authors confirmed the important role

of commercial bank lending in Thai economy

In the same year, Podpiera (2007) had employed commercial banks data to study theimpact of monetary policy shocks on loan market in Czech case; meanwhile Kubo.A.(2007) concentrated credit channel when investigate the monetary transmissionmechanism in Thailand, highlighting credit channel Both empirical studies supportedthe important role of credit channel at research timing More specifically, Podpieraadopted Kashyap and Stein model, with balance sheet data of Czech banks covers1996:Ql to 2001 :Q4 The empirical finding showed that the changes of monetary policyalter the growth rate of loans, special period 1999-2001 And Kubo used a structurevector autoregression (SV AR) to learning the effect of exogenous monetary policyshock influence to price and other domestic macroeconomic Monthly observationsbetween May-2000 to December-2006 were conducted and contained five variables:customer price index, industrial production, producer price index, inter-bank overnightlending rate and private credit aggregates From the paper's result, the authors realizedthat behind the success the BOT (Bank of Thailand's), credit channel contributed asimportant factor during that time Moreover, the empirical found that

negative movement effects on import demand when examined the impact of monetary policy shock on international variables in SV AR system.

Balazs Egert (2009) had been investigated the achievement of research in the context ofmonetary transmission mechanism, in which Central and Eastern Europe concentration.The paper showed that a reducing in inflation rate is basic factor made the degree ofexchange rate transmission downward over time And credit channel demonstrated as akey channel in monetary policy transmission, whereas asset price channel could notprove its powerful in flat of stock and bond market The same that work of Balazs Egert,Fiorentini.R and Tamborini.R (2001) had raised a ring to Italy's policy makers whenrealized the importance role of credit supply during past decade's research

Once again, with objective to examine the monetary policy transmission for India case.Abdul (2009) also employed VAR model combined with macroeconomic variables like:bank rate, repo rate, reserve repo rate; etc The same previous study, researcheradmitted that bank lending channel was crucial important in monetary policytransmission to Indian's economic activities Furthermore, Fed's rate was recommendedinclusion when analysed in monetary shocks, because of its strong affected to emergingcountry like Indian Nearest study, Catao and Pagan (2010) employed an expectation-augmented SV AR to study monetary transmission in Brazil and Chile Most of datawhich they accounted from IMF's International Financial Statistics (IFS) and theBrazilian Planning Ministry Research Institute (IPEA) and Central Bank of Chile Theyrealized the important role of a bank-credit channel when incorporated key structuralfeatures of Emerging Market economies by structure model They also exhibited whenthe typical size of credit shocks happens would robust effects on output and inflation,especially in Chile where the penetration in bank system was higher

In the context of credit role in monetary policy transmission in Vietnam, there are hasbeen not much study related to this topic Only in 2008, in line with this subject, in spite

of not directly touch on the role of credit problem, Hung and Pfau (2008) have beenanalyzed the monetary transmission mechanism of Vietnam The authors employed thevector autoregression approach (V AR) which focused on the reduced-form relationshipbetween money, real output, price level, real interest rate, real exchange rate and credit

A remarkable conclusion was the weakness connection between monetary policy andeach channel in Vietnam case and the credit and exchange rate channel played animportant role than interest rate channel

In short, this chapter has toughed core of thesis through credit channel presentation.Credit theory is explained by external finance premium Monetary policy shock caninfluence loan market through bank lending channel and balance-sheet channel.Regarding to Vietnam monetary policy framework; National Assembly acts sovereignmonetary policy activities whereas SBV exercises the policies as orientation Reserverequirement, OMOs, discount policy are main monetary instruments of Vietnam Inempirical literature part, a majority empirical study recognizes the important role ofcredit channel despite of different country or econometric technique However, there is

CHAPTER 3: MODEL SPECIFICATION AND DATA

This part will include the analytical framework aim to give an overview aboutmethodology which be conducted in my thesis Next, V AR model will be introduced asthe key methodology to test the role of credit channel in monetary policy transmission inVietnam And finally, the steps of estimation which are employed in this thesis, arebriefly explained

3.1 ANALYTICAL FRAMEWORK

Rely on theory and empirical studies, an analytical framework is conducted below

Figure 3.1: Analytical Framework

When Vietnam's government implements new monetary policy through money supplyadjustment, this will be transmitted four channels; namely; interest rate channel,exchange rate channel, asset rate channel and credit channel All channels will affectmacro economy variables such as output, inflation through different ways as theory.Asset channel does not work as expected because of inexperience stock market inVietnam; hence, I do not analyze that channel in the study Otherwise, Vietnam's capitalmobility had controlled strictly in past Capital inflow or outflow is mainly driven byinterest rate in Vietnam Other words, Vietnam's capital mobility is imperfect, exchangerate channel does not including in my paper Lastly, interest rate channel and creditchannel are consider in my thesis, in which concentrate the role of credit channel in thetransmission of monetary policy in the case of Vietnam Two markets are classicalmarket (without credit) and augmented market (with credit), that are introduced toexplore the credit role VAR model will be employed both markets through three tests,they are Granger causality, impulse response, and variance decomposition From thecollected results, we can realize the differences between two markets At last, the role ofcredit channel in monetary policy transmission mechanism will be indentified.

3.2 MODEL SPECIFICATION

In order to meet the objective thesis, Vector autoregression (VAR) model will bedeveloped to answer a question: whether credit channel is key factor in monetary ·policytransmission in the case of Vietnam

Following the result of Stock and Watson (2001), VARs comes in with three varieties:reduced form, recursive and structural The thesis uses VAR approach and focusing onreduced form as convenient method to reap its targets

A reduced form describes each variable as linear function of its own past value and the past value of all other variables A reduced form ofVAR model can be derived as:

Yt is an m-dimensional vector of endogenous variables

C denotes a vector of constants;

<I> (L) denotes vector polynomial of lag operator with optimal lagorder;

Et is assumed to be vector white noise residual

The error term (Et) in the regression is the unpredicted movements in the variables aftertaking its past value into account Each equation is estimated by ordinary least squaresseparately and the number of optimal lagged value will be resolved by differentmethods

The variables used for this thesis are quarterly from 1996 :Q 1 to 2010 :Q3 Because of aspecific characteristic of Vietnam, hence, we are hardly to access data for longer period.Those variables are M2, customer price index, domestic credit, real industrial output,refinancing rate, lending rate Table 3.1 will describe in details the definition, also thesources of data in briefly Those macroeconomic variables represent a parsimonious butpotential complete for macroeconomy in the case of Vietnam There have severalmotivations for choosing this particular set of variables As the work of Romer andRomer ( 1990 ), a decreased in the quantity of reserves leads to a reduction the quantity

of loan availability Furthermore, that reduction in stock of reserves has caused bycontrationary monetary policy M2 is chosen because of it is the most widely usedmeasures of money and policy shock in Vietnam case And refinancing rate is

another tool of State Bank of Vietnam to tighten monetary policy (Hung and Pfau, 2008).

The customer price index is also included with purposes of inflation because theinflation rate is known as important predictive power for output Certainly, domesticcredit variables must be included in the model to measure supply loan in domesticeconomy Similarly, lending rate is an important component in transmissionmechanism of policy that has already mentioned at theory section GDP is the typicalvariable to measure the economic growth for one country, however, in the case ofVietnam, this data only exists since 2000 year Hence, real industrial output will beemployed as a proxy of GDP In the empirical paper of (Hung, L.V and Pfau,W.D.,2008) also used this way in VAR model to analysis the monetary transmission inVietnam Spurious regression need be controlled of all variables, because Asteriou andHall (2007) suggested that most of macroeconomic time series are trended, means thatthey are non-stationary

Base on the resulting of empirical study ofLown and Morgan (2002) had done to look

• for evidences the role of credit channel in U.S case They classified loan market into

two scenarios: a classical market with quantity and price and augmented market withcredit included We will apply this improvement in Vietnam case: a classical market(comprising: customer price index, money-quasi, industrial output, refinancing rate andlending rate) and augmented market with including credit as proxy for loan supply ordomestic credit to economy

3.3 DATA SOURCES

M2denoted broad of money stock and are defined by formula:

M2= Money + Quasi-money

According to IFS's definition in 2009, M2 comprises money (Ml) and saving, timedeposit in national currency and demand deposits in foreign currency, other than those

of the central government, with other depository corporations

CPI denoted consumer price index The indices are calculated by 37 largest provinces that

presenting 8 economic regions and the weights is derived from the 2004 VietnamHousehold Living Standard Survey (IMF world and country noted, 2009)

credit to private sector and other account

OUTPUT denoted real industrial output As already represented, Vietnam's industrial output

is used as proxy for GDP, due to data limited

Table 3.1: The data sources

REFIN symbolized refinancing rate That is the rate charged by the State Bank of Vietnam

on its lending to facilities to all credit institution (IMF world and country noted, 2009)

LR symbolized lending rate This index is calculated by average rates at the end of period on

short-term working capital loans for four large state-owned commercial banks (IMF worldand country noted, 2009)

Excepting for output that is extracted from Vietnam General Statistic Office, thesevariables are taken from the International Monetary Fund's (IMF) InternationalFinancial Statistic (IFS)

3.4 STEPS OF ESTIMATION

Stock and Watson (200 1) stated that due to the complicated dynamics in the VAR,below statistics are more informative than estimated V AR regression coefficients or R2statistics

Stationary and unit-root test: According to Gujarati (2003 ), stationary time series are so

important, because if a time series is non-stationary, its behavior only for the time periodunder consideration And if we regression with non-stationary time series may have nomeaning, called "spurious" as usual Hence, it is necessary to test stationary for all variablesbefore we apply VAR model

There have various formal statistical tests for unit-root problem Among them,Augmented Dickey Fuller (ADF) and Philips-Perron (PP) test are preferred than inwhich includes extra lagged terms of the dependent variable in order to eliminateautocorrelation

The Granger causality test: is the second step when regress VAR model And this test has

been popular in economic policy analysis It is a useful tool to check the significance of thecoefficients X1 can be predicted accuracy by using the past value of

Yt variable rather than not using such past value, or causality represents the ability of one variable to predict another variable.

The impulse response and variance decomposition: Impulse responses express the

response of current and future values of each variable to a one unit increase in the currentvalue of one ofVAR errors This experiment implied the changing of one error, whileholding the others constant Moreover, it also plotted± 1 standard error bands, which yield

an approximate 66 percent confidence interval for each impulse response And with forecastthe error decomposition econometric tool, we can see the percentage of the variance of errormade in forecasting a variable due to a specific shock at given horizon (Stock and Watson2001)

CHAPTER 4: FINDING AND DISCUSSION

Firstly, this chapter will depict the descriptive statistic of all variables in which relevant tothesis Next, estimation results when employ econometric techniques are presented anddiscussion Last, we will compare our findings with previous papers to realize what thecontributions of study are

4.1 DESCRIPTIVE STATISTIC

This part reports the descriptive statistic of all variables of original data, also changed It

summarizes the mean, median, max, min, standard deviation and count of eachvariable

Table 4.1: Description statistic ofvariables

Source: Calculated from IMF-IFS and GSO data

The standard deviation ofCPI, CREDIT, M2, and OUTPUT are too high, as well as the

large spread between maximum and minimum point indicates that the high volatility

during this time (table 4.1 ) Therefore, the estimation results base on their original

value can be unreliable By transforming to logarithm form of variables and

multiplying by 100, or estimating those variables in percentage changes otherwise

makes the standard deviation ofthem drop significant

More details, Figure 1a&b in appendix helps us overview glance for original data in this

thesis The domestic credit supply and quasi-money have same the trend, extending also

increasing continued and sharply, special after 2007 year While the incremental output

changes not much As have already mentioned in Chapter 2, we can explanation for

increasing sharply of credit by a huge capital inflow and estate price bubbles

4.2 UNIT ROOT TESTS

Supporting of Asteriou and Hall (2007) commence that macro economic variables

usually have trended Both of two tests, Augmented Dickey-Fuller (ADF) and

Phillip-Perron (PP), showed that all variables are non-stationary (Table 4.2 & 4.3).

Table 4.2: Augment Dickey-Fuller test

Meanwhile changed data are stationary; excluding CL_ CPI variable has not satisfied

criteria to conclude stationary at ADF test However, it is satisfied at PP test case

Therefore, those data can be employed to find the keys answer of thesis

Table 4.3: Philips-Perron test

Source: Calculated from IMF-JFS and GSO data

Concern to the optimal lag problem for V AR model, different criteria are used to

determine

Table 4.4: Optimal lap-Classical market

Table 4.5: Optimal lap-Augmented market

* indicates lag order selected by the criterion

LR: sequential modified LR test statistic (each test at 5% level)

FPE: Final prediction error

AIC: Akaike information criterion

SC: Schwarz information criterion

HQ: Hannan-Quinn information criterion

As shown at table 4.4&4.5, various statistical methods can be used to choose theoptimal lag length for our model But AIC and SCare known two most important ones.With aim to minimize an "information criteria", the optimal number of laps is five based

on the minimum AIC criteria both two markets So that, I decide to choose five lags fortwo cases when apply V AR model

4.3 VAR REGRESSION STATISTICS FOR CLASSICAL AND AUGMENTED

MARKET

Regression statistics for VAR with a classical market are presented at table 4.6 Thenumbers in this table are p-values when run VAR Granger Causality test include 5 lags.The null hypothesis states that independent variable does not cause dependent variable.Some of relationships may be revealed interesting matters Lagged values of most ofvariables are highly significant predict output at 5 percent level, excluding lending rate

at 10 percent but output does not Additionally, lending rate does not help to predictmoney-quasi, but it is useful about forecasting consumer price index, output, andrefinancing rate at 10 percent level Even, refinancing rate contains not much

information to predict remain macro variables at 10 percent significant level, exceptingoutput And what happen with money supply, it does not Granger cause lending rate,

however it is useful for predict output, also price level and refinancing rate at 10 percentlevel For long time, from the late 80's to 2000 year, Vietnam's interest rate mechanismtends to maintain positive real interest rate, as a solution of inflation control (Dung, 2010)

Then, this objective had been achieved Sometimes, deposit rate was higher than lendingrate, for instance, in March 1989 the spread between interest rate on industry loans and threemonths household deposit was minus 1.5 percent (IBP USA, 2005) Since August 2000, theSBV replaced the ceiling mechanism with the base interest rate mechanism combine withamplitude with this rate Under this mechanism, the SBV could limit the lending ratecharged by banks (IBP USA, 2005) With actual situation of Vietnam, obviously, lendingrate is not liberalized in Vietnam until recently, so can not reflected the demand and supply

in money market (Hung and Pfau, 2008) Notably in market without credit, no independentvariable in classical market is Granger cause for money supply The absence of a strongcorrelation between lending rate and money supply, those macro variables and moneysupply suggests that classical market might be missing something

Table 4.6: VAR Regression Statistic- Classical market

VAR Granger- CausalityTestDeQendent Variable

Table 4.7: VAR Regression Statistic- Augmented marketAugmented VAR Granger- CausalityTest

Source: Calculated from IMF-IFS and GSO data

Note: The reported are p-value

Continue with augmented market, with credit variable appearance Some findings may

be familiar with credit channel literature The lagged values of credit are stronglysignificant in forecasting money supply (the p-value is zero) But credit Granger causedneither output nor price level (p-value are 0.67 and 0.19 respectively) The result impliesthat State Bank of Vietnam used credit as mainly channel to inject liquidity into moneymarket Price level is another usefully ones to forecast money supply at 5 percent level

At augmented credit market, lending rate still does not predict output and a significantGranger cause either money policy shock or credit but somewhat weaker (p-value is 0.1

or 10 percent significance) However, this improvement compare to above market oflending rate's result has proved the crucial role of credit appearance in case Price leveland refinancing rate together Granger caused output Output and lending rate helppredict credit at 10 percent significant, whereas M2 fails to forecast either credit oroutput

In general, we can draw some worth findings from regression statistic Firstly, VARresults with classical market might be unduly explained monetary transmission andlending channel operating, while augmented model, including credit, highly significant

in forecasting money supply Secondly, the role of lending rate seems overshadowedmoney market regulation in model without credit; however; its role seems to beimproved in model with credit Thirdly, price level and lending rate are second and thirdvariables respectively that useful to predict money supply beyond credit

4.4 IMPULSE RESPONES AND VARIANCE DECOMPOSITIONS

Let's look at the dynamics implied by these regression estimates and concentrate thatshocks to monetary policy as well as to credit variables have on the macroeconomy.Following the literature, in the case of Vietnam, we indentify the changes in monetarypolicy with shocks to the money supply or M2