The impacts of capital flows on vietnam stock market

With the competitiveadvantages of lower production cost and investment risk than in other SoutheastAsian countries, Vietnam has become an attractive destination of foreign capitals.Vietn

UNIVERSITY OF ECONOMICS

HO CHI MINH CITY

VIETNAM

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

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

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

I am deeply grateful to my supervisor Dr Nguyen Hoang Vu from Department

of Mathematic and Statistics, Dr Nguyen Trong Hoai-Vice President, Dr PhamKhanh Nam from Department of Development Economics , University ofEconomics Ho Chi Minh City whose support, stimulating suggestions andencouragement helped me in all the time of research for writing this thesis

I am also very grateful to all lecturers of the Vietnam-Netherlands Programmefor 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 andresearch 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 warmencouragement

ACRONYMS AND ABBREVIATIONS

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 onVSM 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 &Grangerapproach 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 statement1 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 17

3 1.1 Stationary and unit root tests 17

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

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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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CHAPTER 1: INTRODUCTION

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This chapter will introduce the thesis topic and identify the problems going to beanalyzed in the thesis It gives the research objectives, research questions and researchscope This chapter also provides the structure of thesis

1.1

After the official joint to the World Trade Organization (WTO) in 2007, Vietnamhas been opening the financial market, economy and trade With the competitiveadvantages of lower production cost and investment risk than in other SoutheastAsian countries, Vietnam has become an attractive destination of foreign capitals.Vietnam is making a good impression on international investors because it isexpanding rapidly in emerging market and obtaining dramatic

policies on foreign investment restrictions in the stock market, Vietnam has further

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enhanced attraction to international equity investors

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

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

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

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

In fact, FPI flows into Vietnam have been increasing rapidly in recent years.Especially, since Vietnam officially joined WTO in 2007, FPI flows have increasedstrongly, 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 921points to 316 points and caused bad effects on macro economy Then, along with theeconomic recovery, the stock market witnessed a net inflow of FPI capitals but thestock market rarely crossed 500 points, with mini-recoveries inevitably followed bylengthy 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 adeveloping country and supplement domestic savings for improving the investmentrate Moreover, FPI also reduces the pressure of foreign exchange gap for the less-developing countries Second, rises in foreign capital inflows can increase theallocated efficiency of capital in a country Therefore, FPI can induce financialresources 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 thedomestic 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 ratiosbecome 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 encouragenew equity issues with higher premium On the other hand, FPI flows also stimulatethe 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 thesocio-economic development plan and state budgeting for 2012, the main targets foreconomic development in 2012 have been set up such as about 6% to 6.5 %in theGDP 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 socialdevelopment accounting for 33.5% of GDP, the expansion in the consumer price indexless 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 fiscalpolicy, stabilizing the macro-economy, maintaining growth rate at a reasonable level

by reinforcing the inspection of market and prices, well-organizing the domesticmarket, encouraging exports, controlling imports and reducing trade deficit On theother hand, they also object to growth model renovation, the national economyrestructure and improvement in the quality performance and competitiveness of thenational economy and enhancement in the performance of external relations andinternational integration by these solutions: restructuring investments focused onpublic investments, restructuring the financial and banking system, especially oncommercial banks, restructuring enterprises focused on SOEs

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

~tudies have focused on the major well- established markets or on the other macrofactors' influences on stock markets Thus, an increased knowledge of how foreignportfolio investments influence on Vietnam stock market (VSM) is a practicalinterest to investors and financial researchers

Therefore, finding the impacts of FPI flows on Vietnam Stock Market, especially inthe long-run, will help policy makers improve policies to attract more FPI flows andachieve 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 toencourage 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 afterany changes in FPI flows? So how long does it take for the change totake 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 fromJuly 2000 to June 2012

1.5 Structure of the thesis

• Chapter 4 shows the statistic results from adopting the econometric modelabove 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 forthe links among FPI & VSM This chapter is divided into five main parts The firstand second parts contain the concepts and the roles of FPI & VSM to economicgrowth The third part, theoretical frameworks include some theories about therelationship between FPI and stock market, conceptual framework The fourth partpresents empirical studies about the impacts from FPI flows on stock market indetail 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

1

• economic growth and expand resources for development finance, governmentsusuallypromote international capital inflows, strengthen capital markets in order to encourageefficient financial markets According to Bakardzhieva et al (2000), capital flows wereclarified into several types "Three distinctive flows appear in the financial account ofbalance of payments, namely foreign direct investments (FDI), portfolio investmentsand other investments" In this paper, we just focus on portfolio investments into theVietnam stock market These flows are referred as the foreign portfolio flows (FPI) inVietnam

Foreign Portfolio Investment (FPI) represents passive holdings of securities such asforeign stocks, bonds or other financial assets, none of which entails activemanagement 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 canbring rapid development, helping an emerging economic opportunity, job creations,

and significant wealth When an economic takes a downturn, or fails to meet theexpectations of international investors, the huge capital inflows can be withdrawngrammatically According to World Bank (2001), the external problem of excessivecapital outflows were as follows: the capital outflows above critical threshold levelsmight impact adversely on the domestic economy by draining foreign exchangereserves, reducing the resources available for domestic investment, and slowing thedeveloping of the financial sector However, the World Bank (2001) report alsofound that there was an existence of a strong relationship between FPI withdomestic investment In the other word, in a research on some East Asia economiesduring 1990s of Henry (2000), stock market liberalization on trading might lead toinvestment booms But, capital inflows might not lead to economic growth because

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

2.2 The role of Vietnam stock market (VSM).

The State Securities Commission, part of the Ministry of Finance, has beenmanaging 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 inadministering 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 stockexchange was inaugurated in July 2000 and became a main Vietnam stock exchangewith approximately 280 companies listed We use the measure of VSM expressed asVN-Index quoted in the Ho Chi Minh stock exchange It is a capitalization-weightedindex of all the companies listed on the Ho Chi Minh Stock Exchange The indexwas created with a base index value of 100 as of July 2000 In order to

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

Stock markets bring benefits to corporations, individual investors and governments

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For corporations, by making an Initial Public Offering (IPO) on the stock exchange, acorporation can gain access to a huge amount of investors, raise capitals by attractingabundant capital resources for their business Moreover, access to the stock markets alsofacilitates growth by merger or acquisition through share purchases For investors, stockmarkets are able to help them improve returns by diversifYing their choices of differentcorporations 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 ofreturn For the economy, stock markets can put people's savings to work, the economycannot get benefits or just a little from individual cash savings or bank accounts Stockinvestment is a direct method in the success of businesses and helps promote strongereconomic growth In the other word, stock markets are also a measure of the economy'sperformance In general, the performance of share prices is a good indicator of itscurrent condition and of the confidence of individuals within that economy So, in someextent, the performance of the stock market is correlated with the health of theeconomy Moreover, the strict regulations and requirements for corporation's stock to belisted on the stock exchange and maintained on trading are a good way for investors toensure corporate governance because management standards and standards of recordkeeping within that corporation are maintained at a high level For governments, stockmarkets can give access to funds because the stock exchange allows individuals to lendmoney to their government when government may issue bonds quoted on the stockmarket 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 andstatistically significant positive correlation between monthly foreign purchases ofMexican 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), whoexamined foreign investors' impacts on the Korean stock index from November 1996 tothe end of 1997, found evidences of foreign investors' positive trading and herdingbefore the Korea economic crisis However, there was no evidence that the foreigninvestors· transactions had a destabilizing impact on the Korean stock market duringtheir sample period The Korean stock market was adjusted quickly and efficiently bylarge sales of foreign investors On the other hand, Bose and Condoo (2004), whostudied the impact ofthe FII policy reforms on FII portfolio flows to the Indian stockmarket through a multivariate GARCH regression model, strongly suggested thatliberalization policies had had the desired expansionary effect and obtained a sensitiveimpact of FII inflows to a change in BSE returns

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

markets because their banks could promote long-term economic growth andindustrialization Moreover, they were able to suffer the burden of globalization1

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 hadnot been utilized in India The prediction that the foreign portfolio investors wouldboost 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 stockownership by institutional and foreign investors in both Japan and Korea, foreigninvestors 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, thepreferred stocks of both institutional and foreign investors had statistically significantpositive abnormal profits in both markets while favored ones by either institutional orforeign investors had statistically significant positive abnormal only in Korea In otherword, Liljeblom, E and Loflund, A (2005), who investigated determinants of foreignequity investment flows after the deregulation of Finnish stock market, indicated thatthe Finish stocks owned by foreigners were found to deviate clearly from the Finnishstock market Portfolios of foreign investors were significantly titled to additionalwithholding tax on low dividend-yield Moreover, large- capitalization and liquiditystocks were preferred with a record of strong profitability (measured by past ROI).Additionally, Thapa and Poshakwale (2012), who found the answer for the questionwhether national equity market characteristics explained specific differentiation indistribution of foreign equity portfolios by using panel data of comprehensive foreignportfolio holdings and different measures of national stock market factors for 36 hostcountries, showed that foreign investors prefered larger and more visible developedmarkets with higher liquidity, higher efficiency and lower transaction costs

However, only a few studies like Froot et al (200 1) found a bilateral impact ,betweenFPI flows and stock returns They studied the behavior of international I portfolio flowsand their relationship with equity returns by employing panel data of

144 countries and found that international portfolio flows were strongly influenced bypast returns while foreign portfolio inflows had positive impact for future equityreturns Moreover, the sensitivity of local stock prices to foreign inflows was positiveand large

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

it drops, the share price comes down If foreign investors invest in a company,

jt is the good signal for this company's growth rate because they have seen the

;;

potential growth in the recipient However, in case, foreign holding rate is too large,

tt means that this company's stock price is very volatile and risky because it's easier for

foreigners to move out of a stock But no one can deny some positive impacts of FPI on

stock markets First, foreign portfolio investors are professionals on stock markets So,

they always purchase stocks on the basic of fundamentals It means that they require

more information to evaluate This leads to growing demands on companies to become

more transparent and more disclosure in order to be more attractive to investors Thus it

helps reducing information asymmetric on stock markets Second, the globalization on

stock markets require to reform securities trading and transaction systems, nurture

securities brokers and liquid markets Third, the stock markets' openness for FPI makes

it more attractive to foreign capital either direct or indirect flows Fourth, FPI inflows

boost financial innovation 'and development in trading instruments Not only does it

enhance competition in

financial markets but also improves the alignment of asset prices to fundamentals

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:However, the other side of the coin is that there are some dangers if certain limits are

exceeded First, FPI flows are free and unpredictable Moreover, foreign investors

always look for profits When FPI flows move investments, they are likely 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

2.4 Empirical studies.

flows and stock returns By applying various methods, most recent studiesdemonstrated the complementary impact of FPI on stock returns

Chakrabarti, R (200 1) analyzed FII flows in India and their relationship with othereconomic variables including stock returns by applying Granger Causality test onmonthly data from January 1993 to December 1999 of FII flows to India, marketcapitalization data and other financial data like the exchange rate, short term interestrate in India, return on the MSCI world index, S&P 500, BSE national index andcountry credit rating data He arrived the conclusions related to stock returns thatwhile the flows were closely related to Idian equity returns, they were effected bythese returns rather than the cause of that Moreover, the Asian crisis marked aregime change in the determinants of FII flows to Indian equity returns becomingthe sole driver of flows since the crisis Moreover, when Fils were compared to thelocal 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 therelationship of foreign institutional investment (FII) flows to the Indian equitymarket with its possible covariates for the period January 1999 to May 2002 Thefirst included variables reflecting daily market return and its volatility in domestic

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

tendency to be caused by stock market returns but not vice versa It meant thatIndian 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 stockmarket's performance, this market performance did not cause FII purchase In otherwords, FII investors did not diversify their investments by Indian stock market.Also, returns from exchange rate differentiation and the Indian economicperformance 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, thereare numerous evidences in a group of specific countries Syriopoulos (20 10)employed weekly stock index closing prices in the Balkan countries such as theBET-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 Germanyexpanding from April 27, 1998 to September 10, 2007 to examine the risk and

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:return of international portfolios allocated by investors to major Balkan equitymarkets They applied linear method like error-correction vector autoregressivemodel and non-linear method like switching regime error correction model to testfor the potential linkages between Balkans and developed stock markets The resultsillustrated the presence of co-integration vectors indicating a stationary long-runrelationship among the Balkan equity markets On the other hand, the Balkan equitymarkets were affected by both domestic and external forces and shaped their long-run equilibrium path However, inflows of international portfolio investments andtrading activity in the Balkan equity markets were growing rapidly

Saxena and Bhadauriya (20 11) collected daily data series on Fils inflows and S&PCNX NIFTY computed by logarithmic returns on daily closing prices for 7financial years from April 2003 to March 2010 to explore the causal relationshipbetween 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 beforeincluding them into a VAR system In order to test the variables' stationary, they usedAugmented Dickey Fuller test and Phillip Peron test They aimed to find the answer forthe question that whether movements in Fil inflows had an effect on stock marketreturns 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 betweenstock market volatility and Fil inflows They found that stock market volatility was acause to foreign institutional investment inflows and the trends of foreign institutionalinvestment inflows did not have that much impact on stock market volatility Also, theyfound that the past data of stock market returns could forecast the present and futuretrend of foreign institutional investment inflows to India

The most recent research is Kumar et al (2012) who studied empirically dynamicinteraction between Foreign Institutional Investor (Fil) flows and Indian stock marketreturns through aggregate daily Fil data comprising three components purchases, salesand net purchases along with the S&P CNX Nifty market index taken by the logdifference from 7th January 2000 to 61

h August 2009 using ordinary least squareregression , vector auto regression and impulse response function along

with Granger Causality test to illustrate a sharp and significant impacts between Filflows 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 theGranger 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 overallresponse function of institutional investors to a one standard error shock revealed asharp 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 10), we

adopt unit root test, co-integration test, Granger Causality test and vector error ~orrectionmodel to study the impact of FPI flows on Vietnam stock market Due to 6ur support tothe 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 FPIflows and stock market returns However, we shall expand the data into monthly datalike the study of Chakrabarti (200 1) to get a general view about the 'impacts from FPIflows on stock returns in month by month Moreover, we shall learn the methods ofSaxena and Bhadauriya (20 11) in testing time series data such ,as unit root test usingboth Augmented Dickey Fuller (ADF) test and Phillip Peron

(PP) test, Granger Causality test in a hi-variable VAR framework Additionally, wealso extend to co-integration test on these monthly data to examine a long-termrelationship between them In other words, we shall adopt a lesson from Syriopoulos(20 10) in using error correction model to investigate a short-run relationship betweentwo 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, wesummarize this chapter into the chapter remark

3.1 Econometric techniques

3.1.1 Stationary and unit-root tests

According to Gujarati and Porter (2009) a time series is stationary when its mean andvariance are constant over time and the value of the covariance between the two timeperiods depends only on the distance or gap or lag between the two time periods andnot the actual time at which the covariance is computed Our thesis uses a set of timeseries data to generalize the behavior of foreign portfolio investment (FPI) andVNindex (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 periodunder-consideration As a consequence, it is not possible to generalize it to other timeperiods So the regression becomes spurious and lead to incorrect conclusions

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

mAYt= ao + ~~Yt-I+Ot: + IeiAYt-I +Et

3.1.2 Co-integration

When we regress two non-stationary time senes, we may produce a spunousregression Suppose we consider two time series data X &Y and subject these timeseries 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)

the most conventional technique But it is very restrictive because it can be appliedonly 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

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relationship between two variables: FPI and Delta-VN According to Gujarati andPorter (2009), the Granger causality test assumes that the information relevant to theprediction of the respective variables is contained solely in the time series data

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

K

Xt =a+ 2: BiXt-1 +

i=lWhere a is the intercept, K and L are the order of auto regression for the variable Xand Z, respectively, Bi is the parameter associated with the ith lag of variable X, A:i isthe parameter associated with the jth lag of variable Z and £ 1 is white noise The nullhypothesis that X does not Granger cause Z is determined by comparing the F-test ofthis full model 2 versus a restricted model in which X is regressed on only its ownlagged values (A:i=O, j=l,2 L)

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

3.1.4 Error correction mechanism

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

k-1

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

i=lWhere ~ is the difference operator, Yt is (Delta-VN, FPI), 90 represents theintercept, 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 errorcorrection 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

1973) In equation 4, the null hypothesis the growth rate of FPI does not cause the growth rate

I

1null hypothesis the growth rate ofDelta-VN does not cause the growth rate ofFPI is

1rejectedI provided either the sum of Aj or ois statistically significant

3.2 Data collection

The analysis is conducted on monthly data from July 2000 to June 2012 Thus, we

have 144 observations All variables are presented in table 3 1

Table 3.2-1: Variables summary.

are computed by taking purchase flows less sales flows and simply named FPI ·

variable in this thesis

On the other hand, we take the last indices of the month as monthly indices for

VN-VNindextDelta-VN=logVNIn de Xt-J

21

' 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

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

3.3.3 Interaction between FPI flows and VN-Index.

5,500 5,000 4,500

3,000 2,500 1,500 1,000

0-h~~:r-,.""""'1""""!-"~

-1,000

-1 ,5oo -2,ooo

-2,500 -3,000 _. _ 0

signing the Bilateral Trade Agreement with United State in July 2000 and officially joiningWorld Trade Organizations (WTO) in 2007, Vietnam had committed to reform and openedthe 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 theVN-Index increase continuously After peaking the mark of 5170 points, VN-Index hadgone down quickly during the next 3.5 months, VN-Ipdex lost 64% of its value, and got

203 points on October 5th 2001 Before 2001,

I

24

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

1 market growth and the restrictions on foreign investment while other emergingmarkets were more attractive to investors than Vietnam During this period, the role

of foreign investors did not stand out on the VSM Due to the long stand-by stage inthe VN-Index, foreign investors did not appreciate the possibility of recovery and

~profitability of the share prices Moreover, the listed companies was too small and thelegal framework was so strict

Then, there was a rebound on the VN-Index up to 301 points before going into thedecline stage lasting for 2 years from November 2001 to 2003 The VSM was goingsideways during the two years 2004 and 2005 On March gth 2005, the HanoiSecurities Trading Center, where the small chartered capital companies were able to

be listed and traded, officially operated with less strict listing conditions toencourage small joint stock companies to list shares on the stock market So, ithelped 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 fromthe end of 2003 to 2006 was the recovery term and booming in FPI inflows whenthe government issued the opening and transparency policies for FPI investors.livforeover, the government aimed to promote privatization, loosen the foreigninvestors' stock holding ratio.Since 2004, foreigners had some positive reactions toVSM, the flows fluctuated around 10 billion dongs and reached the peak in thisperiod at 189.96 billion dongs on March 2004 In 2006, the interest of foreigners toVSM was increasing dramatically The net inflows had risen to over 500 billiondongs and hit the peak of2006 at 2,323.67 billion dongs on December

Before 2007, Vietnam economy performed regularly the low growth rate of CPIwhich 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

December During the first three months of 2007, the VN-Index increased with theaverage growth rate of 16.41% per month and the average transaction value of LOOObillions 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 Index rebounded strongly but still not escape the downward trend in the market In thesecond quarter, the index as well as the volume and value of transactions of VN-Indexagain bottomed 890.02 points on 20th August Then the market began to recover on09th May, the VN-Index peaked at 1,106.06 points on 03th October After that, due tothe coming IPO deluge and the date of Implementation of the Directive No 03 regulated

VN-to control the rate of loans in Securities lending investment not exceed 3% of the VN-totaloutstanding loans of aommercial banks, the market started coming down withtransaction value decline and the VN-Index plummeted on 28th December at 927.02points, 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 listedmarket, the rest was in

1 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 ltheheat development in the VSM The foreigner investors'trading had become morevibrant because foreign investors were paying more attention on the VSM since wejoined the WTO Whole the year 2007, the trading volume and value !accounted for36.09% 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 bankhad withdrawed cash from circulation by many strong methods forced

commerical banks to push up interest rates to raise capitals due to cash scarcity Whilethe 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, theVN-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 StateSecurities Commsion of Vietnam (SSC) decided to reduce trading amplitude to calmdown investors in trading As a result, speculative psychology came back themarket However, the macro-economy stage was still so bad that this short-term uptrendwas ended soon on April 091 h 2008 after the VN-Index increased continuously in 11sessions 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 bigsales-off shares which were the large capitalized blue chips from the Repocontracts of securities companies and commercial banks Combination of thesefactors had pulled VN-Index decline exceeded easily 400 points and touched thebottom at 367 points on June 11th 2008 Since the macro policies had come toeffectiness in the middle June, the trade deficit decreased significantly, creditgrowth slowed down selectively After the market fell to the bottom at 367 points,

speculators came back to collect the cheap

stocks When the market was recovering, on 17th July, the government announced toincrease gasoline price up to 31.05% from 14,500 VND /litre to 19,000 dong /litre ofA92 As a result, the VN-Index fell consecutively for 6 sessions as investors lostconfidence in the policy makers The July inflation rate rose 1.13 percent than that

1of in June which proved that the tightening monetary policies had been uneffective.The shocks in increasing fuel prices suddenly came to an end, investors returned to themarket so that the VN-Index had increased consecutively in August When the policywas on the good progress, we met the financial crisis in the last quarter of 2008 whichmade the demand decreased.In September, the market influenced by the U.S financialcrisis continued its bearish long-term stage The VN-Index nearly bottomed at 303.54points on 2ih November Thus, the government had to tackle

the recession Instead of tightening monetary policy to control inflation, in order to

·stimulate the demand, the government decided to loosen the monetary policy

negative impacts on macroeconomic stability

Although the state bank loosens monetary policy, the high lending rate preventedenterprises from accessing capitals since commercial banks were racing to mobilizecapitals to cover the liquidity

On December 2008, the state bank also offered a fiscal stimulus package valued 6billion US dollars, equivalent to 100 trillion dongs to prevent the effects of the globaleconomic recession The package aimed to recover the slowing growth of economy bystimulating consumption and investment by tax cuts and interest rate assistance forbusiness, infrastructure, schooling, hospital Since the early of October 2008, foreigninvestors had sold off about 2,150 billion dongs equivalent to U.S.$126 millions Thisperiod was the most deeply impacted by the global ,financial crisis in this year.However, the net flows of whole year were bought off about 5,000 billions The reasonwas that the VSM was higher risky than that of in other countries in the region whenthe VN-Index declined approximately 10.1% of the value The second reason was thelow liquidity in the VSM as the total market

capitalization in 2008 was only US$13 billions which was too smaller than other Asianstock markets.

Due to the global financial crisis in 2008, the dramatic decrease in demand made theinflation rate in 2009 fallen to 6.5% In 2009, facing economic recession and thedownturn in the stock market, the government has adopted some indirect instruments

to stimulus the stock market such as personal income relaxation, tax exemptions forincome from equity investments or transfers On the other hand, it was not onlyaffected by the government's intervention in lessening the interest rate

I and required reserve along with the supporting package in stimulating theconsumption, but also the investment of 100 trillion dongs and 17 trillion dongs tosubsidize enterprises the low interest rate of loans with 4 % Thus, theimplementation of the loosening monetary policy focusing on subsidized interest

· rate of 4% in 2009 is considered as one of the important solution in stimulating thesecurities investment In the first quarter of 2009, these policies had been successfuland remarkably effective The interest rate reduced about a half from their peak in

2008 from 8.5% to 7% sustaining to the end November As a result, the stock market in

2009 had finished a spectacular year with many records over expected In the first 6months, the VN-Index increased about 118% From July to October, the

stock market boomed stronger and hit the peak at 587 points in October supported I byeconomic recovery signals, especially by financial leverage from the securities ·firms.However, the economic stimulus policies also had side effects and potential risks Thesupporting mechanism made credit growth rate become excess The credit growth in thefirst 10 months of 2009 reached over 33% which created the strain on interest rates, leading

to higher rate of capital cost and production cost Moreover, it made government difficult

in mobilizing capitals by bonds On the other hand, this policies also affected the stability

of interest rates and exchange rates, affecting the balance of payments and causing thedecline in foreign exchange reserves From November, the stock market entered therecession stage The market went to adjusting cycles caused by the impacts of tighteningmonetary policies, the