Access to credit and household income in the northern mountains of vietnam

Số hóa bởi Trung tâm Học liệu – ĐHTN http://www.lrc.tnu.edu.vn LIST OF ACRONYMS AND ABBREVIATIONS ADB Asian Development Bank AMK Angkor Mikroheranhvatho Kampuchea ANOVA Analysis of vari

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Số hóa bởi Trung tâm Học liệu – ĐHTN http://www.lrc.tnu.edu.vn

JUSTUS-LIEBIG UNIVERSITÄT GIESSEN

Fachbereich 09: Agrarwissenschaften, Ökotrophologie und Umweltmanagement

Access to Credit and Household Income in the Northern

Mountains of Vietnam

Inaugural-Dissertation zur Erlangung des Doktorgrades (Dr Agr.)

Fachbereich Agrarwissenschaften, Ökotrophologie und Umweltmanagement

Institut für Betriebslehre der Agrar - und Ernährungswirtschaft

Professur für Projekt – und Regionalplanung

Eingereicht von: Do Xuan Luan (MSc.)

Erstgutachter: Prof Dr Siegfried Bauer Zweitgutachter: Prof Dr Rainer Kühl

Giessen – November, 2015

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The empirical findings reveal that the poor, especially the poorest households are still underserved by overall rural credit The Agribank credit tends to provide to wealthier households and informal credit serves households that are closer to and above the relative poverty line Subsidized credit successfully targeted the poor, implying that governmental subsidies are necessary to reach the poor Credit accessibility analysis has highlighted the importance of social capital and agricultural extension services in determining credit accessibility by rural households Whereas a significant increase in household income can be achieved through accessing commercial and informal loans, there is no significant increase in all income components for associated recipients of subsidized credit Based on the findings of the study, a set of policy implications aimed at improving poverty targeting and credit access can increase the impact of credit on reducing poverty in a sustainable manner

For the editors: Siegfried Bauer, University of Giessen, Germany

ACKNOWLEDGEMENTS

First and foremost, I am deeply indebted to my first supervisor Prof Dr Siegfried Bauer for his continuous guidance, moral support and encouragement throughout this process I am also thankful to my second supervisor Prof Dr Rainer Kühl for his constructive suggestions Guidance and understanding from both supervisors proved crucial to the successful completion

of this work My thanks also go to the members of the examination committee, Prof Dr Ingrid-Ute Leonhäuser, Prof Dr Joachim Aurbacher and Prof Dr Michael Schmitz The administrative support and cooperation of Mrs Schlocker, Dr Evelina and Dr Tarig is also worth mentioning I would also like to express my appreciation to Heinz Lakos for his technical support, to Mr Danner McCulloh for his English correction of the text, to Mr.Max and Dr Aaron for their correction of the German summary I also acknowledge the Vietnamese Ministry of Education and Training for the doctoral scholarship My sincere thanks go to the faculty of economics and rural development at Thai Nguyen University of Agriculture and Forestry I would like to thank the Central Institute for Economic Management (CIEM) of Vietnam for providing the data and Dr Kieu Thi Thu Huong for supporting me in my application for the doctoral program I would like to take this opportunity to thank Mr Nguyen Thanh Vu and international colleagues for their support

The inspiration and support of my father Do Xuan Luong, mother Vu Thi Sau, my brothers and sisters were my main source of strength My heartfelt appreciation goes to them My deepest thanks go to my son Do Anh Duc, my daughter Do Khanh Linh and my wife Duong Thi Thu Hang for their inspiration, support and sacrifice

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TABLE OF CONTENTS

TABLE OF CONTENTS i

LIST OF TABLES viii

LIST OF FIGURES x

LIST OF ACRONYMS AND ABBREVIATIONS xi

1 INTRODUCTION 1

1.1 Background of the study 1

1.2 Statement of the problem 1

1.3 Objectives 3

1.4 Hypotheses of the study 4

1.5 Scope and limitations of the study 4

1.6 Contribution of the study 4

1.7 Structure of the study 5

2 AN OVERVIEW OF ECONOMY, POVERTY AND RURAL CREDIT SYSTEM IN VIETNAM 6

2.1 Geography 6

2.2 Macroeconomic performance 6

2.2.1 Key development indicators 6

2.2.2 GDP, credit and inflation in Vietnam 7

2.2.3 Economy‘s structure share in Vietnam 8

2.3 Agriculture and Poverty 9

2.3.1 Agricultural performance 9

2.3.2 Rural labors 11

2.3.3 Fragmentation of agricultural land 11

2.3.4 Poverty in Vietnam 12

2.3.5 Agricultural insurance in Vietnam 13

2.4 Rural credit in Vietnam 14

2.4.1 Brief history of rural credit policy in Vietnam 14

2.4.1.1 Credit cooperatives before 1986 14

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2.4.1.2 Replacement of the mono-tier banking system after 1986 15

2.4.1.3 The separation between preferential and commercial lending 16

2.4.1.4 Incorporation of microfinance institutions in the financial system 17 2.4.1.5 Priorities for lending agricultural and rural sector 18

2.4.2 Rural credit demand 18

2.4.3 Supply side of rural credit in Vietnam 20

2.4.3.1 Formal, semiformal and informal credit 20

2.4.3.2 Market share and financial sustainability 22

2.5 Summary of the chapter 24

3 THEORETICAL AND EMPIRICAL FOUNDATIONS OF THE STUDY 25

3.1 Concept of credit and general issues 25

3.1.1 The credit concept 25

3.1.2 Types of credit 26

3.1.3 The triangle of credit 27

3.1.4 Challenges for the provision of credit to rural households 28

3.1.4.1 Principle of marginal return to capital 28

3.1.4.2 Information asymmetry 29

3.1.4.3 Characteristics of farming activities 30

3.1.4.4 Principal – agent problem in rural credit market 31

3.1.4.5 Transaction cost and borrowers‘ risk management 32

3.2 Poverty outreach of credit 33

3.2.1 Depth of outreach concept and measurement 33

3.2.1.1 Concept 33

3.2.1.2 Measurement 33

3.2.2 Empirical evidence on poverty outreach of credit 35

3.2.2.1 The extent to which credit serves the poor 35

3.2.2.2 Reasons explaining the credit exclusion of the poor 35

3.2.3 Credit subsidy 37

3.2.4 Summary 37

3.3 Access to credit 38

3.3.1 Concepts and approaches of analyzing credit accessibility 38

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3.3.2 Empirical determinants of credit access at household level 40

3.3.3 Summary 41

3.4 Credit repayment 42

3.4.1 Role of credit repayment 42

3.4.2 Measurement for repayment performance 42

3.5 Welfare impact of credit 44

3.5.1 How credit affect households 44

3.5.2 A foundation for impact estimation 46

3.5.3 Empirical evidence on impact of credit 47

3.5.3.1 Significantly positive impact of credit 47

3.5.3.2 Limited impact of credit and reasons 49

3.5.3.3 Mixed impacts of credit under certain conditions 50

3.5.4 Summary 50

3.6 International experiences in rural credit development 51

3.6.1 Germany 51

3.6.2 Bangladesh 52

3.6.3 Philippines 54

3.6.4 Indonesia 55

3.6.5 Thailand 56

3.6.6 Lessons to be learnt 57

3.7 Conceptual framework 58

4 RESEARCH AREA AND ANALYSIS OF SAMPLED HOUSEHOLD CHARACTERISTICS 60

4.1 Overview of the Northern Mountainous Region of Vietnam 60

4.1.1 Overall socio-economic conditions 60

4.1.2 Overview of the selected communes 62

4.2 Data source 63

4.3 Composition of selected households by sources of loans 66

4.3.1 Loan characteristics 68

4.3.1.1 Loan amount, duration and interest rate 68

4.3.1.2 Collateral security 69

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4.3.1.3 Mode of repayment 70

4.3.1.4 Credit use purposes 70

4.4 Demographic characteristics of selected households 72

4.5 Main agricultural activities 74

4.5.1 Crop production 74

4.5.2 Livestock production 75

4.5.3 Land size and land use certificate 76

4.6 Access to extension services 78

4.6.1 Receives of extension services categorized by sources of loans 78

4.6.2 Feedback of household to extension services 79

4.6.3 Extension and credit access 81

4.6.4 Extension and household income 82

4.6.5 Extension and other household endowments 84

4.7 Shocks and economic losses 86

4.7.1 Type of shocks and distribution of shock affected households by loan sources and provinces 86

4.7.2 Economic losses due to shocks 88

4.7.3 Household endowments categorized by shock affected 89

4.7.3.1 Income difference 89

4.7.3.2 Differences in selected variables between shock-affected and shock non- affected households 91

4.7.4 Household responses to shocks 93

4.8 Household savings 94

4.8.1 Savings and credit access 94

4.8.2 Motives for savings 96

4.8.3 Savings and household endowments 98

4.8.3.1 Savings and income 98

4.8.3.2 Savings and other household endowments based on loan sources 99 4.9 Ethnicity and credit access 101

4.9.1 Credit recipients categorized by ethnicity group 101

4.9.2 Ethnicity and credit volumes 102

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4.9.3 Ethnicity and household endowments 103

5 POVERTY OUTREACH OF RURAL CREDIT 108

5.1 Introduction 108

5.2 The methodology for evaluating poverty outreach 108

5.2.1 Principal Component Analysis: main ideas 108

5.2.2 Selection of variables for Principal Component Analysis 110

5.2.2.1 Point-Biserial Correlation 111

5.2.2.2 A description of selected variables 112

5.3 Empirical results and discussion 114

5.3.1 Results of Principal Component Analysis 114

5.3.2 Poverty outreach of rural credit 116

5.3.2.1 Depth of outreach based on relative poverty 116

5.3.2.2 The association between poverty scores and loan amount 118

5.3.2.3 Depth of outreach based on categories of credit exclusion 119

5.3.3 Summary of the chapter 120

6 DETERMINANTS OF CREDIT ACCESSIBILITY BY RURAL HOUSEHOLDS 121

6.2 Methodology 121

6.2.1 Choice of explanatory variables 121

6.2.1.1 Social capital 121

6.2.1.2 Human capital 123

6.2.1.3 Financial capital 124

6.2.1.4 Physical capital 125

6.2.2 Bayesian Model Average applied to the Heckman Selection Model126 6.2.2.1 Credit access model 127

6.2.2.2 Credit Amount Model 129

6.3 Results and discussions 131

6.3.1 Endowment difference between household groups 131

6.3.2 Result of Bayesian Model Averaging (BMA) 134

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6.3.3 Determinants of credit access 135

6.3.3.1 Determinants of accessing overall credit 136

6.3.3.2 Determinants of accessing subsidized credit 140

6.3.3.3 Determinants of accessing Agribank credit 141

6.3.3.4 Determinants of accessing informal credit 144

7 INCOME IMPACT OF CREDIT ON RECIPIENTS 147

7.2 Impact Estimation by Using Propensity Score Matching 147

7.2.1 Reasons for choosing Propensity Score Matching 147

7.2.2 Main ideas of Propensity Score Matching 148

7.2.3 Assumptions of Propensity Score Matching 150

7.2.4 Choice of matching algorithm 151

7.2.4.1 Nearest neighbor matching and radius matching 151

7.2.4.2 Kernel matching 153

7.2.4.3 Stratification matching 153

7.2.5 Assessment of the matching quality 154

7.2.6 Bootstrapping with Propensity Score Matching 155

7.3 Estimation Results 156

7.3.1 Income Impact of Credit without Using Matching Techniques 156

7.3.2 Income Impact of Credit by Using Matching Techniques 159

7.3.2.1 Income impact of overall rural credit 160

7.3.2.2 Income impact of subsidized credit 162

7.3.2.3 Income impact of commercial credit by the Agribank (VBARD) 166 7.3.2.4 Income impact of informal credit 169

7.3.2.5 Income impact per VND million of credit 171

8 SUMMARY OF THE STUDY: RATIONALE, MAIN FINDINGS, CONCLUSIONs AND POLICY RECOMMENDATIONS 173

8.2 Rationale of the study 173

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8.3 Methodological approaches 174

8.4 Main findings 174

8.4.1 Household characteristics 174

8.4.2 Poverty outreach of credit 176

8.4.3 Determinants of credit access 176

8.4.4 Income impact of credit 177

8.5 Conclusions 177

8.5.1 The extent to which credit reaches the poor 177

8.5.2 Factors influencing credit access 178

8.5.3 Income impact of rural credit 178

8.6 Policy implications 179

8.6.1 Improve the extent to which credit reaches the poor 179

8.6.2 Credit schemes should be adaptable to the farming seasonality and the cash flow of households 179

8.6.3 Development of risk copping measures for the poor 180

8.6.4 Encouraging the provision of commercial loans 180

8.6.5 Informal credit still retain as a necessity for the poor 181

8.6.6 Facilitating access to extension services 181

8.6.7 Mobilization of rural savings as the important source of credit 182

8.7 Limitations and suggestions for further studies 182

ZUSAMMENFASSUNG 183

REFERENCES 188

APPENDIX 200

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LIST OF TABLES

Table 2.1: Development indicators of Vietnam 7

Table 2.2: Production of main agricultural commodities 10

Table 2.3: Rural labors in Vietnam 2001-2011 11

Table 2.4: Poverty headcount and composition by regions and sector in 2010 (Based on General Statistics Office- World Bank poverty line) 12

Table 2.5: Percentage of crops and livestock covered by agricultural insurance 13 Table 2.6: Financial sustainability of credit institutions as of June 30th 2009 23

Table 4.1: Socio-economic indicators of the Northern Mountainous Region (NRM) in relation to other regions and the whole country 61

Table 4.2: Commune characteristics in selected provinces (% of communes) 63

Table 4.3: Loan characteristics by lenders 68

Table 4.4: Share of loans with collateral (% of borrowed households) 69

Table 4.5: Modes of repayment by sources of loans (% of accessed households) 70 Table 4.6: Credit use purposes by sources of loans (% of households) 71

Table 4.7: Demographic characteristics of households categorized by credit sources 73

Table 4.8: Crop production per household by provinces (kg) 75

Table 4.9: Average number of livestock reared per household 76

Table 4.10: Average number of plots per household and land size per plot 77

Table 4.11: Share of land plots with red book (%) 78

Table 4.12: Feedback of receivers to extension services (% of households with access to agricultural extension) 80

Table 4.13: Feedback of households to formal extension categorized by provinces 81

Table 4.14: Income of household groups categorized by extension access and loan sources (VND 1000 per household) 83

Table 4.15: Description of selected household endowments 84

Table 4.16: Differences in household‘s endowments based on credit sources and extension access 85

Table 4.17: Share of shock affected households (% of households) 87

Table 4.18: Mean and standard deviation of shock losses by credit access and provinces 88

Table 4.19: Total income of household groups categorized by shock-affected and loan sources (VND 1000 per household) 90

Table 4.20: Test for the difference in means of endowments between household groups 92

Table 4.21: Household responses to shocks by sources of loans (% of affected households) 93

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Table 4.22: Household responses to shocks of households categorized by

provinces (% of affected households) 94

Table 4.23: Credit amount of households categorized by savings status (VND 1000 per household) 96

Table 4.24: Reasons for household savings categorized by lenders (% of households) 97

Table 4.25: Reasons for household savings categorized by provinces (% of household with savings) 97

Table 4.26: Total income of household groups categorized by savings and loan sources (VND 1000 per household) 98

Table 4.27: Differences in household endowments based on credit sources and savings 100

Table 4.28: Differences in means of endowments between ethnic minority households and Kinh majority households 104

Table 4.29: Total income of household groups categorized by ethnicity and loan sources (VND 1000 per household) 105

Table 5.1: Descriptive statistics for selected variables used in PCA 113

Table 5.2: Results of Principal Component Analysis 115

Table 5.3: Poverty outreach of rural credit 117

Table 5.4: Correlation coefficient between relative poverty scores and loan amount 118

Table 5.5 Depth of outreach based on the categories of exclusion 119

Table 6.1: Description and assumptions of selected explanatory variables 126

Table 6.2: Difference in explanatory variables used in Bayesian credit model 132

Table 6.3: Probability of inclusion by Bayesian Model Averaging 134

Table 6.4: Probit estimation of accessing overall credit 136

Table 6.5: Determinants of credit volumes 138

Table 6.6: Probit estimation of accessing subsidized credit 140

Table 6.7: Probit estimation of accessing Agribank credit 142

Table 6.8: Determinants of Agribank loan volumes 143

Table 6.9: Probit estimation of accessing informal credit 144

Table 6.10: Determinants of informal loan volumes 145

Table 7.1: Comparison of income between household groups without matching (VND 1000 per household) 157

Table 7.2: Income impact of rural credit on accessed households 161

Table 7.3: Income impact of preferential credit on recipients 163

Table 7.4: Income impact of commerical credit by the Agribank 167

Table 7.5: Income impact of informal credit on accessed households 170

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LIST OF FIGURES

Figure 1.1: Agricultural credit share in total national credit disbursed (%) 2

Figure 2.1: GDP, credit and inflation growth in Vietnam (%) 8

Figure 2.2: Real GDP structure by economic sectors (%) 9

Figure 2.3: Vietnam‘s exports by products in 2005 and 2010 10

Figure 2.4: Labour forces and the structure of poverty in Vietnam 18

Figure 2.5: Demand for credit and other financial services of low income population 19

Figure 2.6: Rural credit suppliers in Vietnam 20

Figure 2.7 Market share of main credit suppliers (%) 22

Figure 3.1: The triangle of credit 27

Figure 3.2 Marginal returns to capital of poorer and wealthier households 28

Figure 3.3: The problem of information asymmetries in rural credit market 30

Figure 3.4 Credit cycle 42

Figure 3.5 Access to credit influences household income 45

Figure 3.6: Evaluation basic for welfare impact of credit 47

Figure 3.7 The conceptual framework of the study 58

Figure 4.1: Map of the research area and selected provinces 60

Figure 4.2: Ethnicity structure in the Northern Mountains of Vietnam 62

Figure 4.3: Share of households with access to different credit sources 66

Figure 4.4: The share of households with access to extension services by source of loans (%) 79

Figure 4.5: Loan amount by extension access 82

Figure 4.6: Types of shocks and number of affected households 87

Figure 4.7: Distribution of shock losses across household categories 89

Figure 4.8: Share of risk losses in total income across household groups (%) 91

Figure 4.9: Share of households with and without savings categorized by loan sources (% of households) 95

Figure 4.10: Share of savings in total household income (%) 99

Figure 4.11: Poverty headcount (%) for the Kinh majority versus ethnic minorities in Vietnam 101

Figure 4.12: Distribution of households in terms of credit sources and ethnicity 102

Figure 4.13: Distribution of loan amounts categorized by ethnic groups 103

Figure 7.1: Box plot for income distribution across household groups 159

Figure 7.2: Income impact per VND million of credit 171

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LIST OF ACRONYMS AND ABBREVIATIONS

ADB Asian Development Bank

AMK Angkor Mikroheranhvatho Kampuchea

ANOVA Analysis of variances

ASA Association for Social Advancement

ATTE Average Treatment on Treated Effect

BARC Bangladesh Rural Advancement Committee

BIC Bayesian Information Criterion

BMA Bayesian Model Average

BRI Bank Rakyat Indonesia

CEP Capital Aid Fund for Employment of the poor

CIEM Central Institute for Economic Management

DANIDA Organization of the Danish International Development Assistance DOI Depth of outreach indicator

FAO Food and Agricultural Organization

FSS Financial self-sustainability

GDP Gross Domestic Product

GNI Gross National Income

GSO General Statistics Office of Vietnam

ILSSA Labor Science and Social Affairs

ISPARD Institute for Policy and Strategy for rural development

KMO Kaiser-Meyer-Olkin measure of sampling adequacy

MFI Microfinance Institution

MRA Micro-Credit Regulatory Authority

NGO Non-governmental Organization

NRM Northern Mountainous Region

OSS Operational self-sustainability

PCA Principal Component Analysis

PCF People's Credit Fund

PKSF Palli Karma Sahayak Foundation

PPP Purchasing Power Parity

PSM Propensity Score Matching

ROSCA Rotating Savings and Credit Association

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VARHS Vietnam Access Resources Household Survey

VBARD Vietnam Bank for Agriculture and Rural Development

VBP Vietnam Bank for the poor

VBSP Vietnam Bank for Social Policy

VHLSS Vietnam Household Living Standard Survey

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1 INTRODUCTION

1.1 Background of the study

Rural development is widely believed to be effective in reducing poverty where a majority of the poor live and depend on farming activities as their main source of income The poor are able to play a part in creating wealth and improving their livelihood if they begin a small business, improve farming productivity or access employment If the poor do not have the chance to become economically independent, the economy is wasteful with human capital and the society then needs to spend more in assisting the poor Nevertheless, the main disadvantage of the poor is that they lack of access to development resources to help in achieving this aim The poor, in general, have a low level of education, limited production skills and limited access to additional resources and that is why they are poor Improving access of the poor to financial services has therefore long been a question of great interest

In the history of rural development, credit has been thought of as a key factor in creating employment for farmers, helping them expand production and increase welfare To this point, a number of studies have emphasized the importance of a broad access to appropriate and sustainable credit services in poverty reduction For example, GUIRKINGER (2008) argued that access to credit is an important tool

in alleviating poverty, as it helps farmers buy necessary inputs such as fertilizer, seed varieties, pesticides, animal feed, irrigation services and to invest in favorable crops and livestock, fostering in gains in productivity and income However, many people around the world have limited to access to credit The credit outreach to the poorest communities remains low (ZELLER & SHARMA, 2000) Nearly half of the world‘s rural poor households have no access to credit services In Asia and the Pacific region, more than 300 million households are constrained to access credit by both formal and informal sources (W WORLD

BANK, 2007) Lack of access to credit is regarded as one of the most crucial reasons explaining why the poor rural households in developing countries remain poor (COLLINS et al., 2009) Poor people's access to credit is therefore a topic of interest not only for the policy makers, non-governmental organizations and donors but also for the academic researchers

1.2 Statement of the problem

While the aforementioned problem could hold true for developing countries in general, they are particularly applicable to Vietnam, a developing country in the Southeast Region of Asia The country has determined three essential pillars for the national sustainable development, including economic growth in association

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with social equity, poverty reduction, and environmental protection However, those tasks pose a host of other challenges Specifically, about 70% of the total population lives in rural areas and 53.9% of total national labor force works in the agricultural sector, which contributes nearly 22% percent of total national domestic product (GSO, 2012) The rural areas in Vietnam are also where nearly 94% of the poor lives Most low-income households are rural households, which account for 44.8% total national households (GSO, 2012)

Despite the fact that agriculture and rural areas play an important role in national development, their share of annual investment only represents nearly 7% of total annual national investment Although the Vietnamese government always pays more attention to poverty reduction through a number of credit schemes, the share

of national credit allocated to the agricultural sector decreased remarkably during the period 2002-2012, as shown in Figure 1.1 Furthermore, average annual credit growth for the agriculture sector in this period was 22%, which was lower than 25% for the whole economy (GENERAL STATISTICS OFFICE OF VIETNAM, 2012)

Figure 1.1: Agricultural credit share in total national credit disbursed (%)

Source: G ENERAL S TATISTICS O FFICE OF V IETNAM (2012)

In addition, MARSH et al (2006) showed that although a number of policies have been implemented to improve access to credit, market failure in the rural credit markets have led to severe credit restrictions by small household farms, and the rural sector in general in Vietnam

The W WORLD BANK (2012) indicated that sustainable growth of the country cannot be achieved without investing in all people across every region and national community This is particularly the case for Vietnam, where the development of the Northern Mountainous Region has been seen as a necessity

30%

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for national socio-economic development as well as national security Although the region represents 28.79% of the total area and 12.83% of the total population,

it is still the most disadvantaged region (GENERAL STATISTICS OFFICE OF

VIETNAM, 2012) This is also the place, where most of ethnic minorities in the country live and draw their primary income from agriculture The poverty rate in the region is 114.41% higher than the average rate of the whole country, and households in this area also have fewer opportunities to access credit schemes According to the national statistics, only 9.86% of the national loan outstanding is allocated to the Northern Mountainous Region, compared to 49% of the Southeast Region and the Mekong River Delta (GENERAL STATISTICS OFFICE OF VIETNAM, 2012) Although Vietnam can look back at an impressive record in reducing poverty during the last two decades, disparities are still emerging Poverty intensity is still substantially higher in in the Northern Mountains

The amount of literature recognizing the importance of rural credit in Vietnam has grown significantly in recent years For instance, CUONG (2008) and QUACH

(2005) replied to the Vietnam Household Living Standard Survey (VHLSS) to evaluate the impact of credit on poverty reduction at the national level However,

it is hypothesized that the success of credit schemes is highly dependent on specific regional contexts Although several studies of rural credit have been conducted in the Northern Vietnam, such as T DUFHUES and BUCHENRIEDER

(2005), SAINT-MACARY and ZELLER (2012), their conclusions are based on a rather small sample size drawn at some communes of one or two districts Further confirmation of the results by a larger and more representative study is therefore desirable

A key motivation for this study is that very little is actually known as to whether

or not rural credit, especially subsidized credit, is an effective tool in fighting poverty or other policy options applied to disadvantaged rural areas Appropriate development of rural credit based on well-informed policies is a key prerequisite for success in reducing poverty

1.3 Objectives

Keeping in mind the importance and related issues of rural credit to sustainable rural development as well as the existing literature gap, this study aims to achieve three main objectives:

(1) To evaluate the extent to which rural credit serves poor households;

(2) To investigate determinants of credit accessibility by rural households; (3) To estimate and assess the income impact of both formal and informal credit on credit recipients

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1.4 Hypotheses of the study

This study is based on following hypotheses:

Hypothesis 1: Credit targets the poor households as part of its contribution to national rural development and poverty reduction

Hypothesis 2: Rural households, especially poor ones, continue to experience constrained access to credit

Hypothesis 3: There seem to be various reasons explaining the poverty reduction

in Vietnam in the last two decades One of these argues that the decrease in poverty may be due to the provision of credit to rural households, especially the government policy targeting credit at reduced rates to the most vulnerable groups

of society

1.5 Scope and limitations of the study

Credit issues can also be influenced at the macro and intermediator levels through policies of government or characteristics of lenders However, the unit of analysis

in this study is limited to the rural household level This study is also limited to the Northern Mountainous Region of Vietnam

The classification of formal credit into preferential and commercial credit is very relative One formal credit source might be considered to be preferential in this region but could be non-preferential in others, depending on specific contexts In addition, formal credit policies could also be changed over time The idea behind the category is to differentiate issues related to the nature of credit and relevant targeted households

This study is also limited to cross-sectional data of rural households; therefore, poverty outreach, credit accessibility, and over-the-year impact of credit is not analyzed in this study

1.6 Contribution of the study

This study contributes to the existing literatures in the field through various points Few previous studies have investigated rural credit in any comprehensive way, with regard to poverty targeting, access constraints, and impact Those components are widely assumed to be represented in an overall credit picture Poverty targeting is an important component in the rural credit system and is fundamental to understanding the extent to which credit serves the poor If households having a high demand for credit are bypassed, it is difficult for them

to improve their income and reduce poverty Exploring the determinants of credit

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access plays a vital role in designing credit schemes On top of that, poverty reduction is considered a key factor in in the sustainable development of rural credit

Additionally, this study focuses on a rural disadvantaged region in Vietnam The success of credit depends on specific conditions under which recipients benefit from accessing credit Few studies exist, which differentiate between credit issues regarding both formal and informal credit sectors Each particular type of loan might have different targeting policies, loan characteristics as well as the policy of loan recovery, and so on These discrepancies are significant in examining issues

of each loan source

This study uses the Bayesian Model Average to address the problem of model uncertainty, which has received scant attention in the current research literature All matching algorithms and bootstrapping applied to the PSM model are key instruments in increasing the reliability of estimation results

1.7 Structure of the study

This study is organized as follows: In chapter 2, a review of Vietnam‘s economy, its agricultural sector and credit system are described Chapter 3 presents the theoretical and empirical framework with discussion of credit-related issues including the poverty outreach, credit access, and impact In chapter 4, the characteristics of the research area and selected households‘ characteristics in relation to credit issues are described Chapter 5 contains the analysis of poverty targeting by both formal and informal credit sources Chapter 6 deals with the problems of credit access using Bayesian Model Average applied to the Heckman Selection Model It focuses on household‘s participation in both formal and informal credit and investigates access determinants to both sources Chapter 7 presents the empirical estimation of the impact of credit on household income using all matching algorithms of Propensity Score Matching approach Chapter 8 reviews the results of the preceding analyses and discusses their limitations It then considers their relevance of findings for policy makers toward credit services for rural households in Northern Vietnam and other developing countries This chapter also suggests directions for future research to further explore the function

of rural credit and related issues

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2 AN OVERVIEW OF ECONOMY, POVERTY AND

RURAL CREDIT SYSTEM IN VIETNAM

The country is divided into 6 main geographical regions, including the Red River Delta, the Northern Mountainous Region, the North Central and Central Coastal Areas, the Central Highlands, the South East and the Mekong River Delta There are two major cities in Vietnam, namely Ho Chi Minh City in the South In 2013, the total population of Vietnam was around 89.7 million, of which about 67.44% remained rural residents The country has total 64 cities under provinces, 49 urban districts, 47 towns, 548 rural districts, and 9001 communes (GSO, 2013)

2.2 Macroeconomic performance

2.2.1 Key development indicators

Before the year 1986, Vietnam applied the command economy model, in which the central government decided production, domestic trade, and international trade There were no commercial transactions among individual production units like households or enterprises horizontally With regard to the agricultural sector, production solidarity groups and cooperatives were common models with which land and equipment were shared, and a system of work points determined distribution of income Under this economic model, a lack of household incentives limited the expansion of production and improvement of productivity

In 1986, Vietnam introduced the economic reform widely known as ―Doi Moi,‖ which has facilitated the transition from a centralized and command economy to a

―socialist-oriented market economy‖ Accordingly, ineffective agricultural collectives were removed and households have since been encouraged to be ― autonomy production units‖, which are able to sell their goods in the marketplace The success of the reform process has encouraged economic growth, increased income per capita, and improved life expectancy (see Table 2.1 for further details)

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Table 2.1: Development indicators of Vietnam

GNI per capita, PPP

(current international $) 2780 3310 3810 4230 4780 5030 Population (million) 81.43 83.31 85.12 86.93 88.77 89.71 GDP (current billion

GDP growth (annual %) 7.54 6.98 5.66 6.42 5.25 5.42 Life expectancy at birth,

total (years) 74.47 74.77 75.04 75.31 75.61

Source: GSO (2013)

2.2.2 GDP, credit and inflation in Vietnam

Macroeconomy of Vietnam was quite stable from about the year 2001 to 2006 The GDP growth reached an average of 7.5%, and the inflation rate was under 10% (see Figure 2.1 for further details) Vietnam joined the World Trade Organization in 2007 and has attracted a huge amount of foreign investment Credit growth in the economy increased remarkably from 25.3% in 2006 to 54.0%

in 2007 From 2007 on, the economy faced instability with the rising inflation rates and higher interest rates When the global financial crisis hit in 2008, Vietnam‘s economy also faced high inflation rising unemployment, slowing growth In the agricultural sector, high volatility of prices of agricultural commodities also caused difficulty in rural financial markets In response to the financial crisis, the government introduced a tight fiscal policy including a reduction in public expenses to reduce the budget deficit As a result, credit growth declined significantly The reduced credit availability of the whole economy was caused by the collapse of the real estate market in 2012 (GSO, 2013) Many real estate projects could not be sold, leading to defaults on real estate loans and a higher rate of bad debts, which in turn reduced lending opportunities in the banking system

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Figure 2.1: GDP, credit and inflation growth in Vietnam (%)

2.2.3 Economy’s structure share in Vietnam

Since the shift from a central planned economy to a market based economy, Vietnam has implemented industrialization, modernization and world integration policies The economy has been heading for open market free trading and attracting foreign investment The industrial, construction, and service sectors significantly contributed to the total GDP (see Figure 2.2 for further details) The top manufacturing sectors include food processing, cigarettes and tobacco, textiles, chemicals and electrical goods In 2010, services accounted for 38% of GDP Vietnam is regarded as one of the top 25 most attractive destinations for tourism in Asia The most popular cities for tourism include Ha Noi, Ho Chi Minh city, Hoi An and Ha Long

The agricultural sector, however, remained an important sector in the national economy Total value of agricultural, forestry and fishery products was about USD 14.5 billion, accounting for 20.23% of GDP in 2010, a 3 % decline as compared to the year 2000 Most of the population and the poor live in rural areas and derive their income predominantly from farming activities However, the higher proportion of agricultural employment when compared to the contribution

of the agricultural sector to the GDP reflects a low rate of productivity in this sector The savings and loan portfolios of rural financial institutions can therefore

be affected by agriculture even if clients earn income in other sectors

0 10 20 30 40 50 60

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Figure 2.2: Real GDP structure by economic sectors (%)

2.3 Agriculture and Poverty

In spite of considerable efforts in industrialization, Vietnam‘s economy is still dominated by agricultural production, where economic reforms have so far had most success The agricultural sector saw remarkable performance during the ten-year period of 2001-2011 The agricultural sector including crops, livestock, forestry, aquaculture and fisheries represented 20% of GDP, 30% of export revenue and 60% of employment Key policies for the agricultural sector introduced in 1986 are the allocation of land to individual households and the encouragement of market incentives for agricultural commodities These policies have contributed to the development potential of the agricultural sector and rural areas in Vietnam Agricultural growth reached an average of 4% per year The agricultural sector produced 558.4 trillions VND, accounting for 22% of total GDP, contributing 0.66 percentage points in 5.89% of GDP growth in 2011 As shown in Table 2.2, total production of the main agricultural products in 2011 increased in comparison to the year 2001 (GENERAL STATISTICS OFFICE OF

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Table 2.2: Production of main agricultural commodities

Agricultural commodities Production

in 2011

Compared to year 2001 (%)

Wood and wooden products

(million cubic meters)

Source: GSO (2011)

Figure 2.3 presents the most important goods for exportation in Vietnam (ranked

by value) for the year 2005 and 2010 Exports represented for about 70% of total GDP of Vietnam in 2010 Vietnam‘s main industrial exportation goods included textiles, sewing products, crude oil, footwear, electronic goods and parts, wood and wooden parts, and coal In 2010, the export value of agricultural products was USD 15.65 billion, accounting for 21.7% of the total export value of Vietnam, of which the agricultural and forestry product was USD 11.4 billion and fishery product was USD 4.25 billion The main export products were rice (USD 3.2 billion), coffee (USD 1.9 billion), rubber (USD 2.4 billion), timber products (USD 3.4 billion) and fishery products (USD 2.7 billion) The value of export for each particular good increased significantly from 2005 to 2010

Figure 2.3: Vietnam’s exports by products in 2005 and 2010

0.7 0.7 0.8 1.4 1.6 1.4 2.7

3

5 4.8

1.6 1.9 2.4 3.2 3.4 3.6

5 5.1 7.4

11.2

Coal Coffee Rubber Rice Wood and wooden products

Electronic goods and parts

Fishery products

Footwear Crude oil Textile, sewing products

USD billions

2010 2005

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2.3.2 Rural labors

As shown in Table 2.3, during the period 2001-2011, the share of laborers working in the agricultural sector reduced from nearly 80% in 2001 to approximately 60 % in 2011, an average reduction of 2% per year For five years, from 2006 to 2011, the share of agricultural laborers reduced by 10.9 %, an average reduction of 2.19% per year In 2011, there were a total of 20.56 million laborers working in agricultural sector, a decline by 2.37 million laborers, or 10%, compared to the year 2006 The decreasing tendency of labor share in total labor forces indicates the process of industrialization and modernization, as well as the overall change in the economic structure of Vietnam

Table 2.3: Rural labors in Vietnam 2001-2011

1 Laborers in agriculture, forestry and

fishery sectors (1000 labors)

24530.1 22928.9 20558.3

2 Share of laborers in agriculture in

total labor forces (%)

2.3.3 Fragmentation of agricultural land

Land is a critical factor of agricultural production Access to agricultural land is considered to be important for farmers to earn income However, land fragmentation is one popular issue in rural areas of Vietnam Fragmentation refers

to the fact that farm size is divided into different smaller plots at farm household level (VAN HUNG et al., 2007) By the year 2012, Vietnam had 26.21 million hectares of agricultural land, accounting for 75% of total national natural area The total number of agricultural production households was 10.37 million, representing 44.8% of total national households However, the agricultural land size per household is quite small Nearly 60% and 34.7% of total agricultural households cultivate in less than 0.5 and 0.2 hectare of agricultural land respectively On average, each farm household owns five plots of farm land About 10% of total farm plots are less than 100 square meters (GENERAL

STATISTICS OFFICE OF VIETNAM, 2012) On average, agricultural land area in the Southern Region is much less fragmented than that in the North Fragmentation of land also poses a challenge to adopting agricultural machinery for plowing and harvesting, hindering the productivity improvement

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2.3.4 Poverty in Vietnam

In Vietnam, nearly 70% of the total population lives in rural areas The government has focused on poverty reduction and seen significant improvement during the last two decades Based on a ―basic needs‖ poverty line, the percentage

of people who live below the national poverty line was reduced from 58% in 1993

to below 10% in 2010 Table 2.4 reports poverty headcount and composition by regions and sector in 2010 based on GSO- WB poverty line Accordingly, the poverty and extreme poverty rates of the whole country were 20.7% and 8% respectively Most of the poor live in rural areas, which make up 91.4% of poverty index and 94.4% of extreme poverty

Table 2.4: Poverty headcount and composition by regions and sector in 2010 (Based on General Statistics Office- World Bank poverty line)

Regions

Poverty Extreme poverty Share of

population (%) Index

(%)

Contribution

to total

Index (%)

North Central Coast 28.4 16.5 9.7 14.6 12.0

Mekong River Delta 18.7 17.1 4.8 11.4 19.0

Source: W W ORLD B ANK (2012)

Table 2.4 also indicates that poverty rate was substantially higher in in the Northern Mountains and Central Highlands In contrast, better-off households were represented in the Red River Delta and the Southwest region The higher density of poverty in the Northern Mountainous Region might indicate a lack of access to supportive agricultural services including credit, agricultural extension, and market information

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2.3.5 Agricultural insurance in Vietnam

Vietnam is one of ten countries in the world severely affected by weather disasters (NATIONS, 2010) The agricultural sector in Vietnam is affected by a variety of risks including natural disasters, spread of disease and pests in agricultural production Severe cold, storms, floods, and heavy rain all damaged crops and killed livestock Economic losses due to natural disasters represented nearly 1.5% of total GDP Agricultural production and rural areas are the most affected areas Farm households, especially the poor are the most vulnerable to shocks (GLOBALAGRISK, 2009) For these reasons, Vietnam is expected to have a great potential for agricultural insurance development Unfortunately, agricultural insurance is a less attractive sector for insurance enterprises

Table 2.5: Percentage of crops and livestock covered by agricultural insurance

A number of issues were identified to explain the limited expansion of agricultural insurance in the last two decades The high intensity of risks and shocks led to higher insurance fees, which farmers were unable to cover, especially poor farmers (VANDEVEER, 2001) In the history of insurance development, most of insurance companies in Vietnam including Vinare, Bao Viet, and Swiss Re reported losses Indemnity was much higher than premium fees For instance, Bao Viet Insurance Corporation implemented a pilot insurance program for rice production from 1983 to 1998 Nearly 200,000 hectares of rice were covered by insurance However, the amount of compensation was 14.4 VND billion, exceeding the insurance fees of 13 VND billion This huge loss prevented the company from expanding insured areas for rice In 1999, the company stopped its agricultural insurance program for rice At present, the company only provides

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insurances for rubber trees in the Central Highlands, dairy farms and a restricted number of fishery farms Groupama from France was another example of a company failing to provide insurance to farmers in Vietnam The company has had more than 100 years of experience working in the field of agricultural insurance In Vietnam, it started to insure agriculture and fisheries in 2001 However, the company decided to stop its operation in 2004 due to low revenue and huge compensation of losses (CONG THANG, 2014)

2.4 Rural credit in Vietnam

2.4.1 Brief history of rural credit policy in Vietnam

GONZALEZ-VEGA (2003) indicated that a stable and favorable macro-economic environment is the precondition for successful financial systems This section aims to review the policies regarding to the development of rural credit in Vietnam

2.4.1.1 Credit cooperatives before 1986

After the dependence in 1975, the Vietnamese economy was characterized by the central planning model, or command model, which centralized both production inputs and commodities in the form of collective ownership Market transactions, while highly regulated, were far underdeveloped By the mid-1980s, Vietnam had about 7200 credit cooperatives, which collected small deposits and provided credit to ineffective production cooperatives and small stated-owned enterprises (BOI & VAN HUNG, 1992) In fact, credit cooperatives represented the state bank

to provide credit and mobilize savings based on the centralized plans of the central government (TAM, 2013) A passive one-tier was a main characteristic of the banking system The state bank served as both a commercial bank and the central bank to allocate loans to the centralized planning projects, which were ineffective (FAN et al., 2004) As a consequence, the banking system served a limited role in mobilizing domestic savings and encouraging economic development Further, households were not allowed to take loans because they were not recognized as self-governed and self-financed production units Lack of incentives for households hindered economic growth (MCCARTY, 2001) The provision of credit to government projects, which run in the absence of incentives, led to high default rates As a result, a continual decline in the production of rice and other commodities as well as hyperinflation led to the collapse of the economy including the credit cooperatives (SEIBEL, 2003) The severe food shortages, trade deficits, aid cuts and budget deficits, high inflation and a declining per capita income were problematic to the country (VAN BRABANT, 1990)

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2.4.1.2 Replacement of the mono-tier banking system after 1986

The collage of the whole economy in the 1980s created high pressure for policy markers in Vietnam In response to the crisis, the government introduced a new policy called ―Doi Moi‖ or ―renovation‖, which opened for market transactions Households were regarded as ―independent economic units‖ and were able to take loans One of the most important policies was the introduction of the new land law in 1993, with four land use rights including sale, lease, inheritance and mortgage (SEIBEL, 1992) Households had incentives to finance farming activities and improve production The administrative allocation of production factors were replaced by the free purchases of production inputs as well as the sale of agricultural products on markets All new rules have encouraged the development

of millions of households and private enterprises The rice production expanded rapidly and Vietnam became the world‘s second largest exporter of rice in 1996 The living conditions of farmers were therefore greatly improved

In 1988, the central bank with four state-owned commercial banks replaced the former mono-tier banking system The supply of credit was restricted to state owned enterprises, which were more efficient The real interest rates were raised

to be positive, based on market principles Private enterprises and farm households returned to their original status of being self-reliant and self-financed business agents Due to those reforms, the economic growth and the stability of the financial system improved remarkably (RIEDEL & COMER, 1997) In 1990, the government introduced a legal framework for the financial system, in which the central bank only specialized in designing the monetary policies and financial regulations

Former credit cooperatives in the command economy were reformed to the network of PCF in 1993, based on the model of the credit cooperatives and community savings of Canada Desjardins Group Most of the original credit cooperatives went bankrupt after the government applied a two-tier banking system Only 78 credit cooperatives survived and were part of 800 people‘s credit funds (SEIBEL, 1996) Nowadays, People‘s Credit Funds provide financial services to communes and operate under the law of cooperatives There were

1042 funds operating in 10% of total communes Those funds have served 1.7 million members, of which 50% of members are low-income households (TAM, 2013) PFCs have operated based on the principle of self-help and self-financed with 85% of capital from their own financial sources However, the funds focus

on the provision of credit to the wealthier households to attain financial sustainability This situation has led to the reduction of credit accessibility by poor households (TAM, 2013)

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In 1995, the National Assembly approved the Civil Code, which regulated the relationship between lenders and borrowers in terms of lending, repayment, interest rates as well as dispute settlements (BAO DUONG, 2013) The private lending and private credit markets have since been recognized and regulated by the government Borrowers have obligations to repay loans and private lenders have been encouraged to extend their loans

2.4.1.3 The separation between preferential and commercial lending

Hunger eradication and poverty alleviation were great concerns leading to the establishment of formal financial institutions like Vietnam Bank for Agriculture and Rural Development (T DUFHUES et al., 2001) The bank emerged from the mono-tier banking system in 1988 and changed its name into Vietnam Bank for Agriculture in 1990 (SEIBEL, 1992) It aimed to provide loans to households as well as small and medium enterprises in rural areas The bank has served clients not only in rural areas but also in urban areas to expand their market share It focuses on providing credit to wealthier households, farms and enterprises In

2008, 45% of its deposits were mobilized from the city and 55% of the savings from the rural areas At present, it is the biggest credit supplier in rural areas of Vietnam It has the full range of services, including both credit and savings Of the 10 million total client households, 4.7 million are lower income households (TAM, 2013)

However, the poor were unable to access credit from the agricultural bank, while poverty was still a severe problem for rural people (IZUMIDA, 2003) This situation led to the separation of the Vietnam bank for the poor (VBP) in 1995

At first, VBP operated as a fund under the management of the Vietnam Bank for Agriculture and Rural Development (VBARD) The provision of preferential loans was based on the assumption that the poor were unable to repay loans at the market interest rates In addition, loans are too scarce of resources for the poor to expand production and improve their food supply In 1997, the law on credit institutions was introduced Accordingly, the state bank of Vietnam was responsible for establishing a special bank, a non-profit bank, which aims to provide preferential credit to the poor to encourage their business and production

As a result, in 2003, VBP was recognized as an independent bank and renamed Vietnam Bank for Social Policies (VBSP) Nowadays, the VBSP has established its own branches focusing on serving the poor and other vulnerable social groups based on government programs Preferential loans disbursed by VBSP have been granted without the requirement of collateral, such as land use certificates At the end of 2003, the bank provided preferential loans to 3.3 million clients, of which

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1 million were poor Since 2010, the bank has disbursed loans to all districts and 98% of all communes in the country (TAM, 2013)

2.4.1.4 Incorporation of microfinance institutions in the financial system

In 2005, the government introduced Decree 28, which regulates the organization and operation of microfinance institutions According to the legal framework, microfinance institutions (MFIs) in Vietnam are regarded as credit institutions, managed by the state bank and under the regulation of the 2010 law of credit institutions Microfinance institutions have been recognized as a type of business with a social mission to provide services in a financially sustainable manner Decree 28 creates opportunities for MFIs to access external capital from donors However, the decree also restricts the range of services that MFIs can offer until MFIs are officially licensed to become a official MFIs (LAN & TRAN, 2005) Also, only local mass organizations such as women‘s unions, farmer‘s unions and local non-governmental organizations (NGOs) are allowed to have the ownership

of MFIs, as opposed to the private sectors This rule makes MFIs less accessible

to commercial funds, whereas the minimum legal capital requirement is perceived too high by smaller MFIs (KIM ANH et al., 2011) In response to the debate on this regulation, the new Decree 165/2007/ND-CP replaced Decree 28 Correspondingly, the minimum legal capital for all types of MFIs is 5 billion VND (about US$313,000) MFIs are now allowed to access equity from donors Furthermore, in order to meet the licensing requirements, MFIs need to meet the qualification standards as determined by the central bank regarding staffs and audited financial statements Despite the new rule making financial access easier for MFIs, it pushes them to achieve financial sustainability rather than deepen their services to the poor

In 2012, the government approved the development project for microfinance sector development in the period 2011- 2020 Under this project, MFIs are prioritized to improve their capacities to become self-financed organizations The project also aims to encourage MFIs to meet their social objectives and provide market-oriented financial products It is seen as a policy breakthrough reflecting the recognition by the government of the role of microfinance in fighting poverty

in Vietnam The project receives USD 40 million in preferential loans and technical assistance from the Asian Development Bank (ADB) On the whole, the project aims to support the development of MFIs to meet financial needs of the poor households in the country

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2.4.1.5 Priorities for lending agricultural and rural sector

In 2008, the Vietnamese Party approved Resolution 26, which emphasized the importance of agriculture, farmers and the rural sector to national socio-economic development Appropriately, the provision of favorable credit is further needed for farmers and rural sector In 2009, the national microfinance steering committee was established to develop a market based microfinance industry The decision 477 issued in 2009 by the prime minister regulates favorable interest rates in lending to famers In addition, the decree 41 in 2010 was introduced to increase the amount of free collateral loans up to 50 million for farm households,

200 VND million for non-farm households, and 200 VND million for agricultural cooperatives

2.4.2 Rural credit demand

As discussed, the agricultural production in Vietnam is strongly affected by natural conditions such as droughts and storms, while anti-risk measures are still limited The rural poor are still faced with the problem of transitory food security, raising a need for the development of rural credit and other complementary services such as savings, insurance and extension services to help the poor recover from these risks (KANBUR &SQUIRE,2001)

Figure 2.4: Labour forces and the structure of poverty in Vietnam

Source: W W ORLD B ANK (2012)

Using the World Bank- General Statistics Office poverty line, the overall poverty rate in 2008 was 20.7% with 8% being considered extremely poor (Figure 2.4)

Total population: 88.77 million people

Labour force at 15 years of age and above: 59.35% (Urban 30.3%; Rural 69.7%) Share of employed in agriculture:

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The top quintile representing 20% of total population have per capital income of

$3,093 and the bottom quintile representing 20% of total population in Vietnam have per capita income of $499 (GENERAL STATISTICS OFFICE OF VIETNAM, 2012)

If the target customers of credit, especially small loans, are people whose average annual income ranges from $500 to $1,500, then the first three quintiles of the population are close to the income target range for microfinance products reflecting the relevance of the demographics to the microfinance model In addition, Vietnam has a high proportion of labor forces living in rural areas and engaging in farming activities The vast majority of the households have low income This segment of the population encounters many occasions on which they demand loans to take advantage of production opportunities and to cope with sudden shocks, such as illness or a bad harvest (W WORLD BANK, 2007)

Although there is a potential to provide credit and other financial services, demand of households those services are different depending on the level of income and enterprise size (LAN & TRAN,2005) For example, with regard to the poor, savings in the form of either formal voluntary deposit services in the financial sector, cash at home, or savings in-kind are relevant to finance production and coping with risks The poor also need credit, which contributes to their own capital (see Figure 2.5 for further details) Good credit and other financial services for the poor are those that fit their demand in the safest, most convenient, most flexible and most affordable way

Figure 2.5: Demand for credit and other financial services of low income population

Source: L AN and T RAN (2005)

Small/

household enterprise (urban) Income

Microenterprise (rural), urban/

rural poor)

Poverty line

Business loans, payment services, insurance, venture capital, bank accounts, loans for purchase of fixed assets,

generating loans, emergency credit, targeted savings,

Income-Consumption loans, liquid savings, house improvement loans

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2.4.3 Supply side of rural credit in Vietnam

2.4.3.1 Formal, semiformal and informal credit

As shown in Figure 2.6, the supply of rural credit is currently served by three main sectors including the formal, semiformal and informal part The last sector, the informal sector, incorporates private moneylenders, private traders, Roscas, relatives and friends

Figure 2.6: Rural credit suppliers in Vietnam

Source: K IM A NH et al (2011)

Note:

VBSP: Vietnam Bank for Social Policy

VBARD: Vietnam Bank for Agriculture and Rural Development

PCFs: People‘s Credit Fund

TYM ―Tao Yeu May‖

CEP: Capital Aid Fund for Employment of the Poor

NGOs: Non-governmental organizations

ROSCAs: Rotating Savings and Credit Association

The formal sector covers the two state-owned banks including the Vietnam Bank for Agriculture and Rural Development (Agribank) and the Vietnam Bank for Social Policy (VBSP) The Agribank was established in 1998 under the reform of the financial system and the introduction of commercial banks in Vietnam It mainly provides loans and other financial services to agricultural and rural sectors Since the end of 2001, it has become the leading commercial bank with the most extensive network of branches in rural areas The bank is currently the leading credit institution for pilot lending to the new rural construction programs The establishment of VBSP represents the governmental intervention on rural

Main rural credit providers

VBSP

VBARD

PCFs

To be officially licensed:

TYM CEP

Relatives &

friends

ROSCAs Moneylenders

57 NGOs

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credit markets in Vietnam The subsidized bank, established in 2002, is a government-owned bank with the mission of providing preferential credits to the poor and near-poor households It has the operating network, which stretches from the headquarters down to provinces, districts and communes The bank has provided several credit schemes, of which more than 80% of annual loans are outstanding, for farm households The initial intention was to contribute to the national program of hunger elimination, poverty alleviation and employment creation The lending procedure is conducted through entrusted local organizations such as women‘s unions and farmer‘s unions Those organizations are the main channels through which preferential loans are delivered, with subsidized interest rates

In Vietnam, after the collapse of rural credit cooperatives in the late 1980s, a network of People‘s Credit Funds (PCFs) was established The key objective of PCFs is to build the confidence of rural people in the formal credit system, to reform and strengthen the country‘s rural banking system PCFs are commune-based entities, jointly owned, operated and managed by their members to provide savings and credit services PCFs operate based on the economic principle of own cost covering and are currently established in regions with better socio-economic development The targeted customers of PCFs are farms,small and medium enterprises rather than poor farm households; therefore, the network plays a limited role in providing credit to the rural poor and reducing poverty (PUTZEYS, 2002)

Apart from the formal credit sector, the semi-formal division mainly consists of microfinance institutions and local mass organizations such as women‘s unions, farmer‘s unions and agricultural extension stations The government introduced the program for developing microfinance in the whole country up to the year

2020 The legal framework has been constructed to promote the development of semi-formal credit organizations Although the new governmental regulations allow for greater accessibility to financial sources, they also raise the question of poverty targeting by microfinance institutions (KIM ANH et al., 2011)

As for the informal credit sector, loans from relatives and friends are common and seem to be less risky The lenders only lend to persons who are part of her or his social network, within which contracts can be enforced Such social capital and informal financial contracts can be exploited and used through the information of member-based institutions Rotating Savings and Credit Associations (Rosca) are also present in Vietnam Roscas pertain to a setting in which individuals or households who know and trust each other form groups Each group member places a fixed amount of money in a kitty The bidding Rosca refers to the case in

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which the group meetings make the bidding rule to decide who wins the kitty The member who bids higher receives the kitty first Another random Rosca relates to the case in which the winner of the kitty is randomly selected regardless of contribution amounts The earlier winner of the kitty has to pay interest rates for the later recipients of the kitty In other words, the earlier winner performs as the borrowers and the later winners take part as savers Roscas are known as chit funds in India, the arisan in Indonesia or the paluwagan in the Philippines In Vietnam, Rosca is in existence in the form of ―Hui‖, a useful type of setting for households with less access to external finance such as commercial banks Households use ―Hui‖ to finance agricultural production, purchase assets or provide for marriage prices and so on However, when the loan volumes are not accessible from close friends, relatives, neighbors or Rosca, households might choose to buy from moneylenders Those moneylenders charge explicit interest rates in order to obtain real positive returns on their capital In fact, interest rates are usually relatively high Moneylenders typically lend to households for whom they possess sufficient information

2.4.3.2 Market share and financial sustainability

Figure 2.7 reports the contribution of formal and semiformal provider to the overall credit sector

Figure 2.7 Market share of main credit suppliers (%)

Source: K IM A NH et al (2011)

By the end of 2009, the Vietnam Bank for Agriculture and Rural Development (VBARD) occupied the largest credit market share followed by the Vietnam Bank for Social Policy (VBSP) and the People‘s Credit Fund (PCFs) Although the

VBSP 26%

Agribank

67%

People's Credit Fund 6%

NGO MFIs 1%

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semiformal credit supplier just represented nearly 1% of total rural loan outstanding, the role of this semi-formal sector is increasing due to the encouragement policy of the government

Financial sustainability might associate with the poverty targeting of credit institutions because focusing on sustainability might ignore the provision of credit

to the poor (CULL et al., 2011; HULME & MOSLEY, 1996) ROSENBERG et al (2003) reported two indicators reflecting financial sustainability of a credit institution Operational self-sustainability (OSS) is the first indicator, measuring the extent to which a credit institution covers its costs through operating revenues The second indicator refers to financial self-sustainability (FSS) FSS is a subsidy-adjusted indicator used to measure the extent to which a credit institution can cover its costs, taking into account a number of adjustments to operating revenues and expenses The purpose of these adjustments is to measure the ability

of a credit institution to cover its costs without the assistance of subsidies Table 2.6 reports two indicators indicating the financial sustainability of credit institutions

Table 2.6: Financial sustainability of credit institutions as of June 30th 2009

Credit institutions Operational

self-sustainability (% revenues in total expenses including loan loss provision expenses)

Financial self-sustainability (% of revenues in total expenses including subsidy and inflation adjustment)

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have not yet reached financial self-sustainability The FSS ratio of the subsidized bank in particular is far below 100%, indicating that the bank has not reached financial self-sustainability

2.5 Summary of the chapter

This chapter has summarized the main characteristics of the Vietnamese economy regarding economy structure, poverty and agricultural performance, as well as the rural credit system Over the last two decades, Vietnam has made significant strides in national economic development in general and in agriculture, particularly in the rural sector National income per capita and human development index have improved The agricultural sector has not only met the national demand for food but also contributed to national exports However, challenges regarding sustainable rural development in Vietnam still remain Most

of the population, especially the poor lives in rural areas A large proportion of the rural poor belongs to ethnic minorities and lives in remote and mountainous areas The rural credit system in Vietnam has experienced major changes in government policies throughout history Before the economic reform in 1986, credit cooperatives served as the key credit providers for state enterprises and cooperatives in the commanded economy However, as a consequence of lacking market incentives as well as inefficient use of credit, the whole economy collapsed and the rural credit system in particular suffered Following the economic reform in 1986 , the mono bank system of a planned economy was transited to a financial system in line with market economic principles As a result, the network of credit cooperatives were reformed to the commune‘s credit funds, which currently operate based on the law of cooperatives and market principles Preferential credit was isolated from the commercial credit system to serve the poor and vulnerable people in the society Also, the government made a policy reform in relation to the land use rights to create incentives for farmers to expand production and access credit Nowadays, a multiple credit sector including the formal, semiformal and informal parts serves as the main source of credit for rural households The policy changes concerning rural credit reflect the fact that the development of credit and the economy are intertwined Without the economic incentives, credit cannot be developed The appropriate legal framework, which changes and amends over time, is crucial for the development of rural credit Nonetheless, the provision of credit is limited considering the credit demand of rural residents

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3 THEORETICAL AND EMPIRICAL FOUNDATIONS

OF THE STUDY

During the last several decades, there has been an increasing amount of literature

on rural credit issues It is the purpose of this chapter to show the studies or ideas which are relevant to the current work in a systematic way

3.1 Concept of credit and general issues

3.1.1 The credit concept

It is necessary here to clarify exactly what is meant by credit The word credit is originated from the Latin word ―Credo,‖ which translates to ―I believe.‖ Credit refers to extending of funds by the lender to the borrower on the belief that the borrower will repay the loan at the specific date or at a specified period with an additional sum i.e cost of credit or rate of interest There have been number of credit concepts, but only two concepts are commonly used in the existing literature

SINGH (2000) uses the term ―credit‖ to refer to a financial facility, which enables

a person or business to borrow money to purchase products, raw materials, components, etc., and to pay for them over an extended time period The term has connection with creditworthiness in the sense that it is a source of honor and pride, with regard to a person‘s financial standing and the acknowledgement of being paid by an entry on the credit side of an account‖ Credit and loans are used interchangeably A loan is an advance of a certain amount of cash or in-kind to a person or business (the borrower) by another person or business, or a financial institution (the lender), which makes their profits from the interest charged on said amount

According to a definition provided by BARRY AND ROBISON (2001), credit is a

―firm‘s borrowing capacity and its utilization in acquiring and managing debt capital.‖ The term has been applied to the modern perspectives of credit, which involves the agency theory, transaction costs, incomplete contracting, and property and control rights These elements are also important in evaluating the performance of the rural credit market

In the rural credit market, lenders provide loans to rural households based on the assumption that credit is beneficial to farmers who are able to repay loans The provision of credit is associated with theory of principal-agent between lenders and household borrowers, transaction costs, information asymmetry and seasonality of production, and household‘s cash flow (CONNING &UDRY,2007)

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