Firms’ Investment – Cash Flow Relationship In The Context Of State Ownership And Banking System Reform In Vietnam.

Firms’ Investment – Cash Flow Relationship In The Context Of State Ownership And Banking System Reform In Vietnam.Firms’ Investment – Cash Flow Relationship In The Context Of State Ownership And Banking System Reform In Vietnam.Firms’ Investment – Cash Flow Relationship In The Context Of State Ownership And Banking System Reform In Vietnam.Firms’ Investment – Cash Flow Relationship In The Context Of State Ownership And Banking System Reform In Vietnam.Firms’ Investment – Cash Flow Relationship In The Context Of State Ownership And Banking System Reform In Vietnam.

MINISTRY OF EDUCATION AND TRAINING OF VIETNAM

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

TU THI KIM THOA

Firms’ Investment – Cash Flow Relationship

In The Context Of State Ownership And Banking System Reform In Vietnam

DOCTORAL THESIS

Ho Chi Minh City, June 2020

MINISTRY OF EDUCATION AND TRAINING OF VIETNAM

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

TU THI KIM THOA

Firms’ Investment – Cash Flow Relationship

In The Context Of State Ownership And Banking System Reform In Vietnam

NGUYEN THI UYEN UYEN, Ph.D

Ho Chi Minh City, 2020

Ho Chi Minh City or any other education institution.

Tu Thi Kim Thoa

June 2020

First and foremost, I would like to express deepest gratitude to mysupervisors, Dr Vu Viet Quang and Dr Nguyen Thi Uyen Uyen, for their continualguidance and mentorship, invaluable support, remarkable patience, useful feedback,and spiritual encouragement during the completion of my thesis My thesis can not

be completed without their supervisions, which provided me with much preciousadvice to expedite my thesis completion

I would like to thank the University of Economics Ho Chi Minh City for itsgenerous financial support of my PhD studies I also wish to thank all thecolleagues at the UEH School of Finance, School of UEH Graduates and others fortheir great and continuing encouragement and full support during my PhDcandidature

My gratitude also goes to my colleagues at UEH who have constantly given agreat help, support and encouragements to me not only during but also before thecompletion of my thesis

Finally and most importantly, I would like to thank my friends and family fortheir unconditional love, immense, constant and endless support andencouragements during my life I would have been unable to finish the thesiswithout their supports and encouragement And I also wish to dedicate this thesis to

my late mother who is always in my heart

TABLE OF CONTENTS

ABBREVIATIONS i

LIST OF TABLES ii

LIST OF FIGURES v

ABSTRACT vi

CHAPTER 1: INTRODUCTION 1

1.1 Thesis motivations 1

1.2 Thesis objectives 5

1.3 Firm’s investment – cash flow relationship in the context of state ownership in Vietnam 5

1.3.1 Objectives and hypotheses 5

1.3.2 Data 6

1.3.3 Methodology 6

1.3.4 Empirical findings 7

1.3.5 Contributions 7

1.4 Firm’s investment – cash flow relation in the context of banking system reform in Vietnam 8

1.4.1 Objectives and hypotheses 8

1.4.2 Data 9

1.4.3 Methodology 9

1.4.5 Contributions 10

1.5 Thesis structure 10

CHAPTER 2: OVERVIEW ON VIETNAM’S ECONOMIC REFORMS 11

2.1 Overview on Vietnam’s economy 12

2.2 Overview on equitization of state owned enterprises of Vietnam 20

2.3 Overview on Vietnam’s banking system reform 24

2.4 Chapter summary 29

CHAPTER 3: FINANCIAL CONSTRAINTS AND INVESTMENT: A

THEORETICAL FRAMEWORK AND LITERATURE REVIEW 31

3.1 Theories of investment 33

3.1.1 The Modigliani-Miller Theorem (MM) 34

3.1.2 Neo-classical model 34

3.1.3 Sales accelerator model 35

3.1.4 Tobin’s Q model 36

3.1.5 The Euler model 38

3.2 Financial constraints and investment: a literature review 39

3.2.1 Financial constraint and investment 39

3.2.2 State Ownership and Investment–Cash Flow Relations 48

3.2.3 Banking system reform and investment – cash flow relation 50

3.2.4 Financial leverage, growth opportunity and investment relation 51

3.3 Chapter summary 53

CHAPTER 4: FIRM’S INVESTMENT – CASH FLOW RELATIONSHIP IN THE CONTEXT OF STATE OWNERSHIP IN VIETNAM 54

4.1 The study introduction 55

4.2 Literature review and hypothesis development 57

4.2.1 Relation between investment and cash flow 57

4.2.2 State Ownership and Investment–Cash Flow Relations 60

4.2.3 State Ownership and Investment–Leverage Relation 62

4.3 Research design 63

4.3.1 Testing Investment–Cash Flow Relation 63

4.3.2 Testing the Impact of State Ownership on Investment–Cash Flow Relations 66 4.3.3 Testing the Impact of State Ownership on Investment–Leverage Relations 67 4.3.4 Data 67

4.4 Empirical results 68

4.4.1 Descriptive Statistics 68

4.4.2 Empirical Results 70

4.4.3 Robustness Check 83

4.5 Conclusion 92

4.6 Chapter summary 93

CHAPTER 5: FIRM’S INVESTMENT – CASH FLOW RELATIONSHIP UNDER THE CONTEXT OF BANKING SYSTEM REFORM IN VIETNAM 94

5.1 The Stuty Introduction 95

5.2 Literature review 98

5.2.1 Investment – cash flow relation 98

5.2.2 Effect of banking system reform on investment – cash flow relation.100 5.3 Research methodology 101

5.3.1 Hypothesis development and model specification 101

5.3.2 Data 106

5.4 Empirical results 107

5.4.1 Descriptive statistic 107

5.4.2 Correlations 109

5.4.3 Regression results 111

5.4.4 Robustness check 129

5.5 Study conclusion 130

5.6 Chapter summary 131

CHAPTER 6: CONCLUSION 133

6.1 Introduction 133

6.2 Firm’s investment – cash flow relationship in the context of state ownership in Vietnam 133

6.2.1 Research findings 133

6.2.2 Research contributions, implications and policy recommendations 134 6.2.3 Research limitations and future research directions 136

6.3 Firm’s investment – cash flow relationship in the context of banking system

reform in Vietnam 137

6.3.1 Research findings 137

6.3.2.Research contributions , implications and policy recommendations 138 6.3.3 Research limitations and future research directions 140

LIST OF AUTHOR’S PUBLICATIONS 141

REFERENCES 142

APPENDIX 148

Association of Southest Asian Nations

BIDV Bank for Investment and Development of Vietnam

JSCB Joint-stock commercial bank

VCB Bank for Foreign Trade of Vietnam

Vietinbank Vietnam Industrial and Commercial Banks

LIST OF TABLES

Table 2.1 Main economic indicators of Vietnam, 1986 – 2018 19

Table 2.2 Stages of SOE equitization in Vietnam (1992 – 2018) 21

Table 4.3 Differences between non state-owned and state-owned

enterprises

70

Table 4.4 Analysis of relation between investment and cash flow 73

Table 4.5 Impact of state ownership on investment – cash flow 76

relationTable 4.6 Impact of state ownership on relation between investment

and cash flow under different growth opportunities

78

Table 4.7 Impact of state ownership on the investment and leverage

relations

81

Table 4.8 Impact of state ownership on the relations between

investment - leverage under different growth opportunities

82

Table 4.9 State ownership and relations between investment and cash 84

flow under different growth opportunities: GMMestimation method

Table 4.10 Classification of state-owned and non-state-owned 87

enterprises using the threshold of 33.15 percentTable 4.11 State ownership and relations between investment and cash 90

flow under different growth opportunities in which highgrowth opportunity is classified by quartile

Table 5.4 Analysis of investment - cash flow relation 115

Table 5.5 Effect of banking system reform on investment – cash flow

Table 5.6 Effect of banking system reform on investment –cash flow

relation of state – controlled listed companies by different growth opportunities

122

Table 5.7 Effect of banking system reform on investment –cash flow

relation of non state – controlled companies by different growth opportunities

124

Table 5.8 Effect of banking system reform on investment – leverage 126

relationTable 5.9 Effect of banking system reform on investment – leverage

relation for both low and high growth opportunities

128

Table 5.10 GMM estimates of investment – cash flow sensitivity 129

LIST OF FIGURES

Figure 2.1 Annual GDP growth rate for the period of 1986 – 2018 (%) 13

Figure 2.2 Vietnam’s Inflation (% change of CPI), 1986-2018 15

Figure 2.3 Vietnam’s volume of imports and exports (% of GDP),

1986-2018

16

Figure 2.4 Vietnam’s Foreign Direct Investment, net inflows (% of 18

GDP)

Figure 5.1 Fitted value of investment (IK) on cash flow (CFK) on a

full sample of Vietnamese listed firms for the period of

112

2009 – 2014Figure 5.2 Fitted value of investment (IK) on cash flow (CFK) on a

subsample of Vietnamese State controlled firms for the

113

period of 2009 - 2014Figure 5.3 Fitted value of investment (IK) on cash flow (CFK) on a

subsample of Vietnamese Non - state controlled firms for

114

the period of 2009 - 2014

The second essay examines the effect of banking system reform, which isdefined by the presence of foreign banks, on investment-cash flow relation in acontext of a small transition economy I find evidence that the presence of foreignbanks in Vietnam results in decreasing in firm’s dependence on local banks and haschanged their financial constraint Company investments are less reliant on internalcash flow in the post reform period Although overinvestment of state controlledfirms can not be reduced but underinvestment problem of non- state -controlledlisted firms is mitigated due to better accessibility to bank loans The investigatedrelation between investment and leverage is robust for this conclusion.

JEL classification: G30, G31, G32

Keywords: financial constraints, investment – cash flow relations, state ownership,

banking system reform, small transition economy

CHAPTER 1 INTRODUCTION

This thesis applies the style of a series of papers in the field of corporatefinance, which mainly composes of the two stand-alone essays This chaptersummarizes the content of the thesis, which brieftly presents the thesis’ motivations,objectives, methodologies, contributions and structure Section 1.1 presents thethesis motivations on impact of financial constraints, particularly state ownershipand banking system reform on firm’s investment – cash flows of a transitioneconomy, Vietnam Section 1.2 introduces the research objectives Section 1.3 andSection 1.4 respectively summarize the two essays: firm’s investment – cash flowrelation under the context of state ownership in Vietnam and firm’s investment –cash flow relation under the context of banking system reform in Vietnam Finally,Section 1.5 presents the structure of the thesis

1.1 Thesis motivations

The thesis was inspired by the following motivations:

Firstly, investment is one of the most important decisions in corporatefinancial decisions The company managers will make all of efforts to conductpositive NPV investment opportunities because these investmens are expected toincrease the firm value Beside availability of positive NPV investmentopportunities, the availability of financing funds (internal or/and external) is anotherimportant factor affecting the firm’s investments Therefore, relationship betweeninvestment and cash flows, especially in the context of financial constraints haveattracted

interests of many scholars Fazzari, Hubbard, Petersen, Blinder, and Poterba (1988)show that financially contrained firms have high investment – cash flowsensitivities because of higher cost of external funds in compared with that ofinternal funds Different types of the relationhip between investment and cash flowhave been found in financial literatures Fazzari et al (1988) find the linearrelationship while Cleary, Povel, and Raith (2007) document the non-linear (U-shaped) ones, which have been confirmed by many other studies (Firth, Malatesta,Xin, & Xu, 2012; Guariglia, 2008; Tsai, Chen, Lin, & Hung, 2014) So, there is noconsistent relation between investment and cash flows found in the literatures.Moreover, the relation has not been under-investigated for Vietnam context.

Secondly, the investment – cash flow sensitivity is one of commonly usedmeasures of financial constraint which is defined as a limit in capital accessibility,either internally or externally In the context of transition economy like China andVietnam, the role of state ownership on financial constraints has been unclear.Many studies shows evidence that state-ownership does have impact on firmfinancial constraints, i.e investment – cash flow relation (Firth et al., 2012; Haider,Liu, Wang, & Zhang, 2018; Tsai et al., 2014) while H.-C M Lin and Bo (2012)shows that state

– ownership does not help to reduce financial constraints on investment even via thestate-controlled banking system

Vietnam used to follow the centrally-planned economy which was entirelydominated by state-owned enterprises (SOEs) This mechanism led the country intocrisis and backward, which required a broad and in–depth renovation of the whole

economy A comprehensive program which is well-known as Doi moi was

introduced in 1986 to transform the economy from a socialist to a market oriented

As one of the components of the Doi moi policy, an equitization (privatization

per-se) program launched in the early 1990s has transformed a number of state-ownedcompanies into joint-stock companies beside for the first time allowing existence ofprivate companies A number of private companies (both equitized and non-equitized) has

been constantly increasing However, the government still plays an important role in

a large number of companies by holding a large percentage of outstanding shares atmany equitized SOEs In the literatures, the impact of state ownership on firmperformance as well as financial decisions is still controversial Sun and Tong(2003) report that the privatization program in China improved earnings, sales, andworkers’ productivity at Chinese SOEs but not profitability Du and Boateng (2015)assert that shareholder value is significantly affected by state ownership, formalinstitutional distance, and reforms in the foreign currency approval system.However, G Chen, Firth, and Xu (2009) find that firm performance is enhanced bycertain types of state ownership SOEs have slow, even negative growth whereas therapidly growing private sector significantly contributes to economic growth (Allen,Qian, & Qian, 2005) It finds that SOEs with a soft budget constraint can easilyaccess external financing, resulting in lower dependence on internal cash flows than

is the case at privately owned firms (Allen et al., 2005; Cull & Xu, 2003) Firth et

al (2012) also report that state ownership has an impact on the relation betweeninvestment and cash flow R R Chen, El Ghoul, Guedhami, and Nash (2018) assertthat an increase in state ownership leads to an increase in corporate cash holdings,which means a positive relation between government ownership and corporate cashholdings More specifically, SOEs have higher investment–cash flow sensitivitythan privately owned firms, especially when cash flow is negative So, whether stateownership has any impact on corporate financial constraint, specifically, investment– cash flow relation of Vietnamese companies is still an unanwered question

Thirdly, in Vietnam, due to the underdevelopment of financial market, besideinternal cash flows, bank loans have been main financing sources of funds forfirm’s investments However, credit market is not a fair play ground for privatecompanies due to some historical reasons1 although Vietnam has done severalefforts to improve

1 Vietnam used to be a centrally-planned economy in which state – owned banks mainly served for state-owned enterprises.

the situation Nhung and Okuda (2015) show that Vietnamese SOEs have anadvantage over privately owned firms in accessing bank loans as well as making aprofit, even after economic booms The higher accessibility to bank loans, the lessfinancially constrained the firm is, meaning the lower investment – cash flowsensitivity Therefore, banking system reform is proved to have an impact oninvestment – cash flow relation (Tsai et al., 2014) In the process of transformingthe economy from centrally – planned to market oriented, Vietnam also hasconducted a number of financial system reforms as a component of overal economicreform One of them is to allow the entry of foreign banks to do business inVietnam This does not only come from the reality but from entrance requirements

of international free trade agreements such as WTO also The presence of foreignbanks on one side would increase competition in credit market, and on the otherside put pressures on domestic banks to improve their transparancy, effeciency andprofitability to be survival and grow in a integrated market As such, the presence offoreign banks – which can be considered a measure to reform the banking system –may have certain impact on companies accessibility to external funds to financetheir investment, or on the other words, firm’s investment – cash flow relation.Therefore, it also motivates me to conduct this thesis

The topic of investment – cash flows have been intensively conducted infinancial literatures, but most of them use the samples of developed countries likeU.S, Canada, or China – a big transitional economy To my best knowledge, therelationship between investment and cash flows, especially in the context of state –ownership and foreign bank entry has still not investigated for the case of a smalltransition economy like Vietnam Furthermore, in spite of sharing some cutural,social and political similarities with China, Vietnam also has many differences such

as size of economy, history of the transformation, openness to the world economy,development of financial market, etc Studying the Vietnamese context is believed

to be worthwhile and valuable for international finance literatures because resultsform

the rather specific case of China may not be generalizable for other small emergingmarkets Therefore, I choose to examine the impact of banking system reform, andstate ownership on investment – cash flow sensitivity in Vietnam for my Ph.Dthesis.

1.2 Thesis objectives

The general objective of the research is to investigate the impact of financialconstraints, which are measured by state ownership and banking system reform onthe relation between firm’s investment and internal cash flows in the context ofsmall transitional economy – Vietnam The general objective is implemented by thetwo essays which are separately presented in the following Sections of 1.3 andSection 1.4

1.3 Firm’s investment – cash flow relationship in the context of state ownership in Vietnam

1.3.1 Objectives and hypotheses

The study examines the effect of state ownership on the relationship betweeninvestment and cash flow in Vietnam, a small transitional economy The studyobjectives are as follows:

- Examine the nonlinear relationship (U-shape) between investment and cash flows of Vietnamese listed companies

- Examine impact of state ownership on the investment – cash flow relation in general, and for state controlled and non –state controlled firms

- Examine impact of state ownership on the investment – leverage relation in general, and for state controlled and non –state controlled firms

- Propose some policy reccommendations to various related parties based on the research findings

To achieve the research objectives, following research questions are set forth:

- Does the investment and cash flow relation of Vietnamese

companies have U-shape?

- Do state controlled companies have higher investment–cash

flow sensitivity than non-state controlled companies?

- Does state ownership has a positive impact on a firm’s

investment– debt relations.

1.3.2 Data

The final sample of the study consists 3,366 firm-year observations of financial companies listed on the two stock exchanges of Vietnam, HOSE and HNXfor the period of 2009 – 20152 Both financial and market data are extracted fromthe Thomson Reuters database Observations with missing data are omitted, andoutliers that may influence the results are also excluded by winsorizing 1% of thetwo tails for each variable

non-1.3.3 Methodology

The study applies quantitative method First, the study tests if investment –cash flow in Vietnam is U-shaped for Vietnamese firms in genternal, statecontrolled and state uncontrolled firms, employing two different approaches Thefirst approach follows Cleary et al (2007) which includes square of cash flowmethod in the standard investment regression equation developed by Fazzari et al.(1988), and the second approach follows Firth et al (2012) which separates cashflows into positive and negative cash flows Secondly, the impact of stateownership on the investment

– cash flow relationship is investigated by using both dummy and continuousvariables of state ownership The investigation is conducted for the full sample,state

2 The period is chosen because there were just a limited number of listed equitized SOEs before 2008 and the study was conducted in 2016.

controlled, state-uncontrolled subsamples as well as high and low growthopportunities sub-subsamples Thirdly, the investment-leverage relationship is alsoexamined in the same manner All the regressions are estimated by usingGeneralized Least Squared (GLS) method on a panel data samples to control for theheteroscedasticity problem and robusted by Generalized Method of Moment(GMM) for endogeneitity potential.

1.3.4 Empirical findings

The results show that the investment–cash flow relation for both state-ownedand non-state-owned firms is U-shaped In addition, state-owned companies havehigher cash flow sensitivity of investment, which perhaps is due to theirsocioeconomic and political responsibilities, poor corporate governance and agencyproblem Moreover, the investment of high-growth companies, both with andwithout state ownership, has lower dependence on internal cash flow Additionally,low- growth state-owned companies have higher cash flow sensitivity of investmentthan those without state ownership, suggesting inefficient investment by the former

1.3.5 Contributions

The following contributions are added into the current literature fromdifferent perspectives First, I shed further light on the implications of financialconstraints by investigating the association between state ownership and corporateinvestment–cash flow in a small transitional economy such as Vietnam Second,generally previous studies examining this important issue have been conducted inthe context of developed countries or China (Cleary et al., 2007; Firth et al., 2012;Tsai et al., 2014) The intensive literature review has indicated that the impact ofstate ownership on investment relations in an emerging and transitional countrysuch as Vietnam has largely been under-examined

1.4 Firm’s investment – cash flow relation in the context of banking system reform in Vietnam

1.4.1 Objectives and hypotheses

The study examines the effect of banking system reform on investment-cashflow relation in a context of a small transition economy The banking system reform

is measured by presence of foreign banks or their branches, outlets, representativeoffices at the location where the company locates its headquarter Followings arethe study objectives:

- Examine the U-shape relationship between investment and cash flow for Vietnamese companies

- Examine impact of banking system reform on the investment – leverage relation in general, and for state controlled and non –state controlled firms

- Examine impact of banking system reform on the investment – leverage relation in general, and for state controlled and non –state controlled firms

- Propose some policy reccommendations to various related parties based on the research findings

To achieve the research objectives, following research questions are set forth:

- Is there a nonlinear investment – cash flow relation (U-shape) at

1.4.2 Data

The final sample of the study consists 2,858 firm-year observations of financial companies listed on the two stock exchanges of Vietnam, HOSE and HNXfor the period of 2009 – 20143 Both financial and market data are extracted fromthe Thomson Reuters database Observations with missing data and outliers areexcluded

non-1.4.3 Methodology

The study applies quantitative method First, the U-shaped investment – cashflow relations in Vietnam are tested The tests are conducted for the full sample,state controlled and state uncontrolled subsamples, employing two differentapproaches The first approach follows Fazzari et al (1988) and the secondapproach follows Firth et al (2012) Secondly, I investigate the impact of bankingsystem reform on the investment relationship for various groups of business such asstate controlled, non state controlled, high growth opportunity and low growthopportunity, etc The variable proxied for banking system reform is manuallycollected from company annual reports Thirdly, I examine the investment- leveragerelationship under the impact of state – ownership All the regressions are estimated

by using Generalized Least Squared (GLS) method to fix the heteroscedasticityproblem and robusted by Generalized Method of Moment (GMM) for endogeneititypotential

3 The period is chosen because there were just a limited number of listed equitized SOEs before 2008 and the study was conducted in 2015.

reliant on internal cash flow in the post reform period Although overinvestment ofstate controlled firms is not reduced but underinvestment problem of non- state -controlled listed firms is mitigated due to better accessibility to bank loans Theinvestigated relation between investment and leverage is robust for this conclusion.

1.4.5 Contributions

This study contributes additional empirical evidence to the financialliterature on the topic of impact of banking system reform on investment – cashflow relation, especially in a context of small transition country Most of myfindings are similar to the previous study results except that overinvestmentproblem of state controlled firms is not mitigated in the post reform period Perhaps,

in the post reform period state controlled firms are still main customers of owned local banks who are dominating the credit market Moreover, presence andoperation of foreign banks in Vietnam is still limited

state-1.5 Thesis structure

The remaining of the thesis is structured as follows Chapter 2 presents theoverview on Vietnam’s economic reforms Chapter 3 reviews related investmenttheories and literatures on financial constraints, and its impact on investment – cashflow relationship Chapter 4 and Chapter 5 repectively presents two importantstudies of the thesis: impact of state ownership and banking system reform on thefirm’s relationship between investment and cash flows Finally, the thesis isconcluded by Chapter 6

CHAPTER 2 OVERVIEW ON VIETNAM’S ECONOMIC

REFORMS

This chapter presents an overview on Vietnam’s economic reforms which arerepreresented by corporation reform – known as equitization programs, and bankingsystem reform After the unificication of the whole country in 1975, Vietnamfollowed the centrally planned economic mechanism in which the state governmentdominated all of the aspects of the economy Without the competitive motivationstogether with many other reasons, the economy fell deep into recession for manyyears, which forced Vietnam to reform the economy In 1986, Vietnam officially

launched the comprehensive economic reform program, which is called Doi moi

policy, including economic, financial, corporation etc… reforms The policy aims attransforming the economy from centrally planned, which lacks motivations fordevelopment, to market-oriented which allows the multiple forms of businessorganizations, and openning the door to the world The policy has made a greatimpact on the economy as a whole Economic structure has significantly changedwith the birth and increasing role of private sector in the economy, includingforeign investors Two – tiered banking system was established, together with anincrease in entry and expansion of foreign banks Many legal frameworks have beenintroduced or revised to support the transformation and openness of the economy

Under the Doi moi policy, the corporation reform which is known as

equitization or privatization program was the key component of the economicreform A large number of state – owed enterprised has been equitized viarestructuring, merger and aquistion, deinvestitures, ownership transfer, etc Theequitization

program have borne a number of joint stock companies, which have been one of thedeterminants of Vietnamese economic development for the last few decades.Similarly, the transformation from a one-tiered to two-tiered banking system as well

as allowing the entry of foreign banks were the focal issues of the banking systemreform as a part of financial reform Both the reforms have greatly contributed tothe well-known success of the Vietnam’s economy so far

Chapter 2 is structured as follow Section 2.1 highlights an overview aboutVietnam’s economy for the last more than 30 years Section 2.2 presents theequitization program in Vietnam and Section 2.3 describles an overview of theVietnam’s banking system reform The Chapter will be concluded by Section 2.4

2.1 Overview on Vietnam’s economy

Vietnam’s economy, after the unification of the country in 1975, followedthe centrally-planned mechanism, in which all important decisions must be made bythe central governmental bodies The period of 1976 – 1985 can be described by thelow national income growth rate (3.7 percent), supper high inflation (453.54 percent

by the end of 1986); domestic production could not meet the basic needs forpeople, leading to reliance on imports; severe budget deficit and foreign debtproblems The failure of this model led the economy to the edge of economic crisis.Therefore, the Sixth Party Congress in December 1986 made an important decision

to launch a comprehensive economic reform, shifting the centrally planned

economy to a socialist-oriented market economy, which is called Doi moi policy The Doi moi policy, which cored by economic reform, aiming at implementing the

country’s industrialization and modernization objectives, as well as opened-door,global integration policy and it has brought recognized remarkable achievements

Over the past more than 30 years, since Doi moi, Vietnam has been one of the

countries which have had the most rapid economic growth and development in theworld Figure 2.1 shows the the growth rate of GDP for the period from 1986 to2017

Since the Doi moi in 1986, Vietnam’s GDP growth rate has notably rocketed

from 2.79 percent in 1986 to 7.36 percent in 1989, and then reached the peak of9.54 percent in 1995 However, under the effect of Asian financial crisis in 1997, itdropped down to the lowest point over the last 30 years at 4.77%, a relatively high

in compared with that of many developed countries Since then, the economy hasmaintained a pretty stable growth at around 6 percent annually In 2018, GDP percapita reached about US$ 2,551 per capita a year Economic sectors have beenrestructured toward the development of a market-oriented socialist economywhereby private sector is freely established and operates in areas legally approved

Source: World Development Indicators

Figure 2.1 Annual GDP growth rate for the period of 1986 – 2018 (%)

Although being an agricultural country, before the Doi moi Vietnam had an

underdeveloped and underproductive agriculture sector, resulting in a serous

shortage of foods Under the Doi moi policy in agriculture, which initiated by

8.15 7.54 7.36

1987 and the well-known Resolution No 10 (issued on April 5, 1988)4 Thesepolicies emphasized on fairer equality in land holding, which enhanced farmers’assessibility to land; applying new and advanced technology in agriculturalproduction, diversifying agricultural products other than rice, increasingcompetivitness and efficiency for agriculturat input and output markets, etc As aresult, agricultural productivity was boosted, shifting Vietnam from a food importer

to one of major exporters in many agricultural products such as rice, peppers,coffee, cashew nuts, rubber, etc

One of major success of the Doi moi program was the control of serious

inflation problem In the early stage of the reform, Vietnam fell into hyperinflationperiod with the peak was 453.54 percent in 1986, which mainly caused by failure of

the General Adjustment of Price, Wage and Money (1985) policy Figure 2.2 shows

the inflation fluctuations over the period 1986-2018 From the peak ofhyperinflation (453.54%) in 1986, the consumer price index (CPI) sharply dropped

to two digit and then 1 digit number in 3 to 5 years Since 1990s up to now,Vietnam’s inflation rates have been well controlled at fairly stable rates at below 10percent annually Inflation of 2018 was only 3.54 percent

4 The Resolution No 10 refers the official agricultural management renovation which allowed the implementation of the output contract system to household farmers instead of only signing the output contract according to differenqt stages of work in production as had been done since 1981.

Source: International Monetary Fund, World Economic Outlook Database, April 2019

Figure 2.2 Vietnam’s Inflation (% change of CPI), 1986-2018

Vietnam used to be considered closed economy in the period before the Doi

moi, when goods and services was not freely traded Foreign trade transactions were

mainly conducted with former socialist counterparts and did not follow the marketmechanism Since the reform was launched, Vietnam has been gradually opened itseconomy to the world Many measures have been done to push up both domesticand international trade such as removing unnecessary trade barriers; engaging inmembership of Association of Southest Asian Nations (ASEAN) in 1995, theASEAN Free Trade Agreement (ATFA) in 2001, World Trade Organization (WTO)

in 2007; signing many bilateral and multilateral economic and trade agreementswith foreign countries and organization such as with EU (1992), US-VietnamBilateral Trade Agreement (2001), etc As a result, both exports and imports havebeen constantly increased for the last more than 30 years As shown in the Figure2.3, the volume of exports of goods and services as a ratio of gross domesticproduct (GDP) rose from only 6.62% percent in 1986 to 101.59 per cent in 2017,while the ratio of

imports of goods and services to GDP also increase to 98.79 percent in 2017 from a low level of 16.6 per cent in 1986.

Source: World Development Indicators

Figure 2.3 Vietnam’s volume of imports and exports (% of GDP), 1986-2018

In the process of opening the economy, Vietnam also issued the Law onForeign Investment in 1987 and its amendment in 1990 to attract foreign directinvestment (FDI) The law has been revised or issued the new versions for severaltimes5 since then to meet the current status of the world and the Vietnameseeconomy With the advantages of cheap, young, skillful and hard working laborsforce, rich natural resources, openness of investment laws, etc Vietnam has been anemerging destination for FDI And FDI has also played an important role in thedevelopment of Vietnamese economy Figure 2.4 shows the net inflows aspercentage of GDP of FDI into Vietnam since the opening the economy FDIinflows was high during the period of 1993-1997, from 7.03 percent of GDP in

1993, rised to the peak of 11.94

5 The first version of the Law on Foreign Investment was issued in 1987, then amended in 1990 A new version was issued in 1996 to replace the first version, and then amended in 2000.

percent and then droped down to 8.27 percent in 1997 Under the impact of theAsian financial ciris in 1997, FDI inflows to Vietnam was low at the level of around

4 percent of GDP for the period of 1998 – 2008, and then slightly rised up again forthe period afterward FDI sector has been a major contributor to Vietnam’s GDP,helping creating jobs and boosting the development of the manufacturing sectorwhich supported for the increase of foreign trade as well as the structural changes inexported products In the late 1980s, about 80 percent of exports were accounted for

by primary commodities, such as rice, coffee, crude oil, and coal, but by 2005,along with the expansion of manufactured exports, that share had declined to about

50 percent

Especially, the Ho Chi Minh Stock Exchange (HOSE) and Hanoi StockExchange (HNX) was founded in 2000 and 2005, respectively to establish anotherhelpful financing and investing channels for companies and investors Law onSecurities was first issued in 2006 and then amended in 2010 in order to make agood environment for the development of stock markets in Vietnam

Source: International Monetary Fund, World Economic Outlook Database, December 2019

Figure 2.4: Vietnam’s Foreign Direct Investment, net inflows (% of GDP)

4.94 5.48 5.37 5.20 4.92

4.80

6.00

6.11 6.14 6.30 6.30 6.14

6.90 7.17 7.03

8.00

8.59 8.65 8.27

9.66 9.71

12.00

10.00

11.94

14.00

In terms of investment, the introduction of Law on Domestic Investment in

1998, which aimed to stimulate the investment of domestic investors, set forth theinitial formation of private sector in Vietnam This sector has been expanded andstrengthened by the equitization of state owned enterprises (SOEs) which will bediscussed more in details in following part

Table 2.1 Main Economic Indicators of Vietnam, 1986 – 2018

$US)

GDP per capita ($US)

Total investment (% of GDP)

Inflation (%

change

in CPI)

Imports

of goods and services (%

change)

Exports

of goods and services (%

change)

Current account balance (bil.$US)

Current account balance (% of GDP)

FDI, net inflows (% of GDP)

2.2 Overview on equitization of state owned enterprises of Vietnam

Vietnam used to be a centrally planned economy entirely dominated by owned enterprises (SOEs) which had large inefficiency regardless of muchfavourable privilege Vietnam began to transform its economy from a socialist to a

state-market economy by lauching a comprehensive reform, namely Doi moi policy in

1986, in which corporate restructuring scheme was one of the major components ofthe reform The corporate restructuring scheme aimed to transform state ownedenterprises into the form of multiple owners, in which it is unnecessary for the state

to own 100% capital; to mobilize capital from both domestic and foreign investors;

to increase financial capacity; and, to renovate technology and managerial methods

in order to raise the efficiency and competitiveness of the economy (Article 1 ofDecree 59) With this scheme, the government would accept the existence ofvarious forms of business organizations other than SOEs and collective enterprises,and hope to create a more equal play field for all economic players The heart of thescheme was a so-called SOE equitization (privatization per-se) program which hasbeen transforming a number of SOEs into joint-stock companies in a slow andgradual manner

A pilot SOE restructuring program6 was launched in early 1990s, whichstarted with profitable but not strategic small and medium size SOEs to beequitized, and then expanded to larger and more difficult ones Employees ofequitized companies should be priorited in purchasing the shares Besides, thegovernment continued to hold tight control role over some key important industriessuch as banking, oil and gas, electricity, etc via controlling ownership In thesecompanies, the government plays a dual role – regulator and owner These statecontrolled companies have to perform not only business but also non-businessfunctions such as being in charge of

6 The pilot scheme was launched in 1992 based on a resolution of the tenth session of the Eighth National Assembly and the Prime Minister Decision 202-CT on equitization programs on 8 June 1992

ensuring social security and poverty alleviation Therefore, state-ownership does play an important role in company’s financial decisions.

Generally, the process of equitization in Vietnam could be divided into stages

as decribled in the Table 2.2 below:

Table 2.2 Stages of SOE equitization in Vietnam (1992 – 2018)

Stage Timeframe Legal Base

Pilot stage 1992 to 1996 Decision 202_CT; Direction 84 (1993);

restructuring

stage

2011 to 2017 Decision 929 (2012), Decrees 59 (2011), 189

(2013), 16 (2015), and decision 1232 (2017)

Source: Author’s compilation based on statistics ISEAS report (Le Hong Hiep (2017), Vietnam’s

New Wave of SOE Equitization: Drivers and Implications, Perspective, No 57, Ministry of

Finance Nguyen Van Tan (2018) Equitization and Firm Performance in Vietnam: Theory and

Practice, International Research Journal of Finance and Economics ISSN 1450-2887 Issue 169

September, 2018

The pilot stage was enforced by Decisions No 202/CT dated on June 8th

1992 and the Direction 84 dated August 4th 1993 In the pilot stage of 4 years, only

5 SOEs (3 central SOEs and 2 local SOEs) were equitized, which wereTransportation Service Company, Refrigeration and Electrical EngineeringCompany, Hiep An Shoe Company, Animal Food Processing Company and Long

An Export Product Processing Company After the equitization, state held only 30percent of total ownership except Transportation Services Company (18 percent).Besises, in this period, 18 general corporations and 64 large comglomeates (specialcorporations) specializing in various industries and areas which are fully state-owned were formed

Source: Author’s compilation based on statistics ISEAS report (Le Hong Hiep (2017), Vietnam’s

New Wave of SOE Equitization: Drivers and Implications, Perspective, No 57, Ministry of

Finance Nguyen Van Tan (2018) Equitization and Firm Performance in Vietnam: Theory and

Practice, International Research Journal of Finance and Economics ISSN 1450-2887 Issue 169

September, 2018.

Figure 2.5 Progress of SOE equitization, 1992 – 2018

Then, the pilot stage was extended for 2 more years from 1996 to 1998 withthe issuance of Decree No, 28/CP dated May 7th 1996, which also ended the pilotprogram This Decree gave systematic guidances to SOEs on purposes ofequitization, criteria of SOEs selection, equitization methods, employment andinvestment incentives for equitized enterprises With this Decree, the governmentofficially allowed non-strategic profitable small and medium sized SOEs into jointstock companies, consequently pushing up the process of equitization with 130companies SOEs equitized during this two years, of which there were only 125SOEs being equitized in 1998

118 134 142 144123

164 200

6% 213

212 206 251 300

8% 359

400

10% 500

12% 537

600

16% 14% 700

18% 753

800

813

20% 900

The accelerated stage which were from 1999 to 2010 were guided byDecrees of 44 issued in 1998; 64 issued in 2002; 187 issued in 2004 and 109 issued

in 2007 With the opening of the Vietnam Stock Mark in Ho Chi Minh City in 2000and espectially constant rise in stock market index under the positive expectation ofbeing the 150th WTO member in early 2007 truly affected the process ofequitization acceleration The number of equitized SOEs steadily increased fromyear to year since 2002 with 164 to the peak of 813 in 2005 As of 2006, more than3,433 companies having being equitized, in which 3,295 had been equitized since

1999 However, most of equitized companies up to 2006 were still small andmedium size Some large SOEs were planed to be equitized in 2007 but the planwas slower due to some reasons, including the concerns on oversupply in the stockmarket after the earlier rocketed stage of acceleration As initially planed, 1,500SOEs should be equitized in the period 2007 – 2010, in which most of subsidiaries

of general corporations were planed to be equitized in 2008; decreasing to morethan 500 SOEs left However, there were only two big names - Bao Viet Insuranceand Vietcombank

– out of 118 being equitized SOEs in 2007, leaving more than 20 big SOE names to

be implemented in the period 2008 – 2010 The acceleration stage of 10 year periodconcluded with 3,983 SOEs being equitized, comprising 84.59 percent of totalnumber of equitized SOEs

Vietnam’s process of equitization has been in economic restructuring stage(2012 – now) Under the negative impact of the global financial crisis and the crash

of the stock market, speed of equitization has been sharply dropped at early of thisstage (2010 – 2012) In addition, general economic and stock market conditionshave not been in favourable shape for SOEs especially big ones to be equitized.Several policies have been made to stimulate the SOE equitization such as Decision

929 issued in 2012; decrees of 59 (2011), 189 (2013), 16 (2015) and Decision 1232(2017) This lead to a sharp increase in number of equitized SOEs in the following

years 2012 – 2015 However, the process seems to be slow down for the last couple

of years

Thanks to the equitization program, a number of SOEs has graduallydecreased for the last more than 20 years, to 1,204 enterprises from more than 6,000enterprises in 1995, proving the effort of the government in corporate restructuring

Source: Author’s compilation from Nguyen (2017) for period of 1995 – 2008, Vietnam’s

GSO, various years for period of 2009 – 2017

Figure 2.6 Number of SOEs, 1995 - 2017

2.3 Overview on Vietnam’s banking system reform

Over the past thirty years, as a part of the comprehensive economic reforms,the Government of Vietnam has initiated many banking reforms to improve theefficiency and competitiveness of the national banking system Moreover, thereforms have also been motivated by Vietnam’s commitments in the process ofgrowing participation in international agreement as well as adopting international

standards such as Basel capital framework The primary objectives of the reformswere restructuring banking system, gradually opening doors for foreign investors,partially equitizing state owned banks, and improving competitiveness of theVietnamese banks The major banking system reform was the removal of thecommercial functions from the State Bank of Vietnam (SBV) in 1990 which havebeen followed by several reforms such as equitizing state owned banks, opening thefinancial market for foreign banks, etc.

Before 1990, the Vietnamese banking system was a one-tier banking system,

in which the State Bank of Vietnam (SBV) played both central bank andcommercial bank functions There were neither private nor foreign bank operating

in the economy Following the Ordinance on Banks, Credit Cooperatives, andFinancial Companies issued in early 1990, SBV was reconstructed by removing thecommercial functions from SBV so that SBV only governed the whole bankingsystem and performed the traditional role of central banks the such as managing thecountry’s foreign exchange reserves; formating of monetary polities; licensing andsupervising credit organizations, etc., while commercial banking functions such asfunds mobilization and lending were delegated to separated commercial banks Assuch, SBV’s four functional departments were separated to establish four new state-owned commercial banks (SOCBs) 7, each targeting a specific sector of theeconomy At the same time, a number of joint-stock commercial banks (JSCBs)have been founded and quicky increased both in bank numbers and size

In the process of interating with the world, to open the economy in generaland financial sector in particular as well as to meet the requirements of membershipfrom international trade and investment organizations, Vietnam has been gradually

7 Specificallly, the current Bank for Foreign Trade of Vietnam (VCB), Vietnam Bank for Agriculture and Rural Development (Agribank), Bank for Investment and Development of Vietnam (BIDV) and Vietnam Industrial and Commercial Banks (Vietinbank) were established from the splits of SBV’s former International Trade Department; Agricultural Department, Infrastructure Department, and Industrial and Commercial Lending Department, respectively.

removing barriers to allow the entry of foreign banks in Vietnam In 2008, SBV forthe first time granted the licences for 100% foreigned owned banks to do business inVietnam In April 2014, the cap for a single and total foreign ownership in localcommercial banks and credit organizations was leveled up to 20% and 30%,respectively Table 2.3 presents Vietnam’s structure of credit institutions (byDecember 31, 2017)

Table 2.3 Credit institutions of Vietnam, 2010 - 2017

No Type 2010 2011 2012 2013 2014 2015 2016 2017

4 Joint stock commercialbanks (JSCBs) 37 35 34 33 33 28 28 28

11 Local people's creditfunds 1057 1095 1032 1144 1145 1147 1166 1178

Source: Author’s compilation from SBV Annual reports of various years;

(*) Including 3 zero dong repurchased banks

As shown in the Table 2.3, number of SOCBs is limited in compared withJSCBs but SOCB account for more than 40% of market share, therefore they havestill played a dominant role in the credit market In addition, presence of foreignbanks in Vietnam has been slightly increased over the last decade Foreign bank’sbranches