UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS FINANCIAL DEVELOPMENT AND FIRMS’ FINANCING CONSTRAINTS: A STUDY OF MANUFACTURING FIRMS IN VIETNAM BY VU THI KHANH MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, MAY 2015 UNIVERSITY OF ECONOMICS HO CHIMINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS FINANCIAL DEVELOPMENT AND FIRMS’ FINANCING CONSTRAINTS: A STUDY OF MANUFACTURING FIRMS IN VIETNAM A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By VU THI KHANH Academic Supervisor: DR.LE VAN CHON HO CHI MINH CITY, MAY 2015 Declaration “This is to certify that this thesis entitled “Financial development and firms’ financing constraints: A study of manufacturing firms in Vietnam”, which is submitted by me in fulfillment of the requirements for the degree of Master of Art in Development Economics to the Vietnam – The Netherlands Programme (VNP) The thesis constitutes only my original work and due supervision and acknowledgement have been made in the text to all materials used.” Vu Thi Khanh Acknowledgments This thesis would not have been possible without the support and the encouragement from many people I would like to make a sincere effort in portraying my deep sense of gratitude in the form of words I owe a debt of gratitude to my supervisor, Dr Le Van Chon for his great generosity and dedication in sharing his wisdom, stimulating my critical thinking skills and guiding me to rethink and to deconstruct my thesis topic He was also not afraid of time-consuming to explain econometric methods as well as data processing techniques to me Moreover, he took time to diligently review my final thesis draft and help me correct errors and inappropriate words usages Furthermore, I am grateful to Ass.Prof Nguyen Trong Hoai and Dr Tran Tien Khai for their valuable comments and suggestions for my concept note and thesis research design Thank to Dr Pham Khanh Nam for his enthusiasm of helping me collecting data I must show my gratitude toward all lecturers VNP who have broadened my perspectives and encouraged me to think harder and deeper about the complexity of the world’s realities Next, I wish to express my thank you to all my friends here at VNP Together we have walked and struggled through this whole treasured journey of learning and shared memorable and priceless moments Then, I want to say thanks to VNP officers as well as VNP librarian for their support of comfort lab room and study materials Finally, I dedicate my thesis to my parents and my brother who are always besides me and never stop supporting me Abbreviations ADB : The Asian Development Bank BTA : The U.S.-Vietnam Bilateral Trade Agreement DM : Demirguc-Kunt and Maksimovic GDP : Gross domestic production GSO : General statistics office of Vietnam HNX : Hanoi Stock Exchange HOSE : Ho Chi Minh Stock Exchange IMF : The International Monetary Fund LLY : Liquid liabilities ratio PCG : Private credit to GDP ratio SMEs : Small and medium enterprises SOEs : State-owned enterprises SVG : Stock market total valued traded to GDP UK : The United Kingdom UN : The United Nations UPCoM : Unlisted public company market US : The United States of America VAR : Vector Autoregression VES : The Vietnam Enterprise Survey WB : The World Bank Abstract Using panel data from the Vietnamese Enterprise Survey (VES) from 20062012, this thesis aims to analyze the relationship between financial development and financing constraints of firms in Vietnam The Euler equation approach is applied to model firms' investment Investment sensitivity to cash-flow is employed as the variable to test for the existence of financing constraints To control for endogeneity and firm heterogeneity, I utilize the first difference GMM estimation proposed by Arellano and Bond (1991) There is robust evidence that Vietnamese manufacturing firms face financing constraints and that financial development significantly relaxes firms' dependence on internal funds for investment In addition, although smaller firms suffer more severe financing constraints, their constraints are alleviated more than those of larger firms in the presence of financial development Keywords: Financial development, Financing constraints, Corporate Investment Table of contents Chapter 1: Introduction 1.1 Problem statement 1.2 Research questions 1.3 The scope of the study 1.4 The structure of the study Chapter 2: Literature review 2.1 Sources of investment financing 2.1.1 External financing 2.1.2 Internal financing 2.2 Financing constraints on firms 2.2.1 Definition 2.2.2 Measurement of financing constraints on firm 2.3 Financial development and financing constraints on firms 2.4 Conclusion 14 Chapter 3: Model specification 16 3.1 Investment modeling 16 3.1.1 Euler investment equation approach 16 3.1.2 Detecting the presence of firm’s financing constraints using Euler equation 24 3.2 Financial development measurement 25 3.3 Empirical model to evaluate the impact of financial development on firm investment 28 Chapter 4: Financial development in Vietnam 30 Chapter 5: Empirical results 37 5.1 Data 37 5.1.1 Sample and variable construction 37 5.1.2 Descriptive (Initial relationship) 40 5.2 Estimation technique: GMM dynamic panel estimation 44 5.3 Regression results 46 Chapter 6: Conclusion 51 6.1 Main findings 51 6.2 Policy implications 52 6.3 Limitations and further research 52 References 53 Appendix 60 List of tables Table 2.1: Share of financing sources in two industries in the United Kingdom Table 2.2 The proportion of financing sources according to different firm sizes Table 5.1: Firm level variable definitions 38 Table 5.2: Panel data structure 39 Table 5.3 The descriptive statistics of the key variables for the whole data sample 41 Table 5.4 Median value of the key variables by different firm types 41 Table 5.5 Correlation matrix 42 Table 5.6 Mean values of the key variables by manufacturing industries 42 Table 5.7 Mean values of the key variables by years 43 Table 5.8 Regression results using first difference GMM estimation 47 Table 5.9 Scenario analysis of firm’s size on investment –cash flow 50 List of figures Figure 4.1 The mono-tier banking system in Vietnam before banking reforms 31 Figure 4.2 Structure of the two-tier banking system in Vietnam (after May 1990) 31 Figure 4.3 Brief on the Vietnamese banking system 32 Figure 4.4 Liquid liabilities (M3) as % of GDP of some countries 33 Figure 4.5 Credit to the economy 34 Figure 4.6 Private credit to GDP of some countries 34 Figure 4.7 Stock Market Capitalization as % of GDP 35 List of appendix Appendix Banking system development progress from 1990’s 61 Appendix Stock market development process from 1990’s 63 Appendix Boxplot chart for each variable (IK,SK,CFK) by industries 66 Appendix Scatter chart for each variable (IK, SK, CFK) by industries 66 Chapter 6: Conclusion 6.1 Main findings It is no doubt that one of the major mechanisms through which economies could gain from financial development is to stimulate firm’s investment financing (Levine, 2005) Financial reforms, whose main purpose is reducing capital markets imperfections, would exert a powerful effect on output by providing larger and more efficient sources of finance to firms This paper inherits the ideas from Love (2003), Laeven (2003) and O’Toole and Newman (2012) Although the idea of using Vietnamese manufacturing data taken from VES rooted from O’Toole and Newman (2012), this study has applied a different approach of testing the presence of financing constraints Firms are tested whether they face financially constrained by using Euler equation approach obtained by addressing firm’s maximizing its value problem after taking first order condition for investment (Love, 2003 and Laeven, 2003) Three main indicators of financial development measurement employed in this paper are liquid liabilities ratio, private credit to GDP ratio, and stock market total value traded to GDP which widely employed in previous studies (Dermirguc-Kunt& Levine, 1996; Levine et al., 2000; Love, 2003;Huang, 2011b; Čihák et al., 2013) As the result, Vietnamese manufacturing firms face financing constraints, and small firms suffer more severe financing constraints than large firms Fortunately, financial development has a significant effect in relaxing firms’ financing constraints Moreover, the effect varies from firm to firm Smaller firms with higher level of financing constraints experience a better reduction in their constraints in the presence of financial development 50 6.2 Policy implications Based on the above results, there are some policy recommendations Firstly, financial development process both in banking and stock market sector should be encouraged in the future due to the positive effects on firm’s investment Financial reforms not only focus on the quantity aspect but also the quality of the financial reforms The second is about large firms In the presence of the financial development, large firms gradually lose their privilege and endure some difficulties in banking credit access External financing sources only come to healthy and prospective firms Thus, large firms, probably consisting of many SOEs, need to improve their efficiency, competiveness and transparency of their activities 6.3 Limitations and further research This research still remains some limitations The first concern belongs to the quality of data Firms taking part in the survey are not forced to provide accurate and sufficient financial information It is really a matter because key variables in the empirical model are derived from firm’s financial statement The second problem is mall number of consecutive years of firm observations It seems not to be long enough to 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The Banking Ordinance took effect - Branches, representative offices of foreign banks were allowed to start up in Vietnam - The joint-stock commercial banks began to be established - In this period, four Joint-Venture banks of state owned banks and foreign banks were set up 1993 - Normalizing relations with international financial institutions (IMF, WB, ADB) 1995 - The Parliament passed a resolution to remove the sales tax on banking operations and banks established to serve the poor 1997 - The 10th convocation of National Assembly passed the Law on the State Bank of Vietnam and the Law on Credit Institutions (launched on 12/02/1997) and effective from 10.01.1998; - The Mekong Delta Development Bank was established (Decision No.769/TTg launched on 09/18/1997) This was also the year when the financial crisis in East Asia Thus, this has a negative impact on the banking system in Vietnam After this period, some banks with weak performance were rearranged From more than 50 joint-stock commercial banks, by the end of 2004, there remained 37 banks 1999 - The Deposit Insurance of Vietnam was established (launched on 9/11/1999) 2000 - Restructure the financial status and operation of state-owned commercial banks and the joint-stock commercial banks 2001 - The asset management companies were set up in the commercial banks - The U.S.-Vietnam Bilateral Trade Agreement (BTA) was signed In this agreement, Vietnam has committed to follow a given opening-up process 2002 - Liberalize the VND interest rates of credit institutions - the final step of full 59 liberalization of interest rate market in both input and output 2003 - Conduct in-depth restructuring activities of commercial banks in accordance with international standards - The Bank for Social Policies on the basis of the Bank for the Poor was established on the purpose of separating policy credit from commercial credit; - Carry out the first step of the amendment of Law of the State Bank of Vietnam 2004 - Amend the Law on Credit Institutions Vietnam 2010 - On 16/6/2010, in order to meet the new requirements of the development process of economic and financial system, the Law on State Bank of Vietnam and the new Law on Credit Institutions were passed by the 12th convocation of National Assembly and took effect from 01/01/2011 - In comparison with the 1997 Law of the State Bank, the 2010 Law of the State Bank has several important changes, including clarifying the legal status of the state bank, and defining the functions and tasks of the State bank as a central bank as follows:  Perform the functions of state management in the fields of monetary and banking activities, confirming tight relationship between two important functions of a central bank, consisting of implementing monetary policies and monitoring the operation safety of the credit institutions system - Meanwhile, in comparison with the old Law, there is a significant change in the new Law on Credit Institutions That is credit institutions are not allowed to take part in any business activities other than banking It means that capital raising activities like banking of non-banking institutions in the field of securities, financial investment services will be terminated from the beginning of 2011 Source: Collected from website of the State Bank of Vietnam (http://sbv.gov.vn/) 60 Appendix 2: Stock market development process from 1990’s Year Event 1993 Establishment of Capital Market Research and Development Department One of the first meaningful steps to set up the Vietnamese stock market was the establishment of Capital Market Research and Development Department (Decision No.207 / QD-TCCB launched on 11/06/1993 by Governor of the State Bank) It was under the supervisor of the State Bank with the main tasks of researching, developing projects and preparing conditions for the establishment stock market 1996 Establishment of the State Securities Commission State Securities Commission, established on November 28th 1996 under Decree No.75/CP of the Government, is a government agency performing functions of organization and state management of securities and the Stock Market Exchange The establishment is crucial for the openness of the stock market three years later 2000 Opening the stock exchange center Although established in 1998 under Decision No 127/1998/QD-TTg launched on 11/07/1998, but after years, on July 28, 2000, Ho Chi Minh City Stock Exchange Center was officially put into operation with two first listed companies, REE and SACOM 2004 State Securities Commission is placed under the supervision of Ministry of Finance Over the five years operation, the State Securities Commission had implemented functions and tasks to achieve many obvious results, expressing its role as an organizer and an operator of Vietnam's stock market However, to facilitate better coordination among ministries in promoting the development of the securities market, on February 19th, 2004 the Government issued Decree No.66/2004/ND-CP with the main content of transferring the State Securities Committee to be under the supervision of the Ministry of Finance 2005 On August 3rd, 2005, the Hanoi Securities Trading Center, which later was transformed and restructured into Hanoi Stock Exchange (HNX) in 2009, officially opened 2006 On 20/06/2006, the Ministry of Finance issued Decision No 2276 / QD-BTC that regulates the centralized procurement of government bonds at the Hanoi Securities Trading Center 61 According to the decision, Hanoi Securities Trading Center is the only organization tasked to conduct bidding for government bond in Vietnam Up to now, the HNX is responsible for organizing securities transactions with two primary activities, including the share auctions and Government Bond biddings to mobilize capital for the State budget Simultaneously, the HNX has operated three secondary trading markets on a modern technological structure, including listed stock market, government bond market, and unlisted public company market (UPCoM) 2007 After years of growing and integrating into the global securities market, the government signed Decision No 599/QD-TTg on May 11th 2007 to transfer the Ho Chi Minh City Securities Trading Center to Ho Chi Minh Stock Exchange (HOSE) On August 8th 2007, Ho Chi Minh Stock Exchange was officially opened Sources: Collected from official websites of HNX and HSX (http://hnx.vn/ and http://www.hsx.vn/) 62 Appendix 3: Boxplot chart for each variable (IK,SK,CFK) by industries 63 Appendix 4: Scatter chart for each variable (IK, SK, CFK) by industries 64 ... external financing and the later internal financing 2.1.1 External financing Early in mainstream economic point of view, external financing is viewed as a source of firm financing and financial institutions,... relationship between financial development and firms investment in Vietnam Of particular interest is the role of financial development via financing constraints on the firms financing investment However,... development and firms financing investment in the case of Vietnamese manufacturing firms The firm panel data for this research is taken from VES from 2006 to 2012 Meanwhile, the macro data of financial