Economic Fundamentals and Financial Sector Development

II.1 Movement of the Major Macroeconomic Variables

Viet Nam has recorded quite high economic growth over nearly 20 years, averaging 7.4% per annum during the period 1990–2007 (Table 2 [ PDF 116.3KB | 1 page ]). Viet Nam is currently the third fastest growing country in East and South East Asia after the People's Republic of China (PRC) and Cambodia, and it offers tremendous growth potential in the coming years. The country is expected to overcome the status of a poor country in the meantime (by the year 2008?) due to the ambitious plans of the Government of Viet Nam. There are some fundamental factors that have allowed Viet Nam to successfully implement the plan: (i) poverty was reduced substantially, from 70% by the end of 1980s to 14.7% in 2007; and (ii) a middle class has emerged in urban cities, especially in Ho Chi Minh City and Hanoi, with continuing wealth accumulation. In recent years, the country has been undergoing rapid urbanization with the urban population increasing at a compound annual growth rate (CAGR) of 3.6% between 2000 and 2006.

Table 2 suggests that Viet Nam had been successful in combating inflation. Yet since 2004, inflation has emerged as a major concern. After a spike in 2004–2005, inflation began moderating progressively and consequently reached the highest level of 12.6% in 2007.

The structure of the economy has changed towards industrialization. The share of manufacturing in the GDP increased from 12.3% in 1990 to 21.4% in 2007. The contribution of services and the financial sector to the GDP did not change correspondingly; there was, however, an impressive contribution by the financial sector to the GDP in 2006 and 2007, at 1.9% and 2.0% respectively, reflecting rises from the steady state level of 1.8% during 2000–2005 (Table 2).

The rather high economic growth corresponded with a significant increase in investment as well as public and private savings (Table 2). The growth has still been driven much by state investment (which is still inefficient), though its ratio in total investment has tended to decline since 2000 (Table 3 [ PDF 112.8KB | 1 page ]).² However, since 2000, the savings-investment gap has been widening as the investment ratio is increasing while the savings ratio has tended to stagnate. A simple regression has shown that there could be a time threshold in which an increase in income could reduce the private savings ratio. A one percentage point increase in economic growth can decrease in the short run and long run of about 0.8 percentage point and up to 2.1 percentage points in the other-than-budget saving ratio.³ Meanwhile, foreign savings have played an essential role and have consistently contributed 14.2%–21.2% to total investment in Viet Nam.

Recently, total retail sales of goods and services have increased by more than 22% per annum, much faster than the nominal GDP. This observation reinforces the conclusion that the savings ratio has stagnated. Moreover, the income gaps between urban and rural areas and between the rich and the poor have also increased quite significantly.

II.2 Development of the Banking System

Key Policy Reforms

Until 1988, Viet Nam had operated under a mono-banking system with the State Bank of Vietnam (SBV), the country's Central Bank which performed both central and commercial banking functions. In 1988, the banking industry became a two-tier system, with four SOCBs created to assume the SBV's commercial banking activities while the SBV retained the central banking responsibilities. Given the state-driven nature of the Vietnamese economy, up until the recent economic reforms, the SOCBs traditionally focused on lending to the SOE sector.

Barriers to entry were reduced in 1991, opening the market to competition from both foreign players (subject to strict restrictions) and joint stock commercial banks (JSCBs). But over-competition among JSCBs eventually brought about a round of restructuring and mergers, particularly during 1999–2001, and as a result, the number of the JSCBs fell from 51 to 34 by 2006. Since 2005, some JSCBs such as Asia Commercial Bank (ACB) and Sacombank have been listed on the stock market. The SOCBs have been under restructuring since 2001 and some are now under equitization, being listed on the stock market.

The banking sector was further liberalized following the VN-US BTA and commitments in the WTO framework (Box 1 [ PDF 248.2KB | 1 page ]). Viet Nam's commitments were subjected to the relevant laws and regulations as promulgated by the competent authorities of Viet Nam to ensure consistency with Article VI of the GATS and Para 2(a) of the Annex on Financial Services. In addition, the provision of banking services and products was subjected to relevant institutional and juridical forms.

The Banking System and Its Major Characteristics

There are at present over 75 banks operating in Viet Nam, comprising five SOCBs, one policy bank (VSPB), 34 JSCBs, 31 wholly-owned branches of foreign banks and 5 joint venture banks, and more than 900 people's credit funds (PCFs) (Table 4 [ PDF 248.2KB | 1 page ]). In addition, there are 47 representative offices of foreign banks operating in Viet Nam.

Viet Nam's banking sector is often considered both heavily fragmented and concentrated. Credit structure by sector has only changed slightly despite a considerable shift in economic structure. Indeed, the shares of total outstanding loans to the agricultureforestry- fishery and industry sector in 1995 were 26.5% and 37.5% respectively; in 2005, the corresponding figures were 29.7% and 39.8% (SBV 2006). The highly fragmented banking market caused by assigned commercial banks⁴ has, to a certain extent, restrained risk-sharing within the banking system and narrowed borrowing choices of businesses.

In 2006, Viet Nam's top 15 banks together controlled 92.4% of market share by assets (excluding foreign bank branches). In 2006, the SOCBs shares had still accounted for nearly 70% of total deposits and 65% of total credits. However, since 2006, the role of the JSCBs has changed significantly and in 2007, they already accounted for much larger shares in total deposits and total credits (Table 5 [ PDF 249.3KB | 1 page ]). In terms of operating features, the SOCBs own the largest distribution networks (AgriBank: 1468; VietcomBank: 207; BIDV: 500; ICB: 832). The JSCBs have also quickly developed a network since 2005 (ACB: 111; SacomBank: 161; Eximbank: 59; Techcombank: 120); in terms of size, however, their branches would qualify only as sub-branches of the SOCBs.

Financial depth has also changed significantly (Table 6 [ PDF 190.6KB | 1 page ]). Until 2004, Viet Nam was still seen as an economy with a rather shallow financial depth. Fast growing credit with an annualized average growth rate of 33.4% fueled by strong credit demand from both the corporate and retail markets since 2004 promoted financial deepening. As a result, in 2007, there were sharp increases in financial deepening with indicators such as the credit/GDP ratio (reaching 82.5%), and M2/GDP (112.1%, increasing from 23.8% in 1996). The outstanding credit of the banking system to SOE had gone down dramatically from 52.7% of total outstanding credit in 1996 to 31.5% in 2007. This movement in the credit business of Viet Nam's banking industry reflects fundamental changes in client appraisal based on normal market practices.

In recent years, the banking industry has significantly developed its financial strength by cleaning up banks' balance sheets and increasing capital through issuing new stocks as well as increasing financial reserves. As a result, the financial position of banks has been improved significantly in terms of capital adequacy and non-performing loans (NPLs) (Figure 1-4 [ PDF 196KB | 2 page ]). For example, the NPLs of the SOCBs were reduced from 13% in 2000 to about 3% in 2006.⁵

Banks' profitability is uneven relative to asset size. The incumbent SOCBs have relatively high provisioning expense levels, reflecting a legacy of loans to the SOEs, whereas the newer JSCBs have lower provisioning expenses. As a result, profitability measured by ROE (Figure 5 [ PDF 119.6KB | 1 page ]) and ROA (Figure 6 [ PDF 119.6KB | 1 page ]) of SOCBs tends to be lower than that of JSCBs (with the exception of VietcomBank).

The differences in profit between SOCBs and JSCBs are also clearly explained by the structure of the assets of those banks as described in Figure 7 [ PDF 149.3KB | 1 page ]. The asset structures show that the outstanding debt/total assets ratio in JSCBs (54.35%) is much lower than that of the SOCBs (62.81%), except again the unique case of VietcomBank (44.24%). This indicates JSCBs' lower riskiness in term of asset allocation, and hence, JSCBs have more chance to increase profitability by increasing asset allocation for credit. The outstanding debt/total assets ratio of JSCBs is slightly higher than the average ratio of ASEAN banks (51.91%) and lower than that of OECD banks (56.48%).

Figure 8: Performance of SOCBs compared to JSCBs and other Countries (2005) [ PDF 149.3KB | 1 page ]

However, in terms of efficiency proxied by ROAE and Cost/Income ratios, Viet Nam's commercial banks, including both SOCBs and JSCBs, are less efficient than their counterparts in ASEAN and OECD. Details from Figure 7 indicate that SOCBs are generally less efficient than JSCBs, and in turn, JSCBs are less efficient than other foreign banks in ASEAN and OCED.

Current Dimensions of Banks' Development and Behavior for Seizing New Business Opportunities

Due to increasing competitive pressure from deepening integration, especially after the VN-US BTA and WTO accession, Viet Nam's local banks have rushed into expanding their business operations by setting up new branches and developing retail banking activities. These areas are basically to build the local banks' competitive advantages against potential foreign competitors. The heightened network and business expansion of banks has given rise to an urgent need for human resources at every level of the banking industry, from senior executive managers to more junior level staff. That is not said about the human resources demand from newly established banks. As an estimate, the banking industry would need about 40,000 people from 2007 to 2010, which the Vietnamese economy is unable to meet.

Up to 2006, more than 70% of the banks' income came from lending. The last 3 years have witnessed a diversification trend in banking services, especially in developing a card market and retail banking. In 2007, consumption and real estate related lending by some JSCBs accounted for 20%–30% (and 30–40%) of the total credits, respectively. Other fee-income businesses of banks have increasingly contributed to their income. In recent years, the off-balance sheet business has gradually prospered, accounting for an average of 20–25% of income for the sector.

Furthermore, the M&A trend has boomed in recent years, especially since 2006. This trend has been enhanced mostly by large State General Corporations (such as PetroVietnam, EVN, VNPT, etc.) intent on acquiring small/rural JSCBs and making them become dependent entities. Consequently, in addition to the core businesses, these corporations could heavily and directly get involved in the financial markets. Not only have major corporations implemented such diversification plans, the banks themselves have also attempted to be universal. Many banks have become engaged in insurance, securities, investment banking activities (equity acquisition and investments in the real estate market) and have had strategic partnerships with large corporations, mostly the State General Corporations or newly established State Business Groups.

The past three years have also seen a lot of marriages between the JSCBs and foreign financial institutions. Several JSCBs have made extensive efforts to secure strategic investments with foreign banking partners (Table 7 [ PDF 112KB | 1 page ]). By building strategic partnerships with very well-known global names, the JSCBs can develop their brand name and take advantage of new products, skills and expertise from the partners. However, the strategic partnerships could also be easily broken, especially if the partner entered to the partnership as a speculative investor rather than a strategic investor.

Besides the mentioned-above trends, in 2007 and for the first time since 1996, the SBV reviewed applications for establishing new local commercial banks and applications from foreign banks seeking to operate locally-incorporated, wholly-owned banking subsidiaries. In December 2007 and January 2008, the SBV approved in principle the setting-up of nine new JSCBs and the licensing of branches of three new foreign banks. Furthermore, the SBV is reviewing the granting of full licenses for HSBC, ANZ, and Standard Chartered to set up wholly owned banks in Viet Nam.

In 2007, the Prime Minister also approved in principle the equitization of three SOCBs (VietcomBank, MHB, and BIDV). However, only the IPO of Vietcombank was conducted in late December 2007 after it was continually delayed.

II.3 Stock Market Evolution and Its Recent Boom

Key Policy Reforms

The most memorable moments in developing the stock market in Viet Nam were the establishment of the State Securities Commission (SSC) in 1995 and two securities trading centres, the Ho Chi Minh City Securities Trading Centre (HOSTC) in 2000 and the Hanoi Securities Trading Centre (HASTC) in 2005.⁶ To promote stock market development, several policy measures were undertaken.

• In parallel with the establishment of the two securities trading centers, the legal framework on listing conditions, information transparency and exposure, and supervision, has been significantly improved (Decree 48/2001/CP, Decree 144/2003/ND-CP, Law of Securities in 2006, etc.).
• The process of equitizing SOEs, especially the large ones, has been gradually tightening to their listing on the stock market.
• The development of financial intermediaries has received more attention. Recent emergence of several financial institutions such as securities companies, investment management funds, and investment funds has created an important pre-condition for development of the stock market.
• The opening up of financial markets with more foreign participation has been undertaken gradually. The equity share of listed companies that foreign investors can hold increased from 20% to 30% in 2003 and to 49% in 2005. Regarding securities services, under the WTO commitments, joint ventures can have foreign capital of no more than 49% upon the accession, but of 100% after 5 years.
• Depending on the health of the stock market, some incentives such as easing the conditions for listing on the market (in 2003) and a provision of corporate income tax deductions for firms listed on the HASTC (in 2006) have been introduced.⁷

Recent Evolution of the Stock Market: the Boom and Shrink

After a short-lived surge up until June 2001 (peak of VN-Index=571), the HOSTC had cooled off. Up to 2005, the stock market was generally very weak and ailing on both the supply and demand sides. In 2006 and 2007, it skyrocketed in terms of market capitalization, number of listed companies and investors' accounts, participation of securities companies, and investment management funds. The corresponding figures are listed in Table 8 [ PDF 269.7KB | 1 page ]. Notably, the total value of the over-the-counter (OTC) stock market is estimated to be 3–4 times higher than that of the former one.

In fact, the boom began in the 2nd half of 2006. The VN-index rose by 144% in 2006 and 40% in the first quarter of 2007, reaching a peak of 1,170 on 12 March 2007. It has since fluctuated within a range of 900–1,100, but has tended to decline from October 2007. Similar trends could also be observed at the HASTC (Figure 9 [ PDF 269.7KB | 1 page ]). As of early March 2008, the VN-index and HASTC-index stood at below 600 and 200, respectively.

Key factors behind the market boom during November 2006–March 2007, inter alia, can be attributed as follows:

• The first is Viet Nam's high economic growth period and the country's bright prospects after the accession to the WTO.
• The second is firms' rapid response following the tax incentive in 2006. A sharp increase in market capitalization for HOSTC (Figure 10 [ PDF 153.1KB | 1 page ]) is mainly due to new listings since November 2006 (predominantly equitized SOEs).
• The third is exuberance and sizeable foreign participation, including overseas Vietnamese in Russia and Eastern Europe. Foreign portfolio investors have shown a keen interest in investing in Viet Nam's equity market not only because of Viet Nam's strong economic growth and bright outlook, but also because of an appetite and room for higher risk–higher return assets in their portfolios.
• The fourth is herding behavior spread amongst local short-term individual investors in the context of insufficient information disclosure and transparency. The boom in stock prices is not attributed to foreign investors alone. Domestic investors, accounting for the major proportion of market capitalization, have also been very active in bidding up prices.

The recent sharp decline of the stock market price indexes can be attributed to various factors, namely, tightening of lending by commercial banks due to stock investment and monetary policies, high inflation rate and higher VND deposit interest rates, and a possible recession of the US economy. However, while local (individual) investors have tried to avoid the market, foreign investors have been more interested in buying rather than selling the stocks they own. On 6 March 2008, the SCIC was forced to intervene in the stock market by purchasing several stocks (mostly blue chip) to prevent further decline in stock prices.

Salient Features

Market liquidity of Viet Nam's stock market is still modest. The average daily turnover stood at USD 51.5 million in August 2007 compared to USD 8.3million in 2006. Table 9 [ PDF 92.1KB | 1 page ] suggests that up to 2007, market liquidity in HOSTC is slightly comparable with that of the Colombo and Philippines Stock Exchanges.

Furthermore, the stock market has seen wide fluctuations in prices of both individual stocks as well as the overall index. Individual shares have frequently hit their daily trading price limits of 5 percent on HOSTC and 10 percent on HASTC in both directions. Dramatic increases in prices inevitably led to questions as to whether the market was overheated. After reaching a peak of 1,170 on March 12, the index fell by almost 23 percent over the following 30 days, leading commentators to posit that a correction was underway. Trading volumes fell sharply and net buying by foreign investors dipped from USD 150 million in February to almost zero at the end of March and of 2007.

The ratio of price to earnings per share (P/E ratio) is commonly used to gauge overexuberance in equity markets. However, the P/E ratio is also a notoriously fickle indicator in rapidly developing markets. Fundamentally, the higher the P/E ratio for a stock, the more investors expect the company to deliver strong incomes in the future, or that future incomes have a low risk accompanying them. P/E ratios tend to vary by industry and the maturity of firms, and it is very difficult to point to a level of P/E which is considered high or reflects an overvaluation of the stock. Historically, while the P/E ratios in excess of 30 have provided signs of overvaluation, it is not unusual to find P/E ratios greater than 75 or 100 for companies in high tech areas. Concerning the P/E ratios of companies on the Vietnamese stock market, the IMF (2007) suggests that the average PE ratio is rather high, while World Bank (2007) concludes that this is not abnormal.

Figure 11 [ PDF 145.9KB | 1 page ] provides a distribution of P/E ratios for firms listed on HOSTC. Most firms have P/E ratios in the 10–20 range. However, several of the larger listed firms have P/E ratios in excess of 30. The average P/E for the market stood at 33 in mid-May 2007 compared with around 36 at the end of 2006. An accurate measure of earnings is required for the Vietnamese stock market, because the figure is highly vulnerable to accounting manipulation. The presented figures are only trailing P/E ratios as they rely on the previous year's earnings. It can be argued that in a fast growing economy, it is better to look at forward P/E ratios based on expected earnings over the following 12 months. The expectation is that faster growth in earnings tends to bring the P/Es down to more normal levels. For example, if the earnings-per-share grows by an average of 25 percent over the next 12 months, the forward P/E would be around 26.

II.4 Development of the Bond Market

Policy Measures

According to the State Budget Law of 1993, the Government can no longer finance the budget deficit by printing money. Since the mid-1990s, it has paid more attention to the issuance of bonds for financing budget deficit and development needs. However, improvement of the legal framework for bond market development has been rather slow. The first decree on the issuance of government bonds was only in 2000 and it was amended in 2003. In 2006, the Government issued Decree No. 52/2006/ND-CP on the modalities for corporate bond issuance. And a decree on the issuance of government and corporate bonds in international markets was drafted in 2007, and is now under consideration for approval.

Characteristics of the Bond Market

Viet Nam's bond market remains relatively underdeveloped despite a recent expansion. At the end of 2007, there were 570 outstanding bonds in the securities market, with a market value of about VND 115.660 trillion, or 10.1% of the GDP. Most of them are government bonds (85%). Other debt securities include municipal bonds (Ho Chi Minh City and Hanoi), Development Assistance Fund's (ADF's and now Development Bank's) bonds, education and infrastructure bonds, SOCB recapitalization bonds, BIDV bonds, Vietcombank convertible bonds, and some other corporate bonds.⁸

Despite continuing improvement, the market is still illiquid as investors hold the bonds to maturity. Long-term bonds (10–15 years), making up about 40% of the total, are typically purchased by insurance companies and held to maturity, while 60% of 2-3-5 year bonds (mostly 5-year) are held by SOCBs.

The market is also highly segmented due to multiple issue channels, methods, and registers, and to the lack of market making function. The State Treasury currently issues more than 100 issues per year of VND-denominated treasury bills, with terms of 6, 9 and 12 months, and bonds of 2, 3, 5, 10 and 15 years through four different channels and methods.⁹ Treasury Bonds accounted for more than 80 percent of the Government's debt securities issued in 2003 and 2004 (Table 10 [ PDF 120.5KB | 1 page ]).

The designated financial institutions are locally called “primary dealers,” but they do not have market making obligations. The State Treasury issues an issuance calendar of auctions and underwritings every quarter. Treasury-Bond auctions are held every week, bond auctions on the securities markets every two weeks, and bond underwritings every two weeks. In addition, the SBV also issues its own short-term securities for liquidity management purposes from time to time.

Some new developments should, however, be noted. In October 2005, the government issued its first international bonds since the Brady issues in the 1990s, amounting to USD 750 million, with a yield of 7.125%, which was lower than Indonesian and Philippine bonds.¹⁰ Meanwhile, the S&P rating upgraded Viet Nam's credit rating outlook from BBpositive to BB stable in September 2006. The funds were on loan to Vinashin, the shipbuilding state-owned corporation. The government is now considering raising another USD 1 billion through a new sovereign issue, the proceeds of which will largely be devoted to the construction of the Dung Quat oil refinery; the rest will go to Viet Nam National Shipping Lines (Vinalines) for purchasing new vessels, and to Song Da Corporation for the construction of a hydro plant. These corporations have yet to obtain international credit ratings.

Beginning in the second half of 2006, foreign buyers started to show an interest in Vietnamese bonds, as many think that they are being undervalued and ripe for higher returns. Foreign participation has created a new liveliness in the bond markets, especially on the HASTC. Forty-four government bond tenders took place in 2007, which helped raise VND 18.939 trillion in capital. The secondary bond market in Hanoi has also experienced rather strong growth. At the policy level, the government has been trying to strengthen the five-year bond as a liquid benchmark issue through big-lot auctions. A specialized bond market will be built up at the HASTC. Government bonds, municipal bonds, and government-guaranteed bond tenders and transactions will take place in this specialized market.

In 2006, Vinashin announced Viet Nam's third and thus far largest corporate issue of 3 trillion dong (10-year bonds with an annual coupon of 9%). The bond was reportedly oversubscribed three times, with 95 percent being sold to foreign investors. EVN had issued a corporate bond that was also sold mainly to foreign investors (10-year bonds with an annual coupon of 9.6% for the first year and 9.96% thereafter). In 2008, EVN and PetroVietnam are likely to issue their own bonds.

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