MONETARY POLICY TRANSMISSION IN VIETNAM

MONETARY POLICY TRANSMISSION IN VIETNAM: EVIDENCE FROM A VAR APPROACH Xuan Vinh Vo Faculty of Banking - University of Economics, Ho Chi Minh City 279 Nguyen Tri Phuong Street, District 10, Ho Chi Minh City, Vietnam Tel: (84 8) 38 551 776 - Fax: (84 8) 38 551 776 Email: [email protected]

Phuc Canh Nguyen Faculty of Banking - University of Economics, Ho Chi Minh City 279 Nguyen Tri Phuong Street, District 10, Ho Chi Minh City, Vietnam Tel: (84 8) 38 551 776 - Fax: (84 8) 38 551 776 Email: [email protected]

Abstract A thorough understanding of transmission mechanism is a key for central bank in implementing monetary policy successfully. This paper investigates the existence of interest rate channel, exchange rate channel and asset price channel in Vietnam employing VAR model analysis using monthly data ranging from 2003M1 to 2012M12. The results from the analysis indicate the evidence of cost channel. However, we find that exchange rate channel and asset price channel of monetary transmissions are not evidenced in Vietnam.

Keyword: monetary policy transmission, VAR, cost channel.

GEL Classification Code: E52, E58, G28

Electronic copy available at: http://ssrn.com/abstract=2482389

1. Introduction

A key factor that significantly affects the successfulness of monetary policy implementation is a clear understanding of transmission mechanism. Many previous studies try to find evidences of monetary policy transmission by employing data from different countries all over the world (Mishra & Montiel, 2013). Some well documented channels in the literature are interest rate channel, exchange rate channel, asset price channel, credit channel and expectation channel (Dabla-Norris & Floerkemeier, 2006; Disyatat & Vongsinsirikul, 2003; Honda, 2004; Mugume, 2009; Mukherjee & Bhattacharya, 2011; Wulandari, 2012).

Interest rate channel transmits monetary policy to output and inflation through market interest rate so that it is effective in developed financial markets. Interest rate channel is seen as the most important channel of monetary policy transmission (Cecchetti, 1995; Friedman, 1956; Hannan & Liang, 1993; Taylor, 1995), especially in developed countries such as England and the U.S. (Engert, Fung, Nott, & Selody, 1999), but it isn’t effective in countries with low-developed financial markets (Ramlogan, 2007) such as Eritrea (Mengesha & Holmes, 2013), Kenya, Uganda, Tanzania (Buigut, 2009). Eritrea has a low-developed financial market and a high-developed banking system so that credit channel is the most important channel (Mengesha & Holmes, 2013).

Exchange rate channel is another important channel of monetary policy transmission beside interest rate channel (Hooper, Mann, & Bryant, 1993). Exchange rate channel is evidenced in many countries such as Czech Republic, Hungary, Poland (Golinelli & Rovelli, 2005), Turkey (Karasoy, Kunter, & Us, 2005), Poland (Kierzenkowski, 2005), Eurozone (H. Bjørnland & J. I. Halvorsen, 2008; Bjørnland, 2009; H. C. Bjørnland & J. I. Halvorsen, 2008). In fact, exchange rate channel does not exist in closed-economy countries and vice versa. Governments of developing countries usually intervene foreign exchange markets in addition to under-integration to international financial market so that exchange rate channel could be weak or non-existed (Mishra & Montiel, 2013; Mugume, 2009).


Asset price channel is also an important channel of monetary policy transmission (Dabla-Norris & Floerkemeier, 2006). Asset price channel includes two sub-channels: Tobin’s q theory and wealth effect (Mishra, Montiel, & Spilimbergo, 2010). Tobin’s q theory and wealth effect transmit monetary policy through the impacts on firm’s investment decisions and household’s consumption decisions through asset price. Asset price channel is found in the U.S. and almost other developed countries (Lettau, Ludvigson, & Steindel, 2002), but it is weak in developing countries (Mishra & Montiel, 2013). Asset price channel not only transmits through stock price but also other kind of assets such as real estate, it transmits the shock in monetary policy to the housing-price then to house-building activities (Elbourne, 2008).

Since great “Doi Moi” reform in mid-1980’s with a comprehensive economic policy implementation, Vietnam economy has been grown at a high rate even though decreased slightly to a lower level after 1997 Asia financial crisis. However, the first economy restructure program promulgated during the 1998-2000 period makes the economy recover to the previous high growth rate. Table 1 presents some key statistics and there is evidence that the 2008 global financial crisis strongly affects Vietnamese GDP which is fluctuated and decreased sharply. Table 1. Vietnam GDP growth rate and trade activities (%) Year GDP Growt h Export/ GDP Import /GDP

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

6.80

6.90

7.10

7.30

7.80

8.40

8.20

8.50

6.30

5.30

6.80

5.90

5.03

55.00

54.60

56.80

59.30

65.70

69.40

73.60

76.90

77.90

68.30

77.50

87.00

93.20

57.50

56.90

62.00

67.70

73.30

73.50

78.20

92.70

93.10

78.70

87.80

91.20

92.97

Source: ADB (2013). Although Vietnam turned from low-income to medium-income country, it is remained as a small country since GDP was just nearly 200 billion USD and per capital just nearly USD 2000 in 2012. Besides, the openness of Vietnam economy increased and expanded quickly then after WTO joining in 2007 (table 1). Vietnam is going to transmit economy to market standard but government has been intervening many economic fields such as exchange rate, interest rate, energy and other sectors. In Vietnam, Ho Chi Minh stock exchange was launched in 2000 and also is small now.


Beside that the banking system is the most important financial system in the economy since their credit balance are about 200% Vietnam GDP in 2012.

Vietnam is a small open country where stock market are still under-developed compared with other emerging markets in the region. Vietnamese banking system dominates the financial market as most of firms consider bank credit are the main source of finance. In terms of policy, Vietnamese government tightly controls exchange rate so that exchange rate channel may not exist while interest rate channel could become the most important channel in Vietnam. Moreover, the monetary policy transmission channels in emerging countries like Vietnam is always deserved more serious and detailed consideration. These are our motivations for the investigation of interest rate channel, exchange rate channel and asset price channel of monetary policy transmission in Vietnam from 2003 to 2012 employing a VAR model analysis.

2. Methodology and data

a. Methodology The VAR model has been used extensively in the literature and experimental work to examine monetary policy transmission (Aleem, 2010; Christiano, Eichenbaum, & Evans, 2005; Ganev, Molnar, Rybinski, & Wozniak, 2002; Primiceri, 2005; Starr, 2005). We employ a VAR model of Sims (1980) and VAR detail specifications similar to the work of Aleem (2010) to examine monetary policy transmission in Vietnam. The form of VAR(p) is:

∑𝑝𝑖=0 𝜑𝑖 𝑌𝑡−𝑖 = 𝜃𝑋𝑡 + 𝜀𝑡

(1)

where Yt is the vector of endogenous domestic variables and Xt is the vector of exogenous foreign variables, 𝜑 and 𝜃 are polynomials, 𝜀𝑡 is the vector of innovations.

Since Vietnam is a small open economy, it is open to the international shocks especially shocks from influential developed countries and area such as the U.S., Japan and Europe. As a result, international shocks are included in the VAR model as exogenous variables. The exogenous variables include: world price level (proxied by WTI oil price – OIL), USD interest rate (proxied by U.S. 3M LIBOR) and U.S. output (proxied by U.S. Industrial production - IPUS).

Xt = [OIL

LIBOR

IPUS]

(2)

The endogenous factors in the equation (1) include Vietnam Industrial Production (IPVN), the domestic price index (CPI) and Vietnam interbank offer rate (VNIBOR) to proxy for Vietnam monetary policy.

Yt = [IPVN

CPI

VNIBOR]

(3)

In addition, we incorporate each endogenous variables to proxy for each channel: interest rate channel, exchange rate channel, asset price channel to examine existence of each channel. Interest rate channel will be proxy by market interest rate (bank lending rate - LER), then vector Y will be:

Yt = [IPVN

CPI

VNIBOR

LER]

(4)

Exchange rate channel will be proxy by USD/VND nominal effective exchange rate (NEER), then vector Y will be:

Yt = [IPVN

CPI

VNIBOR

NEER]

(5)

And asset price channel will be proxy by VNindex (VNI – Vietnam composite stock market index), then vector Y will be:

Yt = [IPVN

CPI

VNIBOR

VNI]

(6)

b. Data Our data are collected from various sources including International Monetary Fund, Asian Development Bank, General Statistics Office of Vietnam and State bank of Vietnam from 2003M1 to 2012M12 in monthly frequency. Data statistical description is presented in table 2. Table 2. Data descriptive statistics Variables Mean Median Maximum Minimum Std. Errors Observation

OIL 69.71 70.28 133.93 28.13 24.81 120

IPUS 103.81 104.04 112.98 91.70 4.80 120

LIBOR 2.16 1.28 5.50 0.25 1.90 120

IPVN 52001.70 51255.50 86118.44 25122.64 16939.06 120

VNIBOR 8.68 7.51 17.57 5.22 2.87 120

NEER 17409.56 16115.52 21013.59 15417.35 2000.43 120

LER 12.76 11.18 20.25 9.30 3.08 120

VNI 443.09 421.90 1137.70 136.20 233.89 120

CPI 10.26 8.41 28.36 2.05 6.42 120

Source: authors’ calculation. We firstly take logarithm of all variables exclude LER, CPI and VNIBOR, then we conduct Dickey-Fuller unit root test (Dickey & Fuller, 1979, 1981) for the series employing in the analysis. The results are reported in table 3. The results indicate that LIPUS, LIPVN, CPI, VNIBOR are stationary at level, meanwhile LOIL, LIBOR, LNEER, LER, and LVNI stationary at 1st difference. Table 3. Dickey – Fuller Unit root test results

Var

Dickey – Fuller Unit

Dickey – Fuller Unit root

Dickey – Fuller Unit root

root test at level

test at 1 difference

test at 2 difference

T – statistic

T – statistic

P - value

LOIL

-1.9506

0.3083

LIPUS

-3.4305

0.0120

LIBOR

-0.7243

0.8356

LIPVN

-5.5670

0.0000

stationary at level

VNIBOR

-3.2883

0.0177

stationary at level

LNEER

-1.6540

0.7653

-8.0918

0.0000

stationary at 1

LER

-2.3343

0.1630

-7.4020

0.0000

stationary at 1

LVNI

-1.9804

0.6057

-7.5692

0.0000

stationary at 1

CPI

-4.1351

0.0013

-7.9811

P - value 0.0000

T – statistic

Conclusion

P - value stationary at 1 stationary at level

-8.4989

0.0000

stationary at 1

stationary at level

Source: authors’ calculation. We retain the original variables which stationary at level, taking first differences and second difference for the variables which stationary at 1st difference and 2nd difference. Then we test Granger causality test for short-term relationship (Granger, 1969). The test results are presented in Table 4. Table 4. Granger causality test result

Var

H01: VNIBOR have no Granger cause to Var

H02: Var have no Granger cause to CPI

F-Statistic

p-value

F-Statistic

p-value

DLER

9.39837

0.0000

0.47024

0.7575

DLNEER

2.77793

0.0306

1.04350

0.3884

DLVNI

1.13542

0.3439

0.18452

0.9460

H03: VNIBOR have no Granger cause to CPI F-Statistic

p-value

2.20954

0.0728

Source: authors’ calculation. The hypothesis H01: VNIBOR do not Granger cause DLER, DLNEER, DLVNI is significani for DLER DLNEER. We can interpret this as VNIBOR causes the change in DLER and DLNEER in short - term. With the hypothesis H02: DLER, DLNEER, DLVNI variables respectively have no Granger cause to CPI is not significance at all. DLER, DLNEER, DLVNI don’t cause the change in CPI in short - term. So, Vietnam monetary policy may be transmitted through lending rate and exchange rate but not stock index. Then, we test Granger causality for VNIBOR and CPI variables (H03). This test demonstrates on the impact of monetary policy to price level. The result shows that VNIBOR has caused to CPI with 10% significance. Vietnam monetary policy has impact to price level in short – term. This transmission may be conducted through interest rate channel and exchange rate channel as evidence from H01 and H02. Finally, we use VAR model to examine monetary policy transmission in Vietnam in the next section. 3. Results and discussions

Interest rate channel We use VAR analysis to examine the interest rate channel of monetary transmission with two variable groups: exogenous variable group (DLOIL, D2LIPUS, DLIBOR) representing external shocks, and endogenous variable group including LIPVN (demand shocks), VNIBOR (monetary policy shocks), DLER (shocks in market interest rates, the interest rate channel of monetary policy transmission) and inflation (CPI). Figure 1 shows that inflation reacts in the same way to demand shock (LIPVN), monetary policy shock (VNIBOR) and market interest rates shock (DLER). Figure 1. Impulse response function for interest rate channel Response to Cholesky One S.D. Innovations ± 2 S.E. Response of CPI to LIPVN

Response of CPI to VNIBOR

3

3

2

2

1

1

0

0

-1

-1

-2

-2 1

2

3

4

5

6

7

8

9

10

11

12

1

2

3

Response of CPI to DLER

4

5

6

7

8

9

10

11

12

10

11

12

Response of CPI to CPI

3

3

2

2

1

1

0

0

-1

-1

-2

-2 1

2

3

4

5

6

7

8

9

10

11

12

1

2

3

4

5

6

7

8

9

Source: authors’ calculation.

Inflation positively responses to aggregate demand shock, this means that Vietnam inflation is caused by demand. Meanwhile, inflation positively responses to Vietnam interbank offer rate and

market lending rate suggesting that cost channel of monetary policy do exist in Vietnam. Cost channel is a monetary policy puzzle, when central bank tightens monetary policy by increasing policy rate lead to increase market interest rates then increase inflation. Monetary policy tightening is not effective in control inflation, it is also simulate inflation in vice versa. Cost channel is due to dependence of firms in bank credit for their operations. Commercial banks usually increase their lending rate to response to monetary policy tightening, meanwhile firms can’t sell inventory so that they can’t reduce debt and they have to bear higher interest expense. Firms then response by raising output price and overall price level will increase accordingly.

Empirical evidence on the cost channel has been found in many papers. Barth III and Ramey (2002) is the pioneering work studying the cost channel using VAR model. According to Barth III and Ramey (2002), firms must borrow capital from commercial banks to maintain operations, cost channel implies that the changes in policy rate lead to change in market rate and change to input cost of firms, then change to price level. Therefore, the nominal lending interest rate is considered as a variable in the production function and affect to manufacturing firm operations. Product price establishments should affect both GDP and inflation. Exchange rate channel We then use the VAR model to investigate the exchange rate channel of monetary policy transmission with DLNEER variables is replaced for DLER in the model. Results of impulse response function are presented in figure 2.

Figure 2. Impulse response function for exchange rate channel Response to Cholesky One S.D. Innovations ± 2 S.E. Response of CPI to LIPVN


3

3

2

2

1

1

0

0

-1

-1

-2

-2 1

2

3

4

5

6

7

8

9

10

11

12

1

2

3

Response of CPI to DLNEER

4

5

6

7

8

9

10

11

12

10

11

12


3

3

2

2

1

1

0

0

-1

-1

-2

-2 1

2

3

4

5

6

7

8

9

10

11

12

1

2

3

4

5

6

7

8

9


Impulse response function shows no transmission of monetary policy through the exchange rate channel because irresponsive of inflation to exchange rate and this result is entirely consistent to theory. In Vietnam, State bank of Vietnam (SBV) strictly controls USD/VND exchange rate, SBV also intervene into the foreign exchange market through the administrative tools and thus exchange rate channel will be weak and almost non-existent. Mishra and Montiel (2013) found that exchange rate channel is weak or non-existent in developing countries since they are usually intervene to foreign exchange market as emerging markets have poorly international financial market integration, underdeveloped debt and capital securities markets. As a result, the issue that exchange rate channel is weak and almost non-existent in Vietnam is commonly reported in emerging markets.

Asset price channel As exchange rate channel is ineffective as a monetary policy transmission, a supplementary transmission channel for interest rate channel is asset price channel. We use VAR with DLVNI replace for DLER to represent asset price. Impulse response function results are presented in figure 3: Figure 3. Impulse response function for asset price channel Response to Cholesky One S.D. Innovations ± 2 S.E. Response of CPI to LIPVN


3

3

2

2

1

1

0

0

-1

-1

-2

-2 1

2

3

4

5

6

7

8

9

10

11

12

1

2

3

Response of CPI to DLVNI

4

5

6

7

8

9

10

11

12

10

11

12


3

3

2

2

1

1

0

0

-1

-1

-2

-2 1

2

3

4

5

6

7

8

9

10

11

12

1

2

3

4

5

6

7

8

9


Results show that inflation is negatively responded to asset price, it is inconsistent to transmission theory. Mishra and Montiel (2013) found that that asset price channel is weak or limited in most developing countries because they are lacking effective debt and capital markets. As the

Vietnamese stock market is still at the infant age of development, monetary policy transmission through stocks and bonds may be limited in Vietnam. Besides, Vietnamese investors usually consider the macroeconomic factors including interest rates, exchange rates, inflation in making investment decisions, interest rate and inflation rate should affect stock prices. We use Granger causality tests to explore this and the Granger causality test results are presented in table 5.

Table 5. Granger causality test result H04(Mishra & Montiel, 2013): Var has no Granger cause to DLVNI Variables F-Statistic

p-value

VNIBOR

2.12739

0.1239

DLNEER

0.52575

0.5926

CPI

3.86024

0.0239


Results indicate that CPI causes changes in DLVNI, meaning stock market is affected by inflation change. However, the reverse relationship is not statistically evidenced.

4. Conclusions Monetary policy transmission study is an interesting subject in monetary theory and policy. Employing VAR model analysis, we attempt to identify the existence and the effective of main monetary policy transmission channels in Vietnam for a data set ranging from 2003 to 2012. We test the existence of three main transmission channels (interest rate channel, exchange rate channel and asset price channel) in monetary transmissions theory and our results suggest that interest rate channel is existed through cost channel in Vietnam. However, we find no evidence of exchange rate channel and asset price channel in 2003 – 2012 period. The existing of cost channel provides Vietnam policy makers some suggestions. Firstly, central bank should not increase policy rate immediately after price increase, because this action leads to

higher in price and harder to control inflation. Secondly, we suggest that State bank of Vietnam should consider to apply inflation targeting policy in monetary policy implementation. This makes central bank policy stable and do not create shocks to the economy.

References

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