October is a quiet month (VN index made no advance between October 2 and 23), but there is no reason to fear. The transition period is over and the market is settling at the new height. The past might still matter but  history is in the making.

The recovery phase that started since August is  losing its steam. The VN index met great resistance since the second half of September after passing  500 points: it reached the four month peak of 541.91 on Oct 4 but fell back to 525.92 on the 23rd. At the time of writing, the market has made no advance this month (October).

But this is no cause for worry; instead, investors should pat each other on the back and rest assured that the market’s adjustment period is over and the VN index is settling down in its new comfort zone.

After the market’s nose dive stopped in July (at 400 points), the strong upturn in August and early September and the flattening out of the indices in October above 500, confirms this new market balance (significantly above the 200-300 points balance level over the last few years).

For those warned of history repeating itself, the unfolding events in Quarter 3 shows that charting the future by looking at the past might be off course. History is not being repeated here; instead,  history is in the making.

It is now certain that the year 2006 is a landmark for the stock market in VN. This is the year the stock exchange started to turn from a vague concept in people’s minds into the hottest topic of interest. People increasingly recognize the bourse as an investment channel. The number of trading accounts continues to rise 50 percent between June and October to 100,000 (the number was under 3,000 by the end of 2005). Meanwhile local companies start to see huge boons when shares are being exchanged at five times their face value.

The regulator is flexing its muscle

The public’s new-found enthusiasm with the stock market and enterprises’ rising interest in getting their shares listed on the bourse has visibly shoved up the regulator’s confidence in exercising tighter controls and setting tougher regulations on the market’s activities and its participants.

Up to 2005, the SSC, the body in charge of market development and regulation, has fought an uphill battle to attract local enterprises and investors’ interests in the market. The young private sector (which was born only after VN embarked on its economic reform program and recognized private ownership) lacked modern management knowledge and was unfamiliar with transparent business dealing. They found it strange, even intimidating, to reveal information on their operations and financial transactions and did not want to know about the stock market.

To attract their interests, the SSC has minimized the requirements for listed companies (VND 5 billion in capital, profitable in two consecutive years prior to listing) and gave significant tax rebates to the listed companies (after their share was available for trading on the exchange, the enterprises only had to pay half of the corporate income tax ( 28 percent) for two years. The privatized State-owned enterprises (SOEs) were also under government’s pressure to get listed after going public. But the sticks and carrots did not work magic: only 30 companies found their ways to the bourse by the end of 2005 ( five years after the market’s establishment). However, this is changing fast.

First, the minimum required chartered capital for a company listed on the market might be raised to VND 50 billion, or 10 times the current level. The companies that seek listing must also have to make profit in the two consecutive years prior to the listing and there is no outstanding accumulated loss. The new rule is currently being discussed but will likely to be introduced before the end of this year, in time for the introduction of the Securities Law on Jan 1, 2007. Its impact would be significant, as the new requirements rule out a significant number of potential candidates for the bourse. Currently half of the listed enterprises and one-third of the 25 companies either preparing to list or have submitted listing applications have chartered capital less than VND 50 billion.

Second, the tax incentives given to listed companies will be scrapped starting next year. According to the new MOF decision, companies that start trading after Jan 1, 2007, will have to pay the full 28 percent corporate tax, while those that managed to list their stocks before that date can still enjoy the tax rebate as specified by the existing regulation.

Racing against time

According to the SSC, it would take approximately two months after the application is submitted for a enterprise to be listed:

• 45 days for reviewing and approving the application,

• 20-30 days for the completion of other procedures between approval and start trading.

It is difficult for application after Oct 31 and especially after Nov 15, to be approved and stocks to be traded before Jan 1, 2007.

As a result, many companies are trying to speed up their preparation to join the market before year’s end. In September alone, 10 companies were given the green light by the SSC, and 14 more applications for listing were submitted in the first two weeks of October (not including companies applying for registering on the Hanoi trading floor). It is expected that between now and mid-November, the number of applications will continue to rise, and on average it is possible that there will be one new application everyday. The most notable companies include two commercial banks – ACB (which just received the go-ahead from the State Bank of Vietnam for its listing plan and now is waiting for SSC’s approval) and SaigonBank (currently in the process of application).

Already, there are signs that the SSC is being overloaded and will not have enough manpower to process all the applications that landed on its table on time.

New (and tougher) rules on stock investors and brokers

Stock investors and brokers are also facing a tougher regulations. Earlier in August, the draft of the personal income tax bill was circulated for public discussion. Under it, stock investors will  be facing five percent income tax on their investment returns (including interest earning, stock dividends, etc) and 25 percent tax rate on capital gains each time their stocks change hands. Although the new tax structure is still under discussion and will not come into force until 2009, the reactions have been largely negative.

Many people think the introduction of tax on stock returns is premature. The market is still small and despite attracting growing attention, it still has a long way to go. Taxing people’s gains from stock trading might discourage them from joining the bourse and impede the market’s development. In  reality there are not many long-term investors who hold their stocks for an extended period of time. Most investors were drawn to the market by the prospect of making quick gains from the rising stock prices, but  25 percent tax rate on capital gains each time their stocks change hands might kill the incentive entirely.

Meanwhile, the Ministry of Finance (MOF) was reported to be toying with the idea of restricting the number of securities firms at between 30 and 40 amid the small size of the market and weak capability among existing brokers. Of the 14 securities firms currently in operation, only five have the necessary financial ability to cover all registered activities (brokerage, investment, consultant, underwriting).

When Vietnam joins the WTO, foreign stock brokers and underwriters will be able to establish joint ventures with an ownership limit of 49 percent , a cap that will be raised to 100 percent over the following five years.

With the stock market’s rapid expansion, securities firms are making healthy profit. Profitability in 2005 for all 14 firms was above 30 percent.

The number of new securities firms asking for licenses is rapidly rising since the second half of the year to beat the Jan 2007 deadline when the Securities Law come into effect. According to the new law, the minimum requirements of capital for each service will be much higher than at present. For instance, in order to provide a brokerage service, a firm will need minimum capital of VND10 billion instead of the VND 3 billion currently required. For underwriting, it will be VND 70 billion instead of VND 22 billion.

By the first week of October, three new firms were offered licenses, bringing the total to 18, and three applications have been accepted in principle. It is estimated that by the end of 2006, the number of securities firms will approach 30 (compared to 14 currently in operation).

Quarter 4’s  prospect: Crouching tiger

With the new regulations being pushed in place next year, Quarter 4 promises to be an exciting time for the market when lots of new names will join the game, matching the positive market sentiment.

Another important issue to watch in the 4th Quarter is the possibility of a change in the foreign investor ownership ceiling in the listed companies. The long overdue Decree on the implementation of the New Investment Law (Decree 108) was introduced in late September. It has specified 14 conditioned investment activities (with restrictions regarding foreign investor involvement). It is expected that the ownership limit (of foreign investors) in each of these activities will be announced soon, after VN’s WTO accession package is adopted in November.

It is also possible that restrictions on foreign ownership in other activities (not in the list) will be lifted in accordance with the Investment Law spirit and WTO’s principles. Such development will be an important factor propelling the next phase of a stock price rally. The stock fever at the beginning of this year can be attributed to the move by the government to raise foreign investor’s ownership limit from 30 percent to 49 percent in October 2005.

Beyond 2006...

Economic target for 2007
•    GDP growth: 8.2 – 8.5percent (Industry: 10.5-10.7percent, Service: 8-8.5percent, Agriculture: 3.5-3.8percent)
•    GDP level: US$ 70 billion (GDP per capita: US$ 820)
•    Export: US$ 45.2 billion (17.4percent increase)
•    Import: US$ 49.1 billion (15.5percent increase)
•    Total investment: 40percent GDP
•    Budget deficit: 5percent GDP
•    Inflation rate is lower than GDP growth rate

The market’s prospects beyond 2006 continue to be bright. Strong economic growth, more active involvement by foreign investors and fast-forward privatization will feed the bull.

GDP is expected to grow 8.2percent this year, and between 8.3percent - 8.5percent in 2007 according to the Prime Minister’s report to the National Assembly earlier this month. GDP per capital is also projected to increase from US$ 720 in 2006 to US$ 820 next year.

The expected WTO accession in December will also have important impacts, providing fresh impetus to economic reforms and development.

Meanwhile, the Prime Minister has announced the government’s commitment to complete the privatization process by 2010 in the Conference on SOEs restructure and equitization period 2006-2010, held earlier in October. That means 550 SOEs will go through the process in 2007 (including 20 general corporations), and by 2008 all subsidiaries of the general corporations will be turned into joint stock companies. All in all, over the next four years, 1,500 enterprises will be transformed.
New regulations are being drafted to broaden the scope of the privatization process, allow deeper participation by foreign investors and link privatization with listings of newly found joint stock companies in the bourse. Specifically, the list of areas where the government will hold 100percent ownership is to be reduced from 30 to 14. Areas where the government holds controlling shares is also being cut back. Companies with activities related to national security and defense will also be subjected to privatization. Of the remaining 2,176 companies under the government’s ownership (with total capital of VND 260 trillion), only 554 companies will remain solely state-owned enterprises in 2010, including 26 groups, general corporations, 178 enterprises operating in the area of national security and defense, and producing and supplying essential products.
With the government’s aim at listing the privatized SOEs on the stock exchange, it is expected that the bourse will continue to expand in the coming years, especially with the participation of large profitable enterprises which surely will attract investor interest including: FPI (the biggest local IT firm), three telecommunication companies (Mobilphone, Vinaphone, Viettel), three state-owned banks, etc...

In the best case scenario, ownership restriction on foreign investors will be lifted while the number of new listings rose at unprecedented rate. The market is expected to start another hyper-growth period when the VN Index can easily hit 1,000 points. This might well be the best time to join the game.