Market logic

Nepali investors seem to have defied common financial sense when investing in the shares traded on the Nepal Stock Exchange (Nepse). Economic logic says that the investors become ready to pay a high price for a share depending on its profitability record or reasonable expectations about its future earnings. In an economy where industry and business have remained sluggish or negative for the past several years, the numbers of commercial banks, development banks, finance companies and cooperatives have mushroomed. This mismatch has puzzled many experts. Perhaps even more puzzling has been the rising trend of the share prices in a manner that does not reflect the state of the health of the economy. This gives greater cause for concern than for jubilation, as ordinary would-be investors are lapping up Nepse stock without critically examining it against the universally accepted investment criteria. At the close of the week yesterday, the Nepse hit a record high.

All this has given rise to suspicion that some unscrupulous speculators may have been swaying the share market for their selfish ends. The Securities Board of Nepal (Sebon) and Nepse have been issuing warnings in recent times that buyers beware before committing their money. But the rising Nepse index suggests that they appear blithely heedless. Not very long ago, in an attempt to check market manipulation, the Nepal Rastra Bank (NRB) had stopped margin lending, and speculators were immediately up in arms, organising closure of Nepse transactions and trying to manhandle Sebon and Nepse officials. Later on, margin lending was permitted again, with restrictions. After that incident, the Nepse index fell, but not below 900 points, from a high of 1,064 points. However, a stock market crash did not happen.

Now, the index has touched a new high of 1,128.13 points. The inflated value is also due to the unchanged old system of calculating the index. Even the purchase of a hundred units of equity is equally reflected on the value of the index as that of 10,000 units. Secondly, the index has largely been driven up by the trading on the shares of financial institutions, whose numbers in the country, according to many experts, are greater than the growth of the economy. Ordinary investors may also have been misled by the fact that banks are required to publish their unaudited financial statements within one week of the end of the fiscal year. It has, however, been found that there have occurred huge discrepancies in net profit or loss figures of some banks shown in unaudited accounts - net profit has been significantly inflated and net loss has been significantly underreported. How to guard possible investors against such gross misrepresentation is an issue that merits immediate serious attention. In a country where auditing standards and punishment for guilty auditors are not stringent, even audited accounts need to be taken with a pinch of salt. Unaudited accounts may well set up booby traps for the general public. Certainly, share-market regulatory mechanism has strengthened over the years, yet it leaves wide scope for improvement. Strict enforcement of what exists is an even greater need.