Nepal | September 30, 2020

Reforming the volatile capital market

Rewat Bahadur Karki
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Kathmandu, September 8

The capital market, popularly known as the stock or share market, is the mobiliser of capital for economic development and the economic mirror of any economy. Although the development of the capital market, especially the primary markets, dates back to the late 1930s (1937) when Biratnagar Jute Mill and Nepal Bank Limited, the first commercial bank of Nepal, started the primary issue of shares, the development of the secondary market started only after the establishment of the regulator of the securities market – the Securities Board of Nepal (SEBON) – and Nepal Stock Exchange Ltd. (NEPSE), the secondary market operator, in 1993. Although it has a long history – almost more than two-and-a-half decades of development, modernisation of the market is, however, a recent development, only after 2016.

Among the three important functions – trading, ownership transfer and payment-settlement of the secondary market, only share trading was automated in 2007, leaving the other two functions to stay manual. Nevertheless, all three functions were automated with the introduction of the paperless trading system in mid-January 2016. This introduced the Nepali capital market to a new era of modernisation, making this market the fifth in South Asia. Following this, total share trading had jumped to Rs. 2.25 billion per day, and total market capitalisation (MC) reached more than Rs 1,900 billion in FY 2015/16, or almost 84 per cent of the MC/gross domestic product (GDP) ratio. However, this ratio has declined in recent years and is between 42 and 45 per cent, based on a MC of Rs 1,400 billion due to high market volatility.

About Rs 5 billion worth of shares (in face value) of the 212 listed companies — 148 banks and financial institutions (BFIs) and insurance, 19 each comprising manufacturing and hydro companies, and the remaining 26 of hotel, trading and other companies – have been mobilised through initial public offerings (IPO). Similarly, a corporate debt of Rs.70 billion has also been mobilised from the public.

But such an important market, which is an indispensible sector of the economy, was locked for 99 days. This is a misfortune whereas other countries, including the developing countries, did not close down their market. After opening the market for a couple of days, the market was closed by the regulator on feeling that the market was going down steeply, which was due to the economic lockdown and economic slump.

Ups and downs in the market are a common feature without showing much volatility. But now the market is very volatile, and not reflecting the trend of the slack economy, which, according to the World Bank, is expected to shrink by 1.8 per cent last fiscal year and will expand by 2.1 per cent this fiscal year. The major reasons for this volatility, among others, are fewer alternative investment opportunities, high liquidity in the market, low financial literacy, lower interest on deposits, rumours, manipulation and insider trading. In this connection, streamlining, stabilising and regulating the market have become a major challenge for the regulator.

In the context of the already automated secondary market, including online trading, if the share market had operated along the lines of banking transactions, it would have provided liquidity to the investors and also made the economy operative. In such a situation, there would have been a buying rush by some investors in the sluggish market too for future benefits. On the other hand, some investors would have benefitted by the liquidity through sale of shares. But due to the short vision and irrational policy, the investors and the economy lost this opportunity.

Investors who had invested as assets only in shares, instead of deposits, were led to a miserable situation as they could not sell their shares. The decision to lock down the share market for 99 days, which is an essential service like banking, was a blunder. This had a severe and longer effect of COVID-19 on the economy than in other countries that did not lock down the market. This decision also reduced the importance of the market and its market participants, including the regulator.

In such a difficult situation posed by the COVID epidemic or even in a normal situation, there are challenges, including structural, to the capital market. In order to make the market stable and fully modernise it, Nepal needs to adopt different measures in addition to reviving the Nepali economy from the COVID effect.

The first thing is to create a market of international standard as SEBON has got membership of the international organisation of securities market regulators/commissions (IOSCO) by adopting or replacing the current local-based online trading system (which is not working properly) by a tested international standard online software system. In addition, to make the secondary market more competitive and wide-reaching, subsidiary companies of commercial banks having countrywide networks should be immediately licensed to function as a share trading broker/company.

The only stock exchange – almost state-owned NEPSE – has neither been modernised in the last 27 years nor has the market been fully modernised. Thus, one more stock exchange in the corporate private sector is strongly needed as mentioned in SEBON’s approved policy and programme in FY 2019/20 to do away with the monopolistic situation, although some developed Asian and European countries having good governance are practising unification to reduce the cost.

If we see the development of the Indian securities market, even the old state-owned (now almost private) Bombay Stock Exchange (BSE), which could modernise neither itself nor the market was modernised and the market was made highly competitive right after the establishment of the modern National Stock Exchange (NSE) in the corporate private sector in 1995. In Nepal too, one more modern stock exchange could see a major breakthrough in daily share-trading of more than Rs. 5 billion while modernising NEPSE, too.

Due to low participation of real sector companies, the NEPSE index has not been a true economic mirror or indicator. Based on the analysis of the data of indices and Nepal’s economic growth in the last 17 years, real sector contribution is just one per cent per one digit increase of index whereas 99 per cent contribution came from other factors, such as interest rate, share supply and the like. But in India and Pakistan, real sector contribution is two per cent and around 40 per cent respectively in this period.

Thus, in order to encourage the real sector companies in the capital market, different measures must be taken such as high tax rebate, putting the sector in the priority list of the central bank and adoption of the international system of free pricing based on book building. However, Nepal has been practising the traditional fixed pricing system in IPO since the beginning. Now SEBON should introduce this system without delay in a phase-wise manner.

Now that SEBON is a member of IOSCO, encouragement of BFIs by the government to borrow from the international market and legal provision to participate in cross border trading under the Foreign Investment and Technology Act 2018, Nepal should internationalise the market by opening the door for cross border listing and trading for limited standard companies in other countries. For this, Nepal should not delay to have a sovereign rating of Nepal from renowned international rating agencies.

Although Nepal’s literacy rate is about 70 per cent, the financial literacy rate is just around 15-18 per cent while it is 25 per cent and 60 per cent in India and USA respectively. Because of the low financial literacy rate, rumours and other irrational factors play a big role in making the market more volatile.

Thus, SEBON should establish a training institute without delay, and side by side the government and regulators of the banking, insurance and capital market sectors should speed up the financial literacy programme intensively and extensively.

Likewise, for the stability and long-term development of this market, a Financial Trust Act, which is lacking, is a must. Additionally, despite enactment of the Commodities Act and its regulation in 2016, establishment of two commodities exchanges, as per SEBON-approved policy and decision, has not been executed. This is a matter of shame for the regulator and government. This development will also help to encourage and develop the agro-market in the country.

As modernisation of the capital market is dependent on development and reform of the economy, the government needs to revive the depressed economy through a stimulus package. The steps of reviving the economy and structurally reforming it as mentioned above will lead to stability and full modernisation of the capital market.

Karki is ex-executive chairperson of SEBON. Twitter: @rbkarki4


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