At a time when the economy is not able to handle even one stock market efficiently and most of the macro-economic indicators are poor, a second market could turn into a white elephant for the economy
An efficient stock market in general indicates the level of economic activities in an economy. Economists, investors, bankers, policymakers and the general public take decisions by studying its performance. In general, the performance of the stock market and economic development have a strong relationship: whether with a past economic recession or depression, it was always preceded by an unusual rise of fall in the stock market.
However, this is not a universal case: in underdeveloped and inefficient markets, as in Nepal, the stock market does not agree with the theoretical aspects. For example, when the country was devastated by the earthquake in 2015, economic growth was a historic low and economic sanctions by India had stifled the Nepali economy, the country’s only stock market, the Nepal Stock Exchange (NEPSE), was soaring to an unprecedented high. This can be construed as immaturity of the Nepali stock market.
The NEPSE has, however, been plunging for the last three years, and investors are wondering if it will ever gain its grip again. And the policymakers have failed in fueling the market towards a bullish trend. For example, the monetary policy for 2019/20, which was expected to gear the NEPSE up, has also failed in providing the much-needed momentum.
Hence, the only stock market in Nepal is expected to see a bearish mood this season also. However, instead of working on policies that could develop and strengthen the NEPSE, the regulatory body, the Securities Board of Nepal (SEBON), is in another mood. SEBON recently made it public that it was speeding up the process of opening a new private-owned stock exchange in Nepal. However, its decision does not seem to be backed by any research on the current need of the market. Its only argument is that this will break the monopoly of the government in the stock exchange. But do we really need a second stock market in Nepal at present?
Nepal is a small country with a small GDP. Moreover, Nepal is a service sector-based economy. And in the service sector, hotels, banking and insurance are the major players in the Nepali stock market. Retail business and real estate sectors are major contributors to the economy, accounting for 25 per cent of GDP, but their participation in the stock market is negligible. According to the annual report of NEPSE, banking and insurance together make up about 80 per cent of market capitalisation at NEPSE. Given the small size of the economy and since most of the companies from these sectors have their shares already listed in NEPSE, the new market as an alternative would face difficulty in attracting and finding companies to list because dual listing does not seem possible in the case of Nepal. Because dual listing would first require legitimacy from the concerned bodies, and even if it does get the green light, why should a company go for dual listing in the same market?
So the new stock market would have two options to get companies listed: either attract new companies not listed with any stock exchange or have companies discontinue at NEPSE. However, both options do not seem feasible given the size of the economy. Similarly, statistics show that most of the manufacturing industries are shy of listing in the stock market in Nepal, with market capitalisation as low as 3 per cent of total capitalisation, although their contribution to the GDP is above 15 per cent. So the only option for the new stock market is to encourage the listed companies in NEPSE to quit and list their stocks in the second stock market. But this will only exacerbate the performance of NEPSE and create new problems in the economy.
The need of the second market will also not be justifiable if it is to be located in the Kathmandu Valley or even in State 3. Nepal’s financial system is urban centric. Out of the 4,701 branches of banking and financial institutions (BFIs), 32 per cent are located in State 3 alone. The argument is not whether Nepal needs a second stock market, but whether this is the right time. Although one of SEBON’s objectives is to make the market more competitive by discouraging the monopoly of NEPSE, the timing of the policy execution is also important. Lessons can be learnt from the Nepali banking industry. The preponderance of BFIs in the Nepali economy has now become a headache for the economy, with them having to go for mergers and acquisitions.
Therefore, the current need is to strengthen the available stock market and reduce market imperfections, such as information asymmetry, cartelling, technical inefficiencies and woes of small investors. Similarly, expanding the horizon of the Nepali capital market throughout Nepal and outside will be a monumental challenge for the Nepali economy. Priority should be given to increasing access to the capital market to those from outside the Valley.
More importantly, policymakers should conduct extensive research on the feasibility of a second stock market outside of the Kathmandu Valley. Similarly, the consequences of giving access to both foreign investors and companies to invest and get listed in here should be analysed. At a time when the economy is not able to handle even one stock market efficiently and most macro-economic indicators are poor, a second market could turn into a white elephant.
Bist teaches at The British College, Kathmandu
A version of this article appears in print on September 16, 2019 of The Himalayan Times.