Taking Stock

After reaching the peak of 1175 on Aug. 31, 2008, the Nepse Index — a market capitalisation weighted index tracking Nepal Stock Exchange (NEPSE) — has been trading around the 500 mark for last couple of weeks. And despite additional listing of shares from both Initial Public Offering (IPO) as well as bonus and right shares, total market capitalisation of NEPSE has plummeted from Rs. 612.5 billion on Aug. 31, 2008 to 405.8 billion on Dec. 14, 2009. The question then is what to make of the dramatic growth in NEPSE preceding the slump and what is causing the recent downward trend. In the paragraphs below, I have analysed what’s ailing Nepal’s stock market today.



Overall economic condition

Over the last couple of years, domestic economy has not delivered substantial post-conflict growth (as expected by many investors) after the resolution of Maoist conflict in 2006. Continuous political flux, uncertain business conditions in terms of strikes and labour problems, and energy crisis, among others, have constrained economic activity. As a result, Gross Domestic Product (GDP) growth has hovered around 3-4 percent during last few years without remarkable progress in Per Capita Income. Moreover, even the sub-par growth was possible only because of record remittance inflows - which are largely being used for consumption purposes. Because of inadequate growth in domestic production, soaring imports (coupled with stagnant exports) have widened trade deficit. As such there hasn’t been any remarkable progress in “real sector”. While agriculture sector is facilitating sustenance of over 80 percent of the population, we haven’t made any considerable investment in manufacturing and infrastructure - the mainstays for any sort of real sector growth.

Stock markets help mobilise large scale funds necessary for profitable investment ventures. Entrepreneurs and business organisations look towards stock market when they seek to raise large scale capital to either start their new business venture or expand an existing one. Because of lack of our real sector growth, participation of real sector in Nepali stock market has been minimal. Service sector - particularly financial institutions - dominates trading and overall market capitalisation of Nepal Stock Exchange. However, in a developing economy like Nepal, long run growth of service sector is dependent on the overall growth of real sectors such as manufacturing and infrastructure. And this is where the whole current foundation of stock market in Nepal turns upside down: how can service sector - such as financial - maintain growth and record profit year after year - without commensurate or even higher increase in the real sector? When a company’s stock price should reflect the discounted future earning of that company and not how many right shares or bonus shares it will dole out, isn’t it no-brainer then that sometimes even naïve investors will figure out that without overall economic growth, financial sector cannot grow alone? The growth in NEPSE preceding the slump belied the fundamentals and we are now witnessing the correction phase.



Supply-demand factors

From Mar. 13, 2008 to Oct. 15, 2009, the number of listed shares on Nepal Stock Exchange has more than doubled from 271 million to 669 million. Financial Institutions account for substantial chunk of the increment in number of listed shares during the corresponding period (from 165 million to 400 million). Bonus and right shares of existing financial institutions as well as Initial Public Offering (IPO) of new financial institutions are primarily responsible for the surge in the listed number of shares. While there has been massive addition in the number of shares, investor demand hasn’t picked up for various reasons. Economics 101 tells us that when supply exceeds demand, price has to come down.

Existing investors were spooked when the Maoist-led government raised the capital gain tax from 10 percent to 15 percent in the budget of Fiscal Year (FY) 2008/09. Despite the reversal in capital gain tax from 15 percent to 10 percent during the current FY’s budget, investors are still chary because of lack of clarity on government policies regarding capital markets. Moreover, participation in our rudimentary stock market is limited to few big scale investors in urban areas and lacks widespread retail penetration. Restricted access to stock brokers, lack of basic stock analysis skills, and paper-based trading system are a few of many constraints preventing new investors from entering the stock market and has restricted investors’ demand. One of the best ways to overcome this and increase retail penetration of stock market is via Mutual Fund. Mutual Fund pools money from general public and uses the pooled money to invest in stock market. They rely on fundamental/technical analysis, sophisticated trading models, and economies of scale to generate superior returns. However, Mutual Fund related policy in Nepal is still awaiting approval amidst the tussle between the Securities Exchange Board of Nepal (SEBON) and Ministry of Finance (MOF).



(The writer, a Chartered Financial Analyst (CFA) level 3 candidate, is associated with Nepal Investment Bank Limited)



This artilce was first published on The Kathmandu Post on December 17th 2009

http://www.ekantipur.com/the-kathmandu-post/2009/12/16/Oped/Taking-stock/3120/