Nepal’s Gross Domestic Product (GDP) is projected to grow by a mere 0.77% in the current FY 2015-16, the lowest in 14 years, as the economy is still struggling to recover from 2016’s devastating earthquake and economic blockade. On the other hand, Nepal’s sole secondary market Nepal Stock Exchange (NEPSE) index is breaking new records every day and has already surged by a whopping 54% since the beginning of the current fiscal year.
The opposite behavior of NEPSE and Nepal’s economic indicators indicates that our stock market is highly unrepresentative of the structure of the economy and is also immature. Nepal’s real sector is weakly represented in the stock market; 84% of the listed companies belong to the financial sector (compelled to be listed by regulation) which account for only 5% of GDP. The market fluctuates based on rumors and speculations about pending changes in government policies; driven largely by retail investors.
As financial markets are not the same as economy, it is difficult to establish a relationship between the magnitude of GDP growth and stock market performance. However, many studies reveal that they tend to move together over time. In well-established stock markets, the health of the economy is reflected in the performance of the stock market. Market participants eagerly wait for various leading and lagging indicators such as GDP, unemployment rates, inflation, interest rates, money supply among others to determine the current state of the economy and its likely impact on the stock market.
As 84% of listed companies in NEPSE constitute the financial sector, the benchmark index in not well-diversified. The value of index is highly vulnerable to the price movement of companies from the financial sector. As seen in the table below; the commercial banking, development banking (also includes micro-finance institutions), finance and the insurance sub-sectors have gained substantial value since the beginning of the current fiscal year thus pushing the benchmark index by 54%. Even though the hotels and manufacturing & processing sub-sector have also gained value, their contribution to the overall index is only moderate.
The thumping surge in the share prices of companies representing Banks and Financial Institutions (BFIs) is primarily due to additional capital requirement stipulated by the central bank. Despite very high Price to Earnings (PE) ratio, investors are attracted towards these stocks expecting to get the right and bonus shares. BFIs are required to meet new capital requirement by the end of FY 2016-17.
The development banking sector has seen the highest gain amongst the sub-sectors aided by increment in shares prices of ‘D’ class micro-finance institutions. The irrational growth of share prices of microfinance institutions has been fueled by anticipation of new capital requirement. Micro finance institutions stocks have the highest PE ration; the average stock price of national level micro-finance companies is around NPR 2000 per unit. Similarly, the share prices of insurance companies have also inflated greatly due to similar anticipation. The new insurance bill, which is currently pending at the Ministry of Finance for final review, plans to increase the capital base by multiple folds. Moreover, the Insurance Board has already barred insurance companies from distributing cash dividends. Share prices of most of the insurance and micro-finance companies are highly overpriced and do not match their performance. Therefore, investors should be cautious before investing to minimize risk.
Despite weak economic indicators, investors’ confidence and sentiment has remained high, signaled by strong market depth backed by impressive third quarter results of listed companies. NEPSE gained 21.46 points and closed at 1,464.13 points during the past two weeks. Due to the recent political development, which normally weighs high on NEPSE’s performance, the market shed 8.88 points during the last two trading days of the week. With further developments falling out, it would be interesting to see how investors will react to it in coming days to come.
On a positive note, as the Nepalese capital market is gaining momentum it provides ample opportunity for the private sector to mobilize financial resources in a productive way. Following developments would be essential in making the market more inclusive and stable:
- Government should introduce favorable polices and remove distorting factors to encourage various real sector companies such as manufacturing, telecommunications, and services, to be engaged in the capital market.
- Secondary market should be opened up for foreign institutional investors and Non-Resident Nepalese (NRNs). Capital markets are unlikely to develop or work efficiently if foreign investors are not allowed to invest in Nepal.
- Various tax incentives should be provided to counter extra cost of listing which shall encourage companies to go public.
- The existing stock exchange should be privatized; a stock exchange operating for profit usually has a higher incentive to grow by developing the capital market.