The recent bull run in Nepal Stock Exchange (Nepse), whereby the benchmark index climbed to an all-time high of nearly 1,200 points, had some analysts worried about 'overheating' of the stock market. The recent crash of the benchmark Chinese index—as a result of which all gains of Chinese stocks in 2015 have been wiped out in the past two weeks—shows how countries with opaque financial markets are vulnerable to sudden market swings. But both in Nepal and China, stock market swings have limited impact on overall economy. In China, most of the big state-controlled entities are unlisted. In Nepal, the most commonly traded stocks are those of Banks and Financial Institutions (BFIs). Since BFIs in Nepal don't rely heavily on stock market for their capital, any market swings have limited impact on their overall health. So there is little chance of a sudden future crash in Nepse reverberating to other sectors of the economy. Nonetheless there is definitely a case for better regulation of the capital and money markets in Nepal so that the health of the traded companies is properly reflected in share price.Broadly, three factors underlie the recent Nepse rally. One is the introduction of dematerialized ("Demat") system. In this system, the shares and securities of investors are held electronically by brokers and no paper share certificates are issued. But not all the listed companies have adopted the system. Currently, only major BFIs have. So only the shares of these few companies can be traded, which increases their value and the overall value of the benchmark index. The second reason for the bull run was the agreement on the six-state federal model among the four major parties. With the long-delayed constitution finally on the horizon, investors were optimistic. The third reason was the new Nepal Rastra Bank (NRB) guideline on higher paid-up capital for BFIs. Higher paid-up capital means more bonus and preference shares and bigger future returns for investors. Since all these are legitimate causes for optimism, it's hard to argue that the shares are overvalued. There are safeguards in place as well.
In the long run, higher capital requirements should make BFIs safe against emergencies like sudden crash in real estate market. Recent cap on real estate investment and higher capital requirements have greatly reduced this risk. But in many ways Nepali stock exchange still resemble a "betting den" as senior Maoist leader Baburam Bhattarai once alleged. Only a handful of brokers are privy to the real health of listed companies at any point. This gives them disproportionate influence in trading of stocks and securities. These brokers reportedly collude to fix market value of shares to increase their earnings. So far the Securities Board of Nepal (Sebon), the regulator of securities markets in Nepal, has been unable to properly investigate these allegations and punish wrongdoing. The sorry state of Nepse was also highlighted earlier this month when normal trading had to be suspended in the absence of power back-up during load-shedding hours. Unless Nepse is better managed and regulated, there will continue to be a cloud of suspicion over the reliability of the benchmark index, to the detriment of investors and the overall economy.
Related story
Wonders of elevators
