Efficiency in Nepalese Capital Market

Dhiraj Rai, Roll 22521

The Stock Market and Economic Fundamentals

The stock market is known as the economic barometer. It serves as a leading indicator of
economic growth. When consumers’ confidence builds up, it leads to an increase in aggregate
demand which stimulates greater investment spending from the business sector that cause GDP
to increase further.
The earnings of firms will increase in a boom period. Higher expected earnings help build up
sustained cash flows in the company which prompts investors to reduce their discount rate while
evaluating the stocks. By contrast, the stock market will fall during the recession period.
Consumers’ spending and investment demand will fall. Firms operate at under-capacity level.
The price of goods and services including stocks will fall for a lack of effective demand.
Therefore, the stock market moves in tandem with macroeconomic fundamentals.

The NEPSE Index and GDP Growth in Nepal

The Nepalese secondary market has shown many ups and downs during the past 15 years period.
The NEPSE index reached its record high of 1175.38 points as of 31st August 2008; it sharply
fell to 298.89 points on 29th March 2012; bounced back up to 1881.45 points on 27 th July 2016;
down to 1168.62 points on 26th March 2018; peaked its highest of 3199.03 points on 18 th August
2021; fell off to 1815.13 as of 25 th September 2022. From past couple of weeks, the NEPSE is
hovering around 1900 points with a daily turnover below Rs 1 billion (Nepal Stock Exchange,
2023).
Whereas the GDP growth was 6.10% for fiscal 2008; 4.67% for 2012 and fell below 1% in 2016;
peaked at 8.97% in 2017 and steadily fell thereafter. It stood at 7.63% in 2018 and 4.24% in
2021 and it has been projected to soften to 4.4% in FY 2022/23 (IMF Data Mapper, 2023).

A Missing Linkage
Looking at the movement of NEPSE index and GDP growth, we can observe some anomalies.
The charts show that whenever the economy has fallen into recession, the NEPSE has bounced

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up (annex 1). The NEPSE reached 1175.38 points in 2008 whenever the economy across the
globe was in a great recession due to the global financial crisis (GFC). NRB had to pursue a tight
monetary policy to control the speculative housing and stock bubbles.
The NEPSE reached a high of 1800 points as of 27 th July 2016 when the economy was
devastated by the earthquake of 2015. The earthquake disrupted the economy’s real sectors and it
was contracted sharply. The GDP growth rate turned below 1%.
The COVID-19 and its subsequent lockdowns again disrupted economic activities. The GDP was
estimated to grow by merely 0.6% in 2021. The NEPSE also closed its online and physical
transactions on 22nd March 2020. Soon after opening, NEPSE kicked off a bullish trend and
reached its record high of 3199.03 points as of 18h August 2021. The economy was faltering
whereas the NEPSE was rallying above 1800 points. The NEPSE could not reflect a true picture
of the economy. The linkage between NEPSE and GDP was missing.

Anomalies in the Nepalese Capital Market

 The Nepalese economy is primarily based on the agriculture sector. About 24% of GDP
comes from agriculture, 16% from trade, 35% from services combined, 9% from real
estate, and 6% from manufacturing. But the agriculture sector has almost nonexistent in
the stock market.
 The stock market is dominated by the trading of shares of Banks and Financial
institutions (BFIs). In total market cap, commercial banks account for 37%, microfinance
12%, development banks 4%, and finance companies 2%. There is no link between the
market cap and the structure of the economy.
 BFIs sector dominates the secondary market. But they are only intermediaries in the
economy. They do not produce on themselves and contribute to GDP growth and not
represent GDP growth.
 Whenever the demand for loanable funds is low due to economic recession and BFIs
remain flush with cash, they start short-term lending with reduced interest rates. With
cheap money available and easy borrowing from BFIs, more money will be chasing the
stocks in the secondary market.

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 During the pandemic period, the hospitality sector nearly collapsed. The trade and
manufacturing sector significantly slowed down. The banking industry alone maintained
strong financial statements. Therefore, investors flock toward the stock market and push
up the price of BFIs shares in particular.
 The greater liquidity available in BFIs gave momentum to the stock market. The stock
market became the first choice when deposit rates dropped and there were few
investment opportunities available.

Sectoral Anomalies

 Within the sub-indices, development banks are more volatile than commercial banks
partly due to the control of a limited number of shareholders. A handful of investors are
deliberately inflating or deflating or cornering the share prices.
 Another anomaly can be seen in the hydropower sector which accounts for about 11% of
the total market cap. Hydro sector IPOs were oversubscribed by over a dozen times and
trading started at a multiple of their EPS. Investors perceived that IPOs were sure-shot
gain and trapped in ‘overconfidence bias’.
 The Nepalese capital market is highly liquid and capitalized. The market cap reached
above Rs 4000 billion and the daily turnover crossed over Rs 21 billion as of 15 th August
2021. This is far greater than that of peer-size European economies such as Malta, and
South Asian countries such as Shri Lanka and Bangladesh.
 Nepal has failed to take advantage of high liquidity for raising capital. This is simply
being used as a speculative market.

Other Behavioral Biases of Nepalese Investors

 Microfinance stocks were highly lucrative as the sector had huge profit margins before
NRB capped dividend distribution. People bought every Laghubitta share (Adarsha,
Samata, Nesdo, Jiban Bikas, Chhimek) with a high multiple of EPS or IPO price
perceiving that they were representative of the microfinance sector. The representative
bias trapped investors and prompted them to divert funds toward microfinance sector.
When prices fell for NRB clamp down, they made huge losses.

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  Nepalese investors are very prone to availability bias. The availability bias is seen in the
case of insurance company’s share. When there came the news that insurers were told to
raise their paid-up capital by 4 times, the secondary market reacted very quickly and the
insurance sub-index up from 5300.55 as of 26th March 2018 to 17753.44 points as of 18th
August 2021. Its an unprecedented growth. Due to the availability heuristic, investors
started chasing the insurance sector until the insurance shares price fell off. With price
correction, it’s now hovering around 9476.65 points as of 4th April 2023.
 The number of Demat account holders in Nepal has reached above 55 lakh. Investors
perceived IPO as a sure-shot gain. The prospective company also took it as a sure success
for a full subscription. NLIC, SCB and SHIVM cement successfully sold their IPO in
premium. Getting anchored to price many multiples of IPO, investors will subscribe IPO
of Ghorahi Cement. Sebon permitted Ghorahi to issue IPO by adding a premium of Rs
300 to the face value of Rs 100 totaling to Rs 400 for the project-affected locals. Getting
anchored to 55 lakh Demat account holders, Ghorahi Cement has confidence in the full
subscription of IPO. Will the anchoring bias of investors and companies work? The
result is soon to be seen.
 Most Nepalese investors who read online share news portals pay much attention to that
item news which helps them verify and support their views. They seek evidence that will
confirm their beliefs. Once there was a rumor that NRB easing the promoters’ exit from
class A commercial banks and investors awaiting to sell long-held shares of commercial
banks just started selling off their holdings very soon after they receive the news. The
confirmation bias led investors to pursue a quick off-load of that long-term-held shares.
 Apart from the above biases, Nepalese investors are predominantly guided by self-
attribution, framing, mental accounting, recency bias, loss aversion, regret aversion
(riding losers, selling hot), affinity, and hindsight bias while making investment
decisions.

Which Sector is More Stable?

Commercial banks are more stable than development banks. Because the daily turnover of
commercial banks is very high, its liquidity is high and it has a greater number of shareholders. If
the price of a commercial bank is up by 10%, there will come and follow supply enough to keep

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the price in equilibrium. There is very minimal possibility of manipulating and cornering
commercial banks’ shares. The manufacturing and hotel sectors are comparatively more stable.
Development banks and microfinance sector stocks are more volatile as it has few shareholders.
A handful of shareholders can influence the market price by controlling the demand and supply
of development and microfinance shares.

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 Appendix 1. The Movement of NEPSE Index and GDP growth

NEPSE
3500.00
3199.03

3000.00

2500.00 1904.40

2000.00 1881.45 1815.13

1500.00
1175.38 1168.62

1000.00

500.00 298.89

0.00
31-Aug-08 29-Mar-12 27-Jul-16 26-Mar-18 18-Aug-21 25-Sep-22 4-Apr-23

Source : Nepal Stock Exchange, 2023.

GDP Growth Rate (%)

10
8.9773
9

8 7.6224

7
6.1046
6

5 4.6701
4.2469
4

1 0.4331
0
Dec-08 Dec-12 Dec-16 Dec-17 Dec-18 Dec-21

Source : IMF, 2023.