The bulls and the bearsThe wildly fluctuating Nepse index does not give a correct picture of the economy
The stock market can impact a nation’s economy in multiple ways. If share prices fall, spending stops, consumers lose confidence, the country’s financial state begins to falter and the growth rate of the Gross Domestic Product (GDP) slows down. If stocks rise, confidence spreads, spending goes up, investments grow and the GDP growth rate swells. A whole nation’s mood can rise or fall with the stock market index. That is why the stock market index is taken as a barometer of the economy. However, this theory does not apply in Nepal’s context.
In general, the underlying economy of a country translates into a company’s profits. Those profits ultimately determine the price of a company’s stock. However, two conditions apply: One, companies must represent the national economy, and two, the country’s economy must be closed. Only a stock market on which domestic companies are listed can represent the status of domestic production. In theory, there is a kind of correlation between GDP growth and stock market returns. Over the long term, aggregate corporate earnings rise when the economy grows, and vice versa.
The stock exchange plays a very important role in strengthening the country’s economy. If public confidence in the stock exchange grows, the economy will see a boom. But a marginal decrease in confidence could lead to the stock exchange collapsing. The stock exchange helps the economy in all sectors directly or indirectly. It generates additional revenue for the government, creates employment, attracts inflows of foreign capital, and most importantly, mobilises savings. It can develop confidence and encourages more investment based on the previous performance of products. A healthy economy attracts foreign capitalists to invest in the country.
The main function of the stock market is to provide a ready market for the sale and purchase of securities. The presence of a stock exchange gives an assurance to investors that their investment can be converted into cash whenever they want. Investors can invest in long-term investment projects without any hesitation as they can convert long-term investment into short- and medium-term investments because of the stock exchange.
Sophisticated financial market systems need to have credibility and accountability if they are to function on behalf of businesses and investors. For this reason, a stock exchange benefits from a formal structure upheld by rules, laws and regulations. Management and operational standards set by governments and regulators overseeing stock exchange operations give stockholders, investors and businesses confidence. However, some stock markets are clearly disconnected from the real economy. Focus on short timeframes, speculation and volatility may create a zigzag line on a graph. In the short term, the stock market in no way represents the nation’s economy because share prices may go up or down not because of a company’s performance but because of speculation. In the long term, a moderate correlation is set between the two. To ensure liquidity and demand and supply of securities, the stock exchange permits healthy speculation on securities, due to which the market value does not reflect the fundamental value of securities.
In Nepal, the stock market is not connected with the real economy even in the long term. For example, stocks plunged to an all-time low in 2018, but the GDP growth rate hit a record 7.5 percent. The agriculture sector accounts for 27 percent of the GDP, but there is not one agriculture company listed on the stock market. Banking and non-banking financial institutions account for 85 percent of market capitalisation. A few hydropower companies, hotels, consumer goods manufacturers and one telecommunication company make up the rest of the companies listed on the Nepal Stock Exchange (Nepse).
Nepal is an import-based country and it depends on remittance. The proportion of remittance to GDP is about 30 percent. A few agro, cement, steel rod, tobacco, liquor and consumer goods factories have a remarkable market size. Unfortunately, these companies are not public companies and they are not listed on the stock exchange, they are private limited companies. A total of 196 companies were listed on the Nepal Stock Exchange as of mid-July 2018. Among them, 147 companies are financial institutions. The paid-up value of all the listed ordinary shares is Rs341.248 billion. Commercial banks and the rest of the financial sector account for 86 percent and hydropower companies 7 percent of the value of ordinary shares. So the stock market index can only serve as a barometer of the financial sector’s performance.
In a theoretical perspective, the performance of the financial sector has a positive correlation with the performance of the industrial sector. The financial sector is a secondary sector which plays a key role in serving the primary sector. In Nepal, the financial sector can flourish even when the real sector is shrinking. In fiscal 2001-02, the real GDP growth was negative, but the financial sector reached an all-time high. In the last fiscal year 2017-18, the performance of financial companies declined but the GDP growth rate rose. The profits of financial companies mainly depend on remittance flow and consumption of imported goods. For this reason, the financial sector’s performance does not reflect the health of the national economy.
Most investors do not have sufficient knowledge and information about the stock market, they learned by imitation. Furthermore, companies do not release true information about their financial health. The market itself is small and manipulated by a limited number of persons. That’s why share prices and transaction volume fluctuates haphazardly. Such a market cannot reflect reality. In order to make the stock market a barometer of our economy, we have to do more things.