It is difficult to be a budding capital market. It has its share of advantages and disadvantages. There are many growing pains. You learn by doing and falling, as Richard Branson once said. At the same time, those who are willing to learn from the mistakes of others will have plenty of opportunities to do so. Markets that have matured today at some point were themselves taking small steps, going through the pain of trial and error. Their negative experiences and how they overcame them can prevent future generation from making the same mistakes. The Nepalese stock market is young. The Nepal Stock Exchange (NEPSE) opened in January 1994 and still has a long way to go before joining the big leagues.
NEPSE began its life by listing just over 60 companies. Today, they are around 222. Its market capitalization has grown from millions to billions of billions. There are 2.2 million broker accounts, of which 70,000 to 80,000 are active daily; online accounts total 725,000. But the market is not evenly distributed. Banks and insurance companies represent more than two-thirds of NEPSE’s market capitalization; hydropower accounts for an additional 9 percent. This is three quarters of the market. For example, Ncell, the main provider of mobile services in Nepal, does not yet deem it necessary to register. The sooner the NEPSE – or the Securities Board of Nepal (SEBON), which regulates the securities markets in Nepal – can change that, the better for the overall investment environment. It can be a win-win situation for all parties involved. The public can diversify its assets into leading domestic companies, and these will have greater access to capital markets.
Give regulators a break
In an emerging market like Nepal’s, it’s easy to point fingers at regulators. The internet has made the world smaller and made information easily accessible. It’s easy to complain when comparing the investing tools available here with those in more mature markets. In the case of Nepal, even the most basic tools are lacking. This is a valid criticism. For all intents and purposes, we can only be long now. Short selling, in which borrowed stocks are sold in the hope of buying them back later at a lower price, is not permitted. But giving decision-makers the credit they deserve, these things take time. The goal should always be to do it correctly and with foresight rather than doing it hastily and without proper preparation.
In a balanced market, both sides, bullish and bearish, should have access to tools to express their bias. It is not for regulators to decide – or to wish – whether markets should go up or down. It should belong to the market participants – the so-called collective wisdom. In any given asset, sometimes longs are right, other times shorts. In fact, there are times when a short squeeze ends up helping the long ones; this happens when overzealous shorts are taken on the wrong foot and forced to hedge, putting upward pressure on prices. From Nepal’s perspective, the next step towards maturity is to expand the investor’s toolbox with options and futures. SEBON, in fact, is preparing to award a license to trade raw materials.
It is never a good idea to have only an upward bias. Devoid of tools such as short selling, this is the case with the Nepalese stock exchange. NEPSE bottomed out in March 2019 at 1099; last month it ticked 3063. Margin debt provided a sustained tailwind for the bull market. Unlike cash accounts, margin accounts allow clients to borrow capital against their cash deposits or invested capital. By mid-June, banks and financial institutions — 27 commercial banks, 18 development banks and 20 finance companies — had issued 94.6 billion rupees in margin loans, up from 45.4 billion rupees at mid-June. July 2019. much success with these loans because they charge higher rates; SEBON should allow richer players to enter the market.
Learn from the mistakes of others
Banks have significantly expanded their portfolio of margin loans as demand for loans in other sectors of the economy weakened. Additionally, unless stocks collapse, margin loans issued using stocks as collateral are considered safe as they can be liquidated quickly. For borrowers, the advantage is that they can borrow on margin, which boosts purchasing power. The downside is exactly that: they can borrow on margin. Leverage will help in an uptrend, but will hurt in a downtrend. When the value of the portfolio drops below a certain level, the lender issues a margin call, forcing the borrower to provide more cash or sell the securities. Failure to do so will give the bank the right to liquidate all or part of the securities.
NEPSE has been under pressure since its peak last month, falling 9% over the next two weeks. It is too early to say whether the unwinding of margin loans played a role. We will know when the mid-July figures are released. In a grand scheme of things, margin debt looks manageable, comprising about 2.3% each of total bank and financial institution loans and NEPSE’s market capitalization. However, it is difficult to get a clear idea of the extent of leverage in the stock market, as investors could easily use personal loans and overdrafts as well. Rising margin debt is a signal that investors’ risk appetite has increased. This is what a bull market usually does.
In mature markets, as margin debt increases, there is a simultaneous increase in other measures of risk; corporate debt issuance, for example, is also surging, particularly of low quality. In Nepal, after the pandemic, demand for loans was negatively affected and the economy collapsed, which in fact pushed more people into actions. This probably led to an over-reliance on leverage. The risk is when the cycle turns. We have seen this saga repeat itself over and over in mature markets. Margin debt, no doubt, should have its place in investing. But just as important are the tools for the other party to place bets. The way it is currently set up, aside from selling and entering cash, bears are unable to express their bias, whether through options, futures, or short sales. It creates an imbalance.
Pandey talks about markets, money and macroeconomics at hedgopia.com.