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Nepal real estate bubble burst

As soon as the stock market plunged in the country, the question arose as to whether it was a sporadic event expected to perk up in due course of time, or whether it was an outburst of irrationality finally returning to a stable level. Thus, before examining the present trend, it will be meaningful to explore the reasons behind the share market peaking at 1175 points only to fall in the space of a little more than two years to 449 points.

In Nepal, the composition and maturity of the capital market are very different from the rest of the world in that here, financial institutions singularly contribute over 70 percent of the share value, leaving only 30 percent to the real sector. In the past, a type of monopoly in the banking sector, narrow scope to invest their savings, and their limited knowledge of the capital market were strengths that proved to be a passport to effortless prosperity for a certain period of time in the form of “small is beautiful”.

Dr Bhattarai, then Finance Minister, with a nod to Mr. Keynes, cynically compared the stock market with gambling, where the fortune of the players is not so much guided by the underlining principle as by the bullishness of investors who are skilled to influence the market for their benefits.  Mr. Keynes, who earned a great amount of wealth for himself and his institute by devoting only half an hour early each morning, did not bother to describe the speculation theory as building castles in the air.  He further claimed that the brokers and insiders — who wished to be called the rescuers of capital markets and offered their services to steer the investors for secure and profitable investment — would have already retired from their works  amassing a fortune for themselves, if their prophesy had any certainty.

While share prices were increasing, everything seemed to be good. Triggered by population growth and increased exposure to the outside world the economy grew larger and many financial entities came to play. Even though the expansion has opened up a world of opportunities, the country has so far failed to harness these prospects, only bringing in the short-term benefits spawned by increased exposure. The short-term benefits such as bubbly asset prices, ever easier credit and an abundance of foreign exchange reserves that fueled the age of consumerism is not likely to return for years to come. Falling real estate prices and the accompanying sluggish capital market are signs of an economic downturn.

The downturn was to come along sooner or later as the economy was not fundamentally sound to veer the market to a positive direction. The credit crunch had already surfaced, the balance of payments has plunged into the red and the investment situation is far from good.  Public and private investments in productive sectors are falling every year. At the present moment, Nepal has the lowest production capacity in South Asia. Even though the revenue collections have exceeded projections, the government has not hesitated to escalate the recurrent expenditure at the cost of long-term growth. Moreover, in the hope of tackling growing liquidity problems, banks have started raising interest rates which, in turn, has made the capital market less attractive for new investors. Those who have been in the circle are also looking for ways to sneak out of the marketplace with liquid money in their hands. The great economist John Kenneth Galbraith rightly said “causes and effects run from the economy to the stock market, never the reverse.”

The fleeting rise in the stock prices was triggered by increased bank financing in the real-estate sector. The property prices went up rapidly encouraging further investment in the sector until it reached an unsustainable level of over 30 percent of overall bank investment. If the financing had been made to households and firms to be paid out of their income sources, the effects on the economy would not have been so devastating. The problem would neither have shaken up the whole economic set-up nor do its yields reach the state coffer to shareholders pocket. Instead, the bank investment in real estate was motivated by feverous speculation that was not likely to sustain for too long. One can ask why the downturn was applied to every bank even though not all the commercial banks were guilty of making a mess of their portfolios. The answer, however, lies in the fact that the banking sector is the one that cannot discriminate its services in the eyes of the consumers. For instance, when a bank gears interest rates up all have to abide by the rule of the market with very narrow leverages.

Just as the market value of the land increased irrespective of the growth of the national economy, so the price of the shares has also irrationally increased irrespective of price-earnings ratio, guided singularly by speculative motives. It would not be surprising if the fate of investors who have bought shares of NTC at the rate over Rs. 600 per share four years hence resembles that of the person who bought laptop four years ago. The fall in the price of laptops is obviously attributed to the technology that has been rapidly growing and the market that has been swiftly becoming competitive. The more the similarity in settings, the greater the chances follow the same doom. The failure to understand the extent to which deregulation and competition would reduce profit margins is the only reason that has contributed to uphold the irrational level of its share prices. 

In recent years the numbers of banks and financial institutions have grown rapidly, breaking the monopoly of a limited number of banks. Competition will have positive effects on holding back unjustifiable profits. In line with the regulation of the central bank, bank capital has increased enormously over the years, ultimately making abundant share issuances to absorb savings in a supposedly viable banking sector. Liquidity crunch also is bound to further reduce the share activities, diminishing its value in the future. Recently the interest rate has gone up that has made investment in the share market more expensive and less attractive. Evidence supports that the share prices are set to decrease further before bouncing back to stable prices.

The imbalances that have been years in the making cannot be undone overnight. Crisis is inherent in a system plugged with rigidities of economic imbalance. The statement that the market will bottom up very soon is only a strategy launched by insiders acting to trick investors. Anyone familiar with the present state of economy can look to national indicators to realise that the market is moving in the perverse direction.  In the situation of slower growth in remittances, rising imports, declining exports, decreasing national savings, an unfriendly investment environment and political instability, no one can expect a turnaround in stock markets any time soon. It represents that the economy still faces significant headwinds. Judged by the events and inclination of the capital market, prospective investors still have ample time to buy shares at a reduced rate, if the market trends have any guidance and direction.

Yoga Nath Poudel