Effect of interest rate in stock market; Where will the market go in future?

  Interest rate and NEPSE relationship: Universally there is an inverse relationship between interest rate and stock price. The connection goes like this- When interest rates fall, fixed income investment like bank deposit become less competitive because of their lower yields and stocks become more attractive as a result. Conversely, when interest rate rise, fixed income investment become more competitive because of its higher yields, therefore stocks become less attractive in turn. No doubt Interest rate and NEPSE index is interrelated with each other.  In the above mentioned graph from the year 2013 to 2016, every time when interest rate rises, NEPSE has moved in an opposite direction. In Nepalese context, interest rate and NEPSE are inversely related. When BFIs’ offer higher interest rate, people go for a safer alternative i.e fixed deposits. In recent time, most of the banks are offering attractive interest rate on fixed deposit than few months back which signals liquidity shortage in the market. When interest rate rises there is dual effect which can affect stock market negatively. One is risk-averter investors exists market and move for safer investment – fixed deposit and trader or speculator who are using bank money for investment also tries to exist market since bank now charges higher interest rate on loan. In general, if interest rate is low, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase. When interest rate is high, consumers tend to save as returns are higher. With less disposal income to spend as a result of the increase in savings, the economy slows and inflation decreases.   Why stock price decline when market interest rises? Example  Suppose the market price of ABC stock trading at Rs 1000 and it declared 35 percent cash dividend. At the same time market interest rate on fixed deposit is 3 percent. Rational Investors always compare the company return with bank return- fixed deposit rate. Here, Dividend yield is 3.5 percent (Dividend Yield= DPS/MPS) and market interest rate is 3 percent. Here investors are getting more return than fixed deposit investment. So many rational investors buy this stock pushing the price further up. Now if the market interest rate on fixed deposit rises to 5 percent. In this case rational investors compare the existing 3.5 percent dividend yield with 5 percent fixed deposit rate. They see more return on fixed deposits and they start withdrawing money from stock market pushing stock price further low. From the above graph we can see inverse relationship between interest rate and NEPSE index. When there is an increment in interest rate, market moves in negative direction and vice-versa. When the interest rate was around 4.86 % in year 2013 Nepse index was at 643.95 points. Afterward, the weighted average deposit rate declined. This event was also one of the causes for upward movement of NEPSE. In July 2016, NEPSE reached its highest point of 1881, interest rate of BFIs’ at that time was 3.28%. However, NEPSE is moving in downward trend lately. This might be the result of increasing interest rate in recent times. Where will the market go in future? Investor cannot assume that increasing interest rate in recent time will lead to complete downward trend or crash in NEPSE. We should first determine the longevity of interest rate- is it for long term or for short duration of time? If the interest rate increment is only for short period of time there is no any strong evidence for market to decline. Present scenario of Nepalese stock market is completely different from the past. There is higher involvement of retails investors at present. The influence of big investors which we felt in past has significantly decreased as market capitalization has drastically increased. Reform activities such as evolution of central depository system, dematerialization of shares, supportive rules and regulations, shorter settlement time are some positive aspects of this market. Paper based share transactions is being completely replaced by the help of Central Depository System and dematerialization of shares. The dematerialization of shares has also been successfully implemented which has shortened the settlement time. We are also heading towards online trading system in near future. Investment of institutional investors like insurance companies, mutual fund, private equity fund etc in the stock market has also provided some strength in market. Mutual funds, insurance companies, BFIs’, investment companies are some of the institutional investors for our stock market. There are 3 mutual funds which are set to launch in near future. Mutual Funds, generally invest around majority of the collected money directly in the stock market. A larger market size has also somewhere downsized the influence of big players which was continually faced in previous years. So many companies are issuing right shares and Further Public Offerings (FPO) in the market at present. Initial Public Offering (IPO), FPO, And Right issue adjustment is one of the causes of declining market. Every year market declines in between Dashain and Tihar festival as investors need more liquid cash in hand for festive purpose. Minor correction is normal in this period of the year. This period of time is also taken as ‘Wait and Watch’ period Positive things such as investment of NRN’s, online trading, issuance of broker license to commercial banks , increased number of mutual funds, accessibility of brokerage facility outside valley etc  in near future can provide new dimension to Nepalese stock market.

Prakash Ghimire

Sabin Manandhar