Understanding The Fundamentals of Capital Market on the Basis of Current Economic Scenario

Fundamentals of Capital Market

In a nutshell, Capital Market facilitates the trade (buy and sell) of financial securities like Share, Bonds etc. which helps institutions requiring long term Capital to access and utilize the financial capital by mobilizing the surplus funds in the economy. Although, Capital Markets definitely supports and uplifts the economy, creates jobs etc., one needs to realise a fundamental concept that Capital Market is the Fruit of the Economy and not the Root of the Economy. To harvest juicy fruits, one needs to understand the climate, water the roots and cater to the plant; similarly, to ensure a thriving Capital Market, we need to create a robust and productive economy.

Let us explore some key areas that are important to build a better and sustainable Economy in the present context of Nepal. I outline the current economic scenario, some imminent risk and possible solutions to address these pressing issues.

1. Export Orientation

Without resorting to a thorough data analysis, a key take away is that the recent average of our Import to Export ratio is about 13:1. To put it simply, for every 13 Rupee worth of Import, we are only exporting a Rupee worth of goods. The widening trend seen in our trade deficit is alarming which implies we are a consumption led economy rather than a production led economy. Hence, our growth is limited by our capacity to consume which makes us prone to economic crisis thus making the Capital Market vulnerable.

One of the biggest threat of being a net importer with continuously widening trade deficit is running out of foreign currency reserves. Based on the Nepal Rastra Bank Annual Data of 2021/22, the Balance of Payment of the country remained at a deficit of NPR.255.26 Billion. Similarly, at the time of writing, Nepal has forex reserve of USD 9.35 Billion based on Nepal Rastra Bank economic report in Mid-September 2022/23, which can support the imports for about 6 to 7 months. Let us consider a hypothetical scenario, if the economic shut down like the one caused by COVID-19 (Corona Virus) lasts longer than expected forcing us to import essential supplies incessantly while our foreign currency inflow through remittance and foreign investments stagnates; we will essentially run out of forex reserve leading to a catastrophic impact on our economy. Our currency will be sharply devalued due to weak demand in the international forex market as we don't export enough, further hindering the revival of our economy.

Although it would be far-fetched to assume that we can compete with our neighboring giant economies, nonetheless we can certainly improve our exports by enhancing our agricultural produce and service sector. Competing in manufacturing or natural resource exploration for export might not be a practical solution right now, because our neighbors will simply beat us in Economies of Scale (i.e. the benefit of reducing cost by producing in large quantity) and Economies of Scope (i.e. the benefit derived by producing multiple goods together). Also, being a land locked country with poor transport infrastructure, our freight cost will come out to be too high. As an agriculture oriented country, I think we should focus on producing high grade organic agricultural products, pack them to improve their shelf life and transport them by utilizing the return cargo. Another area we should focus on is of course the Service Industry like Business Process Outsourcing (BPO), Call Centers, Software/Graphic Development, Financial Services, Business Consultancy, Training and Higher Education (i.e. establishing world class universities to attract bright students from all over the world and retain our own students from going abroad) etc. which does not require raw materials to be imported. Moreover, we must significantly improve our Tourism Industry to make it commensurate with the incredibly beautiful nature that we are blessed with.

A stronger economy means a stronger Capital Market. Wouldn't it be great to participate in the Initial Public Offering (IPO) of an export oriented Agro Based company that generates majority of its income in foreign currency?

2. Globalization

Our generation has the privilege of living in a world that is better connected across the globe by every means, whether its communication or transportation. In this globalized world, one thing that stands out is that none of the Company Listed in the Nepalese Capital Market has a full-fledged overseas operation generating significant portion of its revenue in foreign currency.

The risk of not going global is that our Companies are highly exposed to the country specific risk and may soon run out of growth opportunities. Our Banks and Insurance companies till now have mostly grown through market penetration, i.e. selling their existing product in the exiting market by adding branches and agents, but this growth is not sustainable. We are already seeing fierce competition in the Banking and Insurance sector as they all are competing in the same small market segment. 

Global or multi-national companies enjoys the benefits of revenue diversification, i.e. their income is not solely dependent on any single country and its policies, and they can explore opportunities for growth in a huge market and find a niche for themselves. In addition to being in a better position to create economies of scale and economies of scope, Global companies can also access the best talents, technologies and resources available globally. Furthermore, they find it easier to raise capital in the international financial markets. There are countless benefits of going Global against staying Local.

I suggest our policy makers to create an environment to encourage and support the Companies willing to expand globally. For example, corporate Tax Exemptions on profits equivalent to the international investments can be one effective policy. Through Global Companies, Nepalese investors will also get an opportunity to indirectly invest globally and reap the benefit of international opportunities. For example, an Investor in the USA who has bought shares of US based multinational company, Apple Inc., also benefits from the growing demand of iPhone in China which is the largest and fastest growing market for smart phone in the world. Multi-national companies will also help in improving our forex reserve. Strong Multi-National Companies listed in the Stock Exchange means stronger Capital Market. Multi-National companies can also help to raise the profile of the local Stock Exchange and can certainly help attract foreign investment, which can be beneficial to all in the long term.

3. Innovation

One cannot fail to notice that countries with strong emphasis towards innovation also has strong Economy and Capital Market performance. This is even more evident at corporate level, highly innovative companies tend to continuously create better value for their customers and their shareholders. Let us take example of Facebook, Google, Amazon, Apple etc., these brands are part of some of the world's largest and most valuable companies whose existence was questionable even just two decades ago. What made them so valuable? Innovation - they managed to come up with products and services that was not conceived of. Another similarity among these company is that they are still investing staggering amount of money and effort in research and development. They are aware that the moment they stop innovating, the game is over for them in this highly competitive and dynamic global economy.

Unfortunately, it is extremely hard to find innovation in the Companies listed in Nepal Stock Exchange. When one goes through their Financial Statements, any expenses or investments related to Research and Development is hardly found. We clearly know that Innovation is very important to sustain growth and create opportunity, and in some cases even for survival. We can see that most publicly listed companies in Nepal are highly regulated, particularly the Banks and the Insurance Companies and as a result they are already struggling to differentiate their products and services, which has led to forced merger for many corporates.

If we analyze the past financial data, the impact of poor innovation is even more evident. Both profit margin and return on equity of majority of listed companies are in a declining trend and the increase in profits are mostly driven by increase in Capital Base (Retained Earnings/Rights/Bonus etc.). Without innovation Capital Market will be at the risk of continuous underperformance.

We should be innovative, both at corporate level and as a Country. We should work towards building an economy that supports innovative start-ups, finances viable leveraged expansion plans and rewards trend setters. We should have Policies supporting Investments in Research and Development and Private Equity Ventures. Furthermore, Regulators should encourage companies to come up with new products and services and play a Supervisory role rather than a Controlling one.

Wouldn't it be great if we could participate in a successful innovative start-up that attempts to enhance and enrich our lives?

4. Digitalization

It's hard to imagine our life without internet but the internet is only as good as the activities that we can do over it and this should not be limited to only entertainment and information sharing. All economic transactions and activities we conduct on the internet creates digital economy. Digital economy is one of the fastest growing sectors providing lots of opportunities for numerous businesses and entrepreneurs. It is important that we realize these benefits of digital economy and switch majority of our process management, data storage and data exchange functions completely online.

Even though online Financial Transaction, online Application Forms and online Shopping is picking up well in Nepal, we are still not able to experience the significant positive impact of the digital revolution in our lives. For example, our Banks should realize that handling online fund transfer is easier than processing cheque payments, and managing IT Servers that can serve hundreds of customers simultaneously is easier and economical to maintain than operating multiple branches, therefore, online fund transfers along with all basic online services, in my opinion should be offered free of cost.

Our government should also follow complete online document management and task processing, service tracking and avoid duplication of physical verification with Bio-Metrics. Block Chain Technologies should be used to trace the exact creation, transfer and maintenance of data to ensure full transparency and security. We must understand that Digital Payment and Receipts are more secured and transparent than physical transactions if we develop a strong IT Infrastructure.

Financial transactions, Shopping with full information about price/quality/availability etc., online access to private or government services, making online enquiring or lodging complaints, tracking service delivery, getting feedbacks from customers, analysing users/consumers data to enhance their online activities and experiences, conducting research and analysis, surveys and polls, sharing knowledge and information and so on – the thing we can do over the internet is limitless. Integrating Digital economy into the mainstream economy not only boosts the overall economic output by saving time and resource but also increases transparency.

We are definitely embracing the information technology and adopting to the digital economy, but it has been a rather slow process. Both the nation and the corporates must put in a huge effort and investment to develop a strong Telecommunication and IT Infrastructure.

5. Human Resource Development

A nation is only as developed and as prosperous as its people. National economy cannot thrive without skilled manpower. Needless to mention that we still have a long way to go in empowering our citizens. The backbone of our economy is foreign remittance which makes up roughly 25% to 30% of our Gross Domestic Product (GDP), but the sad reality is that majority of this remittance are sent by our brothers and sisters who work in relatively low skilled jobs overseas. If only we could create a more skilled workforce, more remittance inflow could be generated which will improve our economy.

As mentioned earlier, to become an export oriented economy, we should focus on exporting our labour (the product and services that we produce domestically) rather than our labourers (the people). All of the aforementioned factors that are critical to our economy is dependent on human resources. To create multinational companies, we need inspiring leaders and great managers. To create digital economy, we need people who understands and can work with technologies. To innovate we need creative and intelligent minds. Without paying proper attention to our workforce, we cannot improve our economy no matter what. It's noteworthy that simply producing skilled manpower does not necessarily aid to economic advancement unless we are able to retain and attract them as it is apparent that many skilled Nepalese are working in the professional sector overseas. To advance in the globally competitive economy, we must have a healthy, happy and skilled citizens.

We must improve our education system at root level, and set up more institutes to develop practical and vocational trainings. Equally important is to create opportunity for our youths to learn, and explore their inquisitiveness while engaging them in productive work. We absolutely need to empower our people socially, culturally and economically. We cannot have a robust and stable capital market without prosperous population who can save and invest.

Conclusion:

To conclude, the factors explored here are by no means a comprehensive guide to improving our capital market but I have hopefully convinced the reader that these factors are indeed of paramount significance. In addition to favourable policies and regulations, the underlying drivers of the economy also needs to be attended to. In the context of Nepal, although, we have witnessed a growing capital market, a lot more needs to be done to ensure a flourishing and stable capital market.

By creating an economy that has balanced international trade and is built on optimal utilization of the resources that is naturally available to us; by creating an apt workforce that is motivated to learn, develop and contribute; by switching to highly digital economy; by encouraging our businesses to be more innovative; I have no doubts that we can significantly improve our Economy, and ultimately transform our Capital Market as one of the best avenues to save and invest.

Author:

Mr Suday Kant Jha, FCCA, CFA, MBA

CEO, Reliable Venture Capital Limited