The decline of capital market in Nepal is not just due to government policies. The government of Nepal is ready for structural changes required for the development of capital market. It is always receptive to suggestions from experts in the form of concrete reform agenda and doable action plans.

Capital markets, which refer to stock exchanges and bond markets where securities (negotiable and fungible instruments representing financial value) are traded, are an important element of modern financial systems. Securities are of two types: equity securities such as shares in companies, and debt securities which include bonds and debentures. Capital markets enable both individuals and firms to lend their savings to those who need them, and allow companies and governments to raise long-term funds. Another vital, and arguably more important, component of financial systems, are commercial banks that accept deposits and grant credit. Capital markets and banks co-exist and constitute the most crucial sources of external financing for individuals, firms, and governments. They provide a means of not only transferring and distributing risks across the economy, but also of mobilizing and channeling savings.

Capital markets have remained on the periphery of national financial systems. Economic literature has identified several policy and institutional impediments to capital market growth in developing countries. These converge on high entry barriers in the securities industry, lack of competition, restricted foreign access to domestic equity markets, government control over operations of securities companies, weak regulatory frameworks, and inadequate supervisory mechanisms. Many governments moved towards reducing these impediments in the 1980s and 1990s, when they were under growing pressures to reform capital markets as part of broader financial liberalization programs.

Instituting capital market reforms is a complex process that encompasses a variety of different yet interlinked measures. For the sake of analytical clarity, these measures can be broadly categorized into two seemingly contradictory sets: deregulatory and regulatory. Deregulatory measures have centered on the decision of governments to open up domestic equity markets to foreign investors and allow them to purchase shares. In most developing economies, restrictions on foreign investments have been removed in conjunction with government efforts to permit stock-broking companies to set their commission rates in line with market conditions, and to remove barriers to entry in the securities industry by encouraging new entrants, both domestic and foreign, to undertake securities businesses.

These deregulatory reforms have been designed to create competition by offering advantages to competitors and imposing disadvantages on incumbent firms in capital markets where government controls have long fostered oligopolistic market structures. They have also aimed to reduce the cost of capital, and increase the pool of financial resources available to local industrial firms, broaden investor base, and make domestic financial sector more efficient.

The liberalization of capital markets has been accompanied by the privatization of state-owned enterprises (SOEs). In many developing and emerging market countries, privatization programs have been enacted to stimulate the development of equity markets as well as to increase government revenues and promote economic efficiency. The programs helped expand the size of stock markets and enliven trading activity, as state assets are sold through share offerings, and large privatized firms get listed. They have also increased opportunities for investors to diversify their portfolios, reduced investment risks, and enhanced the depth of equity markets.

The trading of listed securities at the stock exchanges, often known as secondary capital market transactions, is new for Nepal. Although Biratnagar Jute Mill and Nepal Bank Limited floated their shares in the market in 1937, the formal trading of secondary market in Nepal was started only in 1994 after the establishment of Nepal Stock Exchange. Initially, there were only 62 companies with 25 brokers. The trading system was open outcry system. The most significant change in Nepali secondary market was the establishment of semi-automated system in August 24, 2007. Currently, NEPSE has increased the number of brokerage houses to 50, and more than 222 companies are listed. Moreover, as a full subsidiary of NEPSE, a separate company for depository has also been established, which is going to kick into operation very soon.

Even in India, the stock market remained underdeveloped till the early 1990s. The interest of general investors was hardly protected. Mechanism for risk management was utterly lacking. Market closures were a recurring phenomenon. Foreign participants were not permitted to trade. Equity shares dominated stock exchange transactions. Debt securities, never received the desired focus.

Of late, the Indian government has allowed FDI in stock exchange. The purpose is to improve the functioning of the stock exchange to make it at par with international standards, and to make Indian stock exchanges a part of the global financial market. This provision has yielded results. In early 2007, the National Stock Exchange (NSE) divested 20 percent of its equity to four foreign investors—5 percent each to New York Stock Exchange, General Atlantic, Goldman Sachs and Softbank Asian Infrastructure Fund.

In the context of Nepal, recently NEPSE and the KRX intended to create a partnership between the two exchanges for enhancing the operational efficiency and competitiveness of Nepali and Korean Capital Market. The NEPSE and the KRX together aim to introduce an efficient and reliable capital market in Nepal by designing new practices and IT system. Both parties shall come up with a solvable financing method by closely consulting with the concerned authorities of Nepal. Since Nepal Rastra Bank has already decided to divest its share of about 36 percent in NEPSE, some percentage of the share could be divested to KRX and/or the other premier exchanges that will bring the needed capital, technology and human resources to Nepal. Moreover, NEPSE is seeking technical assistance for Automated Trading system (ATS) for Risk Management, Broker Back office, and stringent surveillance mechanism. There is more likelihood that Nepal will receive technical assistance with the help, co-operation and support from grant agencies and/or countries.

The author is former CEO of Nepal Stock Exchange Limited (NEPSE)

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