Protect the nascent capital market

It takes time for a bud to blossom into a flower, and the process isn’t always straightforward. Some buds never flower, others simply wither. Emerging democracies work the same way. They need to be fed. The weeds of existing customs and practices that cling to the status quo are a constant obstacle. Then there are times when righteous individuals or institutions rise to the occasion, which helps remove the weeds and lay the groundwork for a change in mindset. Many times the current generation does not realize the importance of what is happening. But the next generation will thank them for having the courage to do the right thing.

Nepal is a young democracy. The current constitution is only six years old. In the new system of governance, in addition to a central federal government, there are seven provinces and 753 local units. It can get chaotic at times. It’s a new system, but it’s made up of the same old politicians and bureaucrats. It is difficult to let go of the beliefs and philosophies that have been ingrained in the brain over years and decades of practice. Old habits die hard, as the saying goes. Corruption was, and is, the way of life – and a necessity at times, as incomes for many are not sufficient to meet basic needs. Abuse of authority is not always despised.

Good precedent

KP Oli’s second term as Prime Minister lasted from February 2018 to July 2021. During his tenure, the Supreme Court twice prevented him from dissolving the House of Representatives. The first attempt took place last December. Lawsuits followed. Many, including part of Oli’s own party, took to the streets. In February of this year, the court ruled the dissolution unconstitutional. Stuck in a party dispute, Oli dissolved the House again in May. Again in July, the court restored the House. The hindsight is 20/20, but it’s safe to say that a move to the contrary had the potential to put off political and economic reforms for years, if not decades.

Time and time again, Oli, as Prime Minister, showed the characteristics of an autocrat and was ready to test the system – an embryonic system in many ways. A bad precedent would have been set if the tribunal had not asserted its independence. The other large independent body in the country, the Nepal Rastra Bank, the central bank, is currently in a similar situation. She, too, is under pressure from the administration of Oli’s successor, Sher Bahadur Deuba, to change a policy in which the ink is barely dry. By nature, politicians care about the next electoral cycle. Institutions like the Supreme Court and Nepal Rastra Bank have a bigger purpose, but they are tested here and there.

The Nepal Rastra Bank aims to formulate and manage the monetary and exchange rate policy necessary to maintain price and balance of payments stability. He’s independent, but with a twist. One of its seven board seats is occupied by the finance secretary, who will likely align with ruling party policy. In addition, the 2016 Second Amendment to the Rastra Banking Law of Nepal added Article 106 C, which states that (1) the Government of Nepal may give directives to the bank with respect to currency, banking and finance, and that (2) it is the bank’s duty to respect them. This gives politicians the opportunity to intervene unnecessarily.

Monetary policy for the 2021-2022 fiscal year was unveiled on August 13. One of the new changes concerned margin debt. The 2020-2021 policy had increased the amount that banks and financial institutions (IFCs) were allowed to offer margin loans from 65% of stock value to 70%. This has remained unchanged in current policy, but there were limits elsewhere. Investors are now only allowed to borrow 40 million rupees from a single BFI and 120 million rupees combined from multiple lenders. As of mid-August, CIBs had 108.5 billion rupees in these loans, up from 50.4 billion rupees in mid-July last year. Investor appetite for leverage has jumped.

That’s what a roaring rally does. The NEPSE, Nepal’s main stock index, hit a low in March 2019 at 1099 and in June of last year at 1150. On August 12, a day before the monetary policy announcement, it closed at 3179 , peaking at 3,227 on August 19. Then the all-in was pulled from below, scoring 2,779 on September 5, for a rapid drop of 14%. The decline is not to be despised, but it also precedes a 181% increase over 14 months. Buyers nonetheless accuse the new margin lending policy of the decline. In protest, they staged a motorcycle rally and sit-in, and held talks with officials, including the finance minister.

The objective is to force the Nepal Rastra Bank to reverse its new policy. Finance Minister Janardan Sharma poured gasoline on the fire, calling Governor Maha Prasad Adhikari to tell him to review the policy. Protesters are now calling for Adhikari’s resignation. What should have been a banal policy change has unnecessarily turned into a circus. Buyers want stocks to recover. Finance ministers would also like the stock market to perform well during their tenure. But the central bank as regulator has responsibilities, not the least of which is investor protection. It is important to remember that the gains multiply with the use of leverage, but so do the losses.

So far, Adhikari has rightly refused to bow to the pressure. Central bankers cannot be at the mercy of politicians. If necessary, the problem can always be reviewed during the next quarterly review. But changing the policy just because some drunk leverage buyers demand it will be fancy and set a bad precedent. Regulators are human and can make political mistakes. In a democracy, citizens can and should cry foul when this happens. This is not one of those times. The leverage party is starting to get too loud, so it’s time to pull the punch bowl out. This should help consolidate a nascent capital market, not weaken it.

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