At first glance Nepal’s stockmarket ought to be celebrating. The average earnings of listed companies that have reported results for the latest quarter soared by an astonishing 202% compared with the same period a year earlier. Of the 122 firms to publish figures, 97 were profitable. Such a gusher of profits would normally push share prices to record highs. Instead the Nepal Stock Exchange (Nepse) index has slumped by some 15% since its recent peak in July. It is now roughly back where it began the year. This shows investors are worried, and rightly so, for beneath booming earnings stand three crises threatening the economy.
The most immediate worry is the sickness of the banking sector, which dominates the index in terms of market capitalisation. Several of the country’s biggest lenders are struggling under the weight of rotten loans. At Himalayan Bank and NIC Asia Bank, for example, more than 7% of their loan books are non-performing, meaning borrowers have fallen behind on repayments. A ratio above 3% is generally considered a sign of distress. To account for these possible losses, banks have set aside large provisions, causing collective net profits for the sector to tumble by 19% year on year. Worse, when banks repossess the property of defaulters, they often cannot sell it. They now hold over Rs43bn ($270m) in such “non-banking assets”, tying up capital that could earn interest elsewhere and undermining their profits.
That points to the second crisis: a sharp economic slowdown. The World Bank projects that Nepal’s real GDP growth will fall to 2.1% in the current fiscal year, down from 4.6% last year. Recent unrest has hit the tourism industry, with international arrivals dropping by a fifth during the key holiday season. The resulting damage to property has also led to an unprecedented Rs23bn in insurance claims, battering that sector. Meanwhile, government spending is set to rise as Nepal rebuilds and prepares for elections, even as tax revenues fall. This will widen the budget deficit, limiting the state’s ability to stimulate the economy.
The third and most insidious problem is a crisis of confidence. The governor of Nepal’s central bank has identified an “investment freeze”, where businesses and individuals with capital are too fearful to spend or invest. This caution can become self-fulfilling. When investment dries up, economic growth falters, in turn validating the original pessimism. Interest-rate cuts by the central bank have little effect when optimism is in such short supply. The physical damage from recent protests has made tangible the risks of holding assets in Nepal, further chilling sentiment.
These three crises explain why the stockmarket has ignored the good news on earnings. Investors are looking ahead, and they see banks with weakening balance-sheets and an economy losing steam, as well as a pervasive lack of faith in the future. This has created a “value trap”: stocks that appear cheap based on current profits, but are in fact pricing in darker days to come. The pain is not evenly distributed. The finance sector is down by 40% this year. Even high-flying industries tell a story of risk: hydropower companies trade at a dizzying 73 times earnings, suggesting rampant speculation rather than investors expecting massive future growth. And hotels trade at 69 times earnings despite an 8% slide in their share prices.
The market’s direction from here will be determined by whether policymakers can restore confidence. The most promising solution would be a “bad bank”, a state-backed vehicle that would absorb the toxic assets clogging lenders’ balance-sheets. This would free banks to resume normal lending. Stabilising the rise in bad loans or a period of political calm would also help. Without such interventions, the stockmarket’s path of least resistance is down. Corporate earnings are a snapshot of the past; share prices are a bet on the future. For now investors are voting with their portfolios. ■