ILLUSTRATION VIA BEHANCE
THE MAP of “political stability” in Nepal has never been a reliable guide to market returns. Too many governments have promised order and delivered paralysis. Yet the turmoil of the past two months is different. The country’s political risk premium, that elusive extra return investors demand for holding assets in a shaky polity, has crashed back into Kathmandu’s stockmarket with a vengeance. And it hurts.
On paper Nepal looks more settled than it has in years. The Rastriya Swatantra Party commands nearly two-thirds of parliamentary seats, a margin that prompted Fitch Ratings in March to declare “short-term political uncertainty” reduced. The Nepal Stock Exchange, known as NEPSE, celebrated with a rally that pushed the index towards 2,960 points on March 24th. That peak now reads like a mirage.
Since then the index has shed more than 250 points, a fall of nearly 9%. Hundreds of billions of rupees in investor wealth have evaporated. Daily turnover, which topped Rs23bn in the rally’s final days, had shrunk to Rs 3.43bn by May 5th. On the worst single session of the sell-off, April 5th, the index crashed 3.79%. Small bounces have been swallowed by larger slides. The index now floats in the low 2,700s.
What went wrong? The answer is that investors priced assets for a stable reforming government and then discovered that stability and reform are not the same thing. The RSP majority has not been idle. It has done exactly what it promised: gone after the crony capitalist networks that have long treated Nepal’s capital markets as a private piggy bank. The result is a textbook case of the second-order effects of anti-corruption zeal. In rooting out abuse, the government has inadvertently shattered the confidence of the very retail investors who kept the market alive.
The immediate trigger was an investigation into what appears to be the country’s largest-ever stockmarket manipulation syndicate. Last month the Securities Board of Nepal published findings on a networked trading operation centred on a businessman named Deepak Bhatta. The scheme was elegant in its ugliness. Trades were executed on credit rather than cash settlement. Unauthorised trading limits were granted to connected individuals through a compliant brokerage infrastructure. An estimated Rs 2.73bn in suspicious trades flowed through a single broker, Bhrikuti Stock Broking Company. Stocks such as NLG Insurance and Nepal Reinsurance Company were pumped in a circular trading ring. When the board released its report, the music stopped.
Then came the arrest that truly spooked the market. On April 23rd police picked up Shekhar Golchha, a former president of the Federation of Nepalese Chambers of Commerce and Industry. Mr Golchha is accused of facilitating the syndicate’s trading structure. This was no minor operation. Mr Golchha sits at the apex of Nepal’s business elite. His arrest told every politically connected player that immunity had expired. Within days market professionals reported a freeze in dealmaking that required regulatory approval. Foreign investors waiting on the sidelines decided to wait longer. The warning was that the rules had changed, but nobody yet knew what the new rules were.
That uncertainty has been amplified by a series of policy stumbles. Early this year the Supreme Court issued an interim order casting doubt on Nepal’s double taxation avoidance agreements with eleven countries, including China, India, South Korea and Thailand. The court ruled that because parliament had not ratified the treaties, they lacked legal force. The proximate case involved the Dolma Impact Fund, a Mauritius-based investor that had put millions of dollars into Nepali startups such as CloudFactory and WorldLink. The fund’s claim to a capital gains tax exemption was suspended. The wider implication was catastrophic for foreign portfolio investment: if no treaty is valid until ratified, every foreign investor faces unpredictable tax exposure. The political risk premium now had a new line item, shaped like a tax bill.
What makes the current moment particularly painful is that the political risk premium had been dormant for years. Investors had grown accustomed to a certain level of dysfunction. They priced it in as background noise. The RSP majority promised to replace that noise with something better. Instead it has replaced it with something more frightening: unpredictability. The old crony system was corrupt but it was legible. Those with connections knew where the boundaries lay. The new system, in which a former chamber president can be arrested and tax treaties can be voided by judicial order, is not yet legible to anyone. Legibility is what markets crave. In its absence they demand a premium.
The question now is how long that premium will persist. History offers conflicting lessons. In other emerging markets, anti-corruption campaigns have sometimes produced sharp sell-offs followed by durable re-ratings once the rule of law became predictable. But that outcome needs sustained reform: a functioning monetary policy, a ratified set of tax treaties and the transparent prosecution of market manipulators without regard to political affiliation.
Nepal has none of those things yet. The Employees Provident Fund, which manages more than Rs500bn, can now invest outside fixed deposits and government bonds. It is not rushing into equities.
So the premium stays. It is a weight on every transaction, every decision to hold or sell. The fall from 2,960 to 2,712 points did not happen by accident. It happened because Nepal’s political class, in its zeal to root out decades of rot, inadvertently triggered a crisis of confidence in the very institutions that markets depend on to function. The irony is exquisite: a government elected to deliver stability has delivered the most destabilising shock in years. Until the new rules become old news, investors will pay the premium. And the market will continue to hurt. ■
