Effect of Liquidity In the Performance of Stock Market In Nepal
July 22, 2021 | Ganesh Adhikari
What is Liquidity?
The term – liquidity has been a hot topic in the Nepalese financial market in recent times. Liquidity is the available surplus cash or an asset/security that can be easily converted into cash. In general, liquidity is the cash equivalent assets used to address financial obligations. The motion of the capital market is more or less driven by liquidity. Excess liquidity helps the capital market rise, and on the contrary, low liquidity means a fall in the index.
The Nepalese investors/traders reaped the rewards from the stock market in the bull run of 2020/21 when the index soared from 1180 points to the sky-high 3000 points. A key factor aiding this Bull Run was the excess liquidity. After the government imposed nationwide lockdown in March 2020 due to the fear of a pandemic, the liquidity in banks had reached as high as 200 billion (Arba) rupees in April – June, as per NRB (Nepal Rastra Bank). This excess liquidity turned out to be a blessing in disguise for the traders after the initial phase of the pandemic.
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Liquidity and Stock Market
Many had assumed the stock market to go into free fall due to minimal economic activities, but the excess liquidity swung the pendulum towards an all-time high NEPSE index. When the lockdown eased, the business and the economic activities got their legs back, the demands for loans increased, the liquidity was less than 50 billion rupees which meant the enthusiasm in the market was subdued. This slowed down the market.
So, why does the excess liquidity help the stock market to perform well?
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How Liquidity Affects Stock Market Performance?
As the banks will be left with excess cash nowhere to land, the interest rates on loans will decrease, which encourages the investors and traders to borrow money from the banks and invest in the stock market. This eventually pushes the market up. The interest rates on loans have fallen within the single-digit range (<10%) during the pandemic, which allowed traders to achieve higher returns from the stock market at a low cost.
Similarly, the other group of people who won’t get paid high interest rates for their savings is discouraged to put their money in the banks. They search for alternative ways for investment and no better than the stock market they find for their big or small amounts. Since March 2020, the interest rates on saving accounts have never been higher than 5% (at most) while ranging at (1.5% – 3%) most of the time. The people weren’t getting fair growth of their hard-earned money and choose the stock market for investments. This scenario could be seen in our community or neighborhood. Before the pandemic, there were hardly four lakhs of people with Demat accounts and applied for IPO (Initial Public Offerings), within a year, the number has increased to more than 37 lakhs. The stock market has attracted every type of investor/trader, where you can start investing with as little as one thousand rupees.
The monetary policy also gets adjusted according to the liquidity available in the banking system. NRB relaxed the monetary policy during the pandemic, increasing the margin lending to 70 percent of the share value. Similarly, the stock valuation consideration was reduced to 120 days average share price, which was before considered from 180 days. According to the NRB’s data, margin lending had outstretched to 77.35 Arba (billion) which is 70.6 percent more compared on the y-o-y basis. In this way, the funds kept flowing into the stock market, rocketing the index sky-high.
The intraday turnover in the capital market has increased significantly in the bull run of 2020/21 reached as high as 19.55 Arba 13th July 2021. When the banking sectors faced the liquidity crisis during late 2019 the intraday turnover was barely 1 Arba. This is an exceptional rise in the volume at which the shares are traded. Thus, the capital market has a high dependency on the liquidity available with the banking sectors in the country.
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Conclusion
The second wave of the Covid – 19 and nationwide lockdown reignited the flare of the capital market in the country, saw the closing of many economic activities with the rise in liquidity. It will be interesting to see if the index does move in the same direction with the same intensity when the lockdown has been relaxed and the other economic activities are slowly coming back to normal, ceasing the excess liquidity in the nation.
The path of the stock market is inversely proportional to the lending interest rates of the banks. The interest rate is driven by the liquidity in the banking sector, thus directly impacting the capital market. The concept of supply and demand is equally equivalent in banking as it is in the capital market.
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