Nepse Index & Interest Rate (A Study Of 27 Years)

May 6, 2020 | SOM THAPA

Introduction

Stock market is the barometer of the economy. It reflects the economic progress of any country. Stock market is the platform for the funding of the business and the creation of wealth. It plays a pivotal role in the growth of the industry and commerce of the country. Stock prices affect the level of investment in the economy. In the booming market, people are more willing to invest in stocks. Huge amount of capital can be generated when the stock market is strong. On the other hand, when the stock prices are incredibly at low levels, people decrease their investment. Due to this, there will be low capital accumulation when the stock prices are depressed.

Hence, it is necessary to find the factors that affect the stock market in the short and long run.

One of the factors influencing the stock market is said to be the interest rate in the economy. Interest rate has direct effect on the demand for loans. High interest rates mean high cost of borrowing so firms invest less. If firms cannot invest it means that the present value of their future cash flows will also decline and this has a direct negative impact on firms’ stock prices.

Study of Stock Market and Interest Rate in Nepal

In case of Nepal, very few studies have been done to determine the relationship between the interest rate and the stock market returns.

Shrestha and Subedi (2014) have examined the determinants of the stock market performance in Nepal and have found that the performance of stock market respond negatively to interest rate.

In this study, I will try to establish the relationship between the Stock Market and the interest rate in Nepal.

For the purpose of Study, I have taken Nepse Index as the indicator of stock market returns. Since, Nepal Stock Exchange (NEPSE) is the only stock exchange in Nepal, Hence, Nepse Index is the only market indicator. Dividend is not included in the calculation of stock market returns for the ease of the study.Similarly, 91-Day Treasury Bills is taken as the indicator of the interest rate since it is more authentic.

Period of Study

This study covers a period of 27 years from 1993/94 to 2019/20 A.D. NEPSE opened its trading floor on 13th January 1994. So, it has been 27 years since the start of Nepal Stock Exchange. Hence, data is taken from the inception of NEPSE.

Interest Rate

91-day t-bills rate is taken in this study due to the availability of data and its relevance.

A Treasury bill (T-Bill) is a short-term debt obligation issued by the Public Debt Management Department of Nepal Rastra Bank with a maturity of less than one year.

The data for weighted average 91-day t-bills interest rate is taken from the monetary policies of the concerned period. The 91-day t-bills rate from F.Y. 1993/94 to 2019/20 is shown in the table 1. Similarly, the weighted average 91-day t-bills rate of 27 years is also represented in the chart 1.

Table 1: Weighted Average 91-Day T-Bills Rate (Last 27 Years)

Fiscal Year	91-Day T-bills rate
1993/94	6.5
1994/95	7.35
1995/96	10.93
1996/97	10.22
1997/98	3.52
1998/99	2.33
1999/00	4.66
2000/01	4.96
2001/02	4.71
2002/03	3.48
2003/04	2.93
2004/05	2.46
2005/06	2.84
2006/07	2.42
2007/08	4.22
2008/09	5.83
2009/10	6.5
2010/11	7.41
2011/12	1.31
2012/13	1.74
2013/14	0.13
2014/15	0.43
2015/16	0.79
2016/17	1.45
2017/18	4.48
2018/19	3.2
2019/20	2.23

In Chart 1: Weighted Average 91-Day T-Bills Rate

Stock Market (Nepse Index)

NEPSE index is the market value weighted index. This index shows the aggregate growth in capitalization of companies listed in Nepal Stock Exchange. The data for NEPSE index from F.Y. 1993/94 to 2019/20 has been collected from Nepal Stock Exchange and its website www.nepalstock.com and economic survey published by Ministry of Finance. The data of 27 year period is shown in the table 2.

Table 2: Nepse Index (Last 27 Years)

Fiscal Year	Nepse Index (‘Mid July’)
1993/94	226.03
1994/95	195.48
1995/96	185.61
1996/97	176.3
1997/98	163.3
1998/99	216.9
1999/00	360.7
2000/01	348.4
2001/02	227.5
2002/03	204.86
2003/04	222.04
2004/05	286.67
2005/06	386.86
2006/07	683.95
2007/08	963.36
2008/09	749.1
2009/10	477.73
2010/11	362.85
2011/12	389.74
2012/13	518.33
2013/14	1036.1
2014/15	961.2
2015/16	1718.2
2016/17	1582.67
2017/18	1200.09
2018/19	1259.02
2019/20*	1251.45

*As of March 22, 2020

The NEPSE index has been highly volatile throughout this period which is the nature of the stock market worldwide. In a period of 27 years, there have been 3 bull markets lasting 2, 5 and 5 years. Also, there have been 4 bear market lasting 4, 3, 3  and 3+ years. So, NEPSE index has gone through 3 complete cycles of bull-bear market. In each of the bull market, NEPSE has surpassed the peak of previous bulls.

In Chart 2: Nepse Index (‘Mid July’)

The movement of Nepse Index and the Weighted Average 91-Day T-Bills Rate in the 27  years is represented in the single chart 3.

CHART 3: Nepse Index and 91-Day T-Bills Rate

Relationship Between Nepse Index and Interest Rate

In order to establish the relationship between Nepse Index and the interest rate, we will divide the study period into equal periods of 4 years. Hence, the 27 years will regroup into 6 four-year periods and one 3 year period. Period 2 which includes fiscal year 1997-98 to 1990-00 will be of 3 years period.

In the seven periods, the change in Nepse index is computed. The percent change in Nepse Index is calculated by subtracting the index level in the last fiscal year of  previous period by the Nepse Index in the last fiscal year of the current period.

The periodic data is represented in the table 3.

TABLE 3: Nepse Index and 91-Day T-Bills Rate

Periods	Fiscal Year	91-Day T-bills rate	Average T-bills rate (4 Years)	Nepse Index (‘Mid July’)	Percent Change in Nepse Index (in 4 Years )
Period 1	1993/94	6.5	8.75	226.03	-22.00
	1994/95	7.35		195.48
	1995/96	10.93		185.61
	1996/97	10.22		176.3
Period 2	1997/98	3.52	3.50	163.3	104.59
	1998/99	2.33		216.9
	1999/00	4.66		360.7
Period 3	2000/01	4.96	4.02	348.4	-38.44
	2001/02	4.71		227.5
	2002/03	3.48		204.86
	2003/04	2.93		222.04
Period 4	2004/05	2.46	2.99	286.67	333.87
	2005/06	2.84		386.86
	2006/07	2.42		683.95
	2007/08	4.22		963.36
Period 5	2008/09	5.83	5.26	749.1	-59.54
	2009/10	6.5		477.73
	2010/11	7.41		362.85
	2011/12	1.31		389.74
Period 6	2012/13	1.74	0.77	518.33	340.86
	2013/14	0.13		1036.1
	2014/15	0.43		961.2
	2015/16	0.79		1718.2
Period 7	2016/17	1.45	2.84	1582.7	-27.17
	2017/18	4.48		1200.1
	2018/19	3.2		1259
	2019/20*	2.23		1251.5

*As of March 22

From the Table 3, we see that decline in 91-day T-bills rate is correlated with in the increase in the Nepse Index in the concerned period. Similarly, the rise in T-bills rate can be associated with the plunge in Nepse Index.

In the period 1, 3, 5 & 7, when the T-bills rate rose from the previous periods, the index has fallen by 22 percent, 38.44 percent, 59.54 percent and 27.17 percent respectively. Likewise, when the t-bills rate fell in the period 2, 4 and 6, the stock index surged 104.59 percent, 333.87 percent and 340.86 percent respectively.

This demonstrates the inverse relationship between the interest rate and the stock market performance. It is clearly represented in the Chart 4.

CHART 4: Average T-Bills Rate (4 Years) and Percent Change in Nepse Index (in 4 Years Period)

  

Conclusion

The evidence supports the theory that there is negative correlation between interest rate and stock market performance. The rise in interest rate will lead to decline in stock index. On the other hands, the decline in interest rate results in the higher stock market performance.

The first reason might be that the low interest rate makes stocks more attractive because of low cost of borrowing as well as low opportunity cost foregone by holding bank deposits. Hence, in case of low interest rates, depositors may use their deposits to buy stock. On the other hand, people can borrow at the low interest rates from banks and financial institution to make investment in the stock market.

The low interest rate environment propels investors to put their fund at the stock market with the expectation of higher returns than the market rate. This induces investors to take risk on the market rather than putting their funds at the banks at low returns. It creates higher demand for stocks, thereby pushing their market price higher.

The second reason seems to be that the low interest rate is associated with business expansion.  With low market interest rate, business firms can exploit the funds at minimum rate thereby generating accelerating profits. As business grows rapidly, the stock prices follow. Higher interest rate is not favorable because it increases the cost of fund of the business, thereby increasing the inflation.

Since its inception, the stock market of Nepal is hugely occupied by the banking stocks. Thus, the interest rate seems to have more effect on the market. At the low interest rate environment, banking flourishes. This leads to huge expansion and the surge in the profit of Banking Institutions. Therefore, during the period of lower rates, the stock market has climbed substantially.

Read Related Contents:

History of NEPSE: Battle of Bulls and Bears (A study of 23 years)