There has been a provision brought by Nepal Rastra Bank which has made it mandatory for the Banking institutions to issue debentures worth 25% of their total paid-up capital. The recent monetary policy has extended the mandate to Ashad of 2079, so the banks have still got 2 years to complete their side of the promise. This move from NRB can be well applauded as we can expect the dormant Bond and Fixed Income markets to ignite and play its part in the Capital Markets in our Country. But after a year of this initiation brought forward by Nepal Rastra Bank, the situation still looks quite gloomy.
In Nepal, there is a lot of ramble in the market whenever an IPO is announced, whatever the Company and its credentials may be. Almost all the IPOs are oversubscribed by a large margin. Nepal’s Stock market is a Speculator’s paradise or hell, as markets can take a turn to worse at a moment of time. Overlooking the actual performance of a Company and how it looks on the books, the market seems to follow the word of mouth or a herd mentality and often influenced and reactive to the news regarding dividends, bonus payments, and how the media portrays the company as. The result? A wide spectrum of differences in the valuation of the company. Many companies trading in NEPSE are underpriced, just because they don’t get the required attention and many are overpriced and fetches in large volumes of trades based on speculations. But it is the market imperfections that lead to gains, so we can look at it in a positive way if we want to.
However, When Bonds and Debentures are concerned, the market hype creation is lacking, considering bonds to be safer investments compared to stocks. The awareness about issues is also lacking and seems to be requiring some push from the media. Bonds and Debentures trading is directly affected by the attention and market interest they get. The primary market can fetch in a lot of investors for bonds, but their trading in the secondary market is too low to even consider it as actual trades.
Comparing bonds with Stocks
When we compare bonds with stocks, Stocks seem to provide a greater return in the long run, but owning a stock can be a roller coaster ride. When we talk about bonds on the other hand, the volatility is low and if you are an investor, your return is locked in a constant stream. When you purchase a stock, you purchase part ownership of the firm and make you a part of the profit and loss of that company, but when you purchase a bond, you are just giving the company a loan, redeemable after a certain time with a fixed rate of interest. A bond doesn’t give you voting rights as a stock does, but it also doesn’t make you liable to the losses a company makes, and even in case of liquidation, you will be among the first to receive your investment back. Also, irrespective of how the company performs, they are liable to provide you the pre-determined interest; the same is not the case with Stock where you only get the return if the company makes a profit (not considering capital gains in the secondary market). So, following a principle of low risk- low return, bonds are a safer investment yielding a lower but constant return while stocks are a more aggressive and risky means of investment where you can fetch an astronomical return.
When we consider the World market, the debt market exceeds the equity market; This means that the debt is a more commonly used medium for financing worldwide compared to equity financing as it is less complex and time consuming compared to equity financing.
Government Bond in Nepal
Government of Nepal issues different types of Treasury Bills and Bonds in regular interval of Time looking into fulfilling a short term working capital requirement or a long term capital requirement. Some of these bonds are open for the general public for investments.
When we look at the Domestic Debt Structure of Government of Nepal, the public participation looks very thin. It may be because of two things, lack of frequent offerings from the GON or the lack of public participation among the general public. The other thing can also be because of the low return that Government Bond fetches sticking by the low risk- low return philosophy. When we consider the risk level, Government Bonds are the safest investment as the default risk can be considered ZERO.
When we go through the Ownership structure of Government Bonds, Commercial Banks have the biggest chunk of cake on their plate and it is mostly dominated by BFIs in total. On the overall Government bonds, the public ownership is less than 1% and that is understandable because only 1.57% of the total issued Government Securities is accessible for the public. Commercial bank's interest in Government Securities can be accredited to the Statutory Liquidity Ratio(SLR) requirements set by the Central Bank. The SLR requirement for Commercial Bank is 10% and 8% and 7% for Development Banks and Finance Companies Respectively. SLR is the ratio between the Liquid assets to the Demand and Time Liabilities. The deposits in saving and current accounts can be withdrawn on demand, which is the Demand liabilities whereas an example of time liabilities can be given as Fixed Deposit accounts. So in order to maintain the SLR, BFIs tend to use Government Securities as a medium, although the liquidity of such securities on demand is questionable.
Corporate Bonds in Nepal
Government of Nepal and NRB have been coming up with ways to promote Fixed Income Markets in Nepal and the most recent being the mandate for banks to come out with bonds and debentures totaling to 25% of their total Paid-up capital. This is definitely going to increase the number of active debentures in the Nepali market but this doesn’t guarantee an increase in Trade of such securities and market based continuous price discoveries; like of that of stocks trading in the stock market. There are currently more than 20 Debentures listed in Nepal Stock Exchange.
Out of the Debentures listed, only 2 are that of Finance companies and the remaining have been issued by Commercial banks in Nepal. The number will keep on increasing as we can see only 18 Commercial banks have come out with debenture issues and we will soon see more Commercial Banks join in to comply with NRB Regulations.
Although Active debentures are 25 in Number, the number of trade executed is very minimal compared to listed Equities. Debentures have not been able to reach even 1% of the total monthly or annual turnover of NEPSE. But still, there are positive signs as the no. of trades is slowly increasing.
Source: NEPSE Reports
Is Bond Investment Risk-Free?
There is no free lunch in the world of Finance and the same principle holds true in the fixed income market as well. Fixed income markets are also exposed to certain risks. In Fixed income markets, the principal amounts are generally locked for a certain period of time and until then, you will not be able to use the fund in other places. So in a way, you will be shielded from market-rate volatility but in the same way, you’ll not be able to use the fund to invest in some higher return instruments.
Although Bondholders are among the priority repayment list in case of liquidation or bankruptcy, such a disastrous situation in BFIs may freeze your principal amount without any interest payments. Worst case scenario, your principal amount may also be lost. There’s also a liquidity risk associated with fixed income instruments as although considered very liquid, the prices and availability of quotes are again influenced by the market demand and other influencers like market interest rate, economic condition etc. Interest Rates are also above the general market rate and for an investor looking for stability in similar lines to Fixed Deposit, Debenture can be a better alternative altogether.
Future of Fixed Income Markets in Nepal
It is fair to say that Nepali Fixed Income Market is just in the Initial Phase and we have a lot yet to see and experience from this market. With support from NEPSE and a more lenient tax rates levied by lawmakers, people would definitely keep debentures as an alternative investment instead of using fixed Deposit Schemes. A better digital platform would be a boon to this market and would definitely increase the trade volumes as well as interest among the mass. Fixed Income market can actually be the next big thing in the Financial Market in Nepal for people with low-risk appetite and looking for a streamline return stream. But public interest and participation is the key and in a country like ours where IPOs are oversubscribed every time, Debentures and other fixed-income instruments have the potential to attract investors looking for a safer bet.