For the past year, the bearish sweeping red flooding the secondary market in Nepal has wreaked havoc on millions of investor portfolios. The declining trend has been caused by a number socio-political factors including political instability and liquidity crunch in the banking sector as well as BFIs being forced to give out large numbers of bonus and rights shares as a result of increased paid up capital requirement. In addition to the supply demand mismatch, a recent directive released by the Inland Revenue Department further triggered a drastic reaction from investors plummeting the market by 76.02 points to a closing at 1231.64 points yesterday (10th June 2018) . This nosedive tailed the first of its kind boycott by Nepalese investors protesting an increase in the capital gains tax on bonus and right shares at the companies’ market value.
Following IRD’s letter to NEPSE on Sunday, 3rd June 2018 – that instructed the revision of capital gains tax threshold on bonus and rights shares (which led to a decrease of 33.71 points), investors boycotted stock trading the following day (Monday) for half an hour (with a closing decline of 5.11 points). The boycott continued for the entirety of Tuesday halting all trading activities. While the market reacted favorably (with an increase of 13.9 points) on Wednesday after the Finance Ministry retracted its decision, the market soon plunged by 25.68 points on Thursday and 25.43 points on Sunday as the news of the formation of a task force to study the capital gains issue surfaced.
The looming uncertainty of the task force’s decision over the capital gains tax on bonus and rights shares at market price- that would greatly affect investors operating at losses in share transactions- has lost investor confidence. This is at a time when investors are already disheartened by the increase in capital gains tax from 5% to 7.5% in the sale of shares effective next fiscal year. The government has been promising an online trading platform for years to no avail – so stock trading remains mostly Kathmandu-centric. It is imperative that the government increases its services to the public at the same rate at which it increases taxes.
At a time when investors in the secondary market are already ailing for a long time, the Finance Ministry seems to be shirking their responsibility of aiding investors by instead choking investments. As with any other form of taxation, the government should focus on increasing the tax base instead of burdening current tax payers with increased rates. In this case, increasing the tax base would depend on creating a frictionless market with easy access to trade all over Nepal, which would lead to country-wide increase in number of investors and higher revenue generation even at lower tax rates. Long term bearish markets will inevitably reduce investments in the secondary market which are a major source of government revenue. A day of boycott itself resulted in millions of revenue loss for the government when zero shares were traded from an average daily turnover of NRs. 400 million.
It is in the best interest of the government to nurture secondary markets since a large flourishing stock market with lower taxes will reap more revenue for the government than a small falling market with higher taxes. 2 years ago on June 9th 2016, NEPSE had experienced a historic high at the time with a closing of 1566.7 points and record breaking single day transaction of NRs.1.89 billion. The rise which came after the introduction of paperless share transactions boasted average daily transactions of NRs. 1 billion. Focusing purely on government revenue generation, keeping other benefits of a healthy secondary market aside, it is clear that the government would have benefited many folds by a bullish market with high transaction volumes and majority gainers even with a lower tax rate two years ago, than with lower transaction volumes with major losers currently which will only get worse with stringent capital gains taxes in the future.
Lastly, the current government and the Finance Ministry should understand that the stock market is extremely sensitive towards the current government’s view of the market. This has been reflected clearly by investor reaction towards the rash announcement of revised thresholds of capital gains tax on bonus and right shares and the impending results of the task force created to address the issue. Non-market friendly and misinformed sentiments expressed by the Finance Ministry like the share market being an unproductive sector greatly thwarts investor confidence and their enthusiasm to trade. Hence, it is critical for the government to carefully analyze all outcomes before issuing any statements and directives that can have catastrophic effects on people’s life-savings within a matter of minutes.