Stock Taking

Budget 2001 & Stock Exchange

By Krishna Shrestha

If transactions in the Nepal Stock Exchange Ltd. during the period of two weeks after the budget nnouncements are guided purely by the budgetary provisions, the market response to the budget is not positive one. Despite announcements to carry out various reforms in the Nepali capital market, a havoc is created by the capital gain tax.

Prices of almost all of the commercial banks went up artificially for the following one week of budget announcement and began to fall from July 17. Investors as well as stockbrokers have still been opposing the provision of capital gain tax. It has raised a big question : is the budget really pro-capital market ?

However, Dambar Prasad Dhungel, Chairman of Securities Board, Nepal, seems optimistic. "The budget has announced numbers of measures. The government wants to develop the Board as capable institution. Issues of transparency and accountability, among others, have been raised. If the measures are implemented well, it will boost capital market activities," says Dhungel.

Contrary to this, Navaraj Pokharel, President of Nepal Stock Brokers Association (NSBA), does not seem satisfied from the present provisions. "The government has only repeated the old announcements," says Pokharel.

In fact most of the provisions announced in the new budget were already announced in the past in budget speeches or in other official documents.

Jagdish Prasad Agrawal, former President of NSBA, too does not seem optimistic. "Some revolutionary steps need to be taken if remarkable growth of Nepali capital market is the objective," says Agrawal.

On the other hand, Mukunda Nath Dhungel, acting General Manager of Nepal Stock Exchange Ltd. seems optimistic. "The government policies will have positive impact. I am optimistic that the provisions will boost the capital market," says he.

Before going into details, it would be worthwhile to have a glimpse on capital market related provisions announced in the budget speech for the fiscal year 2001/2002. The government has promised to submit a bill to make necessary changes in existing Security Exchange Act. Nepal Auditing Standard will be formulated and implemented. Preliminary work on organisation structure, ownership and operational modalities will be carried out. And, companies found as defaulters in making the audited financial statement public, will be penalised. (see Box)

But capital market can not be developed in isolation, as it is only a part of the whole economy. So, the other provisions made in the budget directly or indirectly affect the capital market. Financial sector reform is of the major things that directly impacts capital market. The government has assured that financial sector reform activities initiated in the last fiscal year would be continued. This sector occupies a big share in the capital market. In the year 2000, commercial banks had occupied 85.46 per cent of the total turnover value of share transactions that were recorded at the trading floor of Nepal Stock Exchange Ltd. The turnover of commercial bank shares was Rs. 1914.27 million.

"The government has announced numbers of measures under financial sector reform programme. It has talked about overall efficiency of the banking sector, which is good", says an optimistic Dambar Prasad Dhungel.

However, to get financial sector reform programme implemented well, the government needs to do series of things including timely changes in existing rules and regulations. The government needs to submit the promised bills in the Parliament. It may be recalled here that the government had announced priority reform action in April 2000. The progress in the ‘action’ is, however, quite slow. So, investors still doubt whether the financial reform measures will materialise soon.

The government has announced various measures to attract domestic as well as foreign investment in the country. Special provision has been announced to attract investment from nonresident Nepalis. In the past, there was a trend of taking loan from banks while launching industrial projects. Today, more and more entrepreneurs opt to go the capital market instead. As the investment increases, so does the size of the capital market. But the overall investment scenario is not much encouraging. Attracting foreign direct investment has become a Herculean task. Finance Minister Dr. Ram Sharan Mahat rightly pointed out in the budget speech: "The society is under the grip of social and economic tension, law and order situation is worsening, strike prone attitudes are on the rise. Above all, the chains of political events have been counterproductive to the domestic and foreign private investors to come forward."

If the budgetary programmes are materialised, the sick industries rehabilitation programme will have positive impact on capital market. The government has announced in the budget that a high level "Sick Industry Rehabilitation Committee" will be formed to rehabilitate the sick industries and tourism businesses. It has been stated that "the committee will identify sick industries and tourism businesses, find out their causes for sickness, explore possibilities of rehabilitation, and implement the rehabilitation programs and facilitate supervision and monitoring of such program by providing an institutional co-ordination mechanism."

Manufacturing industries should be the backbone of a capital market. But that has not been the case in Nepal. There is not even a single manufacturing entity, which could be considered as a blue-chip company. Manufacturing units constitute the majority in terms of the number of listed companies, but they have been performing worse compared to others. Majority of the manufacturing companies are not in position to give dividends. Some of them have not held their annual general meetings since long time back. And, there are still others such that even shareholders do not know their whereabouts. If industrialists’ claim is to be accepted, majority of the companies are sick due to one reason or another. If sick industries rehabilitation programme is seriously materialised, the capital market will benefit. The turnover of the manufacturing and processing companies was 3.05 per cent only in the stock market in the year 2000.

The budget has announced that listed companies found as defaulters in making the audited financial statements public for two consecutive years will be penalised. Considering the present state of information dissemination, the provision gives rays of hope, as many companies do not disseminate information in time. Still, many listed companies including Nepal Bank Ltd and Rastriya Beema Sansthan have not fulfilled their duty of completing audit in time. But who will penalise them? Till date, no mechanism for this has been made public.

Definitely, budget has made some announcement that would be helpful for the healthy development of the stock market. Though most of them are old, they are useful. However, overall impact of the provisions depends upon implementation of the provisions. Right now, we can just wait and see.

 Budget Announcement

1. To enhance the monitoring capacity of Securities Board, Nepal, and to make the security transaction effective, a bill will be submitted in the present session of the Parliament to make necessary changes in the existing Security Board Act.

2. To make the professional auditing system and practices consistent with the standard of international practices, Nepal Auditing Standard will be formulated and implemented.

3. To make Nepal Stock Exchange Limited’s activities further transparent and consistent with the international standard, preliminary work on its organisation structure, ownership and operational modalities will be carried out.

4. If company listed with Nepal Stock Exchange Limited default in making the audited financial statements public for two consecutive years it will be penalised by cancellation of registration and by subjecting to further legal action.

5. Ten per cent capital gain tax will be imposed on the sale of securities and shares on the basis of initial price of 1st day of fiscal year 2001/2002. The Nepal Stock Exchange Limited will collect this tax at source during the transaction. The Stock Exchange needs to deposit the revenue in government account within one month. Other provisions will be as specified by the government.

Two Comments & Three Questions on Capital Gain Tax

"The concept of capital gain tax is not bad. But the government introduced it at the wrong time and with wrong policy. It may down the market. It would have been better if the government had introduced it two years back when investors were making money."

Jagadish Prasad Agrawal, former President of Nepal Stock Brokers Association.

"The government introduced the provision at the wrong time. Market is weak. Investment environment has deteriorated. And, there does not exist proper mechanism to implement it properly,".

Navaraj Pokharel, President of Nepal Stock Brokers Association.

Question 1. "If profit on sale of securities and shares are considered as capital gain, and capital gain tax is imposed accordingly, what will be the provision in case of loss?"

Questions 2. "What will happen with right shares and bonus shares? What will be the provision for portfolio managers? Do people need to pay income tax even after paying capital gain tax?"

Question 3. "Is Securitie

nge Limited capable of handling the issue? Is it well equipped and manned?"

Budget Impact on Share Market

By Atmaram Ghimire

The share market has received a new shock with the budget proposals for FY 2001-02 presented in the rliament on July 9, and some of its effects are already visible in the market, though the long-term impact is still to come. Nepali authorities have always believed in Keynesian doctrine that in the long run we all will die. That principle has governed most cases, even the newly proposed budget.

One of the major proposals in the budget concerning the share market is 10% tax on capital gain. Principally this is not a wrong concept if viewed against our limited revenue base. But it is a question of timing, percentage of tax levied and subsequent rules to be framed to cover the whole issue. Some of the provisions are still not clear as to what will happen to certain kinds of transactions. Investors hope, these would be clarified in due course of time. But the major concern at present is the immediate impact of the new provision.

If we look at it from South Asian perspective, India implemented capital gain tax in 1964 with base price of July 1, 1964. It was levied up to 30 per cent and currently the rate stands at 10 percent. Sri Lanka also has the capital gain tax of 10 per cent. But the major question now is about when did they start it? It is not that Nepal should wait till it reaches the same volume and/or the number of transactions. We are underdeveloped and we need to take some faster steps than other South Asian nations to tap the revenue resources that we need for our development efforts. The growth of Nepali share market has been two year phenomenon after the great crash of 2051 BS. That means, it took almost five years to take the market to its previous level. February of this year started a real tumble in the share prices after substantial growth in the months before that. People were coming to share market with strong belief that an alternative investment opportunity is finally available to them. But it is apparent that government has now closed that avenue.

This article is being written on 14th July but it can be forecast that the volume of transaction between 16th July to 15th August is going to be very small in comparison to the previous year in terms of transaction, market capitalization, revenue to the stock exchange and share price index.

The authorities seem to be ready to kill the hen in an anticipation of grabbing all the gold that is in her stomach. Only last year, the government imposed a 5 per cent dividend tax on the shoulder of the shareholders. The dividend tax itself is ‘double taxation’ because it is levied on an income in which the corporate tax is already paid as per the income tax rule prevailing in the country. It is the patience of investors/shareholders that they did not go the court with existing income tax law to challenge this infamous decision. After one year of that the government has started capital gain tax. As mentioned earlier, this is not a bad concept in principle, but it had to be smaller percentage, like 2% or even just 0.5%, which would not have hurt the investors and at the same time the government could have some increased revenue.

The provision is impossible to implement, given the current ability of Nepal Stock Exchange. If they still are not able to cope efficiently with the age-old crying system of transaction, how can they now track each and every transaction that also within less than a week as required by the rule for capital gains tax. Secondly, the revenue is going to be minimum as the share trading will be in minimum numbers because it discourages trading for small profits (it should earn at least 25 per cent so as to pay the broker commission, charges to the stock exchange and 10 per cent tax for the government).

It is still not clear as to what will happen with bonus shares, BT (blank transfer) shares, primary issue shares and right issue shares. One of the high officials of the stock exchange was talking of the base prices to be as of first of Shrawan (16 July) and that the July 16 price will be the base price for every transaction then after regardless of the price at which the subsequent transaction is made. I think it reflects the lack of knowledge of the term "Capital Gain". When high officials are that ignorant, how can the investors expect true accounting. Obviously, the stock exchange does not seem consulted nor warned about this arrangement. The mess that is going to develop in coming months in the stock exchange is unimaginable.

The policy of liberalization that the government adopted after restoration of democracy in 1990 calls for promotive and facilitative role of the government together with its strict regulatory functions. In practice, it seems, the government just issues permits and forgets all the required roles. As a result, the so called private sector makes all the mistakes necessary to make the policy a failure and demands protection from the government. Then the government tries to motivate/regulate/ promote, but by that time there is enough demage already inflicted and the situation becomes unmanageable. This is because the government does not permit, regulate and promote at the right time. The same has happened in the stock market and also in information technology (IT). Both were emerging fields, and so were not strong enough to stand on their own. Heavy taxes are now imposed making both of them struggle under the burden.

To convince and to act in time would be the right policy. The share market is already providing 5 per cent to the government as dividend tax since last year. Therefore, this year could have started with 2 per cent capital gain tax allowing investors and share traders to be accustomed with it. It would then be easy to gradually increase the rate over the years, say, to 10 per cent. And the implementing agency has to be strong enough. We all have the glaring example of VAT implementation which is still not implemented successfully though it was introduced after so much homework.

Rules alone cannot regulate or promote the stock market

There have been couple of rules, regulations, directives and positive messages issued during the last quarter of the year 2057 BS and first quarter of 2058 (ie during the last six months). Prominent among them are Nepal Rastra Bank’s directives for commercial banks, directives for stock registration and issuance, proposed amendment in Stock Exchange Act to be tabled in current session of parliament and a project launched to privatize Nepal Stock Exchange Limited. All of these are expected to bring better results but the stock market is plunging continuously.

There are, however, reasons for this ineffectiveness : One is the general perception of the investors about current political and economic condition of the country, and second is the doubt in the minds of investors whether the rules will be implemented in their true spirits. The investors are justified in the context of existing rules not being implemented earnestly.

To cite one example, let us take the directive for registration and issuance of shares. Chapter 6 Rule 22 of the directive related with Annual General Meeting says that any licensed listed company must include new shareholders in the general meeting. But the qualifying clause states that if and when necessary, the board can consider and grant an allowance on this provision. This rules gives room for ‘Hakimko Tajbij’ and for corruption. There are so many rules in this directive and also in Nepal Rastra Bank’s directives to give enough scope for suspicion. The exercise by FNCCI and Nepal Bankers Association to press for revisions in the directives is primarily because of exactly this.

(Ghimire is an IT consultant and an active participant in the stock exchange as investor.)

Stock Changes

(Selected scrips, closing prices in Rs.)