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Capital Market Role to Re-build Nepal
Post the devastation caused by the earthquake, many investors and stock market experts sat busy analyzing the affect in the Nepali capital market. The total loss caused, over one third of total GDP had investors, media people and researchers from inside and outside the country keen on knowing the effect of the natural disaster in capital market.
Previous data and reports of disaster stricken countries show a sharp downfall in the capital market immediately after the disaster and further showed signs of recovery after few months to over a year. However, NEPSE (NEPal Stock Exchange) index, which closed at 938.19 before the earthquake saw a downfall only for four days falling to 837.83 after reopening after the disaster. The stock market again bounced back to cross 938.19 within the next eight days. Immediate earthquake effect in Nepali capital market was only less than 10 percent which was also recovered within few days. This may be mainly because the market remained closed for a month which gave enough time for the investors to think, analyze and cool down.
One part of the coin is the effect of natural disaster on capital market and many have concern about it. But the second part which could be more important is the possible role of capital market to rebuild the damages from the disaster. The first important tool to restore the losses caused by natural disaster is insurance. If used effectively, insurance can minimize or eliminate the government expenses for the compensation toward the losses due to natural disasters. But in developing countries like Nepal, natural disaster can be calamitous due to low level of insurance protection. Thus, transferring the burden to the government forcing them to reallocate the budget resources to finance the disaster response and recover accordingly. April 25’s earthquake has taught lessons to Nepali policy makers and people about the importance of insurance. Similarly, efficient capital market can also be used to cope up with the devastations caused to diversify the possible risk of financial losses.
Capital markets have a potentially huge capacity to absorb catastrophe risks. It can be used to create low cost capital for reconstruction and to share risk among investors. Many researchers have indicated that with an efficient capital market, government can increase its expenditure by approximately 55 percent after natural disasters. Use of financial equipment like catastrophe bonds (CAT Bonds) can also be used to collect pool of capital for the possible financial losses due to such catastrophes.
Importance of Capital Market in Natural Disasters
Issue of government bonds for reconstructions:
Following the earthquake, Nepal Rastra Bank on behalf of Nepal Government, has undertaken a sudden strategy to raise debt from the domestic market. Previously, the volume of government bond issued in the market was very thin. With the flotation of such bonds, government can theoretically raise a substantial amount of debt from the domestic market in very short time. Even in case of Nepal, we can issue “Dharahra Bond” to rebuild the Dharahra tower.
After rebuilding the tower, the revenue received can be used to provide return and refund the bond amount. Similarly, a name can be given to the bonds used to rebuild heritage sites and other affected infrastructures.
Capital markets have a potentially huge capacity to absorb catastrophe risks. It can be used to create low cost capital for reconstruction and to share risk among investors.
Catastrophic bonds to transfer the risk:
A catastrophe bond, if introduced in Nepal, would have great significance given the vicious catastrophe. A catastrophe bond (CAT Bond) is a tradable instrument that facilitates a transfer of the risk of a catastrophic event to capital markets. CAT Bonds are issued against possible future disasters by the sponsor (normally reinsurance companies) which invests the collected amount in low risk securities in the market. If the bond matures without the pre-specified event, the principal of the bond is repaid to the investors as regular bond. In the event, the pre-specified catastrophe does occur within the life time of the bond, investors agree to forfeit parts or their entire claim. The catastrophe risk is thus transferred to the investors. As Nepal is venerable to natural disasters and reinsurance companies have been recently established here, it is the right time to bring CAT Bonds into practice to mitigate the possible future disasters.
Exploring new domestic markets:
Reconstruction works post devastation requires fundings. In developing countries, funds from government or foreign aid are not sufficient for reconstruction and new development. Private sectors have potentiality to employ funds for these activities. A good way to involve private sector is equity participation. Even a new company can partner for reconstruction and development. It can float shares and bonds to the general public and other commercial institutions to collect the funds. We have experience of collecting tens of billions of rupees in a single IPO which shows that we can collect huge amount from market for reconstruction. Thus the established company can collect toll from the reformed and newly developed infrastructure to generate revenue. Further, once reconstruction works are finished, it can continue its activities for new infrastructure development. This will help the entire country to collect cheap capital for rebuilding and new development with public participation.
In conclusion, the capital market and different instruments like bonds, equities etc. can help the economy by creating less cost capital as well as effective tool to prepare against the financial losses that could be caused by natural disaster. The tie-up between insurance and capital market can help to diversify the risk of such disaster. Moreover, capital market can be used to collect huge amount of funds in such difficult situations for reconstruction and further development. We have seen various examples of speed recovery and new development after natural disasters in different part of the world. It could also be true for us by making the public participation for the reconstruction and new development through the capital market.