CHAPTER V DETERMINANTS OF STOCK MARKET DEVELOPMENT

Transcription

1 CHAPTER V DETERMINANTS OF STOCK MARKET DEVELOPMENT 5.1 Introduction Stock Market Development is a multidimensional concept. In the previous chapter, we investigated the hitherto neglected role of stock market development on economic growth in India and found evidence to support the hypothesis that stock market development robustly affects the rate of economic growth. In consideration of these favorable results, it is understood that there are exogenous components which determines stock market development. The question that needs to be answered is what determines stock market development. Therefore, in order to deepen our analysis we need to identify the macroeconomic determinants of stock market development in India. In India since 1991, all the stock market development indicators have shown considerable increase following the reforms implemented in the capital markets as a part of structural reform and macroeconomic stabilization programs. Given this background, the determinants of stock market development in India need to be examined carefully, since stock markets are found to have played an important role in promoting economic growth. Although most of the theories and models suggest that the stock market plays a vital role towards economic growth within a country, many contrasting theories have been highlighted which support the view that the development of the stock market could adversely affect economic growth. The answer to the above question could have policy implications for India and for other countries with a similar economic structure. Providing evidence as to causes of stock market development will help policy makers design reforms that do indeed promote growth, enhancing stock market development. Thus the focus of the present chapter is the identification of macroeconomic determinants of stock market development in India. The empirical analysis on the determinants of stock market 148

2 development in India is preceded by the literature review on macroeconomic determinants of stock market development. 5.2 Literature Review Various empirical tests have illustrated that macroeconomic variables have significant impact on stock market development. Garcia and Liu(1999) examines the macroeconomic determinants of stock market development particularly market capitalisation using data from 15 industrialized and developing countries for the period from 1980 to This study uses stock market capitalisation as a proxy for stock market development rather than constructing a composite index of stock market development. The effects of real income and income growth rate, savings and investment rate, financial intermediary development, stock market liquidity and macroeconomic stability of stock market capitalisation are examined. Real GDP is used to measure the income level and calculate the real income growth rate. The measures of financial intermediary development used in this study are domestic credit to private sector divided by GDP and broad money supply, M3 to GDP. Stock Market liquidity is measured using the ratio of total value traded to GDP and ratio of total value traded to market capitalisation. The effects of macroeconomic stability on market capitalisation are measured using inflation rate, inflation change and standard deviation of inflation rate. The study finds that real income level, savings rate, financial intermediary development and stock market liquidity are important predictors of market capitalisation while macroeconomic stability does not prove to be significant. Ben Naceur et al (2007) attempted to identify the macroeconomic determinants of stock market development in the Middle East and North Africa(MENA) region using an unbalanced panel data from 12 MENA countries for the period from The study uses stock market capitalisation as a proxy for financial market growth. The effect of income, savings rate, credit to private sector, M3, stock market liquidity and macroeconomic stability on stock market development are examined. Real GDP in US dollars is used to measure income level. The saving rate is calculated as the ratio of gross saving to gross disposable income. Financial intermediary development is 149

3 measured using the domestic credit to the private sector divided by GDP. The ratio of broad money supply M3 to GDP is used as an indicator to measure bank development. Stock market liquidity is measured using the ratio of total value traded to GDP and turnover ratio. Macroeconomic stability is measured using inflation change. The results of the study show that saving rate, financial intermediary (credit to private sector), stock market liquidity (the ratio of value traded to GDP) and the macroeconomic stabilization variable (inflation change) are the important determinants of stock market development, while income as well as investment do not prove to be significant. Also, the results of the study show that financial intermediaries and stock markets are complements rather than substitutes in the growth process. The results suggest the role of economic development in promoting stock market development. Cherif and Gazdar(2010) attempted to examine the influence of macroeconomic environment and institutional quality on stock market development, using data from 14 MENA countries over the period of The macroeconomic factors defined by Garcia and Liu(1999), namely, income, savings rate, investment rate, financial intermediary development, stock market liquidity and macroeconomic stability on stock market development and their effect on stock market development is examined. To assess the role of public institutions in determining stock market development, a yearly composite political risk index using the Inter Country Risk Guide(ICRG) variables from the PRS(Political Risk Services) Group was constructed. The composite index constructed was the sum of 12 indices of government stability, socioeconomic conditions, investment profile, internal conflict, external conflict, corruption, military in politics, religion in politics, law and order, ethnic tensions, democratic accountability and bureaucracy quality. This index ranges from zero to one hundred, with lower values suggesting poorly performing institutions. The results of the study show that savings rate, financial intermediary, stock market liquidity, interest rate and income are important determinants of stock market development, and investment and inflation do not prove to be significant. Also, it is seen that the banking sector is a complement to the stock market in financing investment and in the growth process in the MENA region. 150

4 Kemboi and Taurus(2012) attempted to examine the macroeconomic determinants of stock market development in Kenya for the period from 2000 to 2009 using the autoregressive distributed lag (ARDL) approach in the examination of a Granger type test of causality with an error correction. The study uses stock market capitalisation for measuring stock market development. The effect of income, macroeconomic stability, stock market liquidity and banking sector development on stock market development was examined. Income level is measured using log GDP percapita in US dollars. Macroeconomic stability is measured using real interest rate and current inflation rate. Stock market liquidity is measured using total value traded ratio and turnover ratio. Banking sector development is measured using M2 relative to GDP. The results of the study indicate that macroeconomic factors such as income level, banking sector development and stock market liquidity are important determinants of the development of the Nairobi Stock market. The results also show that macroeconomic stability is not a significant predictor of the development of the securities market. Mohammad and Mohammad(2010) attempts to examine the empirical relationship between economic growth and its determinants with special focus on stock market development in Pakistan in the shortrun and longrun using ARDLbounds testing(autoregressive Distributive Lag Model) for the period from 1971 to The indicators used to assess economic growth and stock market development are real GNP per capita, market capitalization (measured by total capital to GDP), financial development (measured by credit availability to the private sector as a share to GDP), financial instability (measured by standard deviation of inflation rate), Foreign Direct Investment as a share of GDP. Literacy rate (measured by ratio of number of people completing primary education divided by total population) and stock market liquidity (measured by value of stock traded as a share of GDP). The findings of the study show a positive relationship between stock markets and economic growth, both in the short run and long run. Financial instability and inflation is found to have negative effect on economic growth while stock market liquidity, human capital and FDI have positive effects on economic growth. 151

5 Billmeier and Massa(2009) assess the macroeconomic determinants of stock market capitalization in a panel of 17 countries that form a part of the IMF s Middle East and Central Asia Department. In addition to the traditional variables like stock market turnover, income, saving/investment, domestic credit, this study includes institutional variables and remittances. The index aggregates 10 components with equal weight, namely, trade policy, fiscal burden, government intervention, monetary policy, capital flows and foreign investment, banking and finance, property rights, wages and prices, regulation and black market. Remittances are measured as the ratio of net amount of workers remittances to GDP. The results suggest that both institutions and remittances have a positive and significant impact in stock market capitalization, both institutions and remittances regressors matter in countries without significant hydrocarbon sectors and in resourcerich countries, stock market capitalization is driven by the oil price. Bahadur(2006) examines the existence of causality relationship between stock market and economic growth in Nepal using time series data for the period from 1988 to 2005 using Granger causality test. The study uses an equally weighted single indicator of three stock market indicators, namely, the average ratio of market capitalization to GDP, annual turnover to GDP and the annual turnover to market capitalization. Economic growth is measured by using variables like real GDP and nominal GDP. The study finds empirical evidence of longrun integration and causality of macroeconomic variables and stock market indicators in Nepal. The causality has been observed in real terms but not in nominal variables. It depicts that the stock market plays a significant role in determining economic growth and vice versa and the causation is evident with a lag for 3 to 4 years. Chee et al(2003) examines the relationship between financial development and economic growth in Malaysia for the period from 1978 to 2001 using VECM approach, cointegration test, ARDL bound test, Economic growth is proxied by per capital nominal GDP and stock market development is measured by size(ratio of total market value to 152

6 nominal GDP) and liquidity(stock market turnover ratio) of the stock market. Two control variables, discount rate and openness ratio, are used to avoid simultaneity bias in the regression. Using the autoregressive distributed lag (ARDL) bounds test approach, this results show that stock market development is cointegrated with economic growth in Malaysia. Moreover, this test also suggests that stock market development has a significant positive longrun impact on economic growth. Granger causality test within VECM framework reveals the dynamic short run causality between the variables whereby the stock market is viewed as a leading sector in stimulating domestic growth. The findings suggest that the evolution of financial sector in particular the stock market tends to be more likely to stimulate and promote economic growth when monetary authorities adopt liberalized investment and openness policies, and improve the size and the regulations of the stock market and macroeconomic stability. Nair(2008) examines the macroeconomic determinants of stock market development in India over a period from 1993 to 2007 using Cointegration and error correction model. Stock Market development is measured using turnover ratio. The macroeconomic variables used in this study are inflation rate, real income and its growth rate, financial intermediary development, foreign institutional investment, exchange rate and SBI Prime lending rate. The results of the study show that the macroeconomic variables like real income and its growth rate and financial intermediary development are significantly and positively affecting stock market development in India for the period of analysis. The results show that interest rate is negatively and significantly affecting stock market development. Variables like FII, exchange rate and macroeconomic instability proxied by inflation do not have a significant impact on stock market development, though there is a long run. The findings of this study have important implications for the policy makers as stock markets have a crucial role in promoting economic growth. The next section will focus primarily on the macroeconomic factors and their impact on stock market development in India. 153

7 5.3 Macroeconomic Determinants of Stock Market Development Based on the various domestic and global literature reviews mentioned in the previous section, the identified factors are classified into economic growth, financial intermediary development, macroeconomic stability and external factors. (1) Economic Growth The value of GDP and its growth rate are generally accepted factors of economic growth. However, the monthly data on GDP is not available and hence the index of industrial production (IIP) is taken as a proxy variable for GDP. The values of IIP used are calculated with 2004 as base year. Figure:5.1 Index of Industrial Production(at prices) Index of Industrial Production(at prices) Source: Economic Survey, various years From Figure: 5.1 and Table: 5. 1, it is evident that the Index of Industrial Production has risen sharply over the years. During the period from to , the index has risen very sharply. 154

8 (2) Macroeconomic Stability Macroeconomic stability is said to have an impact on stock market development. One would generally expect that with instability, firms and investors would be discouraged from participating in the market. This situation is particularly prone in developing countries where instability through either high or volatile inflation or badly structured monetary and fiscal policies results in a high level of uncertainty, thus making their stock markets less attractive. In such scenarios, macroeconomic instability will have a negative impact on stock market capitalisation and hence its development (Garcia and Liu, 1999). On the other hand, an improvement in macroeconomic stability provides firms and investors with an incentive to participate in the stock market in anticipation of earning higher returns. There are two variables used for macroeconomic stability. They are the interest rate and inflation rate. The SBI prime lending rate is used for representing interest rate and monthtomonth inflation based on WPI is used for representing the inflation rate for the analysis. The trends in SBI prime lending rate and inflation rate are shown in Table 5.1. (3) External Factors Yartey (2008) shows the influence of private capital flows as a determinant of stock market development. He highlights the impact of foreign investors and how they have become major participants in emerging stock markets in the last few decades. Foreign investment has been noted to be associated with institutional and regulatory reform, while also providing for strict disclosure requirements and fair trading practices. Overall, this increase in both informational and operational efficiency will boost confidence in the local markets, which in turn will result in an increase in the number of investors. The external factors are represented by the exchange rate of domestic currency and the flow of net FDI towards the country. The trends in exchange rate and the inflows during the period of analysis are shown in Table

9 (4) Financial Intermediary Development Another factor to take note of is that of financial intermediary development. Both stock markets and banks intermediate savings towards investment, and hence they may be either complements or substitutes towards each other. On one hand the banking system may be seen to play a critical role in mobilizing savings and allocating funds to the most profitable activities, while on the other hand the capital market is said to play an important substitution role to the banking sector in the sense that it facilitates risk sharing, expands the scope of opportunities for raising capital and hence helps reduce the cost of capital. In light of its complementary role, an efficient banking system would help to facilitate the transaction procedures by improving the clearing and settlement process, thus reducing transactions costs and the time frame to settle. However, if the banking system had to be underdeveloped, sluggish trading activity may be experienced in the market. As such, investors who wish to diversify their funds in an effort to obtain a lowerrisk portfolio may spread their savings between the banking sector and the stock market. DemirgucKunt and Levine (1996) support this view by suggesting that the level of stock market development across numerous countries is positively correlated with financial intermediary development. Among the various indicators of financial intermediary two important indicators are the ratio of M3 to GDP and the role of banking sector represented by creditdeposit ratio. Since the monthly data is not available for GDP, the Creditdeposit ratio is used as an index for financial intermediary development. The trends in the above mentioned macroeconomic indicators during the post liberalization period are shown in Table

10 Table: 5.1 Trends in selected Macroeconomic Indicators Credit/Deposit Month IIIP(at current Exchange Rate US Ratio Year prices) SBI PLR Inflation Rate % Dollar Average Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Mar Source: RBI Bulletin, Various Issues, Mumbai and Economic Survey, Various Issues The stock market development is visualized differently by different studies. In general, the stock market development is represented either by stock market size or the stock market liquidity. The stock market size is represented by the value of total market capitalisation, which means the value of shares floated in the stock market at a particular time. The stock market liquidity is measured in terms of value traded in the stock market. Based on the size and liquidity in stock market, there are three stock market development indicators. They are: i.market Capitalization Ratio (MCR): This measure equals the value of listed shares divided by GDP. This is an index of stock market size. The assumption behind this 157

11 measure is that overall market size is positively correlated with the ability to mobilize capital and diversify risk on an economywide basis. ii. Total Value of Shares Traded Ratio (VTR): This measure equals total value of shares traded on the stock market exchange divided by GDP. The total value traded ratio measures the organized trading of firm equity as a share of national output and therefore should positively reflect liquidity on an economywide basis. The total value traded ratio complements the market capitalization ratio: although a market may be large, there may be little trading. iii. Turnover Ratio (TR): This ratio equals the value of total shares traded divided by market capitalization. Though it is not a direct measure of theoretical definitions of liquidity, high turnover is often used as an indicator of low transaction costs. The turnover ratio complements the market capitalization ratio. A large but inactive market will have a large market capitalization ratio but a small turnover ratio. Turnover also complements the total value traded ratio. While the total value traded ratio captures trading relative to the size of the economy, turnover measures trading relative to the size of the stock market. A small liquid market will have a high turnover ratio but a small total value traded ratio. Since the monthly data on GDP is not available, the estimation of market capitalisation ratio (MCR) and value traded ratio(vtr) are not possible, only measure of stock market development left for the analysis is the turnover ratio (TR). TR is used as measure of stock market development in this context. 5.4 Stock Market Response and Macroeconomic Variables Identified Theoretically, there exists causative relationship between the stock market development and macroeconomic variables identified. In general, when there is economic progress as represented by GDP growth or index of industrial production, it may boost up the savings and investment in the economy, which may augment the stock market activities. Higher volume of income enhances the financial intermediation through stock market which may further boost up the economic growth and stock market development. Inflation can be used to proxy macroeconomic instability. It is expected 158

12 that higher the volatility of the underlying economic situation, the less incentive for economic agents to participate in the market. However, the impact of inflation on stock market volume depends on its varying impacts on other segments and financial instruments in the economy. Regarding financial intermediary development, banking sector development and stock market development can be either complementary or substitutes. Theoretically, when interest rate is lower, the fixed income groups have less incentive to deposit in banks and more incentives to divert to stock market assets. This may boost up the stock market business. In general, interest rate has a negative relationship with stock market development. Exchange rate affects the stock market development. A fall in exchange rate of domestic currency increases the value of earning in foreign currency. This may encourage the foreign investment in domestic stock market. A stock market which is integrated to the world economy might expect to have this repercussion emanated from changes in exchange rate. Foreign direct investment also affects the stock market development. Higher foreign net investment is an indicator for better business opportunity domestically which will have certain positive impacts on the stock market. Along with the foreign direct investment, foreign institutional investment in shares and bonds also increases in general. In short, in growing economy there may be a positive association exists between net foreign investment in the economy and stock market development. 5.5 Empirical analysis on macroeconomic determinants of stock market development The following Table:5.2 show the descriptive statistics of indicators of stock market development and other macroeconomic variables used in the study. The data used is monthly data from November 1994 to March

13 Table:5.2 Descriptive Statistics of Macroeconomic Determinants TR IIP Interest rate Inflation Net FDI Exchange rate CD ratio Mean Median Maximum Minimum Std. Dev Skewness Kurtosis JarqueBera Probability Sum Sum Sq. Dev E Observations The trends in data reveal that the turnover ratio (TR) witnesses a large variation over the period. TR has a very high skewness and it is highly positively skewed as is evident from the value of Kurtosis. Compared to stock market development variable, the proxy variable of GDP i.e, IIP does not witness much variation. The variables inflation, net FDI and exchange rates also witness high positive skewness over this period. The JarqueBera and its significance for all variables highlight the fact that no variables are normally distributed. 5.6 Causality test and its result The causal relationship between TR and other macroeconomic determinants are evaluated by using pairwise Granger causality test as is given in the Table 5.3. The log values of the selected variables are used for the analysis. 160

14 Table:5.3 Granger Causality Test Result between Stock Market Development and Macroeconomic Determinants Pairwise Granger Causality Tests Lags: 2 Null Hypothesis: Obs F Statistic Prob. IIP does not Granger Cause turnover ratio Turnover ratio does not Granger Cause IIP Interest rate does not Granger Cause turnover ratio Turnover ratio does not Granger Cause interest rate Inflation does not Granger Cause turnover ratio Turnover ratio does not Granger Cause inflation Net FDI does not Granger Cause turnover ratio Turnover ratio does not Granger Cause net FDI Exchange rate does not Granger Cause turnover ratio Turnover ratio does not Granger Cause exchange CD ratio does not Granger Cause Turnover ratio Turnover ratio does not Granger Cause LOGCR The result indicates that the null hypothesis of IIP does not Granger cause the turnover ratio is rejected. However, turnover ratio does not cause IIP is not rejected. It implies that there unidirectional relationship between economic growth and stock market development in India. Economic growth influences the stock market development and not vice versa. Similarly the change in interest rate does not affect the stock market development. However, changes in stock business affect the interest rate in Indian context. Changes in inflation do not cause changes in turnover ratio while the changes in turnover ratio may affect the inflation. The changes in net FDI and CD ratio cause changes in turnover ratio in India and not in reverse direction. Granger causality test also highlights that there is no relationship exists between changes in exchange rate and changes in stock market business as reflected in turnover ratio. 161

15 5.7 Unit root and cointegration analysis If there is any causal connection exists between economic growth and stock market development, the next immediate concern would be to understand the longrun relationship between these variables. The existence of long run relationship can be understood through the integration test. If the two variables are cointegrated, then it could be presumed that these variables have a long run relationship. For the cointegration analysis, stationarity is first verified with estimates in Table :5.4. The initial hypothesis is that the variables contain a unit root. As discussed before, the unit root test are conducted by using Augmented DickeyFuller (ADF) test, PhillipsPerron (PP) test and the Kwiatkowski, Phillips, Schmidt and Shin (KPSS) test. The tests are conducted at variable levels and first difference levels. The results show that the hypothesis of unit root is not rejected at levels for BSE and the same null hypothesis of unit root is rejected at first difference levels. Hence all variables are integrated of order 1, I(1) for BSE. Table:5.4 Unit Root Result (Log Values) of Stock Market Indicator and Macroeconomic Variables TR IIP Inflation Prime lending rate FDI Exchang e rate CD ratio Level Variables First Difference variables ADF PP KPSS ADF PP KPSS t value P value Pvalue LM stat LM stat BSE t valu e Critic al value at 5% tvalue P valu e tvalue P valu e Critica l value at 5%

16 5.8 The Engle Granger Method As the variables are integrated at order (1), next step is to evaluate their long run relationship. The cointegration and long run relationship between stock market development and economic growth are evaluated based on the Engle Granger method. According to this method, suppose we expect that there exists a single longrun relationship between the two I(1) variables Y and X of the form : Y = X. Two steps involved in this procedure. As a first step, estimate by OLS the long run relationship using the cointegrating regression: Y = X +u (5.1) ^ ^ ^ It is estimated as: Y = X Defining and saving the disequilibrium errors as: ^ ^ ^ ^ u = Y Y = Y ( X) (5.2) If Y and X are cointegrated, u should be stationary I(0). If u is stationary, there exists a long run relationship between these variables and in the long run the market disequilibrium will be corrected to certain extent by the movement of these variables. The Engel Granger method is known as residual method for evaluating the cointegration. Once it is cointegrated, then the Residual based Error Correction model will be the next step, which is given as below. From the basic model of Y = X +u, the Error Correction model (ECM) specification is as follows. ^ ^ ^ Y= X + 2 (Y t1 0 1 X t1 ) +v (5.3) The interpretation is that Y is purported to change between t1 and t as a result of change in X between t1 and t and in part to correct for any disequilibrium that existed in 163

17 previous period. The Cointegrating vector is [ 0 1 ]. 1 measures the long run relation between Y and X, 1 measures the short run relation between X and Y and 2 speed adjustment back to equilibrium. In the present model, initially an ordinary OLS is run by using TR (stock market development variable) as dependent variable and the variables such as IIP, inflation, interest, net FDI, exchange rate and CD ratio as independent macroeconomic determinants. The resultant error term is subjected to unit root analysis and result shows that the values of error term are nonrandom in nature. This result indicates that there exists some long run relationship between stock market development and macroeconomic indicators. The cointegrating equation in the present analysis is written as TR= IIP+ 2 inflation+ 3 interest+ 4 netfdi+ 5 Exchange+ 6 CDR+ 7[Y t 1 ( 0 1 IIP t1 + 2 inflation t1 + 3interest t1 + 4 netfdi t1 + 5Exchange t1 + 6CDR)]+v t (5.4) The result of the above relation is written as: TR= IIP0.113 inflation0.511 interest0.003 netfdi+ 0.4 Exchange CDR0.148 [Y t1 ( IIP t inflation t interest t netFDI t Exchange t CDR)]+v t (5.5) The values of coefficients and their corresponding level of significance are given in a Table:

18 Table:5.5 Error Correction Model for Stock Market Determinants Dependent Variable: DTR Coefficient Variable Coefficient values Std. Error tstatistic Prob. Constant of TR IIP inflation interst net FDI Exchange CDR U(1) Constant of TR IIP Inflation Interest Net FDI Exchange CDR Rsquared Akaike info criterion Adjusted Rsquared Schwarz criterion Fstatistic HannanQuinn criter Prob(Fstatistic) DurbinWatson stat The above result can be interpreted for shortrun as well as long run relationship between stock market development and macroeconomic determinants. In the short run, the economic growth is positively influence the stock market development and it is significant also. Inflation, interest rate, net FDI and CD ratio are negatively influence the stock market development. However, their association with stock market indicator turnover ratio is not significant. In the long run, economic growth and stock market development are not positively related. The result highlights that the relationship between IIP and TR is negative, but not significant. The relationship between inflation and stock market development is significantly negative in the longrun. It implies that the macroeconomic instability in the form of high inflation reduces the stock market 165

19 development. The relationship between interest rate and stock market development is also negative at a very high significant level in the long run. The increase in interest rate encourages people to invest in nonequity assets which may reduce the equity and other transactions in the stock market. The relationship between creditdeposit ratio (CD ratio) is negative from the result. The increase in credit given by the banks may discourage the companies to raise capital through floating equity shares and other instruments in the stock market. The relationship between net FDI and stock market business is positive and the relationship is statistically significant also. The foreign capital decisively influences the business in stock market and the increase in the inflow of foreign capital augment the business in stock market. The exchange rate and stock market business is positively related. The increase in exchange rate reduces the value of domestic currency which increases the value of export earnings and consequent increases in the domestic money supply. The increase in domestic money supply increases the business of stock market in the country. The coefficient of 7 shows the value of error correction term. The sign of the error term is towards the desired direction. It shows that if there is a deviation of stock market variable due to macroeconomic variables in the short run, there is a possibility of adjusting this disequilibrium in the long run. In the long run, the movement of macroeconomic variables may correct the deviation by percent per time unit. Another important inference derived from the analysis is that as compared to domestic macroeconomic variables, the global factors such as net FDI and exchange rate variation have significant role in influencing the stock market development in India. 5.9 Vector Autoregression (VAR) model of macroeconomic determinants of stock market development The VAR model tries to decipher the mutual interrelationship exists between various variables used in a model. It is assumed that each variable is a function of its own lagged variables as well as other endogenous variables used in the model. In VAR all variables are treated as endogenous variables. The coefficient of VAR model is given in the following Table. The VAR coefficient is estimated from the log values of various 166

20 macroeconomic determinants and stock market development index. The lags of VAR model is based on Akaike Information Criterion and Schwarz Criterion. With regard to first lagged values, the stock exchange indicator i.e, the turnover ratio is negatively related to IIP, inflation, exchange rate and CD ratio while it is positively related to net FDI and interest rate. With regards to second lagged values, the turnover ratio has a positive relation with all macroeconomic variables. In the case of IIP, except for net FDI, exchange rate and CD ratio, it has negative relationship with other macroeconomic variables for the first lag. The values of IIP increase with the increase in FDI, exchange rate and creditdeposit ratio. The positive relationship between IIP and C D ratio is statistically significant. However, the IIP decrease due to increase in inflation and interest rate. The inflation rate is positively related to TR, IIP, net FDI and exchange rate. At the same time, inflation is negatively related to interest rate and CD ratio for first lagged values. The interest rate is negatively associated with the TR, IIP and net FDI with respect to first lagged values. At the same time, interest rate is positively related to inflation, exchange rate and CD ratio. The net FDI is positively related to IIP, inflation and interest rate. The exchange rate is positively related to inflation, interest rate. CD ratio is positively related to inflation, interest rate and exchange rate. However, most of the relationships are not statistically significant. 167

21 Table:5.6 Result of VAR Model of Macroeconomic Determinants TR IIP Inflation Interest rate Net FDI Exchange rate CD ratio E05 TR(1) [ ]* [ ] [ ] [ ] [ ] [ ] [ ] TR(2) [ ]* [ ] [ ] [ ] [ ] [ ] [ ] IIP(1) [ ] [ * [ ] [ ] [ ] [ ] [ ]* IIP(2) [ ] [ ]* [ ] [ ] [ ] [ ] [ ]* Inflation(1) [ ] [ ] [ ]* [ ] [ ] [ ] [ ] inflation(2) [ ] [ ] [ ]* [ ] [ ] [ ] [ ] Interest rate(1) [ ] [ ] [ ] [ ]* [ ] [ ] [ ] Interest rate(2) [ ] [ ] [ ] [ ] [ ]* [ ] [ ] Net FDI(1) [ ] [ ] [ ] [ ] [ ]* Net FDI(2) [ ] [ ] [ ] [ ] [ ]* Exchange rate(1) [ ] [ ] [ ] [ ] [ ] Exchange rate(2) [ ] [ ] [ ] [ ] [ ] CD ratio(1) [ ] [ ]* [ ] [ ] [ ] CD ratio(2) [ ] [ ] [ ] [ ] [ ] C [ ] [ ] [ ] [ ]* [ ] [ ]* [ ] [ ] [ ] [ ]* [ ] [ ]* [ ] [ ] [ ]* [ ] [ ] [ ] [ ] Rsquared

22 Adj. Rsquared Sum sq. resids S.E. equation Fstatistic Log likelihood Akaike AIC Schwarz SC Mean dependent S.D. dependent Determinant resid covariance (dof adj.) 6.25E18 Determinant resid covariance 3.61E18 Log likelihood Akaike information criterion Schwarz criterion Variance Decomposition The variance decomposition of Turnover ratio shows that during the initial period the changes in stock market are emanated from the stock market itself. As time passes, the variation in turnover ratio is due to changes in other macroeconomic variables. Among the macroeconomic variables, the most important factor which leads to variation in turnover ratio is the economic growth variable ie, the IIP index. During the 10 th period, out of total variation, 12 percent is due to changes in macroeconomic variables. During the 20 th period, nearly 23 percent of variation in stock market business is due to changes in macroeconomic variables. These findings highlight the fact that the influence of macroeconomic variables on stock market business is not very immediate. 169

23 Table:5.7 Forecast Variance Decomposition of Stock Market Development Period TR IIP Inflation Interest rate Net FDI Exchange rate CD ratio Impulse Response Function with respect to TR The impulse response estimates is given in the Table5.8. It provides normalized responses for the Indian stock market index (Sensex) for a typical shock to and from the Indian market. These responses represent unit shocks measured standard deviations. The impulse response values given in the Table 5.8 shows that during the initial period, shocks in macroeconomic variables do not have much response in turnover ratio in stock market. A major shock of stock market is emanated mainly from the stock market itself. The impulse shocks arise from IIP, inflation and CD ratio have negative response on turnover ratio. The changes in interest rate and net FDI create positive response on TR. The impulse response created by TR has varying impacts on macroeconomic variables. Except for net FDI and exchange rate, the one unit shock in turnover ratio creates negative response on other macroeconomic variables. Also these impacts of changes in TR on macroeconomic variables are not very significant. 170

24 Table:5.8 Result of Impulse Response Function of Stock Market Development Period TR IIP Inflation Interest rate Net FDI Exchange rate CD ratio Response to TR Response from TR E E Conclusion As one of the objectives behind the large scale reforms in the capital market since 1991 is to augment capital formation both internally and externally for promoting economic growth, it is very essential to understand the changes in macroeconomic determinants on the capital market particularly the stock market. The empirical analysis as given in the chapter helps us to evaluate whether the development in stock market favourably affects the economic growth or not. The empirical results show that in the shortrun, the economic growth is positively influence the stock market development and it is significant also. Inflation, interest rate, net FDI and CD ratio are negatively influence the stock market development. However, their association with stock market indicator turnover ratio is not significant. In the long run, economic growth and stock 171

25 market development are not positively related. The result highlights that the relationship between IIP and TR is negative, but not significant. The macroeconomic instability in the form of high inflation reduces the stock market development. The relationship between interest rate and stock market development is also negative at a very high significant level in the long run. The increase in interest rate encourages people to invest in nonequity assets which may reduce the equity and other transactions in the stock market. The relationship between creditdeposit ratio (CD ratio) is negative from the result. The increase in credit given by the banks may discourage the companies to raise capital through floating equity shares and other instruments in the stock market. The relationship between net FDI and stock market business is positive and the relationship is statistically significant also. The foreign capital decisively influences the business in stock market and the increase in the inflow of foreign capital augment the business in stock market. The exchange rate and stock market business is positively related. The increase in exchange rate reduces the value of domestic currency which increases the value of export earnings and consequent increases in the domestic money supply. The increase in domestic money supply increases the business of stock market in the country. In the long run, the movement of macroeconomic variables may correct the deviation by percent per time unit. Also, as compared to domestic macroeconomic variables, the global factors such as net FDI and exchange rate variation have significant role in influencing the stock market development in India.The knowledge on varying impacts of macroeconomic fundamentals on stock market development helps the policy makers to frame suitable macroeconomic policies to influence the stock market activities for the promotion of economic growth. REFERENCES 1) Ben Naceur, S., Ghazouani, S., and Omrani, M. (2007), The determinants of stock market development in the MENA region, Managerial Finance, Vol 33 (7), pp

26 2) Cherif, Monther and Gazdar, Kaothar (2010), Macroeconomic and Institutional Determinants of Stock Market Development in MENA Region: New Results from a Panel Data Analysis, International Journal of Banking and Finance, Vol. 7: Issue1, Article 8, pp ) DemirgucKunt, A. and Levine, R. (1996), Stock Markets, Corporate Finance and Economic Growth: An Overview, The World Bank Economic Review, Vol 10, pp ) Garcia, V., And Liu, L.(1999), Macroeconomic Determinants Of Stock Market Development, Journal Of Applied Economics, Vol 2 (1), pp ) Kemboi, Jooseph K and Taurus, Daniel K(2012), Macroeconomic Determinants of Stock Market Development in Emerging Markets: Evidence from Kenya, Volume 3(5), pp ) Nair, Lekshmi R.(2008), Macroeconomic Determinants of Stock Market Development in India, NSB Management Review, Vol 1(1), pp 19. 7) Yartey, Charles Amo(2008), The Determinants of Stock Market Development in Emerging Economies: Is South Africa Different?, IMF Working paper. 173