DEMONETIZATION DEMYSTIFIED: IMPACT ON NIFTY 50 AND INR- USD EXCHANGE RATE VOLATILITY

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1 DEMONETIZATION DEMYSTIFIED: IMPACT ON NIFTY 50 AND INR- USD EXCHANGE RATE VOLATILITY CHARITHRA C M 1 DR. BHAVYA VIKAS 2 DR. MUKUND SHARMA N 3 1 Assistant Professor, BNM Institute of Technology, 12 th Main, 27 th Cross, Banashankari II Stage, Bangalore Assistant Professor, BNM Institute of Technology, 12 th Main, 27 th Cross, Banashankari II Stage, Bangalore Professor, BNM Institute of Technology, 12 th Main, 27 th Cross, Banashankari II Stage, Bangalore ABSTRACT Demonetization implies stripping a currency of its status as legal tender.demonetization is necessary whenever there is a change in national currency unit.the effects of this on the Indian stock market were evident in the far end of November 2016 with decline in share price of various sector stocks and the index itself. The influence of demonetization was also visible in the Indian rupee exchange rate against the US dollar because of the co interaction and internationalization of the Indian markets with other foreign markets and economy. The Role played by Random Walk Theory and Efficient market Hypothesis has also been undertaken in the study. The article highlights the probable impact of demonetization on volatility of the S & P Nifty50 index and also on the exchange rate of rupee. The volatility of Indian stock market 60 days prior to demonetization and 60 days post demonetization has been considered. The data related to the stocks and the index return is collected from NSE and analysis is done to understand the volatility and also see if there exists a relationship between the volatility of index and exchange rates using descriptive statistics, Pearson s Correlation and Students T Test. Keywords: Demonetization, S & P Nifty, Exchange rate, Volatility, black money Introduction Demonetization is when any Government takes away the legal tender rights of any value of currency.the total currency in circulation in India as on October 28, 2016, was Rs lakh crore (US$260 billion). Nearly 86 (i.e. Rs lakh crore (US$210 billion)) of the total notes, was 500 and 1000 rupee notes. The main objective behind recalling Rs. 500 and Rs notes was to flush out a huge amount of black money hoarded in cash and the long- run aim was to convert into digital economy from the current cash-based economy. In this backdrop it becomes very relevant to relate to two theories related to stock market volatility; The Random Walk Theory and The Efficient Market Hypothesis (EMH). The theory mentions that the stock prices reflects all known information relating to a stock or security and that there is rapid modification in the price based on the information availability. Future expectation along with current information is reflected on the stock price. It seeks to explain that the random walk hypothesis is based on the fact that the movement in stock price is effected by only new information or announcements. Since new information is presently unknown and occurs at random, it becomes difficult to predict the random movements of share prices icmrrjournal@gmail.com

2 No single investor can outperform the market as the information is available to the general public and all investors will have access to the same information. The Indian Equity markets have exhibited volatility in the short run due to uncertainty and economic slow-down. However, in the long run the GDP and corporate performance are expected to do well which will lead to higher growth and stability in the stock market. It is important to understand the impact of demonetization on exchange rate of the Indian rupee. The Indian rupee has become stronger than 60 currencies out of 161 countries currency and is at same exchange rate with 5 currencies. But Rupee has became weaker by 2.66 against US Dollar ($) from to INR per unit US Dollar. Previous Instances of Demonetization Demonetization is a significant step in the monetary decisions in which a country s currency status as legal tender will be declared invalid. This will be followed by Remonetization where a new currency will be introduced. The European Monetary Union nations decided to adopt Euro as a uniform currency. Sufficient time was given to ensure smooth conversion of other currencies into euro and led to effective demonetization. The other countries that had opted for demonetizaton are Zimbabwe, Fiji, Singapore and Philippines. Even in India, demonetization is not a novel concept as it has been done twice before, in January 1946 and January Review of Literature Several studies have been conducted on Effects of Demonetization on macro economic factors, on social development etc. As the law of nature explains that old has to be replace by new, like way, India has taken this step towards replacing two of its old currency notes. Sunitha V Ganiger, Ranganatha B (2017) have made an attempt to study impact of Demonetization on Sociological interpretation. Jishi Rajendran &Vidhi Maggo (2017) have conducted a study to understand the likelihood of success of the demonetization move by India. In the year 1991, Mikhail Gorbachev withdrew Ruble notes from circulation in order to curb black market operations (Sachdeva 2016) A theoretical study analysis of Demonetization has been done by Dipankar Dasgupta, where conclusion about merits and demerits of demonetization have been analyzed and explained. A number of studies have been conducted on volatility of stock market by various researchers from various angles. Based on empirical studies various researchers have concluded that the flow of information which is available in macroeconomic news and other political factors have a direct impact on stock return volatility (Ross, 1989; Andersen and Bollerslev, 1998; Andersen et al., 2006, among others). There are few studies that examine the effect of private information on the volatility of security value. Private information includes information found out through informed traders who are motivated to ensure liquidity etc. (Brandt and Kavajecz, 2004; Evans and Lyons, 2008; Jiang and Lo, 2011, among others). Investors are considered not to be exactly rational but tend to be irrational and their decisions are based on sentiments which affect the stock price movements. The growth of behavioral finance and economics brought in another dimension to the sources of stock market volatility (Kaniel et al., 2008). The Noise trader model has also been studied in context to relating investor sentiment as one of the 14 icmrrjournal@gmail.com

3 sources of potential stock price volatility (De Long et al., 1990) (Lee et al., 1991; Neal and Wheatley, 1998; Baker and Wurgler, 2006, among others). Several studies have been done on analysis of currency revolution. Michael, Christopher & Marc (October 2009) have identified the effects of depreciation of exchange rate on country risk by conducting a natural experiment. It was found that external factors like demonetization has an impact on the currency exchange rate. In the year 1876, France had suspended coinage of silver which led to depreciation of all silver standard countries with respect to gold standard currencies like the British pound. Abhay Pethe and Ajit Karnik (2000) have done a study on stock market indices and macro-economic variables that include exchange rate of rupee vis-à-vis the dollar, index of industrial production, broad money supply, narrow money supply and prime lending rate. The outcome reflected a positive correlation between the stock market prices and macro factors. Thomas Dimpfl, Stephan Jank (2016)have tried to analyze the impact of internet search queries on prediction of stock market volatility. They have found a strong co-movement of the volatility of Dow Jones with the volume of queries in its name. Objectives INTERCONTINENTAL JOURNAL OF FINANCE RESEARCH REVIEW In this paper an attempt is made to understand the pattern of Volatility in Stock market index and Currency exchange. In this regard the following Research questions were posed Is there a variation in Stock Market and Currency Exchange volatility across time( Pre and Post Demonetization) If there is a variation in Volatility across time, is this volatility uniform in Stock market and Currency Exchange rates Is there a significant difference in the extent of Volatility pre and Post Demonetization? Research Design Period of the Study: The study measures and compares the volatility of Index and Currency for a period of four months, from September 2016 to Jan This period is significant because it includes the effect of Demonetization. Data Collection and Tabulation: The study is designed to measure and compare volatility in Stock index and Currency exchange rate. The closing values of Nifty 50 and INR-USD exchange rates are collected on daily basis during the period of the study. Nifty is a well varied basket of 50 shares representing 24 sectors of the Indian economy. Tools of Data Analysis: To make the data comparable, the coefficient of variation (CV) is calculated using mean and Standard deviation. Standard deviation is a measure of deviation from the average. The higher the deviation the higher is the uncertainty of that stock. The CV value expresses the range of variation in percentage basis. These CV values plotted on XY graph to study the pattern of variation across different weeks. Students t test is used to compare the mean CV values of Stock Index and currency. The t-test is used to measure the significance of volatility pre and post Demonetization for index and currency exchange rates icmrrjournal@gmail.com

4 The uniformity of volatility across different time periods is studied with help of Pearson s Correlation Coefficient between index and currency exchange rates. Analysis & Interpretation Patterns of Volatility across time periods The weekly CV values of the stock market and currency rates are used to represent the volatility due to demonetization. Table 1: Weekly CV Values for Index and Currency Pre- Demonetization Date Index Currency 7-Sep Sep Sep Sep Oct Oct Oct Oct Nov Nov Interpretation: From the data we can see inter week variation in Index and INR exchange rates. The variation in exchange rates are relatively higher than the Index returns for the period under consideration 16 icmrrjournal@gmail.com

5 Table II: Weekly CV Values for Index and Exchange rates Post- Demonetization Date Index Currency 16 _ Nov _ Nov Nov Dec Dec Dec Dec Dec Jan Jan Jan Interpretation: From the data we can see inter week variation in Index and INR exchange rates. To test if the variation is uniform between the two, we will calculate the Pearson s coefficient of correlation for the data Table III : Correlation coefficient between Index value and currency Pre- Demonetization Index Currency Index Pearson Correlation Sig. (2-tailed).447 N Currency Pearson Correlation Sig. (2-tailed).447 N icmrrjournal@gmail.com

6 Interpretation: There does not exist a statistically significant correlation between the variation in Index and currency exchange rates before Demonetization. Table IV: Correlation coefficient between Index value and currency Post- Demonetization Index Currency Index Pearson Correlation 1.750(**) Sig. (2-tailed).008 N Currency Pearson Correlation.750(**) 1 Sig. (2-tailed).008 N ** Correlation is significant at the 0.01 level (2-tailed). Interpretation: There exists a statistically significant correlation between the variation in Index and currency exchange rates after Demonetization. The relationship is positive which means the variation was in same direction. To Study if the variation in volatility at two time periods are significant, the following Hypothesis are proposed Ha1: There is a significant difference between the volatility in the Index values Pre and Post Demonetization Ha2: There is a significant difference between the volatility in the INR- USD exchange rates Pre and Post Demonetization. Table V: Students t- test for Index Pre and Post- Demonetization Paired Differences Mean Std. Deviatio n Std. Error Mean 95 Confidence Interval of the Difference Lower Upper t df Sig. (2- tailed) Pair 1 Index pre Index post icmrrjournal@gmail.com

7 Table VI: Students t- test for Index Pre and Post- Demonetization Pair 1 Currency Pre Currency Post Mean Paired Differences Std. Deviation Std. Error Mean Confidence Interval of the Difference Lower Upper t df Sig. (2- tailed) Interpretation: We can conclude that there is no statistically significant difference between the mean variation in Index and INR- USD exchange rate before and after demonetization. Findings: The Study has attempted to understand the pattern and extent of volatility across time periods and across the Index and Currency exchange rates. From the analysis, the following inference can be drawn. By taking into consideration the inter week variation in Index and INR exchange rates it is found that the variation in exchange rates are relatively higher than the Index returns for the period under consideration. Pearson s coefficient of correlation was used to test if the variation is uniform between the two. There does not exist a statistically significant correlation between the variation in Index and currency exchange rates before Demonetization There exists a statistically significant correlation between the variation in Index and currency exchange rates after Demonetization. The relationship is positive which means the variation was in same direction. Testing of Hypothesis was done to study if the variation in volatility at two time periods are significant, there is no statistically significant difference between the mean variation in Index and INR- USD exchange rate before and after demonetization. Limitations of the Study The study is limited to impact of demonetization only on the volatility of the Indian Stock market. The study is restricted to a tenure of 60 days prior and post demonetization. The exchange rate fluctuation of rupee against dollar is only considered and not with any other international currencies. Scope for further research The present study is limited to impact of demonetization only on the volatility of the Indian Stock market. There is a scope to further extend the study to analyzing the impact of Demonetization in India on volatility of other international indices like Dow Jones, ATX, NYSE, NASDAQ, HangSeng etc icmrrjournal@gmail.com

8 Conclusion and Suggestion The government s goal to eradicate counterfeit currency, fight tax evasion, eliminate black money gotten from money laundering and terrorist financing activities have been successful to an extent and has led to the promotion of a cashless economy. This essentially represents a change in regime for the real and financial economy. Domestically, there could be some turmoil as the effect will be disproportionately felt by the lower and upper income classes. Internationally, the government is likely to get thumbs up for the move and more countries could potentially see this as a viable option to curb black money and stem illegal financial activity. This paper also throws light on the fact that it is advisable to invest in stock market (mutual funds, equity etc.) rather than fixed deposits in banks. The returns from stock market are any day higher than the rate of inflation if the stocks are chosen wisely. It is suggested to the investors to hold on to their investments for a longer period of time as the volatility will ease and average out in the long run. With stock markets falling due to demonetization uncertainty, it can be suggested that one can invest in good equity mutual funds, at a low price. Expect to get good returns, from equity linked mutual funds, in the long term. No doubt Nifty 50 is a bit lower now since Demonetization, but then there are many other factors besides demonetization that have affected the markets, not the least of which has been Donald Trump s election as president of the US and the subsequent rise in US bond yields and the strengthening of the dollar. That has led to funds flowing out from emerging markets and India too has been affected. Lastly, though this move by the government may not be a first (having being tried by earlier governments as a tool to fight corruption), such an action achieves larger significance for a globally connected India as it shows boldness in tackling an issue which has remained a thorn in the growth success story of this generation. Taking these yardsticks, it does look as if demonetization hasn t really affected the overall market much and investors can hence believe the impact is temporary, with lower interest rates and more government spending offsetting any adverse effects. Of course, this also indicates that if the negative impact persists, then the market correction is still ahead of us. References INTERCONTINENTAL JOURNAL OF FINANCE RESEARCH REVIEW 1. Abhay Pethe and Ajit Karnik (2000), Do Indian Stock Markets Matter? Stock Market Indices and Macro-Economic Variables, Economic and Political Weekly, 35(5), Andersen, T.G., and Bollerslev, T. (1998).Answering the Skeptics: Yes, Standard Volatility Models Do Provide Accurate Forecasts.International Economic Review, 39(4): Andersen, T.G., Bollerslev, T., Diebold, F.X., and Labys, P. (2003). Modeling and Forecasting Realized Volatility. Econometrica, 71(2): Brandt, M., and Kavajecz, K.A. (2004). Price Discovery in the U.S. Treasury Market: The Impact of Order Flow and Liquidity on the Yield Curve. Journal of Finance, 59: Dasgupta, D. (2016). Theoretical Analysis of Demonetisation. Economic and Political Weekly, 51(51) JishiRajendran&VidhiMaggo (2017), Demonetisation: An Exuberate Sight Or Plight Of Indian Economy?,Indian Journal of Applied Research, 7(1) 7. J. Bradford De Long, Andrei Shleifer, Lawrence H. Summers, Robert J. Waldmann, (1990), Noise Trader Risk in Financial Markets, The Journal of Political Economy, 98(4), MALCOLM BAKER and JEFFREY WURGLER (2006), Investor Sentiment and the Cross- Section of Stock Returns, The Journal of Finance, 60(4) 20 icmrrjournal@gmail.com

9 9. Michael D Bordo, Christopher M Meissner& Marc D Weidenmier (October 2009), Identifying the effects of an exchange rate depreciation on country risk: Evidence from a natural experiment, Journal of International Money and Finance,28(6), Neal, Robert, and Simon Wheatley, 1998, Do measures of investor sentiment predict stock returns, Journal of Financial and Quantitative Analysis, 34, Ross, M. (1989).Relation of Implicit Theories to the Construction of Personal Histories.Psychological Review, 96 (2): Sunitha V Ganiger, Ranganatha B (2017), Demonetisation And Its Impact On Social Development, Indian Journal of Applied Research, 7(1) 13. Thomas Dimpfl, Stephan Jank (2016), Can Internet Search Queries Help to Predict Stock Market Volatility?,European Financial Management, 22(2), icmrrjournal@gmail.com