Effect of Select Macro Economic Variables On Stock Returns in India

International Journal of Marketing, Financial Services & Management Research_____________________ ISSN 2277- 3622
Vol.2, No. 6, June (2013)

Online available at www.indianresearchjournals.com
EFFECT OF SELECT MACRO ECONOMIC VARIABLES

ON STOCK RETURNS IN INDIA
P. BHANU SIREESHA
ASSOCIATE PROFESSOR (FINANCE),
DEPT. OF BUSINESS MANAGEMENT,
METHODIST COLLEGE OF ENGG. & TECH. HYDERABAD, INDIA
_________________________________________________________________________________
ABSTRACT
This paper attempts to investigate the impact of select macroeconomic factors upon the
movements of the Indian stock market index, Nifty along with gold and silver prices by using
linear regression technique. The behavior of nominal and real returns at various levels of
inflation, GDP, IIP and Money Supply is studied. The interdependence of the returns on
stock, gold and silver is also identified.
__________________________________________________________________________________
INTRODUCTION
Stock markets are said to reflect the health of the countrys economy. On the other hand,
major economic indicators determine stock market movements to a large extent. From a
thorough analysis of the various economic indicators and its implications on the stock
markets, it is observed that stock market movements are largely influenced by broad money
supply, inflation, credit / deposit ratio and fiscal deficit apart from political instability.
Besides, fundamental factors like corporate performance, industrial growth, etc., always exert
a certain amount of influence on the stock markets.
The decade of 1990s has been very eventful for the Indian Stock Market. One of the
important events has been the decision allowing Foreign Institutional Investors (FIIs) directly
on the Indian Stock markets since 1992. It is well recognized that their presence has
contributed significantly to the advancement of increasing sophistication of our markets. But
it is argued that the trading behavior of FIIs reflects a sort of myopia, which causes excess
volatility in the domestic stock markets. In other words, these investors are shortsighted,
highly speculative and move large amounts of funds into and out of the countrys stock
markets with no regard for fundamentals. Such a development has important implications for
macroeconomic management as the trading pattern of these investors may create excess
volatility in the Indian stock market.
Stock market volatility has been a major cause of concern for policy makers, investors and
academia throughout the world, especially for the last two decades. Rapid financial
innovations, regulatory and non-regulatory reforms, SEBI interventions, globalization of
Indian capital market, new classes of investors, etc. have all shown a great impact on the
behavior of share prices in India. Together, the new participants and the new market
environment have impacted the market structure which in return resulted in high volatility.
Perhaps, there is a feeling that fragility of the stock market in general and the Indian stock
market in particular has increased over the last decade. The market volatility has been
impacted by various factors like the macro economic variables, operations of Foreign and
Domestic Institutional Investors, derivatives market operations as well as the international
stock market operations.
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Time variations in market volatility can often be explained by macroeconomic and micro
structural factors. Volatility in national markets is determined by world factors and part
determined by local market effects, assuming that the national market is globally linked. It is
also consistent that world factors could have an increased influence on volatility with
increased market integration. Research has also shown that capital market liberalization
policies too, are likely to affect volatility. It would be of interest to policy makers that the
correlation between the two has been found to be positive in the case of some countries.
There has been a lot of discussion on the effect of macroeconomic variables on stock returns.
Raj Kumar and Bhartendu Singh (1998) observed that the joint impact of trading volume,
rate of exchange and the rate of gold standard was highly significant on Sensex. The
individual effect of rate of exchange and rate of gold standard on Sensex were also found
highly significant but the individual effect of trading volume was not found significant.
Gupta et al (2000) examined the relationship between interest rate, exchange rate and stock
price in Jakarta stock exchange and identified sporadic unidirectional causality from closing
stock prices to interest rates and weak unidirectional causality from exchange rate to stock
prices. They felt that the Jakarta market is efficiently incorporated much of the interest rate
and exchange rate information in its price changes at closing stock market index.
Campbell et al (2001) found that stock market volatility has significant forecasting power
for real gross domestic product growth. Golaka Nath and Samanta (2003) identified a
strong causal influence from stock market return to forex market return in India. However,
they expressed a need for further in depth research to identify the causes and consequences of
the findings.
Seshaiah et al (2003) examined the impact of inflation and exchange rates on gold, silver and
stock returns before and after liberalization. They found that over the longer period of time,
positive real rate of return was being provided by stocks after liberalization, by gold in both
periods, but in short run the real return of stocks was often negative. Negative real rate of
return was being provided by silver in both the periods.
Diebold FX and Yilmaz K (2004) felt a relative neglect of the connection between
macroeconomic fundamentals and asset return volatility, and analyzed a broad international
cross section of stock markets covering forty countries. They found a clear link between
macroeconomic fundamentals and stock market volatilities, with volatile fundamentals
translating into volatile stock markets.
Sangeeta Chakravarty (2005) reexamined the relationship between stock price and some
key macro economic variables in India for the period 1991-2005 using monthly time series
data. She found unidirectional effect of IIP and inflation Granger causing stock prices and
stock prices granger causing money supply. On the other hand there is no causal relation
between stock price and exchange rate, and between gold price and stock price.
Bhupender Singh (2005) examined the effect of significant macroeconomic variables,
inflation and exchange rate on the inflows of FII in India, and also tried to develop a
theoretical framework to analyze such inter-relationship. Paritosh Kumar (2008) validated
the long term relationship of stock prices with exchange rate and inflation in Indian context.
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Vol.2, No. 6, June (2013)
Lena Shiblee (2009) studied the impact of inflation, GDP, unemployment and money supply
on stock prices on New York exchange, and identified that money supply and inflation
displayed strong positive influence and the other factors displayed weak influence on most of
the companies selected for the study.
Ananthanarayanan et al (2009) observed that unexpected flows of FIIs have a greater
impact on stock indices than expected; and found no evidence that FIIs employ either
momentum or contrarian strategies.
Krishna Reddy (2010) studied the movements in BSE Sensex in relation to FII investments
and identified that FIIs are significant factor determining the liquidity and volatility in the
stock market prices.
Xiufang Wang (2010) found evidence that there is a bilateral relationship between inflation
and stock prices, while a unidirectional relationship exists from stock prices to the interest
rate. But no significant relationship between stock prices and real GDP was found.
Govind and Mihir Dash (2012) considered macroeconomic variables like exchange rates,
crude oil prices, interest rates, gold prices and FIIs to be analyzed along with the movements
of S&P CNX Nifty. Using vector autoregressive techniques and Granger causality tests, the
study determined whether each of the factors have a significant impact on market volatility.
Pramod Kumar Naik and Puja Padhi (2012) observed bidirectional causality between
industrial production and stock prices, unidirectional causality from money supply to stock
price, stock price to inflation and interest rates to stock prices. The authors conclude that
macroeconomic variables and the stock market index are co-integrated and, hence, a long-run
equilibrium relationship exists between them.
Mohapatra and Panda (2012) correlated top ten rises and top ten falls of Sensex with
corresponding net flows of FIIs and also tested the impact of other macroeconomic factors
along with FIIs affecting Sensex for a 10 year period and found that IIP and Exchange rate
(INR/USD) have a higher influence than FIIs on the stock markets.
These studies give a strong subjective background to test for the existence of such
relationship in India.
Objectives of the Study
The overall objective of the present study is to understand the relationship between select
macroeconomic variables with the stock returns in India, S&P CNX Nifty. However, the
following are set as the specific objectives for the study:
1. To examine the effect of each economic variable on stock return, gold return and
silver return
2. To analyze whether stock, gold and silver returns form hedge against each of the
economic variables
3. To study the relationship between stock, gold and silver returns with each of the select
internal economic variables
4. To find whether stock, gold and silver returns form hedge against each other
Database
The study is performed on a monthly data for a period of 20 years from January 1993 to
December 2012 totaling 240 months for each variable.
For analysis, the principal stock index of the country, S&P CNX Nifty is selected.
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Vol.2, No. 6, June (2013)
The various economic variables selected for the study are divided into two categories, viz.
internal variables of the country [Inflation rate as annual change on CPI, Gross Domestic
Product (GDP) growth rate, Index of Industrial Production (IIP) and Money Supply (M3)],
and external variables for the country [exchange rate returns of USD-INR, GBP-INR, EURINR and JPY-INR, Foreign Institutional Investors (FIIs) and Domestic Institutional Investors
(DIIs)1]. Gold returns, Silver returns are also selected for the analysis and are studied along
with the stock returns.
Monthly average closing values for Nifty are obtained from NSE and yahoo finance websites.
The monthly percentage change values for Inflation and IIP; and monthly average values of
M3 are obtained from the trading economics website.
Annual average values of GDP are obtained from index mundi website.
Monthly average exchange rates of INR with the select 4 prominent currencies over the globe
are obtained from oz forex website.
Monthly net investments made by FIIs and DIIs are obtained from money control website.
The monthly average gold and silver prices are obtained from RBI website.
Stock Returns, Gold Returns, Silver Returns, Exchange rate Returns of each of the four
countries, net investments made by FIIs, net investments made by DIIs and money supply M3
are all calculated as monthly percentage change using the formula [(P1-P0)/P0 * 100]. GDP
values are calculated as a yearly percentage change.
Methodology
1. The study adopts linear regression models consisting of two variables for attaining the
stated objectives. A stepwise regression method has been adopted as there is strong multicollinearity between the variables included.
The relationships between returns on stock index, gold and silver, and the select economic
variables, are expressed in matrix notations as given below:
(a)
(f)
(b)
+ G
(g)
(c)
+ I
(h)
(d)
+ M
(i)
+ F
(e)
+ $
(j)
+ D
As DIIs follow FII pattern of investments in the country, hence are included into the external variables category
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Vol.2, No. 6, June (2013)
Where
St Stock index returns
G Gold price returns
S Silver price returns
Inflation rate
G GDP rate I IIP rate
M Money supply rate
$ - USD-INR rate
- JPY-INR rate
- GBP-INR rate
- EUR-INR rate
F FII net investment rate
D DII net investment rate
1 to 30 Constants of the different regression equations
1 to 30 Coefficients of the different regression equations
U1 to U30 Error terms of the different regression equations
In these regression equations, it has to be seen that the value of beta coefficient could be
either negative or positive. The positive value of the coefficient signifies that the respective
returns increase during inflationary period, otherwise inflation has a negative impact on stock
returns. If the positive beta coefficient is one or more, it means that the respective returns are
a complete hedge against inflation. If the positive beta coefficient is less than one, it signifies
that the respective returns are a partial hedge against inflation. A negative beta coefficient
indicates that the respective returns are declining during inflationary periods.
2. To find the effect of various levels of the select internal variables, each of these has been
classified into sub categories as follows:
Inflation into 5 categories [<0; 0-3; 3-6; 6-9; and >9]
GDP into 4 categories [<3; 3-6; 6-9; and >9]
IIP into 6 categories [<0; 0-3; 3-6; 6-9; 9-12; and >12]
M3 into 5 categories [<0; 0-1; 1-2; 2-3; and >3]
For each of these analyses, a table is formed with columns showing the various levels of sub
categories, the total number of periods of returns falling within each sub category, the number
of periods showing positive returns, the average value of the variable in the sub category, the
average nominal return of the stock index or gold or silver; and the average real return
(average nominal return () average value of variable)
Empirical Investigation: Linear Regression Approach
A linear function has been fitted to get the regression of stock returns, gold returns and silver
returns with each of the following:
a. Inflation rate
b. GDP rate
c. IIP rate
d. Money Supply (M3) rate
e. US Dollar Exchange rate
f. Japanese Yen Exchange rate
g. Pound Exchange rate
h. Euro Exchange rate
i. Net investment rate by FIIs
j. Net investment rate by DIIs
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International Journal of Marketing, Financial Services & Management Research________________________ ISSN 2277- 3622
Vol.2, No. 6, June (2013)
Results of the regression are presented in Tables 1 to 10 below.

Table 1: Inflation Rate (Independent Variable)
Dependent Variable
Coefficient t value
R2 value
Stock Return
-0.163
-2.557 *
0.027
Gold Return
-0.066
-1.018
0.004
Silver Return
-0.073
-1.134
0.005
* Statistic is significant at 5% level of significance
F value
6.536
1.036
1.286
It may be observed from Table 1 that the stock returns are influenced by the movements of
inflation rate at 5% level of significance which means that investment in stocks provides an
investor a partial hedge against increasing inflation rates. But the negative beta coefficient
values indicate that the returns are declining during inflationary periods.
Table 2: GDP Rate (Independent Variable)
Dependent Variable Coefficient
t value
Stock Return
0.578
3.006 *
Gold Return
0.251
1.100
Silver Return
0.245
1.071
R2 value
0.334
0.063
0.060
F value
9.036
1.211
1.147
It may be observed from Table 2 that the stock returns are influenced by the movements of GDP
rate at 5% level of significance. The positive beta coefficient values indicate that an investor can
derive a partial hedge against rising GDP rates.
Table 3: IIP Rate (Independent Variable)
Dependent Variable
Coefficient
t value
Stock Return
-0.051
-0.764
Gold Return
-0.041
-0.613
Silver Return
0.009
0.132
R2 value
0.003
0.002
0.000
F value
0.583
0.375
0.018
It may be observed from Table 3 that the stock, gold and silver returns are all not influenced by
the movements in IIP rate. The low R square values could be due to the randomness in the
returns of stocks, gold and silver.
Table 4: Money Supply (M3) Rate (Independent Variable)
Dependent Variable Coefficient t value
R2 value
Stock Return
0.014
0.214
0.000
Gold Return
0.127
1.969 *
0.016
Silver Return
0.188
2.957 *
0.035
F value
0.046
3.876
8.744
It may be observed from Table 4 that the gold and silver returns are significant at 5% level. This
may imply that the returns on gold and silver are affected by the broad money supply into the
country.
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Table 5: USD-INR Exchange Rate (Independent Variable)

Dependent
Coefficient
t value
R2 value
Variable
Stock Return
-0.382
-6.379 *
0.146
Gold Return
0.166
2.593 *
0.027
Silver Return
-0.119
-1.854
0.014
Table 6: JPY-INR Exchange Rate (Independent Variable)
Dependent
Coefficient
t value
R2 value
Variable
Stock Return
-0.261
-4.166 *
0.068
Gold Return
0.296
4.790 *
0.088
Silver Return
-0.055
-0.843
0.003
F value
40.687
6.722
3.438
F value
17.356
22.939
0.710
It may be observed from Tables 5 and 6 that the dependence of stock returns on USD and JPY
exchange rate movement is significant at 5% level of significance. This may be due to huge
inflows of foreign portfolio investments into the Indian capital markets since 1993 most of which
is in USD. This means that the exchange flows are affecting the stock returns.
Table 7: GBP-INR Exchange Rate (Independent Variable)
Dependent
Coefficient
t value
R2 value
Variable
Stock Return
-0.110
-1.702
0.012
Gold Return
0.268
4.288 *
0.072
Silver Return
0.093
1.435
0.009
F value
2.897
18.389
2.060
Due to the liberalization policies, the restrictions on gold imports and on free forex transactions
have been removed since 1992. It is observed from Tables 5 to 8 that the forex rates show a
significant influence on gold returns and also the beta coefficient values for gold returns are
positive. This indicates that investment in gold provides a partial hedge to protect an investor
against exchange rate fluctuations.
Table 8: EUR-INR Exchange Rate (Independent Variable)
Dependent
Coefficient
t value
R2 value
F value
Variable
Stock Return
-0.022
-0.289
0.001
0.083
Gold Return
0.350
4.800 *
0.123
23.037
Silver Return
0.168
2.188 #
0.028
4.787
# Statistic is significant at 5% level but not significant at 1% level of significance
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Vol.2, No. 6, June (2013)
It is observed from Table 8 that though significantly influenced at 5% level, there is no

significant relationship between exchange rates and silver returns at 1% level of significance #.
This means that the exchange flows do not affect silver returns.
Table 9: FII Net Investment Rate (Independent Variable)
Dependent Variable
Coefficient t value
R2 value
Stock Return
0.110
1.700
0.012
Gold Return
-0.053
-0.811
0.003
Silver Return
0.093
1.439
0.009
F value
2.890
0.657
2.071
It may be observed from Tables 9 and 10 that there is no significant relationship between returns
on stocks, gold and silver, and net investment rates by FIIs and DIIs. The lower R square values
depict randomness in the returns from stock, gold and silver investments.
Table 10: DII Net Investment Rate (Independent Variable)
Dependent Variable
Coefficient t value
R2 value
Stock Return
-0.136
-1.115
0.018
Gold Return
0.156
1.285
0.024
Silver Return
0.075
0.607
0.006
F value
1.243
1.652
0.369
Through tables 1 to 10, as none of the positive beta coefficient values is greater than 1, it can be
said that returns from stock, gold and silver can only offer partial hedge and not complete hedge
to investors against inflationary periods.
Inter dependence of stock returns with returns from gold and silver:
To evaluate the inter dependence of stock returns with the returns from gold and silver, it can be
observed from Table 11 (below) that Gold and Silver can form reasonably good hedge against
each other. Silver can form partial hedge against stocks. Hedging between stocks and gold is
not advisable.
Table 11: Interdependence of Stock, Gold and Silver Returns
Variable
Coefficient t value
R2 value
Stock vs. Gold 0.002
0.033
0.000
Return
Stock vs. Silver 0.205
3.229 *
0.042
Return
Gold vs. Silver 0.559
10.390 *
0.559
Return
F value
0.001
10.423
107.955
Empirical Investigation: Internal Variable Evaluation Approach

The internal variables of Inflation, GDP, IIP and Money Supply (M3) are classified into sub
categories for analysis. The results are presented in Tables 12 to 15 below.
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Vol.2, No. 6, June (2013)
Table 12: Level of Inflation with Stock, Gold and Silver Returns
Level of Inflation (Percent)
Below 0 0 to 3
a. Stock Returns
Total No of Periods
2
23
No of Periods with Positive Nominal Returns 1
16
Average Nominal Returns
1.574
4.182
Average Inflation
-0.350
1.896
Average Real Returns
1.924
2.286
b. Gold Returns
Total No of Periods
2
23
15
1.065
1.530
Average Inflation
-0.350
1.896
1.415
-0.366
c. Silver Returns
Total No of Periods
2
23
13
1.195
0.879
Average Inflation
-0.350
1.896
1.545
-1.017
3 to 6
6 to 9
Above 9
90
53
1.168
4.405
-3.237
58
36
1.651
7.624
-5.973
67
31
-0.500
10.700
-11.200
90
55
1.195
4.405
-3.210
58
32
0.237
7.624
-7.387
67
40
0.908
10.700
-9.792
90
57
1.792
4.405
-2.613
58
29
0.523
7.624
-7.101
67
32
0.665
10.700
-10.035
It is observed from Table 12, that both the nominal and real returns for stock, gold and silver
decrease as inflation rate increases. This implies that, all the three returns have an inverse
relationship with inflation.
Table 13: Level of GDP with Stock, Gold and Silver Returns
Level of GDP (Percent)
Below 3
a. Stock Returns
Total No of Periods
0
No of Periods with Positive Nominal Returns
0
Average GDP
b. Gold Returns
Total No of Periods
0
0
Average GDP
c. Silver Returns
Total No of Periods
0
0
Average GDP
3 to 6
6 to 9
Above 9
6
3
-1.313
4.790
-6.103
10
4
10.241
6.860
3.381
4
4
36.640
9.662
26.978
6
3
0.608
4.790
-4.182
10
9
0.715
6.860
-6.145
4
4
1.899
9.662
-7.763
6
3
1.254
4.790
-3.536
10
6
1.002
6.860
-5.858
4
4
3.155
9.662
-6.507
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It is observed from Table 13, that both the nominal and real returns of stock increase with rising
GDP rates. The nominal and real returns for gold and silver are decreasing with increasing GDP
rates. This implies that GDP rates have a direct relationship with Stock returns, and an inverse
relationship with Gold and Silver returns.
Table 14: Level of IIP with Stock, Gold and Silver Returns
Level of IIP (Percent)
Below 0 to 3 3 to 6
0
a. Stock Returns
Total No of Periods
14
22
52
No of Periods with Positive Nominal 7
15
27
Returns
3.529
0.847 0.358
Average IIP
-2.607 2.077 4.444
6.136
1.230 4.086
b. Gold Returns
Total No of Periods
14
22
52
11
31
Returns
1.526
0.906 1.054
Average IIP
-2.607 2.077 4.444
4.133
1.171 3.390
c. Silver Returns
Total No of Periods
14
22
52
13
29
Returns
1.810
1.236 0.004
Average IIP
-2.607 2.077 4.444
4.417
0.841 4.448
6 to 9
9 to 12 Above
12
69
40
30
17
37
21
1.296
7.451
6.155
-0.568
10.497
11.065
1.295
14.651
-13.356
69
41
30
20
37
20
0.574
7.451
6.877
0.822
10.497
-9.675
1.163
14.651
-13.488
69
39
30
15
37
20
1.530
1.586
1.219
7.451
5.921
10.497
-8.911
14.651
-13.432
It is observed from Table 14, that the real returns for stock, gold and silver decrease as the
industrial production rate increase. This means that all the three returns have an inverse
relationship with IIP.
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Table 15: Level of Money Supply (M3) with Stock, Gold and Silver Returns
Level of Money Supply (M3) Below 0 0 to 1
1 to 2
2 to 3
(Percent)
a. Stock Returns
Total No of Periods
10
102
78
35
60
41
22
Returns
2.390
1.158
0.633
1.381
Average Money Supply
-0.256
0.599
1.441
3.422
2.646
0.599
-0.808
-2.041
b. Gold Returns
Total No of Periods
10
102
78
35
63
42
20
Returns
1.654
0.792
0.782
0.703
-0.256
0.599
1.441
3.422
1.910
0.193
-0.659
-2.719
c. Silver Returns
Total No of Periods
10
102
78
35
54
42
18
Returns
2.755
0.800
0.523
0.923
-0.256
0.599
1.441
3.422
3.011
0.201
-0.918
-2.499
Above
3
15
7
1.390
3.958
-2.568
15
12
2.436
3.958
-1.522
15
10
5.102
3.958
1.144
From Table 15, it is observed that the stock returns have an inverse relationship with the money
supply rate, and except for the periods in which money supply rate crossed 3 percent, the returns
for gold and silver also possess an inverse relationship with increasing money supply rate.
Conclusion
This study is carried out to examine the impact of select macro economic variables on stock,
gold and silver returns by using linear regression technique. The behavior of nominal and real
returns at various levels of inflation, GDP, IIP and Money Supply is studied. The
interdependence of the returns on stock, gold and silver is also identified.
The following concluding points can be made:
On an average 55% to 64% of sub periods show positive returns for stocks, gold and
silver.
As stock returns are significantly influenced by inflation, GDP, USD-INR and JPY-INR,
stock returns can be used to hedge against these variables.
As gold returns are significantly influenced by money supply, all the four currencies
exchange rates, gold returns can be used to hedge against these variables.
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Vol.2, No. 6, June (2013)
As silver returns are significantly influenced by money supply and EUR-INR, silver
returns can be used to hedge only against these variables.
The positive beta coefficient values for gold returns vis--vis the exchange rate returns
provide partial hedge to protect investor against exchange rate fluctuations.
The exchange flows do not influence silver returns, hence hedging is not possible.
Net investments by FIIs and DIIs are not significant. This may be due to the randomness
in returns from stocks, gold and silver.
Gold and silver can form reasonably good hedge against each other and silver can form
partial hedge against stocks. However, hedging between gold and stocks is not advisable.
Returns from stocks, gold and silver have an inverse relationship with inflation, IIP and
money supply.
GDP shows a direct relation with stock return and an inverse relation with gold and silver
returns.
It can thus be suggested that by improving the GDP figures and controlling the inflation
rates, an attempt to stabilize Nifty can be made at the time of heavy selling made by FIIs
on the Indian stock market.
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Effect of Select Macro Economic Variables On Stock Returns in India

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International Journal of Marketing, Financial Services & Management Research_____________________ ISSN 2277- 3622

Vol.2, No. 6, June (2013)

EFFECT OF SELECT MACRO ECONOMIC VARIABLES

Results of the regression are presented in Tables 1 to 10 below.

Table 5: USD-INR Exchange Rate (Independent Variable)

It is observed from Table 8 that though significantly influenced at 5% level, there is no

Empirical Investigation: Internal Variable Evaluation Approach

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