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Impact of changes in Oil Price on Indian Stock

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Conference Paper April 2014

DOI: 10.13140/RG.2.2.10527.56488

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 Impact of changes in Oil Price on Indian Stock
Market
Virendra Pratap Rai
FMS, BHU
Varanasi - 221005
E mail: virendrarai1987@gmail.com
Abstract - The purpose of this present paper is to contribute to
the literature on stock markets and energy prices by studying
the impact of oil price changes on Indian stock market returns.
The study employed various statistical tools like trend analysis,
correlation analysis and regression based modelling in order to
try and establish a relationship between Crude Oil Prices and
Indian Stock Market based on available past data. The span of
this study includes data of Crude Oil Price (Brent Crude) and
Indian Stock Market Index (BSE Sensex) for last 10 years
(2003-12) in monthly Time Series format. As the above
mentioned period (i.e. 2003-12) has witnessed various turmoils
and changes in both Indian and World economy, namely the
Global Recession (2008), Iraq War (2003), Arab Spring (2011),
Iran Nuclear Crisis (2007), etc. Among the four last three had a
significant impact on Oil Prices as they have caused political
instability to major oil producing nations of the Middle East
like Iraq, Iran, Libya, Bahrain, etc. Consequently, the period
experienced marked fluctuations in global crude oil prices and
thus, would prove to be significant for our study. The findings
of the study indicate that oil prices generally follow economic
principles of supply and demand in the long run. Also there
exists a weak but significant relationship between oil price
changes and returns on Indian stock market (BSE Sensex).
Keywords: Oil price, BSE-Sensex, India.
INTRODUCTION
Crude Oil price is one of the most significant
macroeconomic variables which affect the cost of
production directly or indirectly, thus, affecting the future
cash flows and profits of companies. Recent years especially
after Gulf War (1990-91) and Iraq War (2003) had resulted
sharp swings in oil prices, with oil price reaching as high as
$148/bbl, followed by an equal dramatic fall in prices.
Despite the fact that, based on previous research,
oil price changes seem to affect equity prices in a negative
manner, a deeper analysis should be done as regard the
different impacts on oil exporting and on oil importing
countries. In the OPEC countries and in other oil exporter
countries the effect of increases in oil prices should be
positive, whereas for the oil importing countries like India
the impact should be negative (Asteriou, Dimitras &
Lendewig, 2013).
As India is a net importer of crude oil so its
economy is highly sensitive to oil prices shocks in the
international crude oil market. India imported $156.97
Proceedings of Manegma 2014 : ISBN No 978 81 929306 0 2
Palash Bairagi
FMS, BHU
Varanasi - 221005
E mail: plshbrg2010@gmail.com
billion worth crude oil and products in 2012-13 and Oil
imports account for 34 per cent of the total import bill and a
dollar increase per barrel raises trade deficit by $900 million
(Ranjan, 01/08/2013). Thus, a rise in crude oil prices affect
Indian Economy in a significant manner as the country has
to produce about $1 trillion of GDP to sustain its huge
population and to do so it requires about 2.5 million barrels
of oil/day which is 6.5% of worlds total oil demand
(Sharma, Singh et. al. 2012).
As oil prices increases cost of production and in
turn affecting the required expected rate of return from the
business. Since, current stock price of a company reflects
the discounted future cash flows from the business, as
specified by the Dividend Discount Model for Stock
Valuation (Value of Stock = Dividend per share/(Discount
Rate-Dividend Growth Rate)). Thus, theoretically, a rise/fall
in oil price influences the required discount rate for arriving
at Present Value of Future Cash Flows of a listed company
which reflects in its current share price. Rising oil prices are
often indicative of inflationary pressures which central
banks can control by raising interest rates. Higher interest
rates make bonds look more attractive than stocks leading to
a fall in stock prices. The overall impact of rising oil prices
on stock prices depends of course on whether a company is
a consumer or producer of oil and oil related products. Since
there are more companies in the world that consume oil than
produce oil, the overall impact of rising oil prices on stock
markets is expected to be negative (Basher & Sadorsky,
2006). Thus, this study would try to empirically test this
relationship between changes in crude oil prices (Brent
Crude) and its impact on Indian Stock Market (i.e. BSE
Sensex).
LITERATURE REVIEW
The trend in crude oil Market has reignited interest
in the macro-economic factors that have a strong impact
over equity returns and volatility in the equity market.
Several studies have explore this aspect among them are
Chittedi (2011) who have investigated long-run relationship
between oil Price and Stock prices in India for the period
April 2000 to June 2011. The Author applied Auto-
regressive distributed lag. The finding suggested that the
volatility of stock price in India have a significant impact on
the volatility of oil prices and the macro-economic factors
204
that have a strong impact over equity returns and volatility
in the equity markets.
Imarhiabel (2010) applied vector-error correlation
modeling to study the impact of oil prices on stock prices of
selected major oil producing and consuming
countries(Mexico, Russia, Saudi Arabia, India, China and
the US) with nominal exchange rate as additional
determinant. The result showed that in all countries
Variance decomposition and impulse response tests confirm
existence of oil prices and exchange rates influences over
stock prices.
Onos (2010) assessed the differences of the impact of oil
price futures in stock markets or companies expected
earnings among BRICs and also an unprecedented oil price
increases from 1990 to 2010. The finding indicated real oil
price for India and industrial production with constants and
trend for Brazil cannot be rejected. The existence of a unit-
root in their levels while on the other hand Null hypothesis
(Ho) was rejected real stock price of the unit root of 1%
level in all cases. Consequently, the author believed that real
stock returns responded positive to some of the oil price
indicators with statistically Significance for China, India,
Russia where as no Significant response was observed in the
Brazilian real stock returns.
Masih, Peter and Mello (2010) analyzed the relationship
between oil prices shocks and the Macro-economic
variables by using modern time series techniques in a co-
integrating framework. The findings suggested that the
financial crises did not affect on the stochastic trend
between ip, op, rvol and rsr. In addition the author believed
that the oil price movements significantly affect the stock
markets and analysis indicates that real stock returns are the
main channel of Short-run adjustment to long-run
equilibrium. (Industrial production as ip, real stock returns
as rsr, interest rates as r, oil prices as op, and oil price
volatility as rvol).
Impact of crude oil prices in Indian economy
growth and the relationship between oil price and inflation
was studied by Sharma et.al. (2012) and analyzed the trend
in oil price and the factors that affect the crude oil prices.
Lis, NeBler, and Retzmann (2007) investigated the impact
of oil prices is different on the overall Market and
automotive companies. In addition showed the differences
in sensitivity among the continents taking Germany, USA
and Japan in to account where result pictured a link between
the Crude oil price and the share price of cars producing
companies in every period as well as every portfolio.
Basher and Sadorsky (2006) examined the impact of oil
price changes on a large set of emerging stock market
returns and found regression for unconditional and
conditional models for the relationship between risk returns
differences and result showed that oil price risk impacts
Proceedings of Manegma 2014 : ISBN No 978 81 929306 0 2
stock price returns in emerging markets although the exact
relationship depend upon the data frequency.
Hale and Chang (2011) titled the impact of oil price
fluctuation on stock markets in Developed and emerging
economies. Suggested that the fluctuations in oil price on
stock market is not so statistically significant although the
presumption of oil price stock price relationship seen some
reasonable area of Japan.
Roselee, Samad, Fazilah, Bhat and Sonal (2009)
examined the effect of oil price movements on the stock
price of oil and gas companies in three different market (US,
India & UK) and found that some co-integration between oil
stocks, oil prices, interest rates, industrial production and the
stock index and there is a significant short-run as well as
long-run relationship between them which concluded that
these variables have co-integrating relationship.
Asteriou, Dimitras, Lendewig (2013) assessed the
differences in the impact of oil price fluctuations on oil
importing countries and on oil exporting countries. The
result of the study showed that the oil price interact with the
stock markets in a stronger manner than with the interest
rates in the short run as well as in the long-run .
Furthermore, the significance of this impacts is higher on oil
importing countries than on oil exporting countries. Finally
the fluctuation in oil price might present different affects
among different countries and a possible explanation for this
can be the degree of development of the countries.
The World Economic Outlook contained an
extensive discussion of the potential impact of higher Prices
where IMF Research department approved by Mussa
(2000), on the topic The impact of higher oil prices on the
Global economy. The researcher suggested some recent
development and outlook in oil Markets & impacts on
global economy and concluded that of the GDP from
global oil importers to oil exporters would be a sustained oil
price increase of that size & imply a permanent transfer.
Christensen (2011) analyzed the impact of oil Price Shocks
on Stock Markets where the author investigated linear, non-
linear & asymmetric oil price shocks, where he found that
all individual countries dependency on oil will have great
impact on the response of the real stock returns.
Papaetrou (2001) studied the dynamic linkage between
crude oil price and employment in Greece using industrial
production and industrial employment as alternative
measures of economic activity. His study was modelled in a
cointegrated VAR framework and extends out by looking at
the generalised variance decomposition and impulse
response functions.
Eika and Magnussen (2000) examined the effects of the
high oil prices on the Norwegian economy in the first half of
the 1980s. They utilized two large scale macroeconomic
205
models i.e. NIGEM and KVARTS on high oil prices from
1979 to 1985. The results showed that the higher oil price
had a rather persistent effect on the trading partners of
Norway, which lowered the demand for Norwegian export
goods and it also resulted in an increase in interest rate.
analysed and then the results of correlation and regression
analysis would be evaluated over the course of this paper.
1. Trend Analysis of Oil Prices (Brent Crude).

Hamilton (2003) investigated the nonlinear relation

between oil price changes and GDP growth in the US
economy. He found strong evidence supporting a nonlinear
relationship between the two factors. Further results showed
that an increase in oil price has a greater impact than oil
price decreases, and oil prices are not much of use for
forecasting of the GDP.

Huang et al. (1996) provided an evidence in favor of

causality effects from oil futures prices to stock prices while
O'Neill et al. (2008) found that oil price increases lead to
reduced stock returns in the United States, the United
Kingdom and France.

Objectives Previous economic researches indicate that the fundamentals

The research study aims to fulfil following major objectives:
1. To study the fluctuations in Crude Oil price (Brent
Crude) in the last ten years (2003-12).
2. To evaluate the impact of Crude Oil price on
Indian Stock market.
Hypothesis
H0 = There is no significant impact of changes in oil prices
on BSE Sensex returns.
RESEARCH METHODOLOGY
The study was empirical in nature and the total
population consisted of all the global Oil Markets and
various stock exchanges functioning today. Out of which
only Brent Crude is selected as reference for oil price and
the study is limited to Indian stock market represented by
BSE Sensex. The time frame for the study was ten years
beginning from 2003 till end of 2012. The sampling
elements for the study were Oil price and its impact on BSE
Sensex. Purposive sampling was used to complete the study
and the data was collected from secondary sources through
official website of NSE, BSE, Index Mundi and Yahoo
Finance.
Tools for Data Analysis
of supply and demand in the oil market are important to
understand the short-run and long-run fluctuations. In
particular, these fundamental changes allow more pricing
information for investors/producers to decide which
investments are profitable. Moreover, the primary source of
oil price fluctuations are not from financial speculation but
from oil supply, oil demand, or precautionary oil demand
expected oil supply disruptions, such as the concern about a
disturbance in Irans oil production can lead to
significantly different economic effects.
Although historically there are several oil price spikes from
oil supply disturbances, these disruptions are typically short-
lived because of production changes around the globe to
profit from price changes. However, aggregate demand
shocks, such as from China and India during the 2000s, last
longer. In the research, it was found that various historic
global events like US subprime crisis and the following
global recession had a negative effect on oil prices as the
total fuel demand came down as a result of reduced
production during recessionary phase. The same is indicated
by sudden steep decline in oil prices in middle of 2008 after
a preceding period of almost continuous rise. Similarly,
global socio-political events like Iraq war (2003), Arab
Spring (2011-), etc. resulted in speculative as well as real
threats in possible decline in global oil production, thus,
pushing the oil prices upwards in international markets.

a. Trend Analysis
b. Correlation
c. Regression Analysis

RESULTS AND DISCUSSIONS

As per the framed objectives for the study, first the
trend graph for the fluctuations in oil prices would be

Proceedings of Manegma 2014 : ISBN No 978 81 929306 0 2 206

 2. Correlation significant relationship between oil prices and stock market
returns, however, the degree of such relationship varies from
Correlations market to markets and different time periods. It is generally
sensex oil_prices observed that rising oil prices tends to result in diminishing
returns from the stock market and vice versa. The results of
Pearson sensex 1.000 .194
the study showed that there is significant although weak
Correlatio
oil_prices .194 1.000 relationship between oil prices and Indian stock market
n
returns which was in line with the studies like Le and Chang
Sig. (1- sensex . .017 (2011) and Basher and Sardorsky (2006). The study also
tailed) oil_prices .017 . indicates that oil prices tend to follow the fundamental
sensex 119 119 economic principles of Supply and Demand in the long run
N
oil_prices 119 119 and are also affected by global socio-economic and political
developments like global recession (2008), Iraq war (2003).
There exists a weak but significant correlation (r=0.194, Thus, this study doesnt not attribute all the fluctuations
n=119, p<0.05) between movements in oil prices (Brent happening in Indian stock market to oil prices, as it is one
Crude) and BSE sensex. This indicates movement in Indian among the large number of factors like inflation, GDP,
stock market are explained by changes in oil prices by a exchange rate, etc. which impact corporate earnings.
very small extent as there exists a very weak correlation Therefore, scope of further study is still left in analysing the
between the two. impact of individual as well as collective impact of other
macro-economic factors affecting the value of stocks in
3. Regression Analysis. Indian as well as global stock markets.

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