Economic activities and impact on the stock market

Abstract
This study investigates the nature of the causal relationships between stock
prices and the key macro-economic variables representing real and financial
sector of the Indian economy for the period March, 2005 to March, 2015
using quarterly data. These variables are GDP growth rate, GDP per capita,
foreign direct investment and NSE Nifty in India and has considerable
influence in the stock market movement in the considered period, while the
other variables have very negligible impact on the stock market.

Introduction
The economic activities and growth of the stock market are highly driven by
the economic growth of the countries. Expectations are influenced by the
micro and macro fundamentals which may be formed either rationally or
adaptively on economic fundamentals, as well as by many subjective factors
which are unpredictable and also non quantifiable. It is assumed that
domestic economic fundamentals play determining role in the performance
of stock market. The variables are GDP growth rate, GDP per capita, foreign
direct investment are the major indicator for any country to show the overall
growth of the country. The other factor that can influences the stock market
may be the economic growth of the world as a whole, GDP of countries like
America and Europe, it can affect to the country. Remittance to the country
from the Gulf countries may be the other reason that can affect the cash
inflow. In India, various economic liberalization measures have been
taken since the early 1990s.
In India, various economic liberalization measures have been taken since the
early 1990s. In parallel, numerous steps have been taken to strengthen the
stock market, such as the opening of stock markets to international investors,
the regulatory power of SEBI, derivatives trading, etc. These measurements
have led to a significant improvement in size and depth. of the Indian stock
markets and are beginning to play their part. Currently, the development of
the stock market in India is being carefully scrutinized and analysed by a large
number of global players. Understanding the macro dynamics of the Indian
stock market can be helpful to policy makers, traders, and investors. The
results can reveal whether the movement in stock prices is the result of
something else or is one of the causes of the movement in another
macroeconomic dimension. The study also hopes to explore whether the
stock market movement is associated with the real sector of the economy or
the financial sector or both. In this context, the purpose of this article is to
explore causal relationships for India, as there is quite a bit of work going on
for this period.

Selection of Variables and Data Collection

Our aim is to find the relationship between real economic variables and the
Nifty 50 indices of National Stock exchange, the main Indian stock exchange
for which data is available over a long period. since there doesn't seem to be
a theory that explains the movements of the share price as a function of
micro and macro indices. The real economic variable like are the variables are
GDP growth rate, GDP per capita, foreign direct investment in this research
paper.

Hypothesis
There is positive correlation between economic activities and stock market
i.e. When economic actives increase in the country the stock indices follow
the same trend.
Literature review

The movement of stock indices is highly sensitive to the changes in

fundamentals of the economy and to the changes in expectations about
future prospects. There are various researches have been done before, to
establish relationship between economics activities in the country and their
impact on the stock market indices. Some researchers find the positive
correlation and some find negative correlation between the economic
variable and stock market. Researches done to check the dependency of
economic indicators on stock indices and vice versa. Many believe that large
decrease in stock prices were reflective of future recession, whereas large
increase in stock prices may reflect the expectation towards future economic
growth.
In the literature, various theoretical reasons have been explained linking
behaviour of stock prices and key macro-economic variables. For instances
Sahid Ahmad (2008), used industrial production, exports, foreign direct
investment, money supply, exchange rate, interest rate to see the impact on
the stock prices. The results of the study reveal differential causal links
between aggregate macro-economic variables and stock indices in the long
run. However, the revealed causal pattern is similar in both markets in the
short run. The study indicates that stock prices in India lead economic activity
except movement in interest rate. Interest rate seems to lead the stock
prices. The study reveals that the movement of stock prices is not only the
outcome of behaviour of key macro-economic variables but it is also one of
the causes of movement in other macro dimension in the economy.
The overbearing influence of the per capita income in the model indicates
that an increase in per capita income is very crucial for economic growth and
it may increase savings, which may in turn help in boosting stock market
activities, other things remaining the same. Studies by Najeb (2013), found
that stock market size in terms of market capitalisation ratio, having positive
significance correlated with real per capita GDP, market liquidity and activity
in terms of value traded, turnover, and further having a positive significant
with growth, namely that market volatility has negatively and insignificantly
correlated with real per capita GDP growth.
The impact of economics activities increases the foreign cash inflow and
which contributed to the development of the country. In the literature,
Letuna (2013) showed that a higher rate of economic growth is definitely
stimulated by the real investments, which indirectly generate positive
externalities on stock market indicators and in the real sector and also
showed that market capitalization and stock value traded do not exert any
impact on economic growth rates, emphasizing the low level of development
of the stock market and its reduce role in the Romanian economy.
Economic growth through the changes in levels of real economic activities
affects profitability and activity of firms. As a result, with changes in
profitability prospects, expected earnings and dividends of shares, stock
prices fluctuate (Fama, 1990; Ferson and Harvey, 1993;)
Economic activity needed liquidity and have significant impact on the stock
market, Paudel (2005) states that stock markets, due to their liquidity, enable
firms to acquire much needed capital quickly, hence facilitating capital
allocation, investment and growth. Stock market activity is thus rapidly
playing an important role in helping to determine the level of economic
activities in most economies.
In the literature, Levine (1991) studies that stock market affect growth in two
ways the first involve firm efficiency and depends on the externality in human
capital production. Stock market increase for efficiency by eliminating the
premature withdrawal of a character from the firms. This accelerates the
growth rate of human capital and per capita output. The second way is stock
market can affect growth is to raise the fraction of a resource devoted to the
firms. This doesn't not necessarily depend on externalities. By increasing the
liquidity of the firm investment, reducing productive risk and improving firm
efficiency, stock market encourages firm investment this stimulate human
capital production and growth.
There are various studies is done to establish the relationship future
expectation of the economic activity and their impact on the current stock
indices, Wai Mun (2009) reveals that expectations for future economic
activity are not simply formed by looking at the past trend in the economy as
the adaptive expectations model would suggest. However, it showed that the
stock market growth Granger cause the economic growth.
In the Indian context economic activities and their impact are very similar to
the past studies on different country, a consistent relationship between
certain variables like exchange rate, interest rate, index of industrial
production, inflation and money supply and the stock market and models
confirm the analysis. However, a few variables like fiscal deficit or the foreign
institutional investment in the capital market have shown very negligible
influence on the stock market. In brief period like those between December,
1998- February, 2000 and February, 200-September, 2001 a single variable
like the money supply or the inflation rate becomes the dominant influencing
variable to the stock market respectively.
Studies done to verify the relationship between development of banks,
financial market and economics activities. Chandra(2011), states that the
cointegration analysis that stock market development and economic growth
are correlated. That relationship is unidirectional from stock market
development towards economic growth, But there is insufficient evidence to
suggest an association between bank development and economic growth.
Hence, we conclude that it is not the banking sector but the stock market,
which shares a relationship with economic growth in India.
By contrast, Singh (1997a) argues that stock market development is unlikely
to help in achieving quicker industrialization and faster long-run economic
growth in most developing countries. He finds that the inherent volatility and
arbitrariness of the stock market pricing process under the conditions that
prevail in developing countries make it a poor guide to efficient investment
allocation. The interaction between the stock and currency markets in the
wake of unfavourable economic shocks may exacerbate macroeconomic
instability and reduce long-term growth.
As mention in other researches, that saving by the people of the country
(Savers) contributes to the development of the stock market as they invest in
the stocks by savings, which increases liquidity in the market and lead to the
development of the financial market But Singh (1997b), in his study of other
developing countries, asserts that there is little or no evidence of an increase
in aggregate savings in India as a result of the growth of the stock markets.
Similarly, Arestis and Demetriades (1997) they find insufficient evidence of
financial development causing growth of real GDP in the case of the United
States.
So different studies about the economic activities and impact on stock market
find mix of positive and negative results. In India post liberalisation period,
the economic activity increases which result to the increases in GDP, after
that stock market followed the GDP but post covid situation the economic
activity is not so good but stock market is at all time high. So we cannot infer
that increase in economic activity always impact positively on the stock
market and vice versa.

Data and Methodology

Data Description
The present study uses the time series data obtained from two main sources
i.e. National Stock Exchange (NSE), stock exchange official website and world
bank data base. It is the general perception that Indian stock market (NSE) is
affected by foreign direct investment (FDI) , Gross domestic product(GDP)
and per capita income. As these variables are also interrelated, this study
attempts to develop various model that find relation between them. Time
series data for the period of March, 2005 to March, 2015 is used for
modelling.
Statistical methods for data analysis
The present study employs the time series data analysis technique to study
the relationship between the stock market index and the selected
macroeconomic variables. In the analysis, correlation results might provide a
spurious regression if the data series are non-stationary.
Correlation is a statistical term describing the degree to which two variables
move in coordination with one another. If the two variables move in the same
direction, then those variables are said to have a positive correlation. If they
move in opposite directions, then they have a negative correlation .
The degree of association is measured by a correlation coefficient, denoted by
r. The correlation coefficient is measured on a scale that varies from + 1
through 0 to – 1. Complete correlation between two variables is expressed by
either + 1 or -1. When one variable increase as the other increases the
correlation is positive; when one decreases as the other increases it is
negative. Complete absence of correlation is represented by 0.

-0.75=> r >= 0.75 strongly corelated.

0.5<=r<0.75 & -0.75 < r= < -0.5 moderately corelated

0<r 0.5 & -0.5<r weakly corelated

Following are the data of the FDI, GDP growth rate , GDP per capita and Nifty
50 for the years between 2005 to 2008.

Year Indian GDP FDI in GDP Per NIFTY

growth rate in Billions capita 50
%
2005 7.92 $ $ 2836.55
7.27 715.00
2006 7.92 $ $ 3966.4
20.03 809.00
2007 7.66 $ $ 6138.6
25.23 1,028.00
2008 3.08 $ $ 2959.15
 43.41 999.00
2009 7.86 $ $ 5201.05
35.58 1,101.00
2010 8.49 $ $ 6134.5
27.40 1,357.00
2011 5.24 $ $ 4624.3
36.50 1,458.00
2012 5.45 $ $ 5905.1
24.00 1,444.00
2013 6.39 $ $ 6304
28.15 1,450.00
2014 7.41 $ $ 8282.7
34.58 1,573.00
2015 7.99 $ $ 7946.35
44.01 1,605.00
Corelation between the various variable are calculated as in the following
table:
r 0.377527 correlation between GDP to NIFTY 50
r 0.377865 correlation between FDI to NIFTY 50
r 0.810232 correlation between GDP per capita
to NIFTY 50

The coefficient of the corelation is highest between GDP per capita and Nifty
50 which is equal to 0.81 it means that income of the individuals in the
country is strongly related to the growth of the equity market. When the
income increase people start investing into the market either through mutual
fund or directly investing.
 NIFTY 50
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
$600.00 $800.00 $1,000.00 $1,200.00 $1,400.00 $1,600.00 $1,800.00

The corelation between Nifty 50 and GDP growth rate are weakly corelated.
The coefficient of corelation is 0.377. GPD is not directly related to the growth
of the stock market which we can see from the given data and also from the
recent pandemic when the pandemic was on the peak at the same time stock
market was outperforming but GDP growth was stagnant although it was in
recession.

NIFTY 50
9000

8000

7000

6000

5000

4000

3000

2000

1000

0
2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00%

The corelation between Nifty 50 and FDI inflow are weakly corelated. The
coefficient of corelation is 0.377.The FDI inflow in India are not major
contributor of the growth of the stock market. They can be major contributor
of the development of the country but not for the stock market.
 NIFTY 50
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
$5.00 $10.00 $15.00 $20.00 $25.00 $30.00 $35.00 $40.00 $45.00 $50.00

Summary and Conclusion

The current study aims to find out the linkage between the real economic
variables and the movement of the stock market. These variables are the
foreign direct investment, GDP growth rate ,GDP per capita and NSE Nifty Bin
India. On the basis monthly data between of March, 2005 to March, 2015, the
study attempts to test the influence of these variables on the sensitive index
Nifty 50 of national stock exchange.
From the corelation analysis if is found that coefficient of corelation is positive
of all analysis, it can be say that that all economic indicator are positively
corelated.

The coefficient of corelation is highest for the GDP per capita and Nifty 50
which shows that both are strongly corelated that is if one variable increase
then second follow the other. Per capita gross domestic product (GDP)
measures a country's economic output per person and is calculated by
dividing the GDP of a country by its population.

There can be various for this for the GDP per capita strongly related to Nifty
50, when people earn more then it may be say that they start investing in the
stock market by which the liquidity increases hence the stock market grow.

Other variable such as GDP and FDI are positively related to the stock market,
when GDP growth rate are higher and FDI inflow increases then the stock
market indices follow the trends.

The study reconfirms the traditional belief that the real economic variables
continue to affect the stock market in the period of March, 2005 to March,
2015 in India and also highlights the insignificance of certain variables with
respect to stock market. This has an important lesson for the national policy
makers, researchers, corporate managers and regulators.

Recommendations
In order to promote the stock market, there was several suggestions to be
discuss as following:
(1) Government could promote the foreign direct investment (FDI) in various
sector. By doing so, it was help to attract greater volume of FDI flow into India
which will affect the economic in positive ways.
(2) Money should be maintain at specific level to avoid inflation and deflation
in the country.
(3) Export should be increased and exchange rate should maintain at constant
level to avoid weaken the rupees against dollars.
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