This project shows the relationship between Inflation and Indian Stock Market. 9 Consumer Price Index (CPI) - A measure of price changes in consumer 10 Therefore, 26 Correlation between Inflation and BSE Sensex. The purpose of the study is to know the relationship of SENSEX with Exchange Keywords: SENSEX, Exchange rate, Inflation, FII, WPI, Stock market, BSE. . The former represent investment for setting up new projects and hence is long term. 15+ million members; + million publications; k+ research projects relationships between BSE SENSEX with the macroeconomic variables. .. index (IIP) and inflation measured with WPI are the important factors which affect the.
Experts ET analyses how a high inflation rate has an adverse impact on the index. The inflation rate has started having an impact on the Sensex. The Sensex has started rocking because of the high inflation. With its widespread reach, inflation affects all aspects of the economy, and thereby the Sensex.
Last week, the markets fell after a sharp rise in food prices heightened concerns that the central bank may tighten the monetary policy more than expected.
The financial stocks were among the big losers as higher interest rates could douse the demand for loans and squeeze the margins of banks. The food price index rose The fuel price index climbed In the prior week, annual food and fuel inflation stood at The primary articles price index was up The Wholesale Price Index, the most widely watched gauge of prices in Indiarose 7.
FII plays a significant role in shaping market sentiments. FII affects both market sentiments and also exchange rate movements. In India FII plays an important role in defining the movement of stock market which is largely affected by exchange rate. The exchange rate is affected by domestic inflation and also the international demand for the home as well as other currencies. Another major reason of volatility in the stock market is value of currency.
A depreciating currency causes a decline in stock prices because of expectations of inflation and an appreciating currency causes increase in stock prices. A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money leads to inflation. Inflation represents an imbalance between the flow of incomes to people and the spending power available with them on the one hand and the availability of goods and services on the other.
How Inflation affects Sensex - The Economic Times
Inflation hit the different sectors of the economy in different manners. Inflation affects the corporate sector in terms of their profitability which affects the share prices of the company and thus the stock market. However inflation can be controlled by the mutual effort of government, RBI and corporate sector.
Government can curb the inflation by changing fiscal policy. RBI can curb the inflation with the help of changes in monetary policies. Inflation can be controlled by proper formulation of economic plans and determined implementation of the plans.
Besides this selective credit control and open market operations are also the instrument of credit control which is used by RBI to curb the inflation.
Foreign investment comes in India in two forms- foreign direct investment and foreign Institutional Investment. The former represent investment for setting up new projects and hence is long term in nature, the latter is in the form of purchase of securities in the capital market.
Participation of FII has made the market more innovative and competitive enabling the issuers of securities and intermediaries to grow. The International capital flows and capital controls have emerged as an important policy issues in the Indian context.
There are some terms which are necessary to understand the fluctuation of exchange rate like-appreciation, depreciation, devaluation and revaluation. If a country lowers the value of its currency in terms of another foreign currency, it is called devaluation while If a country raises the value of its currency in terms of foreign currency, it is called Revaluation.
Exchange rate of a currency is affected by the demand of that currency, inflation level and interest rate in that country. Suppose there is higher rate of inflation in India as compared to America then the US goods will become relatively cheaper and Indians goods expensive. This leads to Indian to import goods from US. This will raise the demand of US dollar because we can purchase US goods in dollars.
At the same time higher price level of Indian goods will leads to American people to reduce the import of Indian goods. This will decrease the demand of Indian rupee because Indian rupee is needed to purchase Indian goods.
Thus as a result of higher rate of inflation in India, the US dollar will appreciate and the Indian rupee will depreciate. Balance of Payment and Exchange Rate Ideally the exchange rate between two currencies should be determined by the balance between exports and imports of the two countries.
That is, the exchange rate is function of both current account movement in the balance of payment as well as capital account movements. Moreover, the moment foreign currency itself becomes a commodity beyond just being a medium of exchange; arbitrageurs enter the market and tend to affect the rates. Beyond the spot market, future market and option market develop which in turn also affect the exchange rate.
Interest Rate and Exchange Rate Another important factor influencing the exchange rate is the interest rate in a country relative to interest rate of other countries with which it trades its goods. For example a relatively higher interest rate in India as compared to US would lead to the depreciation of dollar and appreciation of rupee.
Fama and Schwert had done research to study the Vol. They analyzed the relationship between stock market and inflation over the period of time from to In their research, they found that the common stock returns are negatively related to inflation.
The multivariate regression analysis helps to understand the impact of macroeconomic factors on Indian stock market.
The data used in the study is in the monthly frequency and period of the study has been considered from April to December Necessary data are collected from secondary sources. The Principal Component Technique after using varimax rotation extracted three factors labelled intuitively as Macro Environment, Economy rates and Foreign Investment.
It has been established that all factors play significant role in influencing the stock market. Since in Indian economy, with the waves of economic reforms Indian capital market has witnessed changes, on adoption of liberalization and globalization policies by the Government. By stabilising the financial sector, an efficient capital market drives the economic growth, which plays a crucial role in the foundation of a stable and efficient financial system of an economy.
It also plays a major role in financial intermediation in both developed and developing countries. From aggregate economy point of view, there is growing importance of the stock market.
Presently, stock markets have become a key driver of modern marked based economy and is one of the major sources of raising resource for Indian corporate, thereby enabling financial development and economic growth. Directly or indirectly numerous domestic and international factors affect the performance of the stock market. By channelizing capital toward investors and entrepreneurs, a healthy and flourishing stock market can be considered relevant of national economic growth.
Actually, Indian stock market is one the emerging market in the world. These stock markets of emerging economies like India are characterised as the most volatile stock markets. Further, the stock markets of emerging economies including India are sensitive to factors such as changes in the level of economic activities, changes in political and international economic environment and also related to the changes in other macroeconomic factors.
The 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. Page 8 Sometimes, share prices can seem divorced from economic factors as movements in the stock market can be quite volatile.
Some underlying factors having strong influence over the movement of share prices and the stock market in general. For any investor in the stock market, Volatility is the main worry as their return depend on various functions in the economy system. It is one of the most important characteristics of any stock market, which is also an important basic statistical risk measures.
Volatility can be used to measure the market risk of a single instrument or an entire portfolio of instruments. This can be expressed in different ways, statistically, volatility of a random variable is its standard deviation. In day-to-day practical life, it is calculated for all sorts of random financial variables such as stock returns, interest rates, the market value of a portfolio, etc.
This is to take the average range for each period, from the low price value to the high price value. This range is then expressed as a percentage of the beginning of the period. Larger movements in price creating a higher price range result in higher volatility.
Lower price ranges result in lower volatility. Volatility makes investors averse to hold various stocks due to increased uncertainty in stock markets. In turn, Investors demand higher risk premium so as to cover increased risk resulted because of market volatility. All this crowns in increase in cost of capital, which consequently lowers physical investment and affects growth of economy negatively. For investors in general and policy makers, Volatility of stock market is matter of serious concern, because it creates panic situation in the market especially for the last two decades.
Its study is always a serious concern for analysts and researchers because high degree of volatility can affect the smooth functioning of any stock market. This also affects the economic growth and development of the economy through its effect on investor's confidence and risk taking ability.
How Inflation affects Sensex
The worldwide researchers have attempted to identify the major factors affecting the level of volatility in the stock markets.
The theoretical and empirical literature suggests that the main source of volatility in any stock market is the arrival of new information or news. Page 9 New classes of investors, Rapid financial innovations, regulatory and non-regulatory reforms, SEBI interventions, globalization of Indian capital market, etc. The new participants and the new market environment, together have impacted the market structure which in return resulted in high volatility. 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.
Time variations also have a important role in market volatility which 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. Factors That Affect Volatility Contribution of Region and country economic factors, such as tax and interest rate policy, to the directional change of the market and thus makes volatility.
For example, the central bank sets the short-term interest rates for overnight borrowing by banks. When they change the overnight rate, it may cause stock markets to react, sometimes violently. Changes in inflation trends influence the long-term stock market trends and volatility.
Increased stock market volatility can also be caused by Industry and sector factors. For example, in the oil sector, a major weather storm in an important producing area can cause prices of oil to jump up.
As a result, the price of oil-related stocks will follow suit.
Some benefit from the higher price of oil, others will be hurt. This increased volatility affects overall markets as well as individual stocks. A strong relationship exists between volatility and market performance. Volatility tends to decline as the stock market rises and increase as the stock market falls. When volatility increases, risk increases and returns decrease. The aim of this paper is to investigate the impact of Macroeconomic Variables on Indian stock market.
Two main stock exchanges in India are: This methodology was changed in to free float market capitalization. Independent Variables A brief description about the role of selected macroeconomic variables in Indian economy: Inflation is one of those macroeconomic variables that affect every Indian citizen, irrespective of an investor, borrower or lender, almost every day.
Inflation is seen as negative news by the stock markets, because it tends to curb consumer spending and therefore corporate profits. It also affects the value of the domestic currency adversely in the foreign Page 11 exchange markets. This rate is fully market-driven and dependent on the demand- supply equilibrium relationships.
Changes in the CMR affect the Indian stock markets by affecting the corporate profits, general demand for goods and services in the economy.
Exchange rates play a vital role in a country's level of trade, which is critical to every free market economy in the world. For this reason, exchange rates are among the most watched analyzed and governmentally manipulated economic measures. A higher currency makes a country's exports more expensive and imports cheaper in foreign markets; a lower currency makes a country's exports cheaper and its imports more expensive in foreign markets. The stock market will get benefit when the domestic currency value is appreciating.
Institutional investors consist of hedge funds, insurance companies, pension funds and mutual funds. The term is used most commonly in India to refer to outside companies investing in the financial markets of India.
International institutional investors must register with the Securities and Exchange Board of India to participate in the market. FII is allowed to enter into our country only through stock exchanges either in the form of equity or debt.
The daily transaction of FII is the reason behind the volatility in the stock markets movement to a greater extent. Monetary aggregates, known also as "money supply", is the quantity of currency available within the economy to purchase goods and services. M3 is a broad monetary aggregate that includes all physical currency circulating in the economy banknotes and coinsoperational deposits in central bank, money in current accounts, saving accounts, money market deposits, certificates of deposit, all other deposits.
It may be favorable or unfavorable for a country. It affects their currency relative value. The large trade deficits are perceived as problematic for an economy, but not the smaller ones.
If it is favorable will generate a confidence among the investors.