The effect of Macroeconomic Determinants on the Performance of the Indian Stock Market


The study investigates the effect of macroeconomic determinants on the performance of the Indian Stock Market using monthly data over the period January 1991 to December 2011 for eight macroeconomic variables, namely, Interest Rate, Inflation, Exchange Rate, Index of Industrial Production, Money Supply, Gold Price, Silver Price & Oil Price, and two stock market indices namely Sensex and S&P CNX Nifty. By applying Augmented Dickey Fuller Unit root test, Johansen Cointegration test, Granger Causality test and Vector Error Correction Model (VECM), the study found that Interest Rate is I(0); Sensex, Nifty, Exchange Rate, Index of Industrial Production, Gold Price, Silver Price and Oil Price are I (1); and Inflation and Money Supply are I (2). It also found the long run relationship between macroeconomic variables and stock market indices. The study also revealed the causality run from exchange rate to stock market indices to IIP and Oil Price.


Financial markets play a crucial role in the foundation of a stable and efficient financial system of an economy. Numerous domestic and international factors directly or indirectly affect the performance of the stock market. The relationship between macroeconomic variables and a developed stock market is well documented in literature. The present study extends the existing literature in the Indian context. This study takes into consideration eight macroeconomic variables – Interest Rate, Inflation, Exchange Rate, Index of Industrial Production, Money Supply, Gold Price, Silver Price and Oil Price, and two widely used composite indices of the stock market of India – Sensex and S&P CNX Nifty.

Money supply and Inflation have a positive relationship among themselves. However, Money Supply and Inflation have a dual effect on stock returns. First, increase in Money Supply will increase Inflation, which will again increase expected rate of return. Use of high expected rate of return will decrease value of the firm and will result in lower share prices. Secondly, increase in Money Supply and Inflation increases future cash flow of the firm, which in turn, increases expected dividend, and will increase stock prices. For this reason, the relationship between Money Supply, Inflation and Stock Return need to be investigated.

A depreciation of the domestic currency against foreign currencies increases export, therefore exchange rate should have a negative relationship with the stock return. But, at the same time, depreciation of domestic currency increases the cost of imports which indicates a positive relationship between them. Hence, the relationship between exchange rate and stock returns needs to be checked. The Index of Industrial Production reflects the growth rate of industries. Positive relationship is expected between the Index of Industrial Production and Stock return. Gold and silver are used as investment avenues. Increase in gold and silver prices attracts investors towards the commodity market, which might decrease investor preference towards the equity market. This indicates that a negative relationship is expected between gold and silver, and stock market returns. For oil supply, India is dependent on the international oil market. Therefore, higher international oil prices increase cost of production, which might decrease profit of firms, and hence decreases stock prices. Therefore, the expected relationship between oil price and stock price is negative.

The aim of this paper is to investigate the effects of ma c ro e c onomi c de te rminant s on the performance of the Indian stock market. The remainder of the paper is organized in the following sections. Section 2 provides Review of Literature. Section 3 discusses Data and Methodology. Empirical Analysis is presented in Section 4. The study is concluded in Section 5.

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