Tenth AIMS International Conference on Management

January 6-9, 2013

Impact of GDP Growth Rate, Inflation Rate & Lending Interest Rate on Sensex Returns
Anand Patil Venkata Mahendra Prasad Kausar K anandp7@gmail.com venkatamahendraprasad@gmail.com kausar.kallur@gmail.com Alliance School of Management
The study aims to find the relationship between Gross Domestic Product Growth Rate, Inflation Rate and Lending Interest Rate on Sensex Performance. The study revealed that there is no significant relationship between the GDP Growth Rate, Inflation Rate & Lending Interest Rate on Sensex Returns. Key Words: GDP, Inflation, Interest Rate & SENSEX Performance

1. Introduction
No economic activity operates in a vacuum. Market reacts promptly and uncharacteristically to rumors of war, changes in regulatory environment. Fluctuating political climate is seen as a negative factor by the business (investing) community and variation of Interest Rate to general performance of the economy. Some of the factors influencing stock price behavior include company profits, political factors and economic performance. Others are Inflationary Rate, GDP, and Shareholder-level taxes. Financial investments associated with risk, with this context investors intend to identify whether portfolio diversification is applied or not. To compensate risk of investment while gaining profit there is a need of tools to understand the behavior of stock market. This study is an effort to help the investors to understand the relationship between the GDP Growth Rate, Inflation Rate, and Lending Interest Rate on Stock Market Returns. GDP Growth (Annual %): GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. Annual Growth Rate of GDP at market prices based on constant local currency, aggregates are based on constant 2000 U.S. dollars. Inflation, Consumer Prices (Annual %) : Inflation as measured by the Consumer Price Index reflects the annual percentage change in the cost to the average consumer, of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. Lending Interest Rate (%): Lending Interest Rate is the rate charged by banks on loans to prime customers. Almost every country in the world suffered their worst stock market declines as measured in real values, during a period of high inflation or hyperinflation as stocks and the other financial assets failed to keep up with the increases in the prices of goods. In addition, it also creates extreme volatility in stock market return. If the government lacks the power to resolve the inflation, the stock will collapse in its value. In addition, SENSEX returns represent activeness of the market. Unfortunately, SENSEX returns can be influenced by other macroeconomic activities and thus create the global phenomenon. Especially the current trend of increasing inflationary pressures, result in the rising international prices of energy and commodities. In Asia, Indian economy has gained importance in the last few years. The Indian stock market is often measured by Sensex and Nifty. The Study of relationship of GDP Growth Rate, Inflation Rate & Lending Interest Rate on the Sensex Performance will become a tool for researcher or policy maker to make further decision on analyzing the key economic indicators for the countrys economy. This paper intends to assess the impact of GDP Growth Rate, Inflation Rate & Lending Interest Rate on Sensex Returns.

2. Literature Review
There has been extensive research across the world with regard to the impact of macroeconomic factors on stock market returns. Some of the relevant literature is reviewed in the following. Maysami et al (2004) studied the long-term interrelationship between selected macroeconomic variables, including inflation, industrial production, money supply, exchange rates and interest rates, and the Singapore 1531

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stock market index, using vector error correction model. They concluded that all the above macroeconomic variables have an impact on the Singapore stock market index. Oskenbayev et al (2011) investigated the causal relationship between macroeconomic indicators, including the index of industrial production, inflation, exchange rate, oil prices volatility, volume of trade and long & short term interest rates, and the Kazakhstan Stock Exchange (KASE). They measured the long-term relationship using Autoregressive Distributed Lag model, while they used the Johansen co-integration test and Granger causality test for identifying the equilibrium relationship. Naka et al (1998) studied the impact of macroeconomic variables, including the index of industrial production, consumer price index, narrow money supply-M1, and money market rate in the Bombay interbank market, on Indian stock markets. They used vector error correction model (VECM) for this purpose. They found domestic inflation and domestic output growth to be key macroeconomic indicators affecting Indian stock markets. Ray and Vani (2003) performed a similar study on Indian stock markets. Their study considered macroeconomic variables such as the index of industrial production, broad money supply (M3), fiscal deficit, wholesale price inflation, INR/USD exchange rate, SBI prime lending rate, and Foreign Institutional Investments. They used Vector Auto Regressive and Artificial Neural Networks in their analysis. The study identified the index of industrial production, inflation, money supply, exchange rates and interest rates as key real economic variables affecting Indian stock markets. Singh (2010) examined causal relationships between macroeconomic variables and Indian stock markets. He considered three macroeconomic variables, IIP, WPI and exchange rates. He applied Granger causality test for this purpose. He found that IIP was the only macroeconomic variable causing changes in SENSEX. Dash and Rao (2011) found that the APM did not have significant better explanatory power over the CAPM for Indian capital markets. Apart from the market factor, they found that interest rates (the MIBOR factor) have a significant role to play in influencing asset returns; but the market factor was found to be the most influential of the factors, more than twice as important as interest rates.

3. Objective of the Study

The Paper aims to achieve the following objectives: 1. To study the relationship between SENSEX returns with respect to GDP Growth Rate, Inflation Rate and Lending Interest Rate. 2. To find the level of significance between SENSEX returns with GDP Growth Rate, Inflation Rate and Lending Interest Rate.

4. Research Design
Nature of the Study 1. The research carried out will be descriptive in nature for the better understanding of the undertaken research analysis. 2. The research will also use Vector Auto Regression Model, to find out the significance level between the variables under study. 3. The data regarding SENSEX returns, GDP Growth Rate, Inflation Rate, Lending Interest Rate will be taken for the last 15 years for the study. Collection of data 1. Information regarding GDP Growth Rate, Inflation Rate, Lending Interest Rate, and SENSEX Returns would be collected from the websites of Ministry of Finance, Economic Survey of India, BSE India, World Bank and RBI. 2. Books will be referred to support the formation of certain conceptual definitions and in-depth knowledge of the subject. 3. Journals, Magazines and Newspapers will be used to accumulate the latest information about the variable under this research.

5. Methodology
The present study was carried out to analyse the impact of GDP Growth Rate, Inflation Rate & Lending Interest Rate on the Sensex returns. Yearly data of various macroeconomic variables, viz. GDP Growth Rate, Inflation Rate (Wholesale Price Index), Lending Interest Rate were collected for the 15 year period 1997-2011 from the World Bank website. The study was conducted on BSE SENSEX. Yearly closing SENEX values were collected from the official website of the Bombay Stock Exchange. 1532

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At the outset, the Dickey-Fuller Unit Root Test was carried out to check for the stationarity /non-stationarity of the variables. It is based on the following model: Yt = Yt-1+ut with rejection of the null hypothesis of a unit root if is significant and negative. The study used a vector autoregressive (VAR) model to test for the impact of the macroeconomic variables on Sensex returns. The unrestricted VAR model is given as follows:

St = +

1j.GDPt-j+

2jWPIt-j+

3jIRt-j+t

In the model, St Represents SENSEX returns, GDP represents percentage change in the Gross Domestic Product Growth Rate, WPI represents the change in Inflation Rate, and IR represents the percentage change in Interest Rate. The model used two-yearly lags for Inflation Rate & Interest Rate, one-yearly lags for GDP Growth Rate as determined from the auto-correlation functions. The F-test of the VAR output was performed to determine the significance of the impact of each macroeconomic variable on SENSEX returns.

6. Data Analysis & Findings

Data
Table 1 Raw Data

Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

GDP 4.9 4 8.5 6.2 4 9.3 9.3 7.8 7.9 3.9 6.9 9.6 8.2 3.9 9.8

Inflation 3.7 4 4.7 13.2 7.2 6.1 4.2 3.8 3.8 4.4 8.9 12 10.9 8.4 6.4

Interest Rate 12.1 12.3 12.5 13.5 13.8 11.2 10.8 10.9 11.5 11.9 10.2 8.3 12.2 13.3 13

SENSEX 3,659 3,055 5,006 3,972 3,262 3,377 5,839 6,603 9,398 13,787 20,287 9,647 17,465 20,509 15,455

Source World Bank

Data after Dickey-Fuller Unit Root Test to check for the stationarity /non-stationarity of the variables
Table 2 Results of Unit Root Test after Creating Lags

GDP 4 8.5 6.2 4 9.3 9.3 7.8 7.9 3.9 6.9 9.6 8.2 3.9 9.8

D Inflation 0.7 8.5 -6 -1.1 -1.9 -0.4 0 0.6 4.5 3.1 -1.1 -2.5 -2

D Interest Rate 0.2 1 0.3 -2.6 -0.4 0.1 0.6 0.4 -1.7 -1.9 3.9 1.1 -0.3

Sensex -16.5 63.83 -20.65 -17.87 3.52 72.89 13.08 42.33 46.7 47.15 -52.45 81.03 17.43 -24.64

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VAR Model Description Model Name Series Name MOD_4 GDP growth DIFF(Inflation,1) DIFF(InterestRate,1) SENSEX Returns Transformation None Non-Seasonal Differencing 0 Seasonal Differencing 0 Length of Seasonal Period No periodicity Maximum Number of Lags 16 Display and Plot All lags Applying the model specifications from MOD_4 1 2 3 4

Results of VAR Model

Exhibit 1 Partial Autocorrelations; GDP Growth Rate

Exhibit 2 Partial Autocorrelations; Inflation Rate

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Exhibit 3 Partial Autocorrelations; Interest Rate

Exhibit 4 Partial Autocorrelations; SENSEX Returns VAR Model Results Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 .445a .198 -.069 43.28445 a. Predictors: (Constant), DIFF(Interest Rate,1), DIFF(Inflation Rate,1), GDP Growth Rate ANOVAb Model Sum of Squares df Mean Square F Sig. .553a Regression 4172.474 3 1390.825 .742 1 Residual 16861.890 9 1873.543 Total 21034.364 12 a. Predictors: (Constant), DIFF(Interest Rate,1), DIFF(Inflation Rate,1), GDP Growth rate b. Dependent Variable: SENSEX Returns

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Table 3 Results of VAR Model; Summary

Coefficientsa Unstandardized Coefficients Standardized Coefficients Model B Std. Error Beta t Sig. 1 (Constant) .651 45.824 .014 .989 GDP growth 2.707 6.020 .142 .450 .664 DIFF(Inflation,1) -.943 3.520 -.081 -.268 .795 DIFF(InterestRate,1) 11.690 8.167 .453 1.431 .186 a. Dependent Variable: SENSEX Returns GDP Growth Rate
Table 4 Results of VAR Model; GDP Growth Rate Unrestricted Model Model Regression 1 Residual Total Restricted Model Model Regression Residual Total ANOVAb Sum of Squares df 4172.474 3 16861.890 9 21034.364 12 ANOVAb Sum of Squares df 3793.670 2 17240.694 10 21034.364 12 Mean Square 1390.825 1873.543 F .742 Sig. .553a

Mean Square 1896.835 1724.069

F 1.100

Sig. .370a

F-Test F Calculation: 0.202186 P Value: 0.663596 From above we can infer that the results are not significant. Hence we can state that GDP has no impact on SEXSEX returns. Inflation Rate
Table 5 Results of VAR Model; Inflation Rate Unrestricted Model Model Regression 1 Residual Total Restricted Model Model Regression Residual Total ANOVAb Sum of Squares df Mean Square 4172.474 3 1390.825 16861.890 9 1873.543 21034.364 12 ANOVAb Sum of Squares df Mean Square 4037.951 2 2018.975 16996.413 10 1699.641 21034.364 12 F .742 Sig. .553a

F 1.188

Sig. .344a

F-Test F Calculation: 0.071801 P Value: 0.794772 From above we can infer that the results are not significant. Hence we can state that Inflation has no impact on SEXSEX returns.

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Interest Rate
Table 6 Results of VAR Model; Interest Rate

Unrestricted Model Model Regression 1 Residual Total Restricted Model Model Regression Residual Total ANOVAb Sum of Squares df Mean Square 4172.474 3 1390.825 16861.890 9 1873.543 21034.364 12 ANOVAb Sum of Squares df Mean Square 333.823 2 166.912 20700.541 10 2070.054 21034.364 12 F .742 Sig. .553a

F .081

Sig. .923a

F-Test F Calculation: 2.048872 P Value: 0.186114 From above we can infer that the results are not significant. Hence we can state that Interest Rate has no impact on SEXSEX returns.

The result of the unit root test was significant for GDP Growth Rate & not significant for Inflation Rate & Lending Interest Rate, hence the lags were created for Inflation rate & Lending Interest Rate, which later indicated that all of the time series were stationary. This validates the application of vector autoregressive modeling in the present context. The results of the Ftest of the Vector Autoregressive Model indicate that GDP Growth Rate, Inflation Rate & Lending Interest Rate to have no significant impact on the SENSEX returns.

7. Limitations of the Study

1. 2. 3. The study has considered only the Annual Data for past 15 Years. The study has considered only 3 Macro Economic Indicators. The results of the same study may vary if Weekly or Monthly data is considered.

8. Conclusions
This study focus mainly to reinvestigate the impact of GDP Growth Rate, Inflation Rate, Lending Interest Rate on Sensex Returns. There is no significant relationship between these variables. Hence any change in these macro variables would not have an impact on Sensex Returns. Though the results of the present study are interesting, there is scope for further study in examining the impact of other macroeconomic variables, as well as in examining the pre- and post- global financial meltdown investment scenarios.

9. References
1. Caroline Geetha , Rosle ,Mohidin Vivin Vincent Chandran Victoria Chong "The Relationship Between Inflation And Stock Market: Evidence From Malaysia, United States And China. International Journal Of Economics And Management Sciences Vol. 1, No. 2, 2011, Pp. 01-16. Daferighe. Emmanuel E " An Impact Analysis of Gross Domestic Product , Inflation, and Interest Rates on Stock Prices of Quoted Companies in Nigeria Kendall, M.G. (1953), The Analysis of Economic Time Series- Part I: Prices, Journal of the Royal Statistical Society, vol. 116(1), pp. 11-34. Mossin, J. (1966), "Equilibrium in a Capital Asset Market," Econometrics 34. Naka, A., Mukherjee, T.K., and Tufte, D.R. (1998), Macroeconomic variables and the performance of the Indian Stock Market, University of New Orleans, Department of Economics and Finance Working Papers. Ray, P. and Vani, V. (2003), What Moves Indian Stock Market: A Study on the Linkage with Real Economy in the Post-Reform Era, oii.igidr.ac.in:8080/dspace/bitstream/2275/123/1/prantik.pdf 1537

2. 3. 4. 5.

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7. 8. 9. 10.

Singh, D. (2010), Causal Relationship between Macro-Economic Variables and Stock Market: A Case Study for India, Pakistan Journal of Social Sciences, vol. 30(2), pp. 263-274. Sharpe, W. F. (1964), "Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk," Journal of Finance 19. www.bseindia.com www.worldbank.org

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