Macroeconomic determinants of stock markets: Indian case

The aim of this study is to investigate the relationships between the Indian stock market index (BSE Sensex) and three main macroeconomic determinants, namely, industrial production index, wholesale price index, and exchange rates to find out whether the economic fundamentals in India explain the stock prices behavior in the market and to what extent the Indian stock price responds to the changes in macroeconomic variables. The reason for this study is that an insignificant amount of research has been conducted for Indian stock market and economic factors since the economic reforms of 1991. Thus, in-depth studies are needed to understand the macroeconomic variables that might influence the Indian stock market due to the fact that India is among the fastest growing economies. Standard time series techniques such as, Johansen Co-integration and Vector Error Correction Model and Variance decompositions have been applied. The significance of this study is that it confirms the belief that macroeconomic factors continue to affect the Indian stock market, which is not always the case with other studies done in the same area. The analysis also reveals that macroeconomic variables and the stock market index are co-integrated and, hence, a long-run equilibrium relationship exists between them. It is observed that the stock prices positively relate to the industrial production and exchange rate but negatively relate to inflation. The results tend to indicate that the Indian stock market is driven by inflation rate and exchange rate (as evidenced by the variance decomposition analysis). This is an essential indicator to the policy makers, which will facilitate them to formulate policies.