European Journal of Scientific Research ISSN 1450-216X Vol.38 No.1 (2009), pp.96-103 EuroJournals Publishing, Inc. 2009 http://www.eurojournals.com/ejsr.

htm

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
Sulaiman D. Mohammad Associate professor, Federal Urdu University of Arts, Science and Technology, Karachi E-mail: Suliaman1959@gmail.com Adnan Hussain M.Phil Fellow, Applied Economics Research Centre, University of Karachi E-mail: adnanaerc@gmail.com M. Anwar Jalil M.Phil Fellow, Applied Economics Research Centre, University of Karachi E-mail: majalilonline@yahoo.com Adnan Ali M.Phil, Fellow, Applied Economics Research Centre, University of Karachi E-mail: adnanaliabbasi@hotmail.com Abstract The purpose behind this study is to explore the correlation among the macroeconomics variables and share prices of KSE (Karachi Stock Exchange) in context of Pakistan. The study consider several quarterly data for different macroeconomics variables are as foreign exchange reserve, foreign exchange rate, industrial production index (IPI), whole sale price index (WPI), gross fixed capital formation (GFCF) and broad money M2. These variables are obtained from the period 1986-2008. The result shows that after the reforms in 1991 the influence of foreign exchange rate and foreign exchange reserve significantly affect the stock prices, while other variables like IPI and GFCF are insignificantly affect stock prices. The result also highlighted the internal factors of firm like increase in production and capital formation insignificant while external factor like M2 and foreign exchange affect positively. The study will be very helpful for national policy makers, researchers and corporate managers.

Keywords: Stock prices, Macroeconomics variables

Introduction
In modern economy the role of stock exchange is very important. It can be very helpful to diversify the domestic funds and channels into productive investment, however to perform this important task it is very necessary that stock market have significant relationship with the macroeconomics variables. Nowadays capital market became a key element of modern market based economy. They transfer the long term funds from savers to borrowers of capital which is very essential for economic development.
Electronic copy available at: http://ssrn.com/abstract=1683357

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)

97

Economic growth and prosperity is possible only when capital market works efficiently. After the globalization international capital markets are integrated rapidly. This integration has positive affects on economic growth, reducing the risk and especially contagion impact on financial crises. The EMH (efficient market hypothesis) suggests that all the necessary or relevant information to investors about profit maximizing and the macroeconomics variables fall the possibility of earning supernormal profit. Therefore the stock prices are fully reflecting the current position of macroeconomics variables. (Chong and Koh 2003). The portfolio managers and investment advisors are not able to help the investors to earn supernormal profit continually. If EMH is continually follow in stock market the role of stock brokerage firms diminishes gradually. Stock market plays the vital role to transfer of funds from capital borrowers to capital investors which is very essential for economic growth. In other words the stock market is very significant to speed up economic growth through increasing liquidity of financial assets and diversification of global risk easier for investors to make a wiser investment decision. (Agrawalla 2006). A well performing stock exchange is very helpful for economic activity through growth and saving, efficient allocation of investment and attracting FDI (foreign direct investment). The stock market gives confidence to savers by providing domestic house- holds having invest able funds, innovation in financial instruments, which diversify their risk and better sharing in investment projects (Agrawalla 2006).

II. History of KSE (Karachi Stock Market)

Since the independence (1947) a number of problems have been stood in the way of economic growth and development in Pakistan. In which included social, economic and political problems such as increasing population, bureaucratic problem, policy inconsistency, violence and political instability. Economic problems include unproductive tax rate, delicate custom duties which adversely affect foreign investment. Pakistan government strategic approach is also towards closed the economy. As discussed that Pakistan has been faced socio and political problems. In 1991 economic reforms were taken to resolve these problems. The most important reforms were to liberalize the stock markets for foreign investors and allowing first time in the history of Pakistan foreign direct and indirect investment landing. These reforms had positive impact on stock market index. Karachi stock exchange (KSE) is the largest and most dynamic stock exchange in Pakistan. The share of KSE is about 70 percent of total stock transition. On October 1, 2004, there are 663 companies were registered or listed in KSE. The market capitalizations were $23.23 billion. Pakistan foreign investment and industrial export is rapidly grown. Pakistan foreign exchange reserves reached $12.327 billion in 2003-04. Nowadays our all stock markets traded on international market. SECP (Security and exchange commission of Pakistan) has permitted foreign and local brokerage houses to make joint ventures which give the newfound interest in the Pakistan stock markets. In Pakistan, Karachi Stock Exchange is a leading stock exchange. It was stated the Best Performing Stock Market of the World for the year 2002. The KSE 100 Index reached at 5315.82 on 1st October 2004. KSE has been ranked for three years of being one of the Best Performing Markets of the world as ranked by Business Week which is an international magazine. As well as a leading US newspaper, USA Today mentioned Karachi Stock Exchange as one of the best performing stock exchange in rest of the world. Karachi stock exchange attained a major landmark when KSE-100 index had reached at the psychological level of 15500 for the first time in the history and later on reached at 15737.32 on 20 April 2008 but due to recent financial crises KSE declined to 9000 because of larger foreign capital outflows. Around 654 companies were listed at KSE with market capitalization of US $ 33.81 billion on September 25 2009.

Electronic copy available at: http://ssrn.com/abstract=1683357

98

Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

Literature Review
Dr. Nishat (2004) evaluates long term association among macroeconomic variables, stock prices and employed money supply, CPI, IPI, and foreign exchange rate as explanatory variable. The result shows that there are causal relationships among the stock price and macroeconomics variables. The data used in this study from 1974 to 2004. Most of the time series data is nonstationary therefore unit root technique is used to make data into stationary. The result also indicates that industrial production is significantly affects to macroeconomic variables. Nishat used Karachi stock exchange 100 index price from 1974 to 2004. Grange causality test is used to find the correlation among the variables the result of granger causality shows that interest rate is not granger cause by stock price. Shahid Ahmed (2003) empirically investigated on SENSEX index price affects due to real and financial sector performance in Indian economy, the data has been chosen from the period 1997 to 2007. The study consists variables export and foreign exchange rate and foreign direct investment. Granger causality test is used to find out the causal relationship between the variables. All the variables are Granger cause to stock prices. Speculation in the market was analysis with the help of AR (Auto Regressive) which was highly significant according to the result. Fazal Hussain and Tariq Masood (2001) used variables investment, GDP and consumption employing granger causality test to define the relationship among the selected variables and stock prices, finding shows at two lags of all variables are highly significantly effect on stock prices. Robert D. gay (2008) evaluated the association among stock prices and macro economics variables in cases of China, India, Brazil and Russia which are emerging economies of the world using Oil price, exchange rate, and moving average lags values as explanatory variables employing MA (Moving Average) method with OLS (Ordinary least square) and found insignificant results which postulate inefficiency in market. Finally they concluded that in emerging economies the domestic factors influence more than external factors i.e. exchange rate and oil prices. Dr. Aftab (2000) examines the association between monetary and fiscal policy of Pakistan to equities market and the result of his analysis is significant. The result shows that fiscal and monetary policy could change market capitalization by liquidity and equity which can significantly effect the market capitalization and stock prices in case of Pakistan from the period 1993 to 1998. Liaquat Ali and Nadeem Ahmed (2008) used data from 1971 to 2006 and try to find out the relationship of economic growth with stock market prices and study shows that there are dynamics association between stock prices and economic growth employing DF-GLS test first time in case of Pakistan. M. Shahbaz (2006) investigated the association between stock prices and rate of inflation using ARDL approach for dynamics analysis. Result of this study depicts that stock hedges are not in favor of inflation in long run as well as in short run and found that black economy effects long run and short run prices of the stock. The study used variables CPI, (inflation) and share of black economy the sample size of the study is 1971-2006. Safail Sharma (2007) used interest rate, exchange rate and reserve, industrial production index, monetary growth and inflation as independent variables with AR and MA to nullify the effects of non stationary in the variables. The result shows that lags values are highly connected with current share prices which recommend the speculation in market. Exchange rate and reserve, industrial production index and monetary growth are significantly associated. The study took data set from 1986 to 2004. Desislava Dimintrova (2005) used multivariate model and try to find out link among stock prices, exchange rate and economics policy (fiscal and monetary policy). The study defines the interest parity condition affects on stock prices. The result shows that ambiguous affects of deprecation on stock prices.

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)

99

IV. Econometrics Methodology and Data Base

4.1. Data Base The assets valuation model and pricing of macroeconomics variables Stock prices and foreign exchange rate and reserve: the positive relation between foreign exchange and stock price is found. FDI is increased if there is liberalization of stock market prevailed in any economy which may cause to increase FDI and raise stock prices.
= + / r + = ps

Where = is total gain which equal to price of share = net dividend / profit = capital gain r = real interest rate = Risk premium ps = price of shares As stock market is liberalized it can cause to reduce the risk premium and increase competitions in stock market ultimately stock prices have been increased. As foreign exchange currency inflows resulting increases in supply which can cause to appreciate local currency consequently prices of share increase and that improve foreign exchange reserves which cause to appreciate exchange rate while other factors remain constant. Stock prices and interest rate: increase in interest rate cause to increase opportunity cost of holding money which can cause to change portfolio diversification between stock and interest bearing securities as a result stock prices fall. Another reason for falling stock prices is that when interest rate increases it can cause to raise cost of production which deteriorate companies profit and dividend results reduce the prices of shares. Stock market and money supply: increase in money supply cause to increase in inflation therefore people maintained there real cash balances consequently they sell shares and other assets which cause to decline the share prices but on the other hand increase in monetary growth reduces the interest rate which cause to reduce cost of capital and increase earning of corporation. Industrial production index and stock prices: the IPI and stock prices are positively related because increase in IPI cause to increase in production of industrial sector which cause to increase the profit of industries and corporations. As dividends increase resulting share prices raise therefore it is found positive association between IPI and share price according to economic theory. Gross fixed capital formation and share price: gross fixed capital formation is defined as fixed assets accumulation. Assets accumulation are increased by bonds financing and equity financing, if corporations want to finance assets they float their shares in stock market as a result supply of shares increase which cause to decline share prices. On the other hand when assets financing is increased by purchasing of bonds consequently firms/corporations credit become worthiness. Economic theory suggests that increase in Gross fixed capital formation cause to decline share prices in short run but in long run production is increased which cause to raise share prices. (1) LSP= 1 + 2 LEXERS + 3LRER + 4 LGFCF + 5LIIP+ 6 LIR+ 7 LM2 + 8 LWPI+ All the variables are taken in a form of monthly data. The data is taken from IFS (International Financial Statistics) from various issues and Economic Survey of Pakistan. The sample size of data is taken from the period 1987-2007. The logic behind of it that the sample period 1987-2008 and 1991 the era of reforms of financial sector and liberalization of stock markets in Pakistan.

100

Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

4.2. Econometrics Methodology The study consists time series data for econometrics analysis so several preliminary statistical steps must be taken. The steps included descriptive statistics, unit root, and Auto Regressive Integrated Moving Average (ARIMA) model testing. The nature of time series data found non stationary in many cases therefore it is necessary to check stationary of the data. Stationary is defined as mean and variance of the data is zero and constant respectively. The ADF (Augmented Dicky Fuller) test is used to analyze the stationary of variables. The model of ADF is used as follow r = + rt j + at + rt 1 + (2) Here null hypothesis is non stationary and alternative hypothesis is stationary. To check stationary of all the macroeconomic variables by ARIMA to change them into stationary.

V. Result Analysis
The empirical result or evidence provided by the various studies mentioned in the section of review literature shows that macroeconomics variables have strong effect the stock market. On the other hand Karachi stock market is declared to be inefficient collaborator with respect to the most macroeconomics variables. If market is ineffective with respect to information then it has essential to analysis the statistical inconsistency of the variables. As shown in table no. 1
Table 1: Statistical Discrepancy
SP 127.6368 103.56 299.21 34.57 78.14981 0.972571 2.73852 14.12381 0.000857 88 EXCRES 3553.989 1322 14435 213 4217.17 1.163066 2.669788 20.23975 0.00004 88 EXR 39.89068 39.765 64.15 15.98 16.81541 0.019702 1.386929 9.546355 0.008453 88 GFCF 110574.6 89578.5 396551 17259 88349.3 1.241375 4.173968 27.65491 0.000001 88 IIP 105.5122 92.29 232 52.52 43.29091 1.104169 3.264533 18.13803 0.000115 88 IR 8.030114 7.89 15.42 1.05 3.050957 0.175299 2.924647 0.471524 0.789969 88 M2 400084.3 395424 1043700 69875.9 280527.7 0.411707 2.089966 5.522628 0.063209 88 WPI 81.3842 84.305 164.25 27.94 38.89997 0.274529 1.960819 5.064995 0.07946 88

Mean Median maximum minimum Std. Dev. Skewness Kurtosis Jarque-Bera probablity observation

As mentioned in above table no.1 that all the variables are positively skewed which show that they are asymmetrical. Kurtosis values of all variables also show that the data is not normally distributed because values of kurtosis are deviated from 3. So the descriptive statistics shows that the values are not normally distributed about its mean and variance. It is said that no randomness in the data therefore, being sensitive to speculation shows periodical changes. This indicated that individual investors can earn considerably higher rate of profit from the Karachi Stock Market. Hence the results of descriptive statistics raise the issue the inefficiency of market. The funds and investment in market are not allocated to the productive sector of the economy. The result of unit roots test suggested that data/variables are not stationary at level except gross fixed capital formation other wise all variables are non stationary at level but they are stationary at first difference level. The value is 5% level significant of first difference level. ADF method is used to find out stationary of data as suggested in section 5 of this paper.

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
Table 2: Unit root test / Augmented Dicky Fuller test
At level -1.426297 3.311289 -1.335140 -1.647429 1.797305 -1.621632 -0.978078 -0.250161 At first difference -3.923520* -5.618675* -4.189409* -9.058792* -13.81579* -4.723153* -6.420688* -4.120358*

101

Variables Share price Gross fixed capital formation Foreign exchange reserve Interest rate Industrial index of production Whole sale price index (wpi) M2 (Broad Money) Foreign Exchange rate

Table 3:

Dependent Variable: SP
Coefficient 462.2149 0.983048* 0.983110* Std. Error 729.6082 0.035285 0.012342 t-Statistic 0.633511 27.85994 79.65724 Prob. 0.5281 0.0000 0.0000

Variable C AR(2) MA(1) Significance level at 5%

As evident from table-3 Karachi stock share prices are autoregressive of order 2 and highly significant, moving average is also very highly significance shows that prices are highly seasonal. Thus studying the impact of macroeconomics variables lagged prices of Karachi stock exchange are also taken as independent variables.
Table 4: Dependent Variable: SP
Std. Error 47.72902 0.002749 1.125605 9.09E-05 0.086775 0.595195 1.86E-05 0.813718 0.075523 0.001822 t-Statistic 1.067134 1.673216 -2.156000 -1.471965 1.740394 -2.087007 -1.931914 2.963239 10.86930 543.0924 Prob. 0.2893 0.0984 0.0356 0.1452 0.0858 0.0402 0.0571 0.0041 0.0000 0.0000

Variable Coefficient C 50.93326 EXCRES 0.004599** EXR -2.645900* GFCF -0.000134 IIP 0.151023** IR -1.242176* M2 -3.59E-05* WPI 2.411239* AR(2) 0.820881* MA(1) 0.989783* *Significance level at 5% **significance level at 10%

Further analysis also reported in table-4 exhibits foreign exchange rate is highly significance at 4% level. It is found that negative relationship with KSE which shows that foreign institutions investment has been significant factor affecting the stock market prices, as foreign investment increases results foreign exchange reserves also increases thus exchange reserve is positively related with stock price at 10% significance level. IPI is also significance at 9% level which suggested that as industrial production increases consequently stock prices increase. Interest rate is negatively related with stock prices as interest rate increases as a result stock prices fall down which is defined in section 4.1. Interest rate is significantly effect at 4% level. M2 is negatively related with stock prices and significant at 6% level.

102

Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

VI. Conclusion
The result of this study pointed out that changes in macroeconomics variables are not trading rule by investors to gain continually supernormal profits in the stock exchange market. The result of AR (Autoregressive) and MA (Moving Average) suggest that current as well as past knowledge about the development of variables are also incorporate with share prices. Thus, the investors are not able to generate supernormal profit using the available information. The main objective of this research paper is to study the association between macroeconomics variables and Karachi stock markets shares prices. For this purpose the quarterly data of foreign exchange rate, foreign exchange reserve, gross fixed capital formation, M2, Call Money Rate (interest rate proxy), Industrial production index and whole sales price index (proxy of inflation) have been chosen. The result shows that exchange rate and exchange reserve highly affect the stock prices. It has been observed since the liberalization in 1991 of stock markets in Pakistan has largely increased stock prices in Pakistan. The empirical result also suggests that IR and M2 is also significant and negatively effect to stock prices. However, few variables like IPI and GFCF neglect able effect to stock prices thus result suggested that increase in capital formation by firms and increase in industrial production do not affect stock prices.

Reference
[1] [2] [3] [4] [5] [6] [7] Shefali sharma and balwinder Singh (2007) share prices and macroeconomics variables in India, retrieved on Artja vijnana June 2007 Dr. Nishat (2004) Macro economics factors and Pakistan equity market retrieved by May 2004 Hasan fazal and Mehmood tariq (2001) the stock market and economy of Pakistan retrieved in PIDE (Pakistan institute of development economics) Stock Prices, Real Sector and the Causal Analysis: The Case of Pakistan (2004) retrieved by journal of management and social sciences Dr. Ayub mehar Stock market consequences of macroeconomic fundamentals (2001) retrieved in MRPA Dr. Shahbaz Akmal (2007) Stock return and inflation in case of Pakistan retrieved in Pakistan social and development review Robert D. Gay, Jr (2008) Effect Of Macroeconomic Variables On Stock Market Returns For Four Emerging Economies: Brazil, Russia, India, And China retrieved in international finance and economic journal Desislava dimitova (2005) The Relationship between Exchange Rates and Stock Prices: Studied in a Multivariate Model retrieved in issue in political economy Song zan chiou wei (1997) macroeconomics determinates of stock return and volatility retrieved in managerial economics journal Chen, N. F., Roll, R. & Ross, S. 1986. Economic forces and the stock market. Journalof Business 59(3): 83-403. Cooper, R. 1974. Efcient capital markets and the quantity theory of money. Journal of Finance 29(3): 887-908. Fama, E. F. 1981. Stock returns, real Activity, ination and money. The American Economic Review 71(4): 45-565. Jorgenson, D.W. 1967. The theory of investment behaviour. In R. Ferber, ed., Determinants of Investment Behaviour. New York: National Bureau of Economic Research Shapiro, M.O. 1986. :Investment, output and the cost of capital. Brookings Papers on Economic Activity, 1: 11 l-52. Economic survey of Pakistan 2007-08 B., Chatrath, A., & Sanvicente, A. Z. (2002). Inflation, output, and stock prices: Evidence from Brazil. Journal of Applied Business Research, 18, 1, 61-76.

[8] [9] [10] [11] [12] [13] [14] [15] [16] [17]

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange) [18] [19]

103

[20]

[21] [22] [23] [24] [25]

Abdullah D. A. & Hayworth, S. C. (1983). Macroeconometrics of stock price fluctuations. Quarterly Journal of Business and Economics, 32, 1, 49-63. Diacogiannis, G. P., Tsiritakis, E. D., & Manolas, G. A. (2001). Macroeconomic factors and stock returns in a changing economic framework: The case of the Athens stock exchange. Managerial Finance, 27, 6, pg 23-41 Sharma, J.L. and R.E. Kennedy, 1977, A Comparative Analysis of Stock Price Behavior on the Bombay, London, and New York Stock Exchanges, Journal of Financial and Quantitative Analysis 17, 391-413. Lee, B.S, 1992, Causal Relationships Among Stock Returns, Interest Rates, Real Activity, and Inflation, Journal of Finance, 47, 1591-1603. Nishat. M., and M. Saghir, 1991, The stock Market and Pakistan Economy. Savings and Development 15:2. 131- 145 Dwyer, G.P. and M.S. Wallace, 1992, Cointegration and Market Efficiency, Journal of International Money & Finance, 14, 801-821. Annual reports of state bank of Pakistan (2007-08) National Accounts of Pakistan (product and Expenditure), Federal Bureau of Statistics, Statistics Division, 1988-89, 1998-1999 and 2008-09 Islamabad.