Impact of Interest Rates On Stock Market in India

A study on ‘….
By
Aarish Jain
VI Semester T.Y.B.F.M
Guide
Prof. HARSHA
Project Report submitted to the University of Mumbai in partial fulfillment of the

requirements of VI semester TYBFM degree examinations 2018-19
Mithibai Motiram Kundnani College, Mumbai – 400050

Mithibai Motiram Kundnani College,
Mumbai – 400050
CERTIFICATE
This is to certify that Mr.Aarish Jain has worked and duly completed his project work for
the degree of Bachelor of Commerce (Financial Markets) under the faculty of Commerce
in the subject of Mutual Fund and his project is entitled, “Impact of Interest rates on
Stock market” under my supervision.
I further certify that the entire work has been done by the learner under my guidance and
that no part of it has been submitted previously for any degree or diploma of any
university.
It is his own work and fact reported by his personal findings and investigation.
Date of Submission: Name:

Program Head Signature:
DECLARATION
I hereby declare that Mr.Aarish Jain has worked embodied in this Project work titled
“Impact of Interest rates on Stock Market” forms any own contribution to the research
work carried out under the guidance of …… is a result of my own research work and
has not submitted previously for any degree or diploma of any university.
Whenever reference has been made to previous work of others, it has been clearly
indicated as such and included in the bibliography.
I hereby further declare that all information of the document has been obtained and
presented in accordance with academic rules and ethical conduct.
Name and Signature
Certified by Name and Signature of Prof.:
1
ACKNOWLEDGEMENT
To list who all have helped me is difficult because they are so numerous and the depth
is so enormous.
I would like to acknowledge the following as being idealistic channels and fresh
dimensions in the completion of this project.
I take this opportunity to thank the University of Mumbai for giving me chance to do
this project.
I would like to thank my Principal, Dr.Vanjani for providing the necessary facilities
required for completion of this project.
I take this opportunity to thank our Coordinator Prof., for her moral support and
guidance.
I would also like to express my sincere gratitude towards my project guide
Prof. , whose guidance and care made the project successful.
I would like to thank my College Library, for having provided various reference
books and magazines related to my project.
Lastly, I would like to thank each and every person who directly or indirectly helped
me in the completion of the project especially my Parents and Peers who supported
me throughout my project.
2
INDEX
Sr No. Particulars Page

No.
Executive Summary 6-8
1. Introduction 9-42
1.1 Interest Rates
1.2 Why Do Interest Rates Change?
1.3 Reasons for changes in Interest Rates
1.4 Advantages & Disadvantages of Interest Rate Effects
1.5 Data of Current Interest Rate
1.6 Impact of Interest Rates on Stocks
1.7 Rise in Interest Rates
2. Research Methodology 43-47

2.1 Research Objective
2.2 Hypothesis Development
2.3 Scope of the Study
3. Literature Review 48-57
4. Data Analysis, Interpretation & Presentation 58-70

4.1 Data collection and Analysis
4.2 Analysis and Interpretation
5. Conclusions & Suggestions 71-72
3
EXECUTIVE SUMMARY
India has entered the high growth trajectory since the last many years. The economic
growth rate during the last decade (2000s) was 7.3%, supported by robust growth in
many segments in the industry and services sectors. Now, the per capita income in
India doubles in very few years, domestic consumption is growing at a fast pace and
consumer markets are expanding each day, savings and investment rates are now
comparable to many competitive economies. India is a home to 1.21bn people, which
is about 17.4% of the global population.
Stocks and gold are the major Investments avenues for Indians. As gold is one of
prime financial assets which can be used as hedge against inflation, the close
relationship between stock market and gold prices are to be observed and analysed.
The aim of this study is to analyze the causal effects of Indian Stock Market on Gold
prices and silver prices. . In past two decades, prices of gold have been highly
volatile. It is not surprising, because gold prices are probably influenced by common
macroeconomic fundamentals like, GDP, Growth Rate, Exchange Rate, Interest Rate,
Inflation, SENSEX and Forex Reserves. So it is important to understand how bullion
market is affected by Indian Stock market and Macroeconomic Indicators of India.
The study was carried out with an objective of studying the long term relationship
between Indian Stock Market and Bullion Market and Cause and Effect Relationship
between Indian Stock Market and Bullion Market. It also aimed at identifying the
relationship of macroeconomic variables with Indian Stock Market and Bullion
Market.
The scope of the study was confined to the impact of NSE Index & BSE SENSEX on
Gold Prices for a ten year period. Also other macroeconomic variables, which have an
indirect effect on the selected variables, were identified, using data of 20 years’ time
period. The study period has its own contemporary economic, political, and social
situations and environment which might affect the prices of the scripts and Gold.
4
Thus, results are subject to overview of the situations and environment prevailing at
that time.
This paper analyses the relationship between interest rates and stock prices in the
context of India. The objectives of the paper are to investigate the impact of interest
rates on stock prices and build a model for forecasting stock prices based on interest
rates. Karl Pearson’s coefficient of correlation and linear regression model have been
applied on the time series data of eleven sectoral indices published by National Stock
Exchange and Bank rates published by Reserve Bank of India for a 10 year period
from 2005 and 2014. Karl Pearson’s coefficient of correlation is tested for
significance and coefficient of determination is also computed to assess the extent of
fit of the regression model in forecasting the stock prices. The results show that six
sectors (auto, bank, FMCG, financial services, IT and Pharma) out of eleven sectors
were significantly impacted by the interest rate. The overall market represented by the
market index (Nifty Fifty) was also impacted by the interest rate. Keywords: Interest
rate, Stock prices, Karl Pearson’s coefficient of correlation, Linear Regression Model
The research is empirical in nature. The time tested data on the selected variables was
collected. A causal research was carried out between the variables, using various
econometric models. Judgmental sampling was used to consider the values of the
selected variables for the above said period. The data regarding the selected variables
were taken from various websites such as www.bseindia.com, www.nseindia.com,
www.rbi.org.in, www.goldpricenetwork.com and www.moneycontrol.com.
First the Augmented Dickey Fuller Unit root method was used to test whether the
selected variables are Stationary using log values of the variables. . Then Johnson co
integration test has been employed in the present research work to study the long term
relationship between Indian Stock Market Indices and Gold Prices. Granger Causality
test was used to find the causal relationship between the variables. Further, to study
the impact of other Macroeconomic Variables on the Indian Stock Market Indices and
on gold price, Regression Analysis was applied.
The primary conclusion from both the Augmented Dickey Fuller illustrate that the
variables are not stationary at level and so were differentiated to make them stationary
5
at lag 1 or lag 2, which is a pointer of long-run relationship or co integration
relationship. Co integration test results indicate that there is no long-term co
integration between Monthly average gold price, Silver price and Monthly closing
levels of Nifty and SENSEX. So they can’t be predicted on the basis of each other.
The granger causality test concludes that, Gold, Silver, Nifty and SENSEX do not
Granger Cause each other. BSE SENSEX and NSE Index are not affected by gold
price and silver price and vice versa, that determines the independency and maturity
of Indian capital market. BSE SENSEX and NSE have low impact on the behaviour
of gold pricing. But they affect gold price negatively. Rise in BSE SENSEX indicates
the higher flow of capital to share market in comparison to gold market. Gold price in
India was increased during the study period because of stock market reaction in India
along with other macro-economic factors.
Empirical research using selected macroeconomic variables suggests that Call and
Notice Money Rate has a negative significant impact on gold prices. Crude oil prices
have a positive significant impact on gold prices. Foreign exchange rate of US Dollar
has a positive significant impact on gold prices. Forex reserve has a positive
significant impact on gold prices. GDP has a negative significant impact on gold
prices. M3 has a positive significant impact on gold prices. It is found that none of the
selected variables have a significant impact on Silver Prices. It is found that SENSEX
has a positive significant impact on Nifty. It is found that GDP and Nifty has a
Positive significant impact on SENSEX.
Empirical research using all variable in the scope of the research suggests that Only
Foreign exchange rate and Forexrev are significant determinants of Gold price. Only
FOREXREVG is a significant determinant of silver price .Only Foreign exchange rate
is a significant determinant of nifty. None of the variables are found to have a
significant impact on SENSEX.
Stock market is an important part of the economy of a country. The stock market
plays a pivotal role in the growth of the industry and commerce of the country that
eventually affects the economy of the country to a great extent. Furthermore it plays a
vital role in the mobilization of capital in many of the emerging economies. This
study will be useful for the investors who might be able to identify some basic
6
economic variables that they should focus on while investing in stock market and will
have an advantage to make their own suitable investment decisions. One can infer
from these results is that if a shock were to occur in the equity market it would have
no significant affect on gold, making gold an attractive alternative for investors when
uncertainty is high in the stock market. If one defines a safe haven as being an asset
insulated from conditional mean and volatility spill over then investors choosing gold
can be assured that it is completely insulated from shocks, negative or otherwise in
the stock market. The stock prices are strongly negatively related to the price of gold
indicating that investment demand for gold is significant and that people switch from
stocks to gold at the time of the poor stock performances leading to rise in the price of
gold. Put differently, since the long-run price of gold and inflation move together,
investment in gold can serve as an inflationary hedge. The Volatility in gold prices is
very less as compared to the equities market instilling confidence in the minds of the
investors to possess gold proving it to be a strong asset class.
Investment in gold is considered as a best way to mitigate the risk and hedge the
portfolio. Allocation of a portion of investment in Gold ETF would diversify the
Portfolio risk. As the return in case of all Gold ETFs is more or less the same,
inclusion of any Gold ETF in the portfolio of assets would diversify the risk. Investors
can take benefit of the results and discussions in their investment strategies
considering external and internal environment of the country.
 Interest rates are rising from all-time low levels across the world, worrying
some equity investors who view higher rates as a threat to equity markets.
 Changes in interest rates affect corporate earnings growth, equity valuations,

investor risk appetite, and the level of the U.S. dollar, all of which have
consequences for stocks.
 The degree to which stock prices rise or fall during periods of rising interest
rates depends greatly on why rates are rising in the first place.
 Gradual increases in rates driven by optimism about economic growth tend to
7
occur in environments in which earnings are strengthening and stocks are
well-supported.
 Across countries and sectors, different segments of global markets respond

differently to changes in interest rates, arguing strongly for diversification
within equity portfolios.
It’s finally safe to say it: Interest rates are rising

Over the past decade, investors have probably seen a number of pieces like this one,
providing analysis and guidance on how to prepare their portfolios for the coming rise
in interest rates. Much of that guidance was likely sound, still more of it well-
intentioned. But there’s been one major problem: interest rates never rose, at least not
for long. Of course, interest rates can increase over the course of a week, a month or
even a year. But by our count there were at least five consensus “bottom” calls for
interest rates between early 2009 and early 2015. Each of them was followed by a
short period of rising rates, which inevitably gave way to a renewed fall in rates and,
in most cases, a new all-time low.
8
CHAPTER 1. INTRODUCTION
1.1 INTEREST RATES
The financial liberalization paved a new way for growth, development and volatile
atmosphere to the Indian economy especially in terms of stock market. The Indian
stock market has emerged as the most active stock market of the world during the last
decade or so. It has also attracted the investors across the globe by expanding the
horizons. It resulted in increase in terms of number of listed companies, shareholders,
volume of trade and market capitalization.
The smoothing development process in Indian stock market continues to be

remarkable. From 3,740 points on March 31st 1999, with in nine years; Bombay Stock
Exchange (BSE) Sensitivity Index (SENSEX) had reached to 21,000 points in
January, 2008. In India, only about two per cent of the total population does involve
in stock markets operations. But the entire economy gets affected directly or
indirectly, if something happens in the stock markets.
It shows clearly that there is a strong correlation between stock markets and real
economy. For example, BSE total market capitalization as a percentage of India’s
Gross Domestic Product (GDP), has increased from 4 per cent in 1978-79 to around
78 per cent in 2011-12. Thus, it is understood that the domestic economic
fundamentals play a vital role in determining the performance of stock market.
Thus, it is observed that the stock market, being an important part of the financial
system should have a systemic linkage with fundamentals of the economy.
The economic reason behind the logic is the price of stock necessarily reflects all the
future cash flows discounted by the appropriate discount rate.
The future cash flows depend on many economic factors like GDP growth, Wholesale
price index (WPI), Interest rate, exchange rate fluctuations, global and domestic oil
prices, etc (Naka, Mukherjee and Tufle (2001). The causal relationships between the
9
BSE Sensex and five specified macroeconomic variables was tested by Bhattacharya
and Mukherjee (2002) applying the techniques of unit-root tests, cointegration and
long-run Granger non-causality test proposed by Toda and Yamamoto and found that
there are no causal linkage between the stock prices and money supply, national
income and interest rate while the index of industrial production leads the stock price
and there exists a two-way causation between stock price and rate of inflation.
There is a long-term equilibrium relationship among the macroeconomic variables

and stock market indicators as shown by the studies of Golaka C Nath and Dr. Y.V.
Reddy (2004) and Soumya Guha Deb and Jaydeep Mukherjee (2008) examined that
there is strong causal flow from the stock market development to economic growth.
A bi-directional causal relationship is also observed between real market

capitalization ratio and economic growth. It is also observed that there is high
correlation between exchange rate and gold prices and it highly affects the stock
prices. The effect of foreign exchange reserves and inflation in the stock price is only
limited as found by Gagan Deep Sharma (2010). The present study is an attempt to
examine the interaction between interest rate and stock returns in India.
The stock market doesn't generally like high interest rates. High interest rates can
increase costs for companies across a wide range of measures. Increased costs can
result in lower profits and subsequently lower stock prices. However, gradually rising
interest rates might actually be beneficial for the stock market, as they may reflect
positive trends in the underlying economy.
An interest rate is the amount of interest due per period, as a proportion of the
amount lent, deposited or borrowed (called the principal sum). The total interest on an
amount lent or borrowed depends on the principal sum, the interest rate, the
compounding frequency, and the length of time over which it is lent, deposited or
borrowed.
It is defined as the proportion of an amount loaned which a lender charges as interest

to the borrower, normally expressed as an annual percentage.[1] It is the rate a bank or
other lender charges to borrow its money, or the rate a bank pays its savers for
10
keeping money in an account.
Annual interest rate is the rate over a period of one year. Other interest rates apply
over different periods, such as a month or a day, but they are usually annualised.
Interest rates vary according to:
 the government's directives to the central bank to accomplish the government's

goals
 the currency of the principal sum lent or borrowed
 the term to maturity of the investment
 the perceived default probability of the borrower
 supply and demand in the market
 as well as other factors.
In the era of globalization and stabilization, one of the macroeconomic variables that
have come into greater focus is the interest rate. This is consequent upon a
strengthened integration of the domestic financial sector with the external sector. In
India, the financial sector has undergone many changes since the stabilization
program initiated in the early 1990s.
With financial liberalization in the economy, flexibility has been imparted to the
movement of interest rates. The relationships between stock market returns and
interest rate has been examined by researchers as it plays important role in influencing
a country’s economic development .
Interest rates are determined by monetary policy of a country according to its

economic situation. High interest rate will prevent capital outflows, hinder economic
growth and, consequently, hurt the economy as interest rates is one of the most
important factors affecting directly the growth of an economy.
The rational for the relationship between interest rate and stock market return are that
stock prices and interest rates are said to be negatively correlated. Higher interest rate
resulting from adverse monetary policy negatively affects stock market returns
11
because higher interest rate reduces the value of equity and makes fixed income
securities more attractive.
On the contrary, lower interest rates resulting from expansionary monetary policy
boosts stock market. This is supposed to be a good sign for the economy as it is
expected to enhance the efficiency in the financial system and thereby leading to the
achievement of a higher growth rate. This policy stance is mostly backed up by the
position of the monetarist and the financial liberalization school as opposed to the
Keynesian school.
According to the Monetarists, ‘a flexible interest rate policy responds to the changes
in the market conditions (demand and supply of credit), thereby enabling the economy
to withstand and control the macroeconomic instabilities as an inflexible interest rate
policy is prone to macroeconomic fluctuations.
A rise in the interest rates affects the valuation of the stocks. The rise in the interest
rates raises the expectations of the markets participants, which demand better returns
that commensurate with the increased returns on bonds. In a low interest rate regime,
corporate are able to increase profitability by reducing their interest expenses.
However in a rising interest rate regime, as interest expenses rise, profitability is

affected. When interest rates rise, investors move from equities to bonds. Whereas
when interest rates fall, returns on bonds fall while the returns on equities tends to
look relatively more attractive and the migration of fund from bonds to equities takes
place, and increasing the prices of equities.
Though financial economists, policy makers and investors have long-attempted to

understand dynamic interactions between interest rate and stock prices, the exact
patterns of the interactions remain unclear, the nature and strength of the dynamic
interactions between them is of high interest and need to be evaluated empirically.
Therefore, the researcher examines the dynamic relationship between interest rate and
stock prices in order to identify the impact of interest rate changes on stock prices
with special reference to Indian Stock Exchange.
12
India Interest Rate
In India, interest rate decisions are taken by the Reserve Bank of India's Central Board
of Directors. The official interest rate is the benchmark repurchase rate. In 2014, the
primary objective of the RBI monetary policy became price stability, giving less
importance to government's borrowing, the stability of the rupee exchange rate and
the need to protect exports. In February 2015, the government and the central bank
agreed to set a consumer inflation target of 4 percent, with a band of plus or minus 2
percentage points, from the financial year ending in March 2017. This page provides -
India Interest Rate - actual values, historical data, forecast, chart, statistics, economic
calendar and news. India Interest Rate - actual data, historical chart and calendar of
releases - was last updated on March of 2019.
Actual Previous Highest Lowest Dates Unit Frequency
6.25 6.50 14.50 4.25 2000 - 2019 percent Daily
Reserve Bank of India delivers a surprise rate cut in February’16.

Taking market analysts by surprise, the Reserve Bank of India’s (RBI) Monetary
Policy Committee (MPC) cut all monetary policy rates by 0.25 percentage points at its
7 February meeting. The repo rate was therefore decreased to 6.25%, the marginal
standing facility to 6.50% and the reverse repurchase rate to 6.00%. The MPC also
officially changed its monetary policy stance from December’s “calibrated
tightening”, which was supposed to rule out a rate cut, to “neutral”. This meeting was
the first presided over by Governor Shaktikanta Das, who took up office on 10
December after his predecessor, Urjit Patel, resigned following pressure from the
government to ease monetary policy.
13
The MPC’s decision was motivated by signs of a slowdown in global economic
activity. This also largely explains why the RBI tweaked down its GDP growth
forecast for FY 2019 (which ends in April) to 7.2% from 7.4%, and its FY 2020
forecast to 7.4% from 7.5%. Despite this, the domestic economy remains on a solid
footing, with survey data showing private-sector economic activity in the October–
December period growing at the fastest pace since current records began in 2015.
Moreover, the RBI lowered its Q4 FY 2019 inflation forecast to 2.8% from its
previous range of 2.7%–3.2%, as well as its H1 FY 2020 inflation forecast range to
3.2%–3.4% from 3.8%–4.2%. All in all, by cutting interest rates, Governor Das gave
President Modi a rate-cut gift given that general elections in May are fast
approaching.
The MPC did not give concrete indications regarding its next monetary policy moves.
However, the fact that it changed its policy stance to “neutral” means it is now clearly
willing to respond in an unconstrained manner to incoming macroeconomic data and
forecasts. The governor reaffirmed this by stating that “the shift in the stance of
monetary policy from calibrated tightening to neutral provides flexibility and the
14
room to address challenges to sustained growth […] over the coming months, as long
as the inflation outlook remains benign”. The next monetary policy meeting is
scheduled for 2–4 April.
FocusEconomics Consensus Forecast panelists expect the repo rate to rise going
forward and end FY 2019 at 6.88% and FY 2020 at 6.93%.
India- Interest Rate Chart
15
1.2 WHY DO INTEREST RATE CHANGES?
The Federal Open Market Committee, a division of the Federal Reserve Board, meets
throughout the year to determine the course of monetary policy. One important aspect
of this policy is the desired level of the federal funds rate. The fed funds rate is the
rate that banks charge each other for overnight lending. However, this rate is also an
important trigger for rates throughout the economy.
The Federal Reserve Board, known simply as "The Fed," changes the fed funds rate in
an attempt to control inflation. Runaway inflation is bad for the economy, as it
increases prices dramatically. This impacts both companies, which have to raise
prices to keep up with their increased costs, and consumers, who may not be able to
afford these raised prices. Increasing interest rates help harness inflation by reducing
the money supply.
16
1.3 REASONS FOR CHANGES IN INTEREST RATES
Political short-term gain: Lowering interest rates can give the economy a short-run
boost. Under normal conditions, most economists think a cut in interest rates will only
give a short term gain in economic activity that will soon be offset by inflation. The
quick boost can influence elections. Most economists advocate independent central
banks to limit the influence of politics on interest rates.
Deferred consumption: When money is loaned the lender delays spending the
money on consumption goods. Since according to time preference theory people
prefer goods now to goods later, in a free market there will be a positive interest rate.
Inflationary expectations: Most economies generally exhibit inflation, meaning a

given amount of money buys fewer goods in the future than it will now. The borrower
needs to compensate the lender for this.
Alternative investments: The lender has a choice between using his money in
different investments. If he chooses one, he forgoes the returns from all the others.
Different investments effectively compete for funds.
Risks of investment: There is always a risk that the borrower will go bankrupt,
abscond, die, or otherwise default on the loan. This means that a lender generally
charges a risk premium to ensure that, across his investments, he is compensated for
those that fail.
Liquidity preference: People prefer to have their resources available in a form that
can immediately be exchanged, rather than a form that takes time to realize.
Taxes: Because some of the gains from interest may be subject to taxes, the lender
may insist on a higher rate to make up for this loss.
Banks: Banks can tend to change the interest rate to either slow down or speed up
17
economy growth. This involves either raising interest rates to slow the economy
down, or lowering interest rates to promote economic growth.
Economy: Interest rates can fluctuate according to the status of the economy. It will
generally be found that if the economy is strong then the interest rates will be high, if
the economy is weak the interest rates will be low.
18
1.4 ADVANTAGES & DISADVANTAGES OF INTEREST RATES
EFFECTS
Advantages of Interest Rate Effects

Slowly rising interest rates can have a beneficial effect on stock prices. Rates
generally creep up when the economy is booming. For example, in 2018, in the midst
of an expanding economy, the Federal Reserve Board indicated that economic
conditions were such that rates could be raised. When the economy is expanding in
this manner, companies are more profitable. Although costs may rise slightly if
interest rates are gradually raised, profit growth generally exceeds these costs. Higher
profits, in turn, typically lead to higher stock prices.
One industry that specifically benefits from rising interest rates is the financial
services industry. Banks make profits from paying depositors lower, short-term rates
and lending that money out at longer, higher-term rates. When rates tick higher, banks
are able to charge more for loans.
Disadvantages of Interest Rate Effects

Higher interest rates increase the cost of borrowing for companies. This directly
reduces corporate earnings. Further, higher interest rates may prevent companies from
taking on additional debt for capital expenditures. Without expanding operations, it
becomes harder for companies to grow their profits. Both of these factors can trigger
lower stock prices.
Higher market interest rates can also create a "buyers' boycott" of the stock market, as
more attractive investment opportunities emerge. For example, Treasury bonds are
considered a "risk-free" asset. If rates rise to the point that an investor can get a "risk-
free" rate of 6 percent on a Treasury bond, for example, many investors will choose
Treasury bonds over the stock market. While stocks have a higher long-term average
return, they are also volatile and carry much higher risks than Treasury bonds. Fewer
buyers mean less money to push up stock prices.
19
1.5 DATA OF CURRENT INTEREST RATES
The Reserve Bank of India lowered unexpectedly its benchmark interest rate by 25bps
to 6.25 percent on February 7th and shifted its stance to "neutral", in an attempt to
boost a slowing economy as inflation rate remains well below its mid-point 4 percent
target. Interest Rate in India averaged 6.65 percent from 2000 until 2019, reaching an
all time high of 14.50 percent in August of 2000 and a record low of 4.25 percent in
April of 2009.
20
Calendar GMT Actual Previous Consensus TEForecast
2018-08-01 09:00 AM RBI Interest 6.5% 6.25% 6.5% 6.5%

Rate Decision
2018-10-05 09:00 AM RBI Interest 6.5% 6.5% 6.75% 6.75%

Rate Decision
2018-12-05 09:00 AM RBI Interest 6.5% 6.5% 6.5% 6.5%

Rate Decision
2019-02-07 07:00 AM RBI Interest 6.25% 6.5% 6.5% 6.5%

Rate Decision
2019-04-04 08:00 AM RBI Interest 6.25% 6.25%

Rate Decision
RBI Unexpectedly Cuts Key Policy Rate to 6.25%

The Reserve Bank of India lowered unexpectedly its benchmark interest rate by 25bps
to 6.25 percent on February 7th and shifted its stance to "neutral" in an attempt to
boost a slowing economy as inflation rate remains well below its mid-point target of 4
percent.
Excerpts from the RBI Press Release:

In the fifth bi-monthly monetary policy resolution in December 2018, CPI inflation
for 2018-19 was projected in the range of 2.7-3.2 per cent in H2:2018-19 and 3.8-4.2
per cent in H1:2019-20, with risks tilted to the upside. The actual inflation outcome at
2.6 per cent in Q3:2018-19 was marginally lower than the projection. There have been
downward revisions in inflation projections during the course of the year, reflecting
mainly the unprecedented soft inflation recorded across food sub-groups.
21
Turning to the growth outlook, GDP growth for 2018-19 in the December policy
was projected at 7.4 per cent (7.2-7.3 per cent in H2) and at 7.5 per cent for
H1:2019-20, with risks somewhat to the downside. The CSO has estimated GDP
growth at 7.2 per cent for 2018-19. Looking beyond the current year, the growth
outlook is likely to be influenced by the following factors. First, aggregate bank credit
and overall financial flows to the commercial sector continue to be strong, but are yet
to be broad-based. Secondly, in spite of soft crude oil prices and the lagged impact of
the recent depreciation of the Indian rupee on net exports, slowing global demand
could pose headwinds. In particular, trade tensions and associated uncertainties appear
to be moderating global growth. Taking into consideration the above factors, GDP
growth for 2019-20 is projected at 7.4 per cent – in the range of 7.2-7.4 per cent in
H1, and 7.5 per cent in Q3 – with risks evenly balanced.
Headline inflation is projected to remain soft in the near term reflecting the
current low level of inflation and the benign food inflation outlook. Beyond the
near term, some uncertainties warrant careful monitoring. First, vegetable prices have
been volatile in the recent period; reversal in vegetable prices could impart upside risk
to the food inflation trajectory. Secondly, the oil price outlook continues to be hazy.
Thirdly, a further heightening of trade tensions and geo-political uncertainties could
also weigh on global growth prospects, dampening global demand and softening
global commodity prices, especially oil prices. Fourthly, the unusual spike in the
prices of health and education needs to be closely watched. Fifthly, financial markets
remain volatile. Sixthly, the monsoon outcome is assumed to be normal; any spatial or
temporal variation in rainfall may alter the food inflation outlook. Finally, several
proposals in the union budget for 2019-20 are likely to boost aggregate demand by
raising disposable incomes, but the full effect of some of the measures is likely to
materialise over a period of time.
The MPC notes that the output gap has opened up modestly as actual output has
inched lower than potential. Investment activity is recovering but supported mainly by
public spending on infrastructure. The need is to strengthen private investment
activity and buttress private consumption.
22
India Money Last Previous Highest Lowest Unit
Interest Rate 6.25 6.50 14.50 4.25 Percent
Cash Reserve Ratio 4.00 4.00 10.50 4.00 Percent
Money Supply M1 33425.70 32785.80 33425.70 80.15 INR

Billion
Interbank Rate 6.36 6.40 12.97 3.10 Percent

Billion

Billion
Foreign Exchange 402040.00 401780.00 426080.00 29048.00 USD

Reserves Million
Central Bank Balance 18123.49 17616.33 23419.03 1624.31 INR

Sheet Billions
Loan Growth 14.60 14.40 18.70 4.10 Percent
Reverse Repo Rate 6.00 6.25 13.50 3.25 Percent
23
1.6 IMPACT OF INTEREST RATES
Interest Rate in common terms signifies a fee that you will be charged for borrowing
money, expressed as a percentage of the total amount of the loan. Usually, our
spending decisions are likewise guided by the interest burden that we would be
bearing.
Being familiar with the relationship between interest rates and the stock markets can
help investors understand how changes might have an effect on their lives, and how to
make better investment decisions.
Short Term and Long Term Impact
In the short term – The instant impact of a rise in interest rate is on companies with
high debt in their balance sheet. The interest payment made by them rises which
reduces their EPS. Thus there would be negative sentiments for such stock; resulting
in a depleted stock price.
In the long term – High-interest rate would have a more sector-specific impact. The
sectors which are most impacted by high-interest rate are the real estate, automobile,
and all the capital-intensive industries. So, any investment in these sectors must be
taken with a considerable amount of caution during the situation of high-interest rates.
So, definitely, the High-interest rate is not the best option for a country.
When the interest rate is very low, you would be obviously saving less and consuming
more. The fixed deposits are no longer attractive. This might leave the banks with
much lower money to lend out to the borrowers, and their profit margins would also
be affected by a lower interest rate.
Hence there would be fall in consumption & investment actions in the economy. The
government in such a scenario would certainly resort to the printing of currency to
infuse more money in the economy. This would lead to an inflationary situation in the
country. At very low-interest rate the inflows are likely to be reduced.
The interest rate that moves markets is the federal fund’s rate. In the US, the Federal
24
Reserve increases or decreases interest rates to fight inflation or ensure it is less
difficult for companies to borrow money. Investors have to figure out how to evaluate
the impact of rate changes in stock prices.
The Fed Funds Rate is the interest rate charged to the world’s largest banks when they
lend money to each other overnight. Also known as the overnight rate, the federal
fund’s rate is the way the Fed attempts to handle inflation. Other countries’ central
banks do the same thing for the similar reason, e.g., in India RBI controls this rate and
RBI announcements also have an impact on the Indian stock market.
Shares represent parts of a business and businesses are funded by loans. As a result, a
rate rise will certainly itself decrease profitability by making their debt more
expensive, cutting into their profits. They will spend more to service their debt, which
means that the capital available for investment decreases.
So in whole, a rate rise will probably generally signify businesses are less profitable
due to increased borrowing rates.
25
26
1.6 CURRENT RBI BANK INTEREST RATES 2019
The interest rate we are talking about here is:

Repo Rate: Repo rate is the rate at which RBI lends to its clients generally against
government securities. Reduction in repo rate helps the commercial banks to get
money at a cheaper rate and increase in repo rate discourages the commercial banks to
get money as the rate increases and becomes expensive. Reverse Repo rate is the rate
at which RBI borrows money from the commercial banks. Why is this so important?
It is a way for RBI to control inflation. If repo rate is high that means the cost of
borrowing is high, leading to a slow growth in the overall economy. Currently, the
repo rate in India is 8%. Markets don’t like the RBI increasing the repo rates.
Increase in repo rate does not merely signify a change in the cost of capital for
business, however, it also redistributes investment in favor of deposits which provide
a higher rate of return. The same happens when the repo rate is cut.
And also,
India’s central banking institution, The Reserve Bank of India controls the monetary
policy of the Indian currency. The RBI was established on 01 April, 1935, to solve
economic troubles after First World War. Major functions of RBI include supervising
banks and financial institutions, managing exchange rates, act as banker’s bank,
control inflation, maintain deflation level and detect fake currency. From time to time,
RBI controls liquidity and money supply in the market and thereby ensures overall
economic growth.
Types of Interest rates fixed by RBI
 Repo Rate: We all approach banks when we face a financial shortfall. Likewise,
banks approach The Central Bank, which is The Reserve Bank of India in our
country if they face financial crisis. Repo Rate or Repurchase Rate is the rate at
which the RBI lends funds to commercial banks and other financial institutions
within the country. Simply put, banks borrow funds from The Central Bank of India
by selling government securities with a legal agreement to repurchase the securities
sold on a given date at a predetermined price. The rate of interest charged by RBI
27
while they repurchase the securities is called Repo Rate. The current Repo Rate
as fixed by the RBI is 6.25% p.a.
On 7 February 2019, the RBI reduced the repo rate (key lending rate) by 25 basis
points. This is the first time since August 2017 that the repo rate has been cut by the
RBI. The reverse repo rate has also decreased to 6.00% from 6.25% and the Marginal
Standing Facility Rate (MSF) and the Bank Rate has decreased to 6.50%.
History of Changes to Repo Rate
The Reserve Bank of India has increased the Repo Rate from 6% p.a. to 6.25% p.a. on
6 June 2018. This hike in repo rate was the first in more than four years. The last time
the repo rate was increased before this was in January 2014. The Reserve Bank of
India increased the Repo Rate again on the 1st of August 2018 from 6.25% to
6.50%. Even the reverse repo rate was increased to 6.25% from 6%, and the Marginal
Standing Facility Rate went up by 25 basis points to 6.75% from 6.50%. The change
in repo rate will also effect changes in all other types of rates fixed by RBI and private
banks, which are discussed in detail below.
Here’s a snapshot of all the repo rate changes that have occurred since October 2005:
 Reverse Repo Rate: When Reserve Bank of India faces a financial crunch, they
invite commercial banks and other financial institutions to deposit their excess
funds into RBI treasury and offers them excellent interest rates. Similarly, when
banks have excess funds, they voluntarily transfer it to RBI as their money is safe
and secure with them. Generally, Reverse Repo Rate is always lesser than Repo
Rate. The current Reverse Repo Rate as set by the RBI is 6.00% p.a.
 Marginal Standing Facility Rate (MSF): When banks face acute financial
shortage, they can avail this special facility offered by RBI. In MSF, banks can
borrow cash from RBI against their approved government securities. This option is
preferred during emergency and critical situations only. MSF rate is always higher
than Repo Rate as banks need the funds instantly. The MSF rate currently stands
at 6.50% p.a
28
 Bank Rate: Bank Rate is the rate of interest charged by The Central Bank of India
against loans offered to commercial banks. Bank rate is usually higher than repo
rate. Unlike repo rate, bank rate directly affects the end user, in this case the
customer, as high bank rates mean high lending rates. When bank pay high interest
rate to obtain loan from RBI, they in return charge the customer high interest rate to
break even. Also known as “Discount Rate”, bank rate is a powerful tool used by
the RBI to control liquidity and money supply in the market. The current Bank
Rate is the same as MSF rate, i.e. 6.50% p.a.
 Cash Reserve Ratio (CRR): In India, banks are required to retain a certain
percentage of their deposits as liquid cash. However, banks prefer to deposit this
liquid cash with the Reserve Bank of India, which is equivalent to having cash in
hand. The percentage of the deposits that should be kept aside by banks is called
Cash Reserve Ratio. CRR is fixed by The Reserve Bank of India. For example: If
the bank deposit amount is Rs.100 and the CRR is 10% per annum, the liquid cash
that the bank should have at all times is Rs.10. The remaining funds, which is Rs.90
in this case can be used for lending and investment purposes. RBI has the power to
determine the lending capacity of the banks in India through CRR. They will
increase CRR if they want to reduce the amount that the banks can lend and vice
versa. The current CRR is 4% p.a.
 Statutory Liquidity Ratio (SLR): At the end of every business day, banks are
required to maintain a minimum ratio of their Time liabilities (when the bank has to
wait to redeem their liabilities) and Net Demand (when bank can withdraw money
from these accounts immediately) in the form of liquid assets like gold, cash and
government securities. The ratio of time liabilities and liquid assets in demand is
called Statutory Liquidity Ratio or SLR. The maximum SLR that The Reserve
Bank of India can set is 40% p.a. However, the current SLR is set at 19.25%
p.a.
 Base Rate: The Reserve Bank of India sets a minimum rate below which banks in
India are not allowed to lend to their customers. This minimum rate is called the
29
Base Rate in banking terms. It is the minimum rate of interest the banks are
permitted to charge their customers. The new Base Rate as fixed by RBI is in the
range of 8.95% - 9.45% p.a
 Marginal Cost of Funds based Lending Rate (MCLR): RBI made changes to the
existing Base Rate system this year. They have introduced Marginal Cost of Funds
based Lending Rate or MCLR which is a new methodology to set the lending rates
for commercial banks. Previously, banks used to lend as per the Base Rate fixed by
The Reserve Bank of India but with the introduction of MCLR, banks will have to
lend using rates linked to their funding costs. Simply put, bank raises their funds
through deposits, bonds and other investments. For the banks to function smoothly,
there are costs involved like salaries, rents and other bills. Considering that banks
also need to make profits every year, RBI has included the expenses of the bank
and have come up with a formula which can be used by banks to determine their
lending rate. With the reduction of repo rate, some banks have reduced MCLR up
to 90 basis points. The current MCLR (overnight) fixed by the RBI stands in
the range of 8.15% to 8.55%.
 Savings Deposit Rate:The interest rate earned by an account holder for the
amount maintained in their savings account is called savings deposit rate. The
current Savings Deposit Rate as set by the RBI is in the range of 3.50% to
4.00%.
 Term Deposit Rate: Customers who deposit money into their account and agrees
to fix it till a particular date is awarded with term deposit rate. The term deposit
rates for senior citizens is usually 0.5% more than that for ordinary citizens. With
effect from 30 January 2018, SBI's revised interest rates on Domestic Bulk Term
deposits above Rs.10 crore ranges from 5.75% to 6.50% for '7-45 days' tenor to '5
years and up to 10 years' tenor, respectively. The interest rate of Term Deposits
that the Reserve Bank of India has set ranges from 6.25% to 7.50%.
 Call Rate: It is the interest rate paid by the banks for lending and borrowing funds
for a maturity period of 1 to 14 days. Call Rate is also known as the interbank
30
borrowing rate. It deals with short-term lending between banks. . The Call Rate set
by the RBI is in the range of 5.00% to 6.60%.
In conclusion, policy rates are subjected to change without any warning as RBI
constantly monitors the supply of money in the economy and takes decisions
accordingly.
Updated On Repo Rate
07 February, 2019 6.25%
01 August, 2018 6.50%
06 June, 2018 6.25%
07 February, 2018 6.00%
02 August, 2017 6.00%
04 October, 2016 6.25%
05 April, 2016 6.50%
29 September, 2015 6.75%
02 June, 2015 7.25%
04 March, 2015 7.50%
15 January, 2015 7.75%
28 January, 2014 8.00%
29 October, 2013 7.75%
20 September, 2013 7.50%
03 May, 2013 7.25%
17 March, 2011 6.75%
25 January, 2011 6.50%
02 November, 2010 6.25%
31
16 September, 2010 6.00%
27 July, 2010 5.75%
02 July, 2010 5.50%
20 April, 2010 5.25%
19 March, 2010 5.00%
21 April, 2009 4.75%
05 March, 2009 5.00%
05 January, 2009 5.50%
08 December, 2008 6.50%
03 November, 2008 7.50%
20 October, 2008 8.00%
30 July, 2008 9.00%
25 June, 2008 8.50%
12 June, 2008 8.00%
30 March, 2007 7.75%
31 January, 2007 7.50%
30 October, 2006 7.25%
25 July, 2006 7.00%
24 January, 2006 6.50%
26 October, 2005 6.25%
32
So how are interest rates related to the stock market? They are contrarily
connected. As the interest rates go up, stock market activities tend to come down. If a
company is observed as restricting on its growth spending or is making less profit –
either via higher debt expenses or less revenue – then the estimated amount of future
cash flows will drop. All factors otherwise being equal, this will reduce the price of
the company’s stock.
If enough companies experience declines in their stock prices, the whole market, or
the key indexes that many people equate with the market, will go down. With a
lowered expectation of the growth and future cash flows of the company, investors
will not get as much growth from stock price appreciation, making stock ownership
significantly less suitable.
However, some sectors do benefit from interest rate hikes. The banking sector is
likely to benefit most due to high interest rates. The Net Interest Margins for banks is
likely to increase resulting in growth in profits & the stock prices.
Sectors like Pharma and IT are less affected by interest rates. The IT sector is more
33
influenced by factors such as currency rate fluctuations, rising attrition level, visa
restrictions, competition from the large global players and margin pressures.
While setting the interest rates the RBI has to strike a balance between growth and
inflation. In a nutshell – if the interest rates are high that means the borrowing rates
are high (particularly for corporations.On the other hand, when the interest rates are
low, borrowing becomes easier. This means more money in the hands of the
corporations and consumers. With increased money, there is certainly increased
spending which means the sellers tend to increase prices leading to inflation.
In order to draw a balance, the RBI has to consider all the factors and should
cautiously set a few key rates. Any fluctuations in these rates can lead to a financial
chaos.
Nothing has to actually happen to consumers or companies for the stock market to
react to interest-rate changes. Rising or falling interest rates also affect investors'
psychology, and the markets are nothing if not psychological. When the Fed
announces a hike, both businesses and consumers will cut back on spending,
which will cause earnings to fall and stock prices to drop, everyone thinks, and the
market tumbles in anticipation.
On the other hand, when the Fed announces a cut, the assumption is consumers and
businesses will increase spending and investment, causing stock prices to rise.
However, if expectations differ significantly from the Fed's actions, these generalized,
conventional reactions may not apply. For example, let's say the word on the street
is the Fed is going to cut interest rates by 50 basis points at its next meeting, but the
Fed announces a drop of only 25 basis points. The news may actually cause stocks to
decline because assumptions of a 50-basis-points cut had already been priced into the
market.
The business cycle, and where the economy is in it, can also affect the market's
reaction. At the onset of a weakening economy, the modest boost provided by lower
rates is not enough to offset the loss of economic activity, and stocks continue to
decline. Conversely, towards the end of a boom cycle, when the Fed is moving in to
34
raise rates—a nod to improved corporate profits—certain sectors often continue to do
well, such as technology stocks, growth stocks and entertainment/recreational
company stocks.
The Bottom Line

Although the relationship between interest rates and the stock market is fairly indirect,
the two tend to move in opposite directions: as a general rule of thumb, when the Fed
cuts interest rates, it causes the stock market to go up; when the Fed raises interest
rates, it causes the stock market as a whole to go down.
But there is no guarantee how the market will react to any given interest rate change
the Fed chooses to make. The interest rate that moves markets is the federal funds
rate. Also known as the discount rate, this is the rate depository institutions are
charged for borrowing money from Federal Reserve banks.
The federal funds rate is used by the Federal Reserve (the Fed) to attempt to
control inflation. Basically, by increasing the federal funds rate, the Fed attempts to
shrink the supply of money available for purchasing or doing things, by making
money more expensive to obtain.
Conversely, when it decreases the federal funds rate, the Fed is increasing the money
supply and, by making it cheaper to borrow, encouraging spending. Other
countries' central banks do the same thing for the same reason.
35
News on 25th September 2018
Fed may hike rates by 25 bps on Wednesday; how it will impact Indian market
NEW DELHI: The Federal Reserve is likely to hike interest rates by 25 basis points
on Wednesday, as strong employment and inflation in the US as well as strengthening
economy have increased hopes for further policy tightening.
As two-day Federal Open Market Committee (FOMC) meeting began on Tuesday,

there are expectations that the central bank will increase the rates to 2-2.25 per cent
range from 1.75-2 per cent.
The apex bank is widely expected to increase rates for the third time this year.
“Fed in its policy statement would consider raising rates by 25bps. The probability is
almost 100 per cent of Fed raising the interest rate in the FOMC meeting,” said
Motilal Oswal Financial Services.
US unemployment is at record low levels, as the rate of unemployment stood at 3.9
36
per cent in August. Inflation has also reached and sustained above the Fed’s 2 per cent
target for some time now. The US economic growth is also booming on the back of
tax cuts and pro-cyclical fiscal policy.
GDP grew above expectations by 4.2 per cent in Q2CY18.
“Such a tax-cut fuelled economy with rising corporate profitability is pulling

unemployment down, all the while widening the fiscal deficit and ballooning the
alarmingly high national debt. The US treasury is likely to borrow extra $430 billion
over last year,” said Edelweiss Investment Research in a report.
The brokerage further added that another factor that the Fed ought to consider is the
continuously flattening yield curve. The Fed is seeking to hike rates so that a balance
between sustained economic growth and economic risks such as inflation would be
reached. However, reaching such a balance might result in an inversion of the yield
curve, which is historically seen as an indicator of recession. If the Fed were to
consider the risks of yield curve inversion they would have slow down the pace of
rate hikes this year.
Market watchers across the globe will closely monitor commentary by Fed Chairman
Jerome Powell on Wednesday. The FOMC policy statement will be released on
Wednesday midnight and impact of the same will be seen on Thursday morning in
India.
Indian markets
On the impact on India, AK Prabhakar, Head of Research IDBI Capital said, “If Fed
will increase interest rates then India will also follow the US central bank. Already
rising interest rates have started to hit corporate as well as multiple sectors. For
example, rising interest rates, as well as crude prices, have started to dent volumes in
the auto sector. Rising interest rates will further strengthen the dollar and thereby may
put further pressure on Indian rupee. Rising crude oil prices, as well as interest rates,
will led to an outflow of foreign money. As a result, Indian markets may see some
short-term pressure amid upcoming elections. One should prepare for 10-15 per cent
cut in broader index.”
37
Rahul Goswami, Chief Investment Officer-Fixed Income, ICICI Prudential AMC on
Monday told ET NOW that with crude oil at close to $80 a barrel and US Fed also
hiking rates along with quantitative tightening continuing in US and other developed
economies like UK or euro zone also expected to hike rates over a period of time.
“We think that it definitely warrants caution for fixed income investors to exercise
caution and remain invested in the shorter end of the curve and very little compulsion
or very little interest for us to increase the duration risk in the portfolio at this point of
time,” said Goswami.
38
1.7 RISE IN INTEREST RATES
When the Fed increases the federal funds rate, it does not directly affect the stock
market. The only truly direct effect is that borrowing money from the Fed is more
expensive for banks. But, as noted above, increases in the federal funds rate have a
ripple effect.
Because it costs them more to borrow money, financial institutions often increase the
rates they charge their customers to borrow money. Individuals are affected through
increases to credit card and mortgage interest rates, especially if these loans carry
a variable interest rate. This has the effect of decreasing the amount of money
consumers can spend. After all, people still have to pay the bills, and when those bills
become more expensive, households are left with less disposable income. This means
people will spend less discretionary money, which will affect businesses' revenues
and profits.
But businesses are affected in a more direct way as well because they also borrow
money from banks to run and expand their operations. When the banks make
borrowing more expensive, companies might not borrow as much and will pay higher
rates of interest on their loans. Less business spending can slow the growth of a
company; it might curtail expansion plans or new ventures, or even induce cutbacks.
There might be a decrease in earnings as well, which, for a public company, usually
means the stock price takes a hit.
When evaluating the likely impact of rising rates on any asset—a stock, bond, or
commodity—it is important to understand the context. Why are interest rates rising?
Figure 2 shows that since the financial crisis, a combination of low inflation
expectations and muted growth prospects has conspired to push Treasury yields down
to levels not seen since the Eisenhower administration (1953–1961). Interest rates are
the bond market’s way of telling the world how it feels about the future. When
prospects are good, interest rates must move up to compensate investors who could
make more money in riskier assets like equities. When rates move lower, they do so
because there is demand for safer and more stable cash flow, even if the investment
39
offers a lower expected return.
Policymakers also play a key role in setting interest rates. Central banks target a level
of short-term interest rates consistent with achieving policy goals such as price
stability and full employment, and the bond market tends to follow suit. Since 2008,
global central banks have been buying government bonds and other securities in the
open market to increase the money supply and shrink the available pool of safe assets,
enticing investors to take more risk elsewhere.
Interest rates can also respond to the way in which governments manage their
budgets. A Treasury that overspends and takes on too much debt may be reined in
from time to time by the bond market, which often but not always expresses its
displeasure when borrowing is too high by charging governments a higher interest
rate. Whether rates rise because of market forces or due to prodding from
policymakers, changes in nominal interest rates can be broken down into two
components: the change in expected growth—the real interest rate—and the change in
inflation expectations. Whether stocks and other assets perform well or poorly in
periods of rising rates can depend greatly on which component—growth or
inflation—is driving the move higher
Ways that interest rates influence stock markets

Because the risk-free rate of interest—the yield on cash held in a bank or on a U.S.
government note—is usually the easiest available alternative to any other type of
40
investment, it’s often used to value or discount potential returns on stocks. One way to
price a stock is to estimate the value of all its future earnings in today’s dollars and
calculate how much investors would be willing to pay to receive their share of those
earnings paid out as dividends. In order to make that calculation, we need to
discount—i.e., divide future profits by the expected prevailing interest rate over the
period. Using this methodology, a rise in interest rates would, in isolation,
mathematically make shares of a company’s stock worth less today, likely resulting in
a price decline.
Rising interest rates can also enhance or dampen investor risk appetite. We often see
this reflected in the price-to-earnings (P/E) ratio, the number by which one would
have to multiply a company’s earnings to find its price. If interest rates rise due to
fears about higher inflation, investors might refrain from taking more risk if they
expect an eventual economic slowdown to erode profit margins. They’d be less
willing to pay a premium for future earnings, which would lead P/E multiples and
stock prices to fall. If, however, rates rise because growth is improving, investors
might be comfortable paying higher prices for the same company’s earnings stream.
In this case, higher interest rates driven by economic optimism can be associated with
increasing stock prices.
A third way interest rates tend to move stock prices is by changing corporate
profitability. Higher interest rates typically create tighter credit conditions in the
economy, which make it more difficult for firms to borrow money to hire workers and
invest. When conditions are too restrictive, potential earnings growth may be limited.
At the extreme, very high interest rates can lead to recession and a bear market—
defined as a 20% or greater drop—for stocks. In some cases, rising rates can also
boost earnings. Banks, for instance, rely on steep yield curves to borrow money short
term at low rates and lend it over longer periods at higher rates.
This practice leads to higher profits when the gap between short-term and long-term
rates widens. In recent years, prices of financial firms’ stocks have become more
interestrate sensitive as rates have fallen to new lows. Lastly, interest rates can
influence the strength of the U.S. dollar—and vice versa—which can dramatically
affect the profitability of companies with significant operations or customer bases
41
overseas. Earnings growth among companies in the S&P 500® Index turned negative
in 2015 partially because of a sharp rise in the U.S. dollar against the currencies of our
major trading partners. This dollar rally occurred largely as a result of U.S. rates
rising sharply relative to plummeting yields in much of the rest of the world.
42
CHAPTER 2. RESEARCH METHODOLOGY
2.1 RESEARCH OBJECTIVE
The general objective of this study is to analyze the correlation between the stock
market prices and interest rate movement in India.
From this above outlined general objective, the specific objectives are as follow:
i. To investigate the presence of causal relationship between stock market prices and
interest rates movement.
ii. To examine the direction of the causal relationship between stock market prices
and interest rate movement, that is determining whether the relationship is uni-
directional or bi-directional.
iii. To examine the response to certain shocks, like political instability, in the Indian
market.
43
2.2 HYPOTHESIS DEVELOPMENT
In order to shed some light on the continual debate on the interrelationship between
the Interest rate and stock market, the present study aims to explore whether the
changes in the Interest rates cause any dynamic effects on the Stock Market Returns
or not.
Accordingly, the null hypothesis that is to be tested by using the granger causality test
is as follows:
H0 : there is no significant impact of changes in the interest rate on Indian Stock

Market.
H1 : there is significant impact of changes in the Interest rate on Indian Stock Market.
Upadhyay, Apeejay-Journal of Management Sciences and Technology, 4 (1), October
- 2016 ISSN -2347-5005 42
In case of accepting the above null hypothesis, it means that there is not any
significant effect of the changes in the interest rate on the Indian Stock Market during
the examined period of time. Alternatively, in case of rejecting the null hypothesis
and accepting the alternate, it means statistically significant
relationship exists between the variables during the same period of time.
44
Index Hypothesis r Significance Hypothesis
At .05 level accepted or
(2 tailed) rejected
1. Nifty H0: Interest rate has no .817 Significant Rejected
Auto impact on Nifty Auto
H1: Interest rate has an
impact on Nifty Auto
Bank impact on Nifty Bank
impact on Nifty Bank
3. Nifty H0: Interest rate has no .114 Insignificant Accepted
Energy impact on Nifty Energy
impact on Nifty Energy
FMCG impact on Nifty FMCG
impact on Nifty FMCG
Financial impact on Nifty Financial
Services services
impact on Nifty Financial
services
6. Nifty IT H0: Interest rate has no .696 Significant Rejected
impact on Nifty IT H1:
Interest rate has an impact on
Nifty IT
7. Nifty H0: Interest rate has no .359 Insignificant Accepted
Media impact on Nifty Media
impact on Nifty Media
45
8. Nifty H0: Interest rate has no -0.158 Insignificant Accepted
Metal impact on Nifty Metal H1:
Interest rate has an impact on
Nifty Metal
Nifty H0: Interest rate has no 0.845 Significant Rejected
9. Pharma impact on Nifty Pharma
impact on Nifty Pharma
10. Nifty H0: Interest rate has no 0.386 Insignificant Accepted
PSU impact on Nifty PSU Bank
Bank H1: Interest rate has an
impact on Nifty PSU Bank
11. Nifty H0: Interest rate has no -0.443 Insignificant Accepted
Realty impact on Nifty Realty
impact on Nifty Realty
46
2.3 SCOPE OF THE STUDY
This study focuses on the impact of the interest rate on stock prices. The period under
investigation is 10 years i.e., from January 2005 to December 2014. Hence the bank
rates and closing prices of the sectoral indices from 2005-14 are considered for the
research.
Eleven sectors (auto, bank, energy, FMCG, financial services, IT, media, metal,
pharma, PSU bank, realty) and one market index (nifty fifty) are selected and sectoral
indices are collected for those respective sectors. The closing prices of these sectoral
indices were considered and then correlated with interest rates to find out the
correlation between the two variables i.e., interest rates and closing prices. These
sectoral indices were collected from the data base of National Stock Exchange. Bank
rates were collected from the data base of RBI.
The statistical tool used for testing of the hypothesis is Karl Pearson’s coefficient of
Correlation. Linear Regression has been used to develop a model for forecasting stock
prices based on interest rate.
47
CHAPTER 3. LITERATURE REVIEW
The relationship between stock market and various economic factors such as interest
rate, inflation rate etc. have been examined by researchers as they play an important
role in influencing a country’s economic development. Interest rates are determined
by monetary policy of a country according to its economic situation. High interest
rates will prevent capital outflows, hinder economic growth and consequently hurt the
economy as interest rate is one of the most important factors affecting directly the
growth of an economy.
In the light of external factors gaining importance, some studies have been conducted
to understand the relationship and quantify the impact. Some significant studies have
been reviewed here. Uddin and Alam (2009) in their study ‘Relationship between
interest rate and stock price: Evidence from developed and developing countries’ seek
evidence supporting the existence of share market efficiency based on the monthly
data from January 1988 to March 2003.
In their study they show empirical relationship between stock index and interest rate
for fifteen developed and developing countries using time series and panel regression.
They also show that for all of the countries interest rate has significant negative
relationship with share price and for six countries changes of interest rate has
significant negative relationship with changes of share price. Senthil Kumar (2013) in
his study ‘Effect of interest rate changes on stock returns of select Indian commercial
banks’ investigates the long term effects of repo rate changes on seven public sector
banks and six private sector banks using regression technique.
He found that any increase in the interest rate adversely affects the bank stock returns.
Faff, Hodgson and Kremmer (2005) analyse the dual impact of changes in the interest
rate and interest rate volatility on the distribution of Australian financial sector stock
returns. In addition, a multivariate GARCHM model is used to analyze the impact of
deregulation on the financial institutions sector. It was found that there is a consistent
inter temporal tradeoff between risk and return over the different regulatory periods.
Moreover, finance corporations were found be highly sensitive to new shocks across
48
the financial sector and deregulation increased the risk faced by finance corporations
and small banks – effectively increasing the required rate of Research Journal of
Finance and Accounting www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847
(Online) Vol.7, No.21, 2016 18 return and explaining the continued rationalization of
these sectors. Muthukumaran and Somasundaram (2014) in their study
‘An analytical study of interest rate and stock returns in India’ estimate causality
relationship between interest rate and stock returns. Using the Granger Causality test
they found that there exists short term relationship among the interest rate and stock
returns. Their study implies that the interest rate neither affects stock returns nor stock
returns affect the interest rate. Uddin and Alam (2010) in their study ‘The impact of
interest rate on stock market: Empirical evidence from Dhaka stock exchange’ show
empirical relationship between stock index and interest rate in Bangladesh based on
monthly data from 1992 to June 2004.
They tested the stationary of market return and found that DSE index does not follow
random walk model, which indicated that DSE is not efficient in weak form. They
determine the linear relationship between share price and interest rate, share price and
growth of interest rate, growth of share price and interest rate, and growth of share
price and growth of interest rate through ordinary least-square (OLS) regression. They
found that interest rate has significant negative relationship with growth of share
price.
The stock market plays an important role in the economic development of any nation.
Besides serving as an instrument for the mobilization of domestic capital for the
corporate sector, the mere presence of the market boosts the international investment
climate of a country. Theoretically, capital market not only knots the domestic
macroeconomic indicators within an economy, but also with the outside economy as
well. Trade, capital and other flows are all tied to it.
The relationship between interest rates and stock prices is of great interest to many
academics and professionals since they play an important role in the economy. The
literature review is organized into four main areas. The first is the review of the
theories that affect the individual variables that form part of the research question,
49
namely share prices and interest rates. The second section summarizes the conceptual
framework and the hypothesis that link share prices to interest rates. The third section
reviews the empirical evidence.
Finally, this chapter concludes with how this research will contribute to the existing
literature.
2.1 Share Price and Market Theories
There are two broad theories that attempt to explain the movement in share prices in
the stock market.
The first is the Efficient Market Hypohesis and the other is Behavioural Finance.
Efficient Market Hypothesis 9 An investment theory that states it is impossible to
"beat the market" because stock market efficiency causes existing share prices to
always incorporate and reflect all relevant information.
According to the EMH, stocks always trade at their fair value on stock exchanges,
making it impossible for investors to either purchase undervalued stocks or sell stocks
for inflated prices. As such, it should be impossible to outperform the overall market
through expert stock selection or market timing, and that the only way an investor can
possibly obtain higher returns is by purchasing riskier investments.
Although it is a cornerstone of modern financial theory, the EMH is highly

controversial and often disputed. Believers argue it is pointless to search for
undervalued stocks or to try to predict trends in the market through either fundamental
or technical analysis.
Meanwhile, while academics point to a large body of evidence in support of EMH, an

equal amount of dissension also exists. For example, investors, such as Warren
Buffett have consistently beaten the market over long periods of time, which by
definition is impossible according to the EMH. Detractors of the EMH also point to
events, such as the 1987 stock market crash when the Dow Jones Industrial Average
(DJIA) fell by over 20% in a single day, as evidence that stock prices can seriously
deviate from their fair values.
50
The related random walk hypothesis of the early 1960s was an empirical result. Based
on time-series analyses of past stock prices, researchers concluded that the prices
behaved like geometric random walks. This threw cold water on the practice of
technical analysis— the study of stock price charts to divine future price movements.
It did not, however, rule out fundamental analysis—the study of a company’s

business, its market and/or the overall economy to divine future price movements.
Developed by Eugene Fama in the late 1960s and 10 early 1970s, the efficient market
hypothesis went beyond the random walk hypothesis to reject both technical analysis
and fundamental analysis.
Between 1965 and 1970, many empirical studies were performed on stock price
behavior or investment managers’ performance. These culminated in 1970 with
Fama’s second landmark paper, which appeared in the Journal of Finance and was
titled ―Efficient capital markets: A review of theory and empirical work.‖ In it, Fama
elaborated on his theory of efficient markets and reviewed the developing literature.
Based on the terminology of his colleague Harry Roberts, he reported on empirical
tests for three different levels of market efficiency:
 A market has weak efficiency if prices fully reflect any information contained in
past price data. Weak efficiency rejects technical analysis. It is essentially the random
walk hypothesis but without as full a characterization of the stochastic process that
describes price behavior.
 A market has semi-strong efficiency if prices fully reflect all readily-available

public information—past prices, economic news, earnings reports, etc. Tests of semi-
strong efficiency are those that study stock price movements following
announcements, such as stock splits or earnings announcements.
 A market has strong efficiency if prices fully reflect all public and privileged
information. Privileged information includes knowledge available to a market maker,
insider information available to corporate managers, or information that investment
managers spend time and money to compile for their own use.
51
Behavioral Finance Theory Behavioral finance is the study of the influence of
psychology on the behavior of financial practitioners and the subsequent effect on
markets. Behavioral finance is of interest because it 11 helps explain why and how
markets might be inefficient.
Behavioral finance takes issue with two crucial implications of the EMH:
(1) that the majority of investors make rational decisions based on available
information; and
(2) that the market price is always right.
Proponents of behavioral finance, or behaviorists, as they often are known, believe

that numerous factors—irrational as well as rational—drive investor behavior. In
sharp contrast to efficient markets theorists, behaviorists believe that investors
frequently make irrational decisions and that the market price is not always a fair
estimate of the underlying fundamental value. Refuting Fama’s crucial assertion that
the market price is always right, behaviorists ―believe investor psychology can drive
market prices and fundamental value very far apart (H. Shefrin).
The origins of today’s school of behavioral finance are generally traced back to the
work of two psychologists, Daniel Kahneman and Amos Tversky, on how people
make decisions involving risk. In the 1980s behavioral finance researchers, such as
Werner De Bondt, Robert J. Shiller, Andrei Shleifer, and Richard Thaler, to name a
few, began to focus on the study of the time series properties of prices, dividends, and
earnings.
The objective was to determine whether stocks exhibit volatility in excess of the
amount predicted by the efficient market hypothesis. ―The [pricing] anomalies that
had been discovered [in the 1970s] might be considered at worst small departures
from the fundamental truth of market efficiency, but if most of the volatility in the
stock market was unexplained, it would call into question the basic underpinnings of
the entire efficient markets theory,‖ Shiller (2003) wrote.
52
In 1981 Shiller published an article in the American Economic Review in which he
documented evidence of price movements much greater than an efficient market
would allow. Four years later Richard Thaler and Werner de Bondt (1985) published a
study that concluded that the stock market tends to overreact to a long series of bad
news. 12 Werner F. M. De Bondt and Richard Thaler published `Does the stock
market overreact?' in the The Journal of Finance (De Bondt and Thaler 1985),
effectively forming the start of what has become known as behavioral finance.
They discovered that people systematically overreacting to unexpected and dramatic

news events results in substantial weak-form inefficiencies in the stock market. This
was both surprising and profound. 2.2 Interest rate theories Interest rate is the price
paid for money borrowed which is in turn invested in viable economic activities with
a view of generating returns. Interest rate in any country is determined by a number of
factors.
The key theory is the demand for money and supply of money framework. Some of
the other factors include the growth in the economy, monetary policy driven by
central banks, rate of inflation among others. 2.3 Theories linking interest rates and
share prices Theoretical framework Fama (1981) argues that expected inflation is
negatively correlated with anticipated real activity, which in turn is positively related
to returns on the stock market. Therefore stock market returns should be negatively
correlated with expected inflation, which is often proxied by the short-term interest
rate.
In theory, the interest rates and the stock price have a negative correlation (Hamrita &
Abdelkader, 2011). This is because a rise in the interest rate reduces the present value
of future dividend’s income, which should depress stock prices. Conversely, low
interest rates result in a lower opportunity cost of borrowing. Lower interest rates
stimulate investments and economic activities, which would cause prices to rise. 13
Research hypothesis Null hypothesis There is no significant causality relationship
between stock prices and interest rates Alternative hypothesis
There is a significant causality relationship between stock prices and interest rates 2.5
Empirical evidence Hamrita and Abdelkader (2011) examined the multi-scale
53
relationship between the interest rate, exchange rate and stock price using a wavelet
transform in US over the period from January 1990 to December 2008. The exchange
rate returns and stock index returns were found to have a bidirectional relationship in
this period at longer horizons.
Findings from other research specifically point out that the interest rate changes affect
the stock market in the long run and there is no significant influence in the short run.
According to Amaresh Das (2005) on his study on the interrelationship between the
stock prices represented by market index and interest rates measured by three month
Treasury bills for monthly observation from 1985 to 2003 by sampling three Asian
countries including Bangladesh, the codependence among variables shows that the
relationship between stock prices and interest rate is not significant for Bangladesh
and Pakistan except India.
The paper further documents that the time series data for Bangladesh and Pakistan
reflects strongly common cycles. In related studies, Officer (1973) explained the drop
in stock market volatility in the 1960s with a reduced variability in industrial
production. Schwert (1989) and Hamilton and Lin (1996) discovered that stock
market volatility increases in times of 14 recession and Glosten et al.(1993) find
interest rates to be an important factor in explaining stock market volatility. Hasan
and Samarakoon (2000) studies the ability of interest rates, measured by treasury bill
rates of three maturities; 3,6 and 12 months which tracks the expected monthly,
quarterly and annual returns in the Sri Lankan stock market for the period 1990 to
1997.
The stock return is measured by the continuously compounded monthly returns on the
All Share Price Index (ASPI) and Sensitive price index. Through the application of
the OLS method it was suggested that the short-term interest rates are positively
related to future returns and they are able to reliably track expected returns prospects.
The authors also concluded that the 12 months maturity is the most powerful tool to
track monthly and quarterly expected return among all the three maturities.
In a study conducted by Lobo (2002) which examines the impact of unexpected

changes in the federal funds target on stock prices from 1988 to 2001; Measures of
54
interest rate surprises are constructed from survey data and changes in the 3-month T-
bill yield. It was discovered that surprises associated with decreases in the target cause
stock prices to rise significantly. Surprises associated with increases in the target
increase stock market volatility on the announcement day, with volatility reverting to
pre-surprise levels on the day after the announcement.
This volatility pattern is only evident since 1994. An implication is that concerns
about immediate disclosure causing persistent and heightened stock market volatility
might be misplaced. Gazi and Mahmudul (2009) sought to find evidence supporting
the existence of share market efficiency based on the monthly data from January 1988
to March 2003 and also shows empirical relationship between stock index and interest
rate for fifteen developed and developing countries
For all of the countries it is found that interest rate has significant 15 negative
relationship with share price and for six countries it is found that changes of interest
rate has significant negative relationship with changes of share price. 2.7 Conclusion
From the literature and empirical evidence review there is mixed findings. There are
studies done by Hsing (2004), Arango (2002), Gazi and Mahmudul (2009) in different
countries that have found a negative relationship between interest rates and share
prices.
However, Lee (1997) found the relationship changing gradually from a significantly
negative to no relationship, or even a positive although insignificant relationship.
Gupta et. al (n.d) in their research failed to establish any consistent causality
relationships between interest rates and share prices. Therefore, there is still no
unanimity in the study of the relationship between interest rate and share prices.
This proposed research will contribute to the growing literature by employing the
Toda and Yamamoto (1995) method in the Kenyan scene. Toda and Yamamoto
(1995) proposed a simple procedure requiring the estimation of an ―augmented‖
VAR, even when there is cointegration of different orders, which guarantees the
asymptotic distribution of the MWALD statistic. Hsing (2004) adopted a structural
VAR model that allows for the simultaneous determination of several endogenous
variables such as, output, real interest rate, exchange rate, the stock market index and
55
found that there is an inverse relationship between stock prices and interest rate. Lee
(1997) used three-year rolling regressions to analyze the relationship between the
stock market and the short-term interest rate.
He found that the relationship is not stable over time. It gradually changes from a
significantly negative to no relationship, or even a positive, although insignificant
relationship. 16 Ishfaq, M., Ramiz, Rehman & Awais, Raoof (2010) examined the
relationship between stock return, interest rate and exchange rates in Pakistani
economy over the period of 1998-2009. A multiple regression model was applied to
test the significance of change in interest rate and exchange on stock returns.
The results indicated that both the change in interest rate and change in exchange rate
have a significant impact on stock returns over the sample period . Hashemdah and
Taylor (1988) found bi-directional relationship causality present in regression models
between money supply and stock return. However, with respect to interest rates the
result was inconclusive. Gupta et. al (n.d) studied the relationship between exchange
rate, interest rate and stock prices in Indonesia.
The study was conducted for five year period from 1993 to 1997 which was divided
into three sub periods. The overall evidence, however, failed to establish any
consistent causality relationships between any of the macro economic variables under
study.
Relationship of interest rate and stock returns has been widely examined by ardent
researchers. In literature, French, et al. documented theoretically, that stock returns
responded negatively to both the long term and short term interest rates. Choi and Jen
reported that the expected returns on common stocks are systematically related to the
market risk and the interest-rate risk. The findings of the study indicate that the
interest-rate risk for small firms is a significant source of investors' portfolio risk and
the interest-rate risk for large firms is "negative". Allen and Jagtianti pointed out that
the interest rate sensitivity to stock returns has decreased dramatically since the late
80’s and the early 90’s because of the invention of interest rate derivative contracts
used for hedging purposes. The empirical results of the divergent researches specify
that growth rates of interest rates negatively affect stock returns with a significant lag
56
in short run dynamic model. Few recent studies carried out in Indian context,
Bhanumurty and Agarwal observed that nominal interest rates adjust only to
movements in the wholesale market prices but the relationship was not robust. They
concluded that interest rate determination in India need not focus much on the
domestic inflation rate, as there seems to be no strong co-movement between them.
Bhatt and Virmani showed that short term interest rates in India are getting
progressively integrated with those in the US even though the degree of integration is
far from perfect.
57
CHAPTER 4. DATA ANALYSIS, INTERPRETATION &
PRESENTATION
This chapter provides a summary of the data analysis, results of the study and the
discussion on the results of the study. The chapter is organized as follows: section 4.1
describes the data analysis and the results of the study and section 4.2 discusses the
implication of the findings of the study.
4.1 DATA COLLECTION & ANALYSIS
The data used for the present research work is principally secondary data. The data
were collected from BSE and Reserve Bank of India (RBI). Other necessary
information was collected from the Centre for Monitoring Indian Economy (CMIE)
reports. The relevant literature was gleaned from books, journals and magazines. The
impact of Interest rate and Stock returns in India is studied, by using monthly data
from April 1997 to March 2014. This period is not only the economic reform period
but also depicted a great deal of volatility.
Variables Justification Dependent Variable Stock Returns
Stock returns has been calculated by using following equation
Rt = In (It / I t-1)
Where,
Rt = Return for month‘t’
It and I t-1 = Average values of BSE-Sensex Index for month‘t’ and t-1 respectively.
BSE SENSEX is taken as a proxy for equity returns. The SENSEX is the benchmark
index of the Indian Capital Markets with wide acceptance among individual investors,
institutional investors, foreign investors and fund managers. The BSE SENSEX is not
only scientifically designed but also based on globally accepted construction and
review methodology. First compiled in 1986, SENSEX is a basket of 30 constituent
stocks representing a sample of large, liquid and representative companies. The base
year of SENSEX is 1978-79 and the base value is 100.
58
Independent Variables Interest rate
Treasury bill rates have been used as proxy of interest rate. At present, the
Government of India issues three types of treasury bills through auctions, namely; 91
days, 182 days and 364 days. The treasury bills are issued in the form of promissory
note in physical form or by credit to Subsidiary General Ledger (SGL) account or Gilt
account in dematerialized form.
Analytical Procedure
The present study tried to analysis the relationship between interest rate and stock
returns, to focus on ‘causality’ among the variables using the method developed by
Granger. Statistical and econometric tools have been used to test and verify the results
of the study for their accuracy. The tools namely descriptive statistics, correlation
analysis, and Granger causality test have been used for examining the short-run
interdependence between variables. The study uses three different tests, i.e.,
Augmented Dickey Fuller (ADF) test, Phillips-Perron (PP) test and Kwiatkowski,
Phillips, Schmidt. and Shin (KPSS) test for finding unit roots in time series.
Hypothesis
In order to answer whether the interest rate causes the stock returns, the following
hypotheses are framed:
Ho: Interest rate does not cause stock returns Ho: Stock returns does not cause interest
rate
Relationship between Interest rate and Stock Returns

A rise in the interest rates affects the valuation of the stocks. The rise in the interest
rates raises the expectations of the markets participants, which demand better returns
that commensurate with the increased returns on bonds. In a low interest rate regime,
corporates are able to increase profitability by reducing their interest expenses.
However in a rising interest rate regime, as interest expenses rise, profitability is
affected. When interest rates rise, investors move from equities to bonds. Whereas
when interest rates fall, returns on bonds fall while the returns on equities tends to
look relatively more attractive and the migration of fund from bonds to equities takes
place, and increasing the prices of equities.
59
Interest rate and stock market are inversely related. As the interest rates go up, stock
market activities tend to come down. Capital intensive industries would be heavily
affected by high interest rates but when the interest rates decrease they would be
gaining the most. It is better to avoid investments in sectors such as real estate,
automobiles etc when the interest rates are rising. Companies with a high amount of
loans in their balance sheets would be affected very seriously. Interest cost on existing
debt would go up affecting their Earning Per Share (EPS) and ultimately the stock
prices. But during low interest rate these companies would stand to gain. In a high
interest rate scenario, companies with zero or near zero debts in their balance sheets
would be the kings. Fast moving consumer goods (FMCG) is one sector that is
considered as a defensive sector due to its low debt nature.
Sectors like Pharma and Information Technology (IT) are less affected by interest
rates. The IT sector is more influenced by factors such as currency rate fluctuations,
rising attrition level, visa restrictions, competition from the large global players and
margin pressures. Certainly, IT sectors are not interest rate-sensitive. Pharma is
considered as the defensive sector and investors can invest here during uncertain and
volatile market conditions. Banking sector is likely to benefit most due to high interest
rates. The Net Interest Margins for banks is likely to increase leading to growth in
profits and the stock prices.
Relationship of interest rate and stock returns has been widely examined by
researchers. In literature, French, K. R., Schwert, G. W. and Stambaugh, R. E. (1987),
French, K. R., Schwert, G.W. and Stambaugh, R. E. (1987) documented theoretically,
that stock returns responded negatively to both the long term and short term interest
rates. Choi and Jen (1991) report that the expected returns on common stocks are
systematically related to the market risk and the interest-rate risk. The findings of the
study indicate that the interest-rate risk for small firms is a significant source of
investors' portfolio risk and the interest-rate risk for large firms is "negative". Allen
and Jagtianti (1997) pointed out that the interest rate sensitivity to stock returns has
decreased dramatically since the late 80’s and the early 90’s because of the invention
of interest rate derivative contracts used for hedging purposes.
60
The empirical results of Muradoglu and Metin (2001) indicate that growth rates of
interest rates negatively affect stock returns with a significant lag in short run
dynamic model. Few recent studies carried out in Indian context, Bhanumurty and
Agarwal (2003) observed that nominal interest rates adjust only to movements in the
wholesale market prices but the relationship was not robust. They concluded that
interest rate determination in India need not focus much on the domestic inflation rate,
as there seems to be no strong co-movement between them. Bhatt and Virmani (2005)
showed that short term interest rates in India are getting progressively integrated with
those in the US even though the degree of integration is far from perfect.
61
62
4.2 ANALYSIS & INTERPRETATION
The short run causality between Interest rate and Equity returns is analyzed as below:
Table - 1 Descriptive Statistics
Levels First Difference
Stock Interest Stock Interest
Variables Returns Rate Returns Rate
Mean 8.932 1.881 0.009 -0.002
Maximum 9.916 2.542 0.193 0.294
Minimum 7.961 1.168 -0.279 -0.374
Std. Dev. 0.692 0.292 0.066 0.074
Skewness 0.076 -0.438 -0.615 -1.071
Kurtosis 1.356 2.702 4.465 9.243
Jarque-Bera 21.799 6.857 29.138 347
Probability 0.000 0.032 0.000 0.000
Sum 1715 361 1.632 -0.343
Observations 192 192 191 191
Table provides the summary statistics on the levels of the variables and first
difference. Summary statistics include the mean and the standard deviation, minimum
maximum, skewness and Kurtosis value for the period 1997-98 to 2012-13.The mean,
median, maximum, minimum and standard deviation can determine the statistical
behavior of the variables. It is observed from the table that Stock returns over the
period of study is maximum at 9.916 with a minimum of 7.961, averaging at 8.932
with a standard deviation of 0.692 which clearly shows that there is no much
fluctuations in the Stock returns over the period of study at levels. As far as interest
rate is concerned the maximum stood at 2.542 and the minimum accounted for 1.168
with an average of 1.881 over the period of study. The standard deviation worked out
to 0.292, thus indicating low fluctuations as for as interest rate is concerned. The table
also shows that average monthly Stock returns as 0.9 per cent and the interest rate as
0.2 per cent.
63
However, the standard deviations of the differences in these variables indicate that
interest rate is more than Stock returns. For a normal distribution, the skewness must
be zero and kurtosis at three. The results show that the frequency distributions of the
variables are not normal. Jarque-Bera statistics also indicates that the frequency
distribution of the underlying series does not fit normal distribution.
Table -2 Correlation Analysis

Correlation Coefficient ( r ) between Interest rate and Stock returns
Series r t-Statistics P-Value Ho Hypothesis

Level
Interest rate Specification -0.17 -2.23 0.03* Rejected
First
Difference -0.11 -1.47 0.14 Not Rejected
* Implies significant at 5% level.
Table 4.3 shows the correlation analysis between interest rate and stock returns for
both level specification and first difference. At level specification, the correlation
relationship between interest rate and stock returns is -0.17, which is significant at
five percent level. It indicates a negative relationship between the variables in a long
run. There is a danger of obtaining apparently significant correlation results from
unrelated data. Such correlation are said to be spurious. To avoid that, correlation
analysis between the first difference variables has also been computed. At the first
difference, the correlation relationship between interest rate and stock returns is -0.11,
which is insignificant.
It indicates that interest rate has very low negative correlation with equity returns. The
results of the study indicate there is no relationship between interest rate and stock
returns in India (r=0). But one point is worth enough to bring into consideration that a
high or low degree of correlation certainly does not signify or rules out causality. It
simply points towards the positive or negative linear relationship that exists between
the two variables.
64
It concludes that the proportion of variation in interest rate is weakly attributed to
stock returns. Since correlation analysis is not a strong analysis to make conclusion of
the study of hypothesis to see the effect of interest rate on stock return, the researcher
sought the help of econometric models to bring more precision to the analysis.
65
66
Table – 3 Unit Root Test
Augmented Dickey-Fuller test Statistics
Null Hypothesis: Variable is Not Stationary
Variables Level First Difference
Constant and Constant and
Constant trend Constant trend
Stock Returns -0.6675 -2.2663 -10.0411 -10.0210
Interest rate -1.5056 -1.2374 -11.8325 -11.8356
Test Critical Value (Mac Kinnon 1996)
1% Level -3.4672 -4.0104 -3.4672 -4.0104
5% Level -2.8776 -3.4354 -2.8776 -3.4354
10% Level -2.5754 -3.1417 -2.5754 -3.1417
Phillips - Perron test Statistics
Null Hypothesis: Variable is Not Stationary
Stock Returns -0.6227 -2.1758 -10.0274 -10.0055
Interest rate -1.9036 -1.6700 -11.8914 -11.8921
1% Level -3.4670 -4.0101 -3.4670 -4.0101
5% Level -2.8775 -3.4351 -2.8775 -3.4351
10% Level -2.5754 -3.1416 -2.5754 -3.1416
Kwaitkowshi-Phillips-Schmdist-skin test statistics
Null Hypothesis: Variable is stationary
Stock Returns 1.5244 0.2070 0.0931 0.0770
Interest rate 0.3977 0.1262 0.1307 0.0719
1% Level 0.7390 0.2160 0.7390 0.2160
67
5% Level 0.4630 0.1460 0.4630 0.1460
10% Level 0.3420 0.1190 0.3420 0.1190
It is essential to test the economic time series data for stationary before proceeding for
Granger Causality tests. The study uses three different tests, i.e., Augmented Dickey
Fuller (ADF) test, Phillips-Perron (PP) test and Kwiatkowski, Phillips, Schmidt. and
Shin (KPSS) test for finding unit roots in time series. ADF, PP and KPSS statistics are
given in Table 4.4.
On the basis of ADF statistics, PP test and KPSS test both interest rate and Stock
returns are found to be non-stationary at levels and stationary at first difference which
is the common phenomenon in most of the economic time series.
Further, ADF statistics and PP test rejects null hypotheses of unit root in case of first
differences of interest rate and Stock returns at one percent. Finally, KPSS test is also
applied which reject null hypothesis at levels and accept the null hypothesis at first
difference. Assuming, interest rate and Stock returns are non-stationary at levels and
stationary at first differences on the basis of ADF, PP, KPSS tests are undisputedly
declared that all the variables are integrated of order one,
Table - 4 Granger causality test
Null Hypothesis Lags F- Prob. Results

Statistics
Interest rate does not cause Stock Returns 2 0.83964 0.4336 ACCEPT
Stock Returns does not cause Interest rate 2 1.55499 0.2141 ACCEPT
68
Table - 5
Interest rate versus Equity returns
Cause Effect Causality Inference Relationship
Interest Stock Interest rate does not cause Stock returns No Relation
rate Returns
Stock Interest rate Stock Returns does not cause Interest rate No Relation
Returns
The study implement the Granger Causality test to answer whether changes in interest
rate cause changes in Stock returns or changes in Stock returns cause changes in
interest rate, applying order one i.e. I (1). Table 4.5 represents the empirical results of
Granger causality test between interest rate and stock returns. The test results suggest
that, fail to reject the null hypothesis of interest rate does not cause stock returns as
well as the null hypothesis of Stock returns does not cause interest rate. This implies
that the interest rate neither affects Stock returns nor stock returns affect the interest
rate.
The study indicates that the interest rate does not cause the Stock returns. It is
consistent with the results of Mok (1993), Gjerde and Saettem (1999), Mukherjee and
Naka (1995) and Humpe and Macmillan, (2009). The results was also consistent with
the findings of many researcher is India like Bhattacharya and Mukherjee (2002),
Pratnik and Vina (2004) and the results is contrary to Mukhopadhyay and Sarkar
(2003), Debabrata Mukhopadhyay and Nityananda Sarkar (2003), Ray, Pranthik and
Vani Vina (2004),Lakahmi R. Nair (2008), Shahid Ahmed (2008 ). The Stock returns
does not cause interest rate. It is consistent with the results of Bhattacharya and
Mukherjee (2002), Shahid Ahmed (2008) and the result is contrary to Ratanapakorn
and Sharma (2007). Thus, it is observed that, stock market has no relation with the
growth of Interest rate in India and vice versa.
This study used the secondary data for the weekly share prices and the interest rates
for the period between the first week of 2004 and last week 2013. The data for share
prices and interest rates were obtained from NSE and the CBK respectively. Based on
the weekly data obtained we produced the two time series graph one for interest rates
69
and the other for share prices and plotted independently.
By observing the trends on the two graphs in figures one ad two below, one for
interest rates and the other share prices we note an important pattern and relationship.
The two series trend in almost opposite directions. For instance, between the first few
weeks of 2004 and the whole 2005 weeks the share prices trended upwards while the
interest rates were trending downwards. Moreover for the period 2009 and the last
weeks of 2010 the interest rate aloft as the share price within those weeks trended
down. In the weeks of 2007/2008 mainly the last and the first 18 weeks of the years
respectively share prices toppled sharply while the interest rates increased slightly.
When taking the spearman correlation coefficient of the two variables the result is
negative 0.058. This depicts a very weak negative correlation between 22 them
Toda Yamamoto method for causality test

The result of the modified causality Wald test, obtained from the SUR estimation of
level VAR model outlined in equations (1) and (2), are depicted in Table 1. The null
hypothesis that interest rate do not Granger cause share price index was accepted at
95% significance level (see appendix 1). Similarly, the null hypothesis that share price
index does not Granger cause interest rate was accepted at 95% level of significance
(see appendix 2). The results shows that the beta-values are less than the test critical
values, the study consequently fails to 24 reject the two null hypotheses. Therefore,
this study doesn’t find evidence that there is a bidirectional causality relationship
between interest rate and share price index.
70
CHAPTER 5. CONCLUSION & SUGGESTION
5.1 CONCLUSION
The analysis of data and discussions show that there is an impact of interest rate on stock
prices. From the data analysis it is found that six sectors- auto, bank, FMCG, financial
services, IT, pharma- out of eleven sectors and one market index (Nifty Fifty) were
significantly impacted by the interest rate. Five sectors which did not show significant
correlation with interest rate were energy, media, metal, PSU bank and realty.
The present study tried to estimate causality relationship between Interest rate and Stock
returns. The impact of Interest rate and Stock returns in India is studied, by using monthly
data from April 1997 to March 2019. The study finds a Short run causality observed
between Interest rate and stock returns revalued the following, that there is no causality
between Interest rate and stock returns. The study implies that the Interest rate neither
affects Stock returns nor a Stock return affects the interest rate. Thus, the present study
empirically proves, stock market has no relation with the growth of interest rate in India
and vice versa.
From the previous studies and my findings now it is easy to say that interest rate has a
negative impact on stock market, higher the interest rate lower the efficiency of stock
market, it is because if investors are getting higher without taking any risk then why
should they invest in stock market, so for a better economy the ruling state should lower
its interest rate so that economy of that country gets developed. It is not the only factor
that has negative impact on stock market there can be many other factors for example
inflation rate etc which are having negative impact on stock market.
Based on the evidence obtained, this study can conclude that there is no significant causal
relationship between interest rate and share price. This study also shows that the market
does respond to certain shocks, as in this case, political instability.
71
5.2 SUGGESTION
This study considered only two variables, interest rates and share prices. However, the
inclusion of other macroeconomic variables likes inflation money supply and exchange
rate which might bring about a different effect to the study. This is important as the
government will be able to set up polices that will be helpful in developing the stock
market. Additional variables can therefore be considered in another study. Also the
significance of the results of this study could possibly be improved upon by applying
daily primary data. The use of more frequent observations may better capture the
dynamics of stock prices and interest rates interrelationships.
72
QUESTIONNAIRE
1. Is interest rate the best tool that keeps the liquidity position in the economy stable over
a period of time?
 Yes
 No
 Can’t say
3. Have you ever bought or sold Bank sector stocks in your portfolio on account of a rise
Bank Interest Rate?
 Yes
 No
 Sometimes
73
4. Is the long term rate of interest an important factor in regard to policies of Capital
Extension?
 Yes
 No
5. Is this a sufficient real rate to attract depositors in a big way from other assets such as
gold and real estate to what is offered by banks?
 Yes
 No
6. Will the fed rate hike affect the Indian stock market?
 Yes
 No
74

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A study on ‘….

Project Report submitted to the University of Mumbai in partial fulfillment of the

Mithibai Motiram Kundnani College, Mumbai – 400050

Date of Submission: Name:

Name and Signature

Certified by Name and Signature of Prof.:

Sr No. Particulars Page

2. Research Methodology 43-47

4. Data Analysis, Interpretation & Presentation 58-70

 Changes in interest rates affect corporate earnings growth, equity valuations,

 Gradual increases in rates driven by optimism about economic growth tend to

 Across countries and sectors, different segments of global markets respond

It’s finally safe to say it: Interest rates are rising

1.1 INTEREST RATES

The smoothing development process in Indian stock market continues to be

There is a long-term equilibrium relationship among the macroeconomic variables

A bi-directional causal relationship is also observed between real market

It is defined as the proportion of an amount loaned which a lender charges as interest

 the government's directives to the central bank to accomplish the government's

Interest rates are determined by monetary policy of a country according to its

However in a rising interest rate regime, as interest expenses rise, profitability is

Though financial economists, policy makers and investors have long-attempted to

Actual Previous Highest Lowest Dates Unit Frequency

6.25 6.50 14.50 4.25 2000 - 2019 percent Daily

Reserve Bank of India delivers a surprise rate cut in February’16.

India- Interest Rate Chart

Inflationary expectations: Most economies generally exhibit inflation, meaning a

Advantages of Interest Rate Effects

Disadvantages of Interest Rate Effects

2018-08-01 09:00 AM RBI Interest 6.5% 6.25% 6.5% 6.5%

2018-10-05 09:00 AM RBI Interest 6.5% 6.5% 6.75% 6.75%

2018-12-05 09:00 AM RBI Interest 6.5% 6.5% 6.5% 6.5%

2019-02-07 07:00 AM RBI Interest 6.25% 6.5% 6.5% 6.5%

2019-04-04 08:00 AM RBI Interest 6.25% 6.25%

RBI Unexpectedly Cuts Key Policy Rate to 6.25%

Excerpts from the RBI Press Release:

Interest Rate 6.25 6.50 14.50 4.25 Percent

Cash Reserve Ratio 4.00 4.00 10.50 4.00 Percent

Money Supply M1 33425.70 32785.80 33425.70 80.15 INR

Interbank Rate 6.36 6.40 12.97 3.10 Percent

Money Supply M2 34936.98 34510.22 34936.98 1127.49 INR

Money Supply M3 150535.59 148946.83 150535.59 123.52 INR

Foreign Exchange 402040.00 401780.00 426080.00 29048.00 USD

Central Bank Balance 18123.49 17616.33 23419.03 1624.31 INR

Loan Growth 14.60 14.40 18.70 4.10 Percent

Reverse Repo Rate 6.00 6.25 13.50 3.25 Percent

Short Term and Long Term Impact

The interest rate we are talking about here is:

Types of Interest rates fixed by RBI

History of Changes to Repo Rate

Updated On Repo Rate

07 February, 2019 6.25%

01 August, 2018 6.50%

06 June, 2018 6.25%

07 February, 2018 6.00%

02 August, 2017 6.00%

04 October, 2016 6.25%

05 April, 2016 6.50%