Universal Review ISSN NO : 2277-2723

The Impact of Stock Market Performance on Economic

Growth in India
Dr R Raghu
Faculty Member, PG Department of Commerce, SIR CRR College
drraghu730@gmail.com

Abstract
The present trend of expansion and liberalization of stock markets in the emerging
economies and the regional financial turbulence of the past decade has made the stock
market-real economy nexus a core issue of macroeconomic theory and policy. This study
examines the link between stock market performance in India and its impact on the
macroeconomic condition of the country, particularly, economic growth. The study
addresses two basic aspects- the link between stock market development and long-term
economic growth, the relationship between stock indices and major macroeconomic
variables. The study uses stock market development indicators like market capitalization
ratio, turnover ratio value traded ratio, and two major stock indices of the country viz. the
S&P Sensex and the CNX Nifty for the period 2008 -13.
The study uses econometric techniques such as OLS regression, ADF, cointegration, and
Granger causality to examine long-term relationships between stock market and
economic variables. The analysis provides support to the view that stock market
development boosts economic growth and influences capital structure decisions of firms.
Keywords: Financial system, Stock market, Economic growth, Stock prices,
Macroeconomic variables.

1. Introduction
Transfer of resources from those with idle resources to others who have a productive need
for them is one of the central concerns of the modern market-led economies. This goal of
financial intermediation is most efficiently achieved through the securities market. The
securities market provides channels for allocation of savings to investments through a
wide range of securities and thereby decouple these two activities. As a result, the savers
and investors are not constrained by their individual abilities, which inevitably enhance
savings and investment in the economy.

The securities market operates through two interdependent segments- the primary market
or the new issue market and the secondary market or the stock market. The primary
market provides the channel for sale of new securities while the secondary market deals in
securities previously issued. The price signals, which subsume all information about the
issuer and his business including associated risk, generated in the stock market help the
primary market in the allocation of funds. The stock market also enables investors to
adjust their holdings of securities in response to changes in their assessment about risk
and return and to sell securities to cash to meet liquidity needs. It essentially comprises of
the stock exchanges which provide a platform for trading of securities and a host of
intermediaries who assist in trading of securities and clearing and settlement of trades.

The modern stock market is both a product and a contributor to the emergence and
development of modern business corporations. Joint stock companies, the forerunners of
the modern corporations, organized in England and Holland in the 1500 and 1600 started
the practice of issuing their tradable shares on the bourses where commodities and coins
were exchanged. The growth of joint stock companies was rather slow till the turn of the
19th century. By the beginning of the 20th century, the number of corporations
multiplied, surpassing other forms of business concerns and it began to take over more

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and more of the control of the industrial system. With this move, the conduct and control
of industrial production have more and more become a matter of corporation finance and
stock market became an institutional necessity for mobilizing finance in the changed
scenario. Today, in modern market-led economies, stock market represents one of the
most important mechanisms for the mobilization of investible funds and its allocation
towards a best form of investment. It is also increasingly recognized that the stock market
plays several other key roles in the economy.

By spreading the risk associated with long-term investments stock market helps to lower
the cost of capital and thereby promote investment and growth; by imposing a degree of
control over the investment behaviour of companies through continuous monitoring stock
market contributes to more efficient resource allocation; and by attracting foreign
portfolio capital, stock market eases the shortage of investible funds in the domestic
economy.

1.1 Expansion of Stock Markets – A Developing Country Perspective

Establishment and expansion of stock markets have become a policy prescription to

developing countries by international agencies, especially the Bretton Woods institutions
following the successful deregulation of stock markets in developed economies in the
1980s. The process of stock market deregulation started in the US during the mid-1970s.
This process continued with the UK, Canada, and France implementing liberalization
programmes throughout the 1980s. Accordingly, various restrictions on the type of
securities and institutions traded in the capital market were removed. The liberalization
programme helped these countries to increase competitiveness and so reduce transaction
cost, to increase public participation in the market, and to encourage increased use of
stock market by industries. Hence it was accepted by heterodox economist’s world-wide
that stock market expansion is a natural progression of the development of a country’s
financial sector so as to finance the growing needs of the country as long-term economic
growth proceeds.

Meantime, the poor performance of the existing financial system characterized by

government-directed credit through Development Financial Institutions (DFI) in many
developing countries strongly urged for the restructuring of these systems and the
expansion of more voluntary and fiscally neutral financial institutions. The financial
liberalization literature pioneered by Mc Kinnon explained the costs of ‘financial
repression’ strategies that were followed by many developing countries. Under financial
repression, credit was highly directed and the banking system was characterized by high
reserve ratios which limited the resources of the banks.

Besides, government deficits often pre-empted limited resources. In the words of

McKinnon under financial repression, “…bank credit remains a financial appendage of
certain enclaves- exclusively licensed import activities, specialized large-scale mineral
exports, highly protected manufactories, large international corporations,
and various government agencies or publicly controlled utilities. Even ordinary
government deficits on current account frequently pre-empt the limited resources of the
deposit banks.”

Thus, financial repression restrained domestic savings within less developed countries and
generated pressure for reliance on foreign capital to supplement domestic savings and to
provide intermediation services capable of identifying high return investment
opportunities. It was also demonstrated that the liberalisation of these repressed markets
will contribute to economic growth by raising the level of saving and investment, and the
productivity of capital. Further, Stiglitz and Weiss have shown that there will still be

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credit rationing, even with financial liberalization because of information asymmetries in

the credit market. It was also shown that given several groups of clearly distinguishable
borrowers, imperfect information leads to adverse selection and moral hazard effects and
agency costs. To reduce such inefficiencies, Cho argued that credit markets need to be
supplemented by well-functioning equity markets.

Another serious case for the expansion and liberalization of third world stock markets was
the need to attract foreign capital in non-debt creating forms in the wake of their high
external indebtedness and decline in the official transfer of funds. The collapse of the
Soviet Union and the end of the cold war also led to the diminution of official funds from
developed countries to underdeveloped countries. Thus creation and expansion of
efficient credit markets in general and stock markets in particular has become a global
trend ever since the 1980s. It was further strengthened by the liberalization drive
following the GATT negotiations, and the information technology boom that redefined
the concepts of time and distance. All these have contributed towards a change in the
perspective on the role of the stock market in long-term economic development of the
country. Today stock markets in developing countries are growing rapidly. Over the past
fifteen years emerging stock markets’ shares in total world market capitalization has
grown almost threefold.

1.2. Indian Perspective

The Indian stock market through one of the oldest in Asia remained largely outside the
process of liberalization and globalization until the late 1980s. Though a number of
developing countries in tandem with the International Finance Corporation and the World
Bank took steps in the early 1980s to revitalize their stock markets, India embarked upon
the reform of the stock market in 1988 with the establishment of SEBI.

However, the reform process gained momentum only in the aftermath of the external
payments crisis of 1991, followed by the securities scam of 1992. The balance of
payments crisis of 1991 compelled India to seek assistance from IMF on the condition of
initiation of a structural adjustment programme (SAP) to get rid of the maladies of the
high fiscal deficit, inflation largely caused by the market repressing development strategy
of the eighties. The SAP, which was implemented in a gradualist pattern, consisted of
comprehensive fiscal, financial and external sector reforms. As part of the financial sector
reforms, capital market reforms were launched in 1992. In fact, it was a strategic necessity
in the backdrop of the paradigm shift from a state-directed to market-determined
development strategy. Liberalization of product markets also required a well-functioning
financial system for mobilization and allocation of savings.

Banks, capital markets and financial institutions were no longer seen as mere conduits for
channelling savings in the predetermined directions, but as important instruments for
allocating savings among alternative investment choices according to their relative
efficiency. Accordingly, comprehensive reform programmes were implemented in the
capital market. The reforms were largely based on the recommendations of various
committees constituted for the purpose.

The implementation of recommendations included the repeal of the Capital Issues

(Control) Act, 1947, through which the Government used to expropriate seignior age and
allocate resources from the capital market for favoured uses; the enactment of the
Securities and Exchange Board of India Act, 1992 to assign statutory status to the SEBI;
free pricing of securities according to market sentiments; permitting private financial
institutions to set up mutual funds and foreign institutional investors to participate in the
stock market; setting up of the National Stock Exchange in 1993; passing of the

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Depositories Act, 1996 to provide for the maintenance and transfer of ownership of
securities in book-entry form; and amendments to the Securities Contracts(Regulation)
Act, 1956 in 1999 to provide for the introduction of futures and options.

Second generation reform measures included the introduction of rolling settlement in

2001, banning of all deferral products such as carry forward, commencement of trading in
futures and options, setting up of clearing corporation for government securities and
dematerialization of debt instruments. These reforms were aimed at creating an efficient
and competitive securities market by overcoming various shortcomings of the market.
The process of reforms has led to a pace of growth almost unparalleled in the history of
any country. The stock market in India has grown exponentially as measured in terms of
amount raised from the market, number of stock exchanges and other intermediaries, the
number of listed stocks, market capitalization, trading volumes and turnover on the stock
exchanges, number of transactions, investor population and price indices. Along with this,
the profiles of the investors, issuers, and intermediaries have changed significantly. The
market also witnessed fundamental institutional changes during this period resulting in a
drastic reduction in transaction costs and significant improvements in efficiency,
transparency, and safety.

2. Review of Literature

Morley investigated the relationship between money and stock prices in developed
countries and whether deregulation during the 1980s and 1990s have affected it. He
used cointegration and Granger causality tests to determine whether a long-run
equilibrium relationship exists between stock prices and various macroeconomic
variables in both stock markets based and bank based economies. The results
suggested that there is strong bi-directional causality between money and stock
prices in both types of economies. It is also found that the causality runs
predominantly from stock prices to money, supporting the view that stock prices are
an important determinant of both narrow and broad definitions of money (Friedman
1988). Overall, the results suggested that it is the nature of the financial system
rather than the extent of deregulation that determines the relationship between stock
prices and money supply.

According to Mc Millan there exist co-integration between both S&P 500 and DJIA
indices and macroeconomic activity variables. The relationship is positive and
significant for industrial production and inflation, negative and significant for long-
term interest rates, and negative but insignificant for money supply and short-term
interest rates. The study also showed that long-term rates of these variables explain
a substantial amount of variability in stock prices, while short-term rates of
industrial production and inflation also have some explanatory power.

Omran and Pointon studied the impact of the inflation rate on the performance of
the Egyptian stock market. They studied the effects of the rates of inflation on
various stock market performance variables indicating market activity and market
liquidity. They found significant long run and short-run relationship between the
variables, implying that the inflation rate has had an impact upon the Egyptian stock
market performance generally.

Panda and Kamaiah investigated the causal relations and dynamic interactions
among monetary policy, inflation, real activity and stock returns in the post -
liberalization period. They found that monetary policy, expected inflation, and real

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activity affect stock returns. However, monetary policy loses its explanatory power
for stock returns when expected inflation and real activity are put in the system.
Moreover, the relationship between monetary policy, expected inflation and real
activity with stock returns lack consistency. Their observation is inconsistent with
the view that stock market rationally signals changes in real activity.

Beck examined the effects of money supply, aggregate spending and aggregate
supply shocks on real stock prices in the US. The study showed that each macro
shock has important effects on real stock prices. It also confirmed the well -known
negative correlation between real stock returns and inflation.

Bhattacharya and Mukherjee tested the causal relationship between the BSE
Sensex and five macroeconomic variables. They found that there are no causal
linkages between stock prices and money supply, national income and interest rate,
while the index of industrial production leads the stock prices and there exists a
two-way causation between stock price and rate of inflation.

Baily studied the impact of switching between silver, gold, and paper money
standards on stock returns. They found that the paper currency regime is often
associated with higher stock market volatility and higher correlation between
markets, Indicators of global economic activity and export commodity prices
typically explain a greater fraction of stock market behavior than currency related
factors. They observed little evidence that abandonment of the traditional currency
has affected stock return volatility and cross-market correlation.

Boon and Hook studied the impact of volatility in the Malaysian financial system
during the Asian financial crisis on the performance of the Kuala Lumpur Stock
Exchange. They found that the volatility of the exchange rate and interest rate had
increased significantly during the crisis period and it affected the stock prices
significantly. Exchange rate volatility exhibited more explanatory power on stock
prices than interest rate volatility during this period.

3. Objectives of the Study

The objective of the present study is to unravel the linkage between the stock market
behaviour and the real economy in the Indian context with reference to the post-
reform era.
Specifically, the objectives of the study are given below.
 To examine the impact of stock market size, liquidity, and efficiency on the
long run economic development of India.
 To analyse the link between various macroeconomic variables like money
supply, interest rate, wholesale price index, foreign exchange rate, the index
of industrial production and major stock indices so as to test the presence of
causality, if any.

4. Research Design and Methodology

The study is both theoretical and empirical in nature. Theoretical analysis is based
on various propositions regarding the link between finance and long-term economic
development in general and the stock market in particular. In the wake of the
heightened attention of economists and policymakers towards the role of finance in
economic growth, the evolution of relevant theories and their significance to
developing countries are discussed in detail.
The data required for the empirical analysis are collected from secondary sources.
Secondary data are collected for the period 2008-2013. It is collected from various

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sources such as Emerging Markets Data Book, IFC; Handbook of Statistics, SEBI;
Report on Currency and Finance, RBI; Handbook of Statistics on Indian Economy,
RBI; RBI Bulletins; Economic Survey, Govt. of India; Review of Indian Securities
Market, NSE; Data on Indian Economy, Data on Corporate Sector, and Data on
Capital Market compiled by CMIE.
The data collected are analysed with the help of statistical and econometric tools.
Linear and semi-log growth equations are fitted under the OLS method of regression
to find out the impact of stock market development on economic growth and capital
structure of corporate firms. E Views statistical software is used to run OLS
regression.
Durbin – Watson test, Correlation, and t-test were employed to find the significance
of the study.

5. Scope and Limitations of the study

Stock market development is a complex phenomenon that supposedly affects the
real economy in a multitude of ways. The scope of the present study is limited to
explore the extent to which stock market affect the real economic growth of the
country. Specifically, it studies the link between stock market and real economic
activities during 2008-2013, in the light of the financial liberalization and structural
adjustment programmes. Since the time period is not too adequate to attempt an
impact analysis, the study tries to make a preliminary step in this regard.

The analysis is based on secondary data collected from various sources. There are
discrepancies in the data from different sources. Besides, the secondary analysis is
limited to the period from 2008-2013.

6. Data Analysis and Interpretation

Indicators of Stock Market Development:
There exists no unique measure of stock market development, due to the diversity of
services provided by stock markets. Considering the significance of the stock market in
the provision of liquidity, and the reduction of market imperfections that obstruct
financial intermediation three indicators of stock market development viz. Market
Capitalisation Ratio, Value Traded Ratio, Turnover Ratio, representing the size, liquidity,
and efficiency of the stock market respectively are developed recently.
Size: The size of the stock market is positively correlated with the ability to mobilize
capital and diversify risk and thereby influences economic growth. The ratio of the total
value of all the listed shares in a stock market to the Gross Domestic Product called the
Market Capitalisation Ratio (MCAP) is used to measure stock market size. It is a measure
of both the stock market’s ability to allocate capital to investment projects and to provide
opportunities for risk diversification for investors.
Liquidity: Liquidity shows the level of activity in the stock market, and is the ratio of
stock markets’ total value traded to GDP (Value Traded Ratio, hereafter VTR). VTR is an
indicator of transaction costs also. This ratio does not directly measure the costs of buying
and selling securities at posted prices. Yet, averaged over a long time, the value of equity
transaction as a share of national output is likely to vary with the ease of trading.
Liquidity of the stock market is supposed to influence growth positively by easing
investment in large, long-term projects and by promoting the acquisition of information
about firms.
Efficiency: Stock market Turnover Ratio (TOR) is the indicator of stock market
efficiency. It is the ratio of the value of total shares traded to market capitalization. It
measures the activity or liquidity of a stock market relative to its size. An active stock
market will have a high turnover ratio and a less liquid market will have a low turnover
ratio. Liquidity and efficiency are two important attributes of stock markets, because,

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liquid and efficient markets improve the allocation of capital and enhance prospects for
long-term economic growth.
Other important attributes of stock market include volatility and concentration. Stock
market volatility indicates the ability of the stock market to handle heavy trading without
large price swings. Concentration refers to the dominance of the stock market by a few
companies. The share of market capitalization accounted for by the ten largest stocks is
used to measure stock market concentration. Developed stock markets are characterized
by low levels of volatility and market concentration. However, these two indicators are
not considered in the regression analysis, since their contribution to long-term economic
growth turned out to be insignificant.
Macroeconomic Determinants of Economic Growth
In line with the endogenous growth regression models, a large set of macroeconomic
variables representing government consumption, capital formation, human capital,
financial depth, external openness, and general price level are also included in the
analysis. Various macroeconomic and their a priori relationship with growth are discussed
below.
1. The ratio of final government consumption to GDP (FGCE) is included to control for
the effect of fiscal policy and taxation. In general, there is a negative correlation between
growth and government consumption expenditure as a share of GDP. This would also
indicate a negative correlation between tax levels and growth
2. The ratio of the gross domestic capital formation to GDP (GDCF). Economic growth is
supposed to be an increasing function of capital formation.
3. The secondary school enrolment ratio (SSER), which is used as a proxy for education.
It is the ratio of total secondary enrolment to the population of the age group that
officially corresponds to that level of education. SSER is expected to be positively
associated with economic growth. Since the measurement of human capital related
variables is problematic, regressions of SSER on growth do not always give consistent
results.
4. The ratio of exports plus imports to GDP (EXIM) is included to proxy for the openness
of the economy to the rest of the world. Though, trade openness has an important bearing
on growth the direction of causality and the nature of the relationship is not conclusive.
5. The ratio of M3 to GDP (MGDP) is used to measure the impact of the overall size and
depth of the financial market on economic growth. The depth and size of the financial
market are positively and significantly related to economic growth theoretically.
Empirical results also show a positive robust correlation between the two variables.
6. Macroeconomic conditions such as price stability, output volatility, real exchange rate
fluctuations etc. have an important bearing on growth. The macroeconomic condition is
proxies by the inflation rate (INFLN) measured in terms of annual average growth rate of
the wholesale price index. It is expected to be negatively related to growth.
7. The time variable is included to test the sensitivity of the regression to the time-variant
factors.
Stock Market Size and Economic Growth:
The relationship between stock market size measured by MCAP and economic growth is
tested in equations (1) and (2). Two alternative measures of economic growth are used,
i.e. Log GDP and the growth rate of per capita real GDP (PERGR). The index of
industrial production (IIP) is used as the dependent variable in equation (3), to test the
relationship between industrial activity and stock market size.

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Growth equation (1)

Log GDP = a + b1 FGCE + b2 GDCF + b3 EXIM + b4INFLN + b5 M3GDP + b6
MCAP + b7 TIME
Table – 1
Growth Equation (1)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 5.77 44.82 0.00
GDCF 0.17 0.21 0.76
FGCE -0.07 -0.32 0.83
EXIM 0.36 2.21 0.07
M3GDP 0.14 2.80 0.03
INFLATION -0.0006 -2.70 0.03
MCAP 0.0004 1.32 0.24
TIME -6.52 -0.41 0.69
R2 =0.99 Adj.R2 =0.98 D-W stat=2.9 F-Ratio=150.61
Computed from the variables specified
MCAP shows a positive association with GDP in the analysis but is not statistically
significant. The size of the financial system measured by M3 and GDP shows a
significant positive association with economic growth. It indicates that the larger the size
of the financial market the greater its contribution towards economic growth. All other
determinants enter the regression with a priori relationships. The openness of the
economy is found to be positively associated with GDP. The R 2 adjusted R2 and F-ratio
are sufficiently high.
Growth equation (2)
PERGR = a + b1 FGCE + b2 GDCF + b3 EXIM + b4 SSER + b5 INFLN + b6
MCAP + b7 TIME
Table – 2
Growth Equation (2)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 30.24 0.99 0.36
FGCE -246.38 -1.12 0.31
GDCF 104.94 2.31 0.06
EXIM -106.37 -1.64 0.16
SSER 0.16 0.49 0.64
INFLATION -0.90 -1.52 0.18
MCAP -0.05 -1.14 0.30
TIME 2.39 2.88 0.03
R2 =0.81 Adj.R2 =0.56 D-W stat=2.8 F-Ratio=3.20
Computed from the variables specified
In equation (2), MCAP shows a negative association with PERGR. However, it is not
statistically significant. R2, adjusted R2 and F-ratio are sufficiently high. Durbin - Watson
statistic is above two which indicates there is no significant serial or autocorrelation. The
results indicate that the most significant factor affecting the growth rate of per capita
income is gross domestic capital formation. Time-variant factors also exert a considerable
impact upon the dependent variable.

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Growth equation (3)

IIP = a + b1 FGCE + b2 GDCF + b3 INFLN + b4 M3GDP + b5 MCAP + b6 TIME
Table – 3
Growth Equation (3)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 122.9 3.69 0.01
FGCE -425.53 -2.06 0.08
GDCF 23.18 0.27 0.79
INFLATION -1.75 -2.29 0.06
M3GDP 69.74 3.12 0.01
MCAP 0.22 2.18 0.07
TIME 1.34 0.87 0.40
R2 =0.99 Adj.R2 =0.98 D-W stat=2.5 F-Ratio= 166.53
Computed from the variables specified

In the regression, MCAP enter with a positive sign and is statistically significant. It
indicates that industrial activity and the size of the stock market are positively associated.
It is noteworthy, since we have already controlled for the size of the financial system as a
whole measured by M3GDP, and it shows a positive and significant association with
industrial production.

Stock Market Efficiency and Economic Growth:

Stock market efficiency measured by the turnover ratio (TOR) is included in the
regression equation (4), (5) and (6). Equation (1) tests the relationship between stock
market efficiency, measured by a turnover ratio, and GDP, equation (2) tests the link
between stock market efficiency and PERGR and equation (3) tests the link between
industrial activity and stock market efficiency.

Growth equation (4)

Log GDP = a + b1 FGCE + b2 GDCF + b3 EXIM + b4INFLN + b5 M3GDP + b6
TOR + b7 TIME
Table – 4
Growth Equation (4)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 5.68 78.7 0.00
GDCF 0.09 0.54 0.60
FGCE 0.44 0.86 0.42
EXIM 0.39 3.29 0.02
M3GDP 0.14 3.50 0.01
INFLATION -0.002 -1.24 0.26
TOR -0.001 2.12 0.08
TIME -5.5 -2.49 0.05
R2 =0.99 Adj.R2 =0.99 D-W stat=2.8 F-Ratio= 213.06
Computed from the variables specified

Stock market efficiency (TOR) shows statistically significant positive correlation with
GDP. The inclusion of TOR has increased the significance of the overall model. The
results with other variables are also not sensitive to model specification. The overall
significance of the model has improved in this equation when compared to equation (1).

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Growth equation (5)

PERGR = a + b1 FGCE + b2 GDCF + b3 EXIM + b4 SSER + b5 INFLN + b6 TOR
+ b7 TIME
Table – 5
Growth Equation (5)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 67.5 3.15 0.02
FGCE -530.23 -3.27 0.02
GDCF 101.81 2.56 0.05
EXIM -159.54 -1.24 0.26
SSER 0.48 1.90 0.11
INFLATION -1.11 -2.29 0.07
TOR 0.01 1.74 0.14
TIME 2.79 3.84 0.01
R2 =0.85 Adj.R2 = 0.65 D-W stat= 2.3 F-Ratio= 4.29
Computed from the variables specified
TOR shows a positive association with PERGR. However, it is not statistically
significant. The overall significance of the model has increased when MCAP is replaced
by TOR. Stock market efficiency, therefore, is a more important determinant of economic
growth than the size of the stock market.

Equation (6)
IIP = a + b1 FGCE + b2 GDCF + b3 INFLN + b4 M3GDP + b5 TOR + b6 TIME
TOR bears a weak positive association with IIP. In contrast to the first two equations, in
this case, the model is more significant when MCAP is included in the model. However,
the nature of the relationship is not model sensitive.
Table – 6
Growth Equation (6)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 67.65 1.67 0.15
FGCE -513.33 -1.70 0.14
GDCF 107.53 1.95 0.10
EXIM -165.27 -1.89 0.11
SSER 0.47 1.23 0.27
INFLATION -1.35 -1.86 0.12
TOR 0.03 0.43 0.68
TIME 2.9 2.53 0.05
R2 =0.77 Adj.R2 = 0.46 D-W stat= 2.90 F-Ratio= 2.40
Computed from the variables specified

Stock Market Liquidity and Economic Growth

Stock market liquidity measured by the value traded ratio is included in regression
equations 7, 8 and 9.
Growth equation (7)
Log GDP = a + b1 FGCE + b2 GDCF + b3 EXIM + b4INFLN + b5 M3GDP + b6 VTR +
b7 TIME
Stock market liquidity also found to be positively associated with GDP. However, it is not
statistically significant. R2 and adjusted R2 are sufficiently high which indicates that the
model is well specified

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Table – 7
Growth Equation (7)
Regressors Parameter Estimate t-statistic p-value
INTERCEPT 5.7 58.22 0.00
GDCF 0.04 0.19 0.85
FGCE 0.56 0.88 0.41
EXIM 0.49 3.60 0.01
M3GDP 0.09 2.17 0.08
INFLATION -0.005 -2.00 0.04
VTR 0.0006 1.28 0.25
TIME -3.33 -1.6 0.15
R2 =0.99 Adj.R2 = 0.98 D-W stat= 2.6 F-Ratio= 148.62
Computed from the variables specified
Growth equation (8)
PERGR = a + b1 FGCE + b2 GDCF + b3 EXIM + b4 SSER + b5 INFLN + b6 VTR +
b7 TIME
The results of the regression show that stock market liquidity shows a weak positive
correlation with PERGR. This indicates that stock market activity is not a significant
determinant of the growth rate of per capita income. However, it is noteworthy that the
positive association exhibited in equation (7) is intact in equation (8) also, which indicates
that stock market liquidity is not detrimental to growth.
Table – 8
Growth Equation (8)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 91.82 2.07 0.08
FGCE -213.6 -0.79 0.45
GDCF 122.83 1.32 0.23
INFLATION -1.80 -1.79 0.12
M3GDP -1.80 -1.79 0.12
VTR 0.069 0.45 0.66
TIME 2.93 1.57 0.16
R2 =0.98 Adj.R2 = 0.97 D-W stat= 2.0 F-Ratio= 95.38
Computed from the variables specified

Growth equation (9)

IIP = a + b1 FGCE + b2 GDCF + b3 INFLN + b4 M3GDP + b5 VTR + b6 TIME
The results show that there is only a weak positive association between stock market
liquidity and industrial activity measured by IIP. Of the three indicators of stock market
development, stock market efficiency measured by the turnover ratio is more strongly
related to economic growth and industrial activity. Stock market size shows a statistically
significant correlation in one out of the three regressions. In contrast to the results of
earlier studies, stock market liquidity shows only a weak positive association with
economic growth and industrial activity. In the wake of the fact that the increased
liquidity in the Indian stock market is largely contributed by the FII inflows, this result is
especially interesting. However, more research is needed to make any meaningful
conclusion in this regard.

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Universal Review ISSN NO : 2277-2723

Table – 9
Growth Equation (9)
Regressors Parameter Estimate t-statistic p value
INTERCEPT 86.55 2.32 0.05
FGCE -202.54 -0.84 0.43
GDCF 123.9 1.35 0.22
INFLATION -1.58 -1.47 0.18
M3GDP 51.26 1.96 0.09
VTR 0.01 0.54 0.60
TIME 2.74 1.50 0.18
2
R =0.98 Adj.R2 = 0.97 D-W stat= 2.0 F-Ratio= 96.79
Computed from the variables specified

7. Findings
Stock Market Development and Economic Growth:
 The size of the stock market, measured as the market capitalization ratio does not
seem to affect the growth prospects of the country. The nature of the relationship
is also not conclusive. However, stock market size shows a significant positive
relationship with the level of industrial activity in the country. This finding is
consistent with the earlier studies that suggest that stock market size is a less
significant contributor towards economic growth compared to stock market
liquidity and efficiency.
 Stock market liquidity is found to be positively associated with economic growth
and the index of industrial production. But this relationship is statistically weak.
Stock market efficiency shows a statistically significant positive association with
economic growth. It shows a weak positive association with the index of
industrial production. Theoretically, stock market efficiency enhances financial
intermediation through the reduction of transaction costs and other imperfections
associated with equity finance. This finding indicates that various measures
implemented towards enhancing stock market efficiency will boost economic
growth.
 Considering the influence of a multitude of factors on economic growth, the
positive association exhibited by stock market development indicators, though it
is weak in some cases, is an indication of the nexus between the services provided
by the stock market and long-run economic growth. It is also noteworthy that the
results do not support the view that stock market development is detrimental to
long-term economic growth.
7. Conclusion
Despite the heightened attention received by the stock market, investor base of the Indian
stock market is miserably low. Theoretically, stock market investment aims at risk
diversification and direct participation in project financing in a widespread manner. It,
therefore, requires the existence of a relatively large number of investors with the
sophistication, means, and ability to shoulder such risks. However, irrespective of the
long array of reform programmes implemented, fraudulent practices and excessive
speculation are still a nightmare to genuine investors in the country. People do not
consider the stock market as formal financial institutions like banks. Instead, it is treated
as a gambling place for speculators. Serious policy initiatives are required in this regard
so as to make the stock market a more relevant institution.
FII flow is the major factor behind the remarkable surge in turn over and liquidity of the
Indian stock market since the past ten years. Besides, the movements of major stock
indices are in tandem with trends in FII flows, and they have become the most crucial
single factor influencing stock market behavior nowadays. However, in a long-term
perspective, FII inflow is more likely to plateau out when interest rate differentials

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disappear eventually as India become more integrated with developed markets. Taking
this in view, it is essential to develop domestic capabilities in terms of better participation
of domestic financial institutions that have large funds to invest in. In addition to the
current reforms implemented by the government allowing pension funds to invest in the
stock market, further steps should be taken to expand the domestic institutional
participation in the stock market.
Domestic institutional participation in various derivative instruments also should be
allowed for the long-term sustainability of the present growth of the Indian stock market.
Indian stock market exhibits positive changes with regard to various aspects of the
market. India exhibits the lowest variation in stock returns among emerging markets.
Contrary to the popular belief, stock market volatility in the Indian stock market has not
increased after opening it up to FIIs.
Similarly, market concentration and transaction costs have come down in major stock
exchanges in the post-reform period. India’s position in this regard is better than many
advanced capital markets. Indian stock market is still a fragmented market. There are
twenty-three stock exchanges in the country of which three are national exchanges.
Seventeen exchanges are providing screen-based services. Internationally, the trend is
towards consolidation of existing exchanges.

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