Relationship between Stock and Commodity Market Development on Economic Growth

By:

Hamza Iftikhar (01-114182-004)

Hafsah Mustafa (01-114182-021)

Ali Sajjad (01-114182-032)

Bachelors in Economics

Supervisor:

Dr. Anees Khan

Department of Management Sciences

Bahria Business School

Bahria University Islamabad

Spring-2022

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 Final Project Submission Form

Viva-Voce Examination

Viva Date __/__/____

Topic of Research: Relationship between Stock and Commodity Market

Development on Economic Growth,

Names of Student(s): Enrollment number:

• Hamza Iftikhar 01-114182-004

• Hafsah Mustafa 01-114182-021
• Ali Sajjad 01-114182-032

Class: BS Economics 8A

Approved by:

Dr. Anees Khan

Supervisor

_______________________________________________________

Dr. Asma Basit

Research Coordinator

_______________________________________________________

Dr. Samreen Fahim Babar

Head of Department

Management Studies

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 Table of Contents
DEDICATION: ........................................................................................................................................... 4
ACKNOWLEDGEMENT: ........................................................................................................................ 5
ABSTRACT ................................................................................................................................................. 6
CHAPTER 1 ................................................................................................................................................ 7
1.1. Introduction:.................................................................................................................................. 7
1.2 Background: .................................................................................................................................. 7
1.3 Problem Statement: ....................................................................................................................... 8
1.4 Research Objectives: ..................................................................................................................... 9
1.5 Research Questions: ...................................................................................................................... 9
1.6 Scope and Limitation of the Study:............................................................................................... 9
1.7 Justification: ................................................................................................................................ 10
1.8 Budget and Resources: ................................................................................................................ 10
CHAPTER 2: LITERATURE REVIEW ................................................................................................ 11
CHAPTER 3: METHODOLOGY........................................................................................................... 16
3.1. Sample and Data Collection............................................................................................................. 16
3.2. Data Collection ................................................................................................................................ 16
3.3. Data Analysis ................................................................................................................................... 16
3.4. Model Specification ......................................................................................................................... 16
3.5 Theoretical Framework ..................................................................................................................... 18
3.5.1 Hypothesis...................................................................................................................................... 18
3.6 Analysis............................................................................................................................................. 22
Descriptive Statistics............................................................................................................................... 22
Correlation (Significance >0.5) .............................................................................................................. 23
Linear Regression (Significance at p<0.05) ............................................................................................ 23
CHAPTER 4: IMPLEMENTATION OF RESULTS ............................................................................ 24
CHAPTER 5: LIMITATIONS, CONCLUSIONS AND RECOMMENDATIONS............................ 25
5.1. Limitations: ...................................................................................................................................... 25
5.2. Recommendations: ........................................................................................................................... 26
5.3. Conclusion: ...................................................................................................................................... 26
References:.................................................................................................................................................. 28

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DEDICATION:

Hamza Iftikhar, Hafsah Mustafa and Ali Sajjad would like to dedicate this thesis to their beloved
mother and father.

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ACKNOWLEDGEMENT:

We would like to say a special thank you to our supervisor, Dr. Anees Khan, his support,
guidance and overall insights in this field has made this an inspiring experience for us. He helped
us with all our questions and queries and made this dissertation a lot more interesting for us.

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ABSTRACT

The stock and commodity markets are integral to the macroeconomic function of the country as a
whole. The stock market allows finances to be raised through shares and bonds while the
commodity market is a great tool for the economy to fulfill its demands of raw materials and can
also be a great procurer of foreign exchange. In this paper FDI, exchange rate, and inflation are
taken as determinants of stock market performance, and for commodity markets, oil is used as a
determinant. Data is taken from 2005-2020 to gauge the performance of each market against the
economy. We found out that inflation and exchange rate were deemed to be significant in the
workings of the stock market and foreign direct investment was deemed to be insignificant. Oil
prices were also deemed to be insignificant in relation to GDP. Structural and supply side
reforms were advised to improve the workings of the stock market by making it more efficient.

Keywords: Inflation, Foreign Direct Investment, Exchange Rate, Oil Prices, World Bank Open
Data, Stock Market, Commodity Market, Regression, Correlation, Descriptive Statistics, GDP

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 CHAPTER 1
1.1. Introduction:
The stock exchange is one of the most preferable avenues of investment for individuals as
well as a great method for companies to muster up equity finances for their long and short term
goals. For individuals, if done prudently, they can have a relatively healthy return on their
savings in the long-run as compared to if they invested in more volatile markets like the foreign
exchange market or the crypto currency markets. For companies, raising capital can be quite
straight forward. Instead of leaning on banks who consistently monitor the workings of the
business and require securities for issuance of debt, issuing shares for the company can be quite
easy. Also, raising capital from banks doesn’t really sit well with onlookers of financial
statements as a higher gearing ratio can deter people from investing and can result in the
demotion of a company’s perceived value.

Commodity markets on the other hand are also integral to an economy. They provide the raw
materials from which further processing can take place and through which more goods can be
manufactured. Commodity markets are like the foundation of a building, they provide integral
support to the manufacturing and tertiary sectors. The commodity markets can also have a great
effect on the inflation and the currency of an economy. A generalized increase in the price of raw
materials can reverberate through the whole of the economy causing price bumps in many
sectors. Also, if the commodity markets are efficient and can satisfy the needs of the parent
economy as well as foreign economies, then a good amount of foreign exchange can also be
expected as a product of such an efficient market.

This paper gauges the performance of these two markets against the economy to see the
effects of the changes which they inflict on the economy as a whole. We would like to see
whether the stock market is working as a more standalone component of the economy or the
circulation is felt throughout the economy. Also, we would like to measure the effect that the
changes in the prices of commodities has on the performance of the economy.

1.2 Background:
As of January 2022, there are about 375 companies listed on the PSX with a total market
capitalization of PKR 7,756 billion (USD$52 billion). One of the constituents of the Pakistan
Stock Exchange and also the oldest of the three exchanges that are present in Pakistan, the
Karachi Stock Exchange has been the best performing stock exchange in the world from a period
of 2009 to 2015.

This paper discusses the relationship between the activities of the stock market and its
correspondence with the economic growth of the country. The investors in the stock market may
be many and the market is in a constant flux; what we want to know is whether the profits and
dividends keep accumulating in the big pockets of the wealthy investors or is there a trickledown
effect that creates a steadier economy?

7
 Commodity markets and their relationship with economic growth will also be looked upon.
Historically and also in the present age, the commodity market of Pakistan is slanted towards
rural products like agricultural goods, animal goods, and textile goods. In 2018, Pakistan’s
highest exports were textiles and on second were vegetable products. Although, these
commodities barely cover the trade deficit of Pakistan as Pakistan is not much adept in
producing commodities that are more expensive as compared to the ones it produces. In 2018,
the three major imports of commodities that Pakistan partook in were mineral products,
machines, and chemical products.

As for most countries, fuel and machine costs are very important for the general price level in
the country. A hike in price of fuel can push an economy towards an inflationary spiral causing
costs and wages to rise substantially and periodically.

Machinery is also integral to the primary, secondary, and tertiary sectors of a country. More
and more technological advancements means that the global economy is moving towards better,
faster, and more efficient ways. To compete with the fast-moving world, Pakistan also has to
import machinery that helps it produce, process, and provide in more competitive ways.

1.3 Problem Statement:

This research explores the relation of stock market development and commodity market
development on economic growth of Pakistan from 2005 to 2020. Pakistan has endured a lot of
hardships when it comes to economic growth, especially in terms of FDI, budget and trade
deficits, inflation, law and order and etc.

The relationship of the Pakistan Stock Exchange and the commodity markets of Pakistan
with its economic growth is in the news for the last decade. The stock exchange fluctuates day to
day, minute to minute with the common sentiment that has been doing its rounds in the news.
Any news of a possible economic mishap can cause it to shed many a points according to the
weight of the news at hand. It can also gain a few points if the sentiment of the investors is a bit
bullish. Hence, the stock market is a great tool for gauging the confidence of the general investor
or business person.

The stock market can also help predict economic bubbles that are about to burst. It’s been
noted time and time again that the biggest economic crashes take place after ravenous amounts
of over-leveraging and mindless investing when the confidence of investors is sky-high and their
ability to reason not so much. With the markets flourishing, investors seem to develop an
aggressive mentality and it gets more and more single-minded as time goes on, and the situation
eventually falls on its face when bad debts seem to rise, panic ensues as a result. Hence, the stock
market is potentially a good tool for predicting rallies and descents of the economy, as well as
predicting booms, busts, depressions, and stagnations.

This paper gauges the performance of the stock market using three determinants, namely
inflation, foreign direct investment (FDI), and exchange rate.
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 This paper also looks at the effect that the commodity market has on economic growth. For
the commodity market, oil is taken as a sole determinant. Oil is generally considered to have a
massive effect on the growth and inflation of an economy. Rising oil prices can cause inflation
throughout the economy as it used to power industries, homes, vehicles, and is in some way
involved in the cost card of every business and household. As of 2020, refined petroleum, crude
petroleum, and petroleum gas made up a cumulative 15.91% of the total $50.5 billion import bill
of Pakistan, the highest of any other commodity.

1.4 Research Objectives:

The objective of this study is to analyze how inflation (selling costs of listed firms), foreign
direct investment (foreign investment that the stock market receives), exchange rate (importing
cost of listed firms) and oil prices and the relation of oil prices with the commodity market
influence the overall economic growth of Pakistan. To analyze this an observational, descriptive,
correlative and regressive analyses is carried out.

1.5 Research Questions:

In our research regarding the stock and commodity market, we had prepared a set of
questions that covered all aspects of our research.

i. What is the impact of inflation and the selling costs of listed firms on the economic
growth of Pakistan?
ii. What is the impact of FDI and the foreign investment which the stock market receives on
the economic growth of Pakistan?
iii. What is the impact of Exchange Rate and the importing costs of listed firms on the
economic growth of Pakistan?
iv. What is the impact of Oil Prices and its relation with the commodity market on the
economic growth of Pakistan?

1.6 Scope and Limitation of the Study:

This study was conducted using 16 years of data gathered from World Bank regarding
inflation rate of Pakistan, exchange rate of Pakistan against the US dollar, and Foreign Direct
Investment of Pakistan. The data collected for oil is sourced from the West Texas Intermediate
(WTI) oil index. The data used is secondary in nature. The limitation of this study is that selling
costs of listed firms, importing costs of listed firms, and foreign investment in the stock market is
inferred from the larger functions that are inflation, exchange rate of Pakistan against the US
dollar, and the inflows and outflows of Foreign Direct Investment. The study would have been
even more detailed if cumulative selling costs, import costs, and foreign investment in the stock
market for the period from 2005-2020 were sourced from the cumulative financial statements of
listed firms in Pakistan. Unfortunately, such data was not found and different measures had to be
used to collect empirical evidence. Also, this study conducts statistical analyses by using linear
statistical tools. More insights could have been gathered if non-linear tools were also added.

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1.7 Justification:
There have been countless papers studying and finding a positive relationship between the
stock market and the economy but none of them looked into the macro-economic determinants or
the larger functions that influence the stock market. Through this paper, we study the larger
functions and find the relationship which they have with the smaller functions of selling costs,
import costs, and foreign investment in the stock market. We also apply the same method to oil
and use it as a proxy for gauging the commodity markets. Most of the papers focused on the
demand-side functions of the economy which are difficult to influence for a developing and
struggling economy like Pakistan. In this study, we provide emphasis on the supply-side,
structural, and policy-making side of government decision making.

1.8 Budget and Resources:

Secondary research was gathered from the World Bank and the West Texas Intermediate
(WTI) oil index. No budget was allocated or utilized for this research. STATA was used to
conduct descriptive, correlative, and regressive analyses.

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 CHAPTER 2: LITERATURE REVIEW

There have been quite a few researches on the topic of stock exchange and economic growth,
some really extensive and some less. Perhaps the most extensive research done on this topic is by
Baier, Dwyer Jr, and Tumura, in their paper published in 2004. Their data contained per worker
values of human capital, output, and physical capital for 145 countries and the average data that
they had was for 57 years. They also had data for 24 countries that was pre-1900. For each
country output per worker, physical capital per worker, human capital per worker and total factor
productivity were calculated. The country’s growth was also calculated 10 to 20 years before and
after the advent of its respective stock exchange so that the empirical evidence which they arose
at wouldn’t be skewed by the natural phenomena of business cycles. Their paper articulated
those countries that had their stock exchanges opened and functioning before other countries
were at a better probability of experiencing faster growth than those that had not opened their
exchanges. They also suggested that the efficient allocation of resources rather than hoarding and
accumulating capital reaped more benefits for the economy. They also commentated on the
causal relation of stock exchange with growth by stipulating that hindering the growth of a stock
exchange can have repercussions for the growth of an economy (Baier, Dwyer Jr, and Tumura,
2004).

Another extensive research done with a large set of data is carried out by Nieuwerburgh,
Buelens, and Cuyvers on the relationship between stock market development and economic
growth in Belgium. They took data from 1830-2000 for the Brussels Stock Exchange and
divided it into five categories. The first category was the Belgian companies whose main
activities were located in Belgium; the second was foreign companies who had their main
activities abroad; the third were the Belgian colonial companies; the fourth were Belgian
companies with main economic activity abroad, and the fifth were foreign companies with main
activities in Belgium. Market capitalization was calculated as the number of outstanding shares
that were present at that time multiplied by the price at the time of December. This paper
stipulated that stock-market financing was integral to economic growth especially in the post
1873 period. They found out that removal of restriction on trading of shares, formation of
companies, and improved liquidity around the year 1870 provided great pace to the Brussels
Stock Exchange. They also found out that developments in the stock market were a better gauge
at measuring the future value of the economy as compared to bank-based development
(Nieuwerburgh, Buelens, and Cuyvers, 2005).

Another paper on stock market development by Nowbutsing and Odit researches the
relationship the Mauritian stock and its respective economy. This paper is quite different from
the other ones as the Mauritian economy is located in the not so developed continent of Africa,
surrounded by the sea, living standards that are not so well-off, and the main attraction that
Mauritius has for foreigners is tourism because of its abundance in beaches, waterfalls,
rainforests and various other tourist attractions. Its stock exchange is also quite new, introduced

11
just in 1989. The researchers for this paper took their data from 1989 to 2006 and took the
liquidity and the size of the stock market as determinants. They preferred the Engle and Granger
methodology for their econometric analysis as they argued that the Johansen approach had a
repercussion to it, which is limitations in degrees of freedom. Through their study, they found
out that the Mauritian economy was positively related to its respective stock exchange in the
short and long-run. They also pointed out that the Human Development Index (HDI) and the FDI
were also important to the growth of the Mauritian economy. They also implied that Mauritius
should continue developing its stock exchange but also keep an eye on its FDI inflows, whose
figures were worrisome (Nowbutsing and Odit, 2009).

Nazir, Nawaz, and Gillani researched the relationship between the economy of Pakistan and
its corresponding stock exchange and used the determinants of size and liquidity. They used
market capitalization as a percentage of GDP as a proxy for size, and they used the total amount
of shares traded on the stock exchange as percentage of GDP as a proxy for liquidity. FDI and
HDI were also taken as independent variables along with the previous two; all of these were
tested against GDP per capita using ADF unit root testing methodology. Their research indicated
that the development of stock market was integral to economic growth but the effect of market
capitalization seemed to be higher as compared to the liquidity in the market. FDI and HDI were
also deemed to have a positive relationship. They also advised that the industrial and
manufacturing sector should be looked after as well as the stock exchange to reap better results.
Better monetary regulations for the transparency and effectiveness of the stock market were also
advised by the authors. They also advised the conglomeration of the three stock exchanges that
were separate at that time; in the present they are conjoined under the name of the Pakistan Stock
Exchange (Nazir, Nawaz, and Gillani, 2010).

Ahmed, Khan, and Tariq took data from 1990 to 2009 in their research for stock market
development and its relationship with the economy. In their study they took four independent
variables. The first two variables were the same as Nazir, Nawaz, and Gillani’s study where
market capitalization was taken as proxy for size, and total traded shares on the market was taken
as liquidity. The additional two variables that were taken were stock turnover ratio which was
also taken as liquidity and the market volume was taken as the total number of listed shares in
the respective exchanges. Log transformation was afterwards applied on the independent
variables of both the countries. They came to the conclusion that the economy of Pakistan and
Bangladesh both had a positive relationship with their respective stock exchanges. They also
came to the same conclusion as Nazir et al that market capitalization had a stronger influence in
the market of Pakistan as compared to liquidity, but they also noticed that the case was vice versa
for the economy of Bangladesh where liquidity was the more predominant factor (Ahmed,Khan,
and Tariq, 2012).

Another study that researched the link of the economy with the stock exchange is the paper
of Ali, Rehman, Yilmaz, Khan, and Afzal. Their paper seemed to contradict the views of the vast
majority of the papers. They collected data from the monthly bulletins of the federal bureau of
12
statistics and took data from 1990-2008. They compared the economic indicators of Pakistan
with the stock exchange prices. They took inflation, exchange rate, balances of trade and index
of industrial production as the economic indicators of Pakistan and they took the general price
index of the Karachi Stock Exchange as stock exchange prices (the three exchanges were still
separate at that time). In their study, they used the augmented dicky fuller test, the johansen’s co-
integration, and the Granger causality test. The results of their study were quite one-sided and
unique. The results, on viewing by an individual, can cause a wave of skepticism to rise because
they found no causality between the stock exchange prices and money supply, no causality
between prices and the index of industrial production, no causality between the stock exchange
prices and inflation, and no causality between prices and the balance of trade. In short, they
stated that there was no relation to be found between the macro-economic indicators of Pakistan
and its stock exchange. They did however try to back these results up by pointing to the
occurrence of the Pakistan Stock Exchange gaining a lot of growth in the period of 2005-2008
without much change in its macro-economic outlook. This does seem to be a valid point as this
period was marked by an economic bubble that was about to burst and send the global economy
tumbling, but as the data set is a lot more wider than this period; therefore, this result still does
seem to spark a lot skepticism. Through their observation, they also shared an educated opinion
for investors and traders that fundamental news—which is news about macro-economic
indicators, cannot be trusted for trading on the stock market of Pakistan (Ali, Rehman, Yilmaz,
Khan, and Afzal, 2010) .

Wang and Ajit also provided a study on the stock market and its implications on the
economy, but their paper again provides a different perspective. Their paper takes data from
1996 to 2011. This period has been a part of the chinese reforms that started from around 1970
and are still important to the chinese economy in the present. Pre-1970 China was in a miserable
condition, brought to a slump by Mao Zedong’s inhuman practices which he labeled as Cultural
Revolution; in his revolution 45 million people died. After the 1970’s reforms were introduced to
reform China from a communist country to a socialist country and they reaped the rewards of the
economic policies that were made to allow such a change. China is still frowned upon because it
still doesn’t match the current world outlook of the free market but it still is arguably out
performing all of the world. Wang and Ajit wanted to know whether this effect had anything to
do with the stock market. They took quarterly data from the National Bureau of Statistics of
China, People’s Bank of China, the Database of China Economic Information, and China
Securities Regulatory Commission. Their study found that there was no real relationship between
the stock market and the economy of China. They formed the opinion that this may have been
caused by the constant mongering of the government in the free workings of the stock market
stating the fact that China still has a long way to go before being a free market economy (Wang
and Ajit, 2013).

Caporale and Spagnolo researched evidence from three countries that are located in the
central and eastern European region, namely Czech Republic, Hungary, and Poland. The authors

13
researched the stock market but were also interested in the relationship which the financial
sectors of these economies had with growth; pertaining to the fact that in the majority of the
papers where financial development was compared to growth, a positive relationship was found.
In the case of these three countries such a relationship was noted to be not so profound and
volatility in output growth was noted as compared to the rest of Europe. These three countries
have the highest market capitalization in the entire eastern European region. Their research came
to the conclusion that there was a unidirectional causality between the stock markets and
economic growth and the relationship became stronger after the countries joined the European
Union. The paper also stated that Germany is an integral economy to these three countries. The
entry of foreign banks into the respective markets, privatization of banks, and reforms were
deemed to have increased credit availability and improved transaction costs (Caporale and
Spagnolo, 2011).

Just like the stock markets, oil is also a commodity that has quite a few research papers on it.
The impact that it has on the economy is generally perceived to be significant, hence researchers
try to see if that is the case.

Latifa Ghalayini, a sole author, researched the effect that oil prices had on economic growth.
This paper was not aimed at a specific country or region but rather wanted to find out whether
the effect of oil prices had an effect on the global economy. Data for the OPEC countries and G-
7 countries was collected and Russia, India, and China were also added in the group. The
research found that there wasn’t a significant growth between the global economy and oil prices.
The author did not agree with the general view of economic growth of oil exporting countries
increasing with oil prices, instead they argued that the inflows that these countries received from
oil slowly found its way back without adding to development. These countries were advised to
develop institutions that would channel this money to better economic projects. There also
wasn’t enough evidence to state that the Russian, Indian, and Chinese economies were effected
by oil prices. Only the G-7 countries’ economic growth were deemed to be related to oil prices
(Latifa Ghalayini, 2011).

Mohsen Mehrara, investigated the relationship between 11 oil exporting countries about the
relationship that energy consumption had with their respective economies. The author selected 6
countries from the middle east, namely Iran, Kuwait, Saudi Arabia, United Arab Emirates,
Bahrain, and Oman; two countries from Africa that are Bahrian and Oman; three countries from
Central and South America that are Mexico, Venezuela, and Ecuador. The causal relationship is
looked into by applying panel unit root test and panel co-integration analysis. The variables used
are per capita energy consumption and per capita GDP. The data taken to infer a conclusion was
from 1971-2002. The results concluded that for oil exporting countries the causality was one-
way which means that GDP is the variable that effects energy consumption rather than vice
versa. Therefore, the author advised oil exporting countries to conserve energy as consumption
of energy had insignificant impact on economic growth. It was also warned that if such measures
weren’t taken then exporters can become net oil importers in the future (Mehrara, 2007).
14
 Atil, Nawaz, Lahiani, and Rouband investigated the relationship that natural resources had on
the financial development of Pakistan. They took data from 1972-2017 and ran long run co-
variability test and cross-quantilogram tests on the data. Economic growth, oil prices, and
economic globalization is compared to financial development in Pakistan. The results found that
oil prices contributed positively to financial growth. The general expectation with oil prices is
that they hinder financial growth but the authors state that the reverse is actually true, perhaps
because a rise in oil prices also leads to a necessary rise in credit creation facilities. The higher
credit creation would benefit the financial sector and might then cause economic growth. The
authors also stipulated that economic growth had a positive relationship with financial
development and vice versa. They also supported the demand side function of finance and stated
that government spending in the financial sector can lead to economic growth. The relationship
of economic globalization with financial development found to be negative (Atil, Nawaz,
Lahiani, and Roubaud, 2020).

Arshad, Zakaria, and Junyang examined the impact that energy prices had on the economic
growth of Pakistan. They used the GMM estimation technique as it their macroeconomic model
and applied it on data from 1991 to 2011. Their research not only highlighted the effect that
energy prices had on the economy has a whole, but they went in-depth and found out the impact
that various economic instruments had to partake as a result of fluctuations in energy prices.
Their research found that overall the economy faced a negative relationship with energy prices
and the instruments that followed the trend of negativity were investment, stock prices, real
exchange rate and unemployment. The effect was found to be positive for only two variables that
are government spending and real interest rate. The study revealed that the most effect was
absorbed by four variables that are stock prices, real exchange rate, government consumption and
unemployment. Real interest rate and captured a comparatively smaller share of the energy price
index (Arshad, Zakaria, and Junyang, 2016).

15
 CHAPTER 3: METHODOLOGY
3.1. Sample and Data Collection
The total data that is collected for this study is for yearly figures of inflation of Pakistan,
foreign direct investment (FDI) of Pakistan, exchange rate between the Pakistani Rupees and the
US Dollar, Gross Domestic Product (GDP) of Pakistan, and the average closing figure of the
west texas intermediate (WTI) crude oil index. The data taken is for 16 years and it ranges from
2005-2020.

3.2. Data Collection

All of the data is collected from the website of World Bank except the WTI index whose data
is easily available across the internet. The data is for a period of 16 years and ranges from 2005-
2020.

3.3. Data Analysis

This data is analyzed using descriptive statistics, linear regression, and correlation which are
run on STATA. Furthermore, observational analysis will also be used with statistical measures to
collect empirical evidence.

3.4. Model Specification

The following model is used for measuring the economic performance of Pakistan:

𝐸𝑃𝑖𝑡 = 𝛽0 + 𝛽1 𝐼𝑁𝑖𝑡 + 𝛽2 𝐸𝑅𝑖𝑡 + 𝛽3 𝐹𝐷𝐼𝑖𝑡 + 𝛽4 𝑂𝐼𝐿𝑖𝑡 + 𝜀𝑖𝑡

Where:

EP = Economic Performance of Pakistan

IN = Inflation Rate of Pakistan

ER = Exchange Rate of Pakistan against US Dollar

FDI = Foreign Direct Investment

OIL = Oil Prices

Additional, 𝛽0represents the constant,𝛽1,𝛽2 , 𝛽3, and 𝛽4 are known as regression coefficients and
𝜀 is known as an error term.

16
Table 1: Explanation of Variables

Variable Expression Variable Calculation and

Type Inference

Dependent
Variables

Economic Performance EP This variable will be used to gauge

of Pakistan the economic performance of
Pakistan against the independent
variables.
Independent
Variables

Inflation Rate IR Inflation is the measure of the rate of

of Pakistan change in the prices of goods and
services over a specified period. The
consumer price index is the standard
instrument for calculating inflation.
This figure will be used to estimate
the effect of the average selling costs
that listed firms face.
Exchange Rate of ER Exchange rate is calculated by
Pakistan against US Dollar dividing your country’s currency
value with the currency value of the
country you want to calculate the
exchange rate in relation to your
country. Through this, inference will
be made about the average import
costs that listed firms face.
Foreign Direct FDI Foreign direct investment is the sum
Investment of equity capital, long term capital,
and short term capital as reflected in
the balance of payments. This will
be used to infer the average foreign
investment that the stock market
attracts.
Oil Prices OIL The price benchmark used for oil is
the West Texas Intermediate (WTI)
oil index. It is part of the two most
accurate oil indexes in the world.
Through this, inference will be made
about the average prices in the
commodity market of Pakistan.

17
3.5 Theoretical Framework

Independent Variables Dependent Variable

Inflation Rate of Pakistan Economic growth
Foreign Direct Investment
Exchange Rate of Pakistan against US
Dollar
Figure.1 Oil Prices

3.5.1 Hypothesis

Variable Null Hypothesis Alternate Hypothesis

β1= 0: Inflation has no impact on β1 ≠ 0: Inflation has impact on
Inflation unemployment unemployment
β2= 0:
Foreign Direct Investment has no impact β2 ≠ 0: Foreign Direct Investment has an
Log(FDI) on unemployment impact on unemployment
β3= 0: Exchange Rate has no impact on β3 ≠ 0: Exchange Rate has an impact on
Exchange Rate unemployment unemployment
β4= 0: Oil Prices has no impact on β4 ≠ 0: Oil Prices has an impact on
Oil Prices unemployment unemployment

18
Figure 1.

As seen in figure.1, from 2005 onwards to 2008, Pakistan had an arguably stable inflation
rate for a developing country, ranging from around 6% to around 8-9%. The economy at this
time was growing at an impressive 9% to 5%. Although, the trend was towards the downside, the
mathematical figures still looked impressive and the descent was stable. In the 2008 period
afterwards, inflation gained massive momentum, perhaps because of the 2008-2009 financial
crises and the economy soon followed. In the period from around 2009-2010, the economy
crashed from just around 5% to just above 0%. In the 2-3 years after the financial crisis the
economy and inflation was trying to stabilize. There was a slight ascent in GDP and the inflation
still wasn’t optimal. After the initial jaggedness of the initial 2 years, inflation turned around to
form a downtrend which lasted till 2019 and the economy also followed growing at a stable rate
of around 4-5%. Post 2019, the economy changed its direction again and so did inflation.
Observationally seen Pakistan’s economy does seem to be negatively related to inflation.

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Figure 2.

In figure.2, the relationship between Pakistan’s exchange rate and its economic performance
can be seen. From 2005 to around 2008, the currency remained stable at around 60, so no
comments can be made. From then onwards the currency depreciated to around 80 and economic
decline was noted in the aftermath. After 2010, the currency was again found to be stable and the
economy started growing gradually. Around the 2013-2014 period, the currency devalued at a
higher rate in less time and the economy slowed down a little as a result. After 2018, the
currency started devaluing at a really fast rate and in 2019, the economy started tumbling. Hence,
it can be observed that the currency market is related to GDP, and that stability in the currency
market is convenient for economic growth.

20
Figure 3

In figure 3, it can be noted that in the period from 2005 to 2008, FDI inflows in Pakistan
were constantly reaching levels close to 1000 USD million and the economy was in the vicinity
of 8-6%. After economic decline post 2008-2009, FDIs started to clamp down in smaller ranges
and after better economic growth in the period post 2012, FDIs can also be seen making peaks at
the 500 USD million level. In the period of 2018-2019, FDIs can be seen to make a big plunge
downwards as inflows became negative and economic decline soon followed. From this
observation, economic growth does seem to have a positive relationship with FDIs.

Figure.4

In figure 4 US gasoline prices are compared with the economic growth of Pakistan. The trend
of US gasoline prices is identical to that of the WTI index. From 2005 to around 2009, the trend
of the oil market was bullish and the economy was also growing in the range of 9-6%. After

21
2009, oil prices crashed and the economy followed. Around 2010, oil prices started to rise again
and so did the economy. Around 2015, the trend in oil prices became bearish but the growth of
Pakistan’s economy continued. After 2016, oil prices remained low but the economy kept on
growing. Around 2019, the Pakistani economy receded while oil prices still remained low. This
observation is in accord with that of Atil, Nawaz, Lahiani, and Roubaud who argued that oil
prices actually had a positive effect on economic growth as higher oil prices contributed to the
cause of more credit creation, hence supporting financial development and economic growth
(Atil, Nawaz, Lahiani, and Roubaud, 2020).

3.6 Analysis

Descriptive Statistics
Table 2

Variable Obs Mean Std. Dev. Min Max

Inflation Rate
of Pakistan 16 8.982004 4.422858 2.529328 20.28612
Foreign
Direct
Investment 16 9.345736863 0.216518526 8.933993164 9.747411808
Economic
Performance
of Pakistan
(GDP) 16 3.78593 2.095605 -0.9353895 6.518778
Exchange
Rate of
Pakistan
against US
Dollar 16 96.68744 29.56433 59.51448 161.8385
Oil Prices 16 70.05375 20.6566 39.68 99.67

The mean is the sum of all values divided by the total number of all values. Standard
deviation represents the difference that the data population faces in comparison to the mean. The
mean value for inflation is 8.982004 which is on the higher side but doesn’t stand out quite a lot
as Pakistan is a developing country and developing country do face inflation rates that are on the
higher side as compared to the developed world. The mean of FDI is 9.345736863 and the
standard deviation of FDI is 0.216518526. The mean of the GDP is 3.78593 which is also on the
lower side as generally smaller economies that are well functioning usually face bigger growth
rates. The mean of the exchange rate does seem to be a stable figure considering that the
minimum value is 59.51448 and the highest value is 161.8385. This implies that the currency of
Pakistan usually remains stable and that devaluation usually takes place in one-off periods where
the economic pressure is hard for the government to maintain and they have to decide on a new
upper value for the currency, and at that level they continue trying to manipulate the supply of
currency through foreign reserves. The mean of 70.05375 for oil prices is also a key level. In

22
figure.4, this level is close to around 0.65 in US gasoline figures. This level is an important level
as a rise above this level usually corresponded with economic growth in Pakistan.

Correlation (Significance >0.5)

Table.3

GDP IR FDI ER OIL

Economic
Performance of
Pakistan(GDP) 1
Inflation Rate of
Pakistan -0.6140234 1
Foreign Direct
Investment -0.0329737 -0.3232088 1
Exchange Rate of
Pakistan against
US Dollar -0.500474 -0.2355143 0.4470465 1
Oil Prices -0.0692527 0.50594786 0.0057694 -0.3942092 1

Correlation shows how closely two or more variables change concerning one another. If a
correlation of variables is positive, then it indicates that two variables are rising or decreasing at
the same time. If there is a negative correlation, then it means that one variable rises while the
other variable falls. The correlation coefficient ranges from -1 to +1. In the above table, there
exists a negative correlation between GDP and inflation rate. The coefficient of correlation is
-0.6140234 which is deemed to be significant. The relation between FDI and GDP is negative
but insignificant as the value is below 0.5. The relationship between the exchange rate and GDP
is deemed to be significant as the value is above 0.5. Their relationship is negatively correlated.
The relationship between oil prices and GDP is negative but insignificant as the value is below
our significance level of 0.5.

Linear Regression (Significance at p<0.05)

Table.4

EP(GDP) Coefficient Std.Error t P>t [95% Confidence Interval]

0.00
IR -0.3840075 0.0766465 -5.01 1 -0.5527054 -0.2153096
0.22336843 0.82
(log)FDI 0.353276908 1.581588345 1 7 -3.127775569 3.834329384
0.00
ER -0.0467184 0.0114213 -4.09 2 -0.0718564 -0.0215803
0.64
OIL 0.0082158 0.0172282 0.48 3 -0.0297033 0.0461348

23
 Linear regression analysis is used to predict the value of a variable based on the value of
another variable. The variable you want to predict is called the dependent variable. The variable
you are using to predict the other variable's value is called the independent variable. The
coefficient signifies the amount by which change in x must be multiplied to give the
corresponding average change in y, or the amount y changes for a unit increase in x. The
standard error represents the average distance that the observed values fall from the regression
line. The P>t value helps us identify whether to accept or reject alternate hypothesis. The values
in the confidence interval contain ranges of values that you can be 95% certain that they are
within the true mean of the population.

When inflation rate increase by 1%, GDP growth decrease by 0.38% which shows that these
variables have a negative relationship. This results in line with the Philips curve which states that
when inflation increases unemployment decreases. The P value of inflation is 0.001 which is less
than 0.05 so we will reject H0 and accept H1 to declare the variable significant. When 1% of Log
(FDI) increases, growth increases by 0.35% which shows a positive relationship between the two
variables. The result contributes to the previous literatures. The P value of FDI is 0.827 which is
greater than 0.05 so we will accept H0 and reject H1 as the variable is insignificant. When
Exchange rate increases by 1% GDP growth decreases by 0.04% which shows a negative
relationship between the two variables. The P value of Exchange rate is 0.002 which is less than
0.05 so we will reject H0 and accept H1 as the variable is significant. When oil prices increase by
1%, GDP increases by 0.008% which shows a positive relationship. The P value of oil prices is
0.643 which is greater than 0.05 so we will accept H0 and reject H1 as the variable is
insignificant.

CHAPTER 4: IMPLEMENTATION OF RESULTS

We used charts and graphs to compare the relationship that various variables have on the
economic performance of Pakistan. We used observation to decipher a relationship, if there was
deemed to be any. Observational analyses would then be compounded by statistical analyses to
collect empirical evidence.

Table no.2 gives us information about descriptive statistics related to our data. The benefits of
analyzing data this way is that we can quantify and describe the basic characteristics of our data,
organize, simplify, and summarize it. The data can be condensed and useful information can be
gathered about the population like the central tendency and how spread out the data is. The
drawback is that no conclusion or generalizations can be made about the data if only descriptive
stats are used and only basic information can be gathered.

Table no.3 gives us data relating to correlation. The benefits of correlational research are that
the strength and weaknesses between two variables can be measured which can give us useful
information in itself and also provide us pointers on whether to conduct more extensive research
on the said variables. The drawbacks are that even if we come to find out a significant correlation

24
between two variables, it does not automatically mean that there is causation between the two
variables as correlation and causation are two different things. Also, a lack of correlation doesn’t
really apply as an absolute result as the tool is a linear tool; there can exist correlation that is
non-linear.

In table no.4, a regression analyses was carried out. The benefits of it are that it is a proven
tool and useful tool for data that is linearly separable or two dimensional data. It is also quite
easy to implement and understand. The beta and p values are also really useful in helping to
shortlist variables. The drawbacks are that it cannot be used for data that is non-linear in nature.
Also, it doesn’t really deal well with outliers in data which means that economic and market
shocks can considerably skew data.

According to the results of correlation and regression, a significant relationship was only
found for inflation and exchange rate, the rest were deemed as insignificant. A possible addition
that could have given us more information is the implementation of non-linear regression where
we could have ruled out a non-linear relationship between oil prices and FDI with the economic
growth of Pakistan.

CHAPTER 5: LIMITATIONS, CONCLUSIONS AND

RECOMMENDATIONS
5.1. Limitations:
One hindrance that we faced was data collection. Government websites are not made to be
user-friendly and intuitive. Design, development, and ease for users are not thought of as a
priority, and therefore it is hard to maneuver such websites. The websites are also not data-
orientated, and not much thought has been given to the potential stakeholder of data except for
what seems obvious. Our data takes into account selling costs of listed firms, import costs of
listed firms, and foreign investment that the stock market receives through inference from their
bigger functions that are inflation, exchange rate, and FDI. If data from 2005-2020 about the
cumulative selling costs, import costs, and foreign investment in the stock market was readily
and easily available on the Pakistan Stock Exchange’s website then such inference would not
have been required and a more easier and direct analyses would have been possible. Time,
workload, and mental stress have also been a huge burden for the authors of this paper. This
thesis had to be incorporated between the already stressful routines of the authors who had to
constantly jump between university and jobs and the mental stress was immense. Also, there
isn’t much ease generally because of the current economic and social conditions of Pakistan, still
recovering from corona and facing a consistent political and economic turmoil. Although, the
process was hard and soul-wrenching, we’re thankful to each member of the group for their
consistent and self-less work towards this project. We’re also deeply grateful to the supervisor
who helped us at every instance that we needed help and was always there for us.

25
5.2. Recommendations:
Usually, researches are carried out in the perspective of demand side functions. Our research
looks at the supply side of government policy making. As selling costs of limited firms are
deemed to be significant in relation to the economic growth of Pakistan, the government can
introduce policies that facilitate cost cutting and promote productivity. The government can
facilitate local businesses in learning to cut costs by investing in skilled cost accountants.
Business employees can also be made to partake in programs that allow them to increase their
productivity through polishing their skills and by helping them manage their time and resources
in a more efficient way.

Business owners can also be taught techniques through which they can be enabled to reduce
their respective business costs. They can be shown ways to improve their marketing efforts,
running better and more cost-efficient campaigns. Cutting supply costs can also be taught to
business owners through helping them maneuver through different supply chains and to decide
on cost-effective quotes. Business owners can also be taught to make better use of their
production materials by encouraging better and more efficient production techniques.

Our research also pointed out the importance of import costs of listed firms to the economic
growth of Pakistan. The government should try to keep the exchange rate stable through better
usage of its foreign reserves. The government should also place emphasis on developing the
local industry of Pakistan so that exchange rate fluctuations have minimum effect on the
performance of businesses as they would be able to procure their production materials locally.

As a developing and struggling economy, it is quite difficult for the Pakistani economy to
manipulate its demand-side policies as compared to its supply-side policies. This study emphasis
and provides pointers on the structural reforms that Pakistan could carry out that would benefit
its economy in the long-run and help it develop at a faster rate, become more efficient, and less
co-dependent on foreign sources.

5.3. Conclusion:
There have been extensive papers on Pakistan as well as foreign countries, stipulating that
the stock market does affect economic growth. Ahmed, Khan, and Tariq and Nazir, Nawaz, and
Gillani both researched the economy of Pakistan and found causality between the stock exchange
development and economic growth. We wanted to find out whether selling costs, importing
costs, or foreign investments in the stock market were more important for economic growth.
Through our research, we found out empirical evidence that inflation is negatively related to
economic growth, and because of the enormous amounts of existing literature supporting stock
market development and economic growth, and selling costs of listed firms being a part of
consumer price index, we can assume that selling costs of listed firms are negatively related to
economic growth as it is a part of the larger function of inflation.

26
 Importing costs of listed firms were also deemed to have a negative relationship with
economic growth. As they are part of the larger function of exchange rate and that there was
empirical evidence from correlation, regression, and observational study. There is a negative
relationship between exchange rate and economic growth as it a significant effect on economic
growth.

FDIs were deemed to have insignificant impact on economic growth. Hence, foreign
investment in the stock market is not necessary for economic development.

Oil which was used as a proxy for the commodity market was also deemed to have an
insignificant effect on the economy of Pakistan.

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