Relationship between

Indian Stock markets

with Forex rates since
liberalisation
Submitted by:
Jay Parekh 138
Rohan Raut 141
Vivek Rawat 142
Vaibhav Shah 152
Group No - 3
Financial Markets and Institutions
2014
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 1
Introduction:
Indian Stock Markets:
The Indian stock exchanges are of great importance not only in Asia but also the world. The
Bombay Stock Exchange (BSE) is one of the oldest exchanges in the world, whereas the
National Stock Exchange (NSE) is amongst the best in terms of sophistication and technological
advancement. The Indian stock markets boomed post the liberalization of the economy in the
early 90s. The whole of those years were used to experiment and refine the markets into an
efficient and effective system. Corporate governance rules were gradually put into effect which
began the process of bringing listed companies at a uniform level. On the global scale, the
economic environment began taking paradigm shift with the Dot-com bubble burst, 9/11
attacks, and rising crude prices. The slowdown in the US economy and interest rate tightening
made the equation more complex. However after 2000, owing to robust growth and a maturing
economy having relaxed regulations, outside investors, both institutional and others, got more
range to operate. The opening up of the economy led to increased integration with increased
cross-border flow of capital, andIndia emergedas a favourable investment destination leading to
our stock exchanges being impacted by global events that never happened earlier.
Indian Forex Markets:
The foreign exchange market in India started less than three decades ago in 1978 when the
government allowed banks to trade foreign exchange with each other. Today, over 70% of the
forex tradingtake place in the inter-bank market. The market comprises of above90 authorized
dealers, chiefly banks, that trade incurrency amongst themselves and end upwithout exposure at
day end. Trading is regulated by the Foreign Exchange Dealers Association of India (FEDAI),
which is a self-regulatory dealers association. Since 2001, clearing and settlement functions in
the foreign exchange market are mainlycarried out by the Clearing Corporation of India Limited
(CCIL) whichmanages transactions of approx $3.5 billion daily, which makes about 80% of the
total transactions.
From a foreign-exchange-starved, control-ridden economy, India has progressedto a position of
more than $150 billion in forex reserves, with a steadily progressing rupee and largely reduced
forex control. As foreign trade and cross-border capital flows continue growing, and the country
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 2
moves towards capital account convertibility, the forex market is set to havea morelarger role in
the economy, but is unlikely to be completely free of RBI interventions.
Impact of 1991 economic reforms on the stock & forex markets:
The 1991 liberalization policies led the Indian economy into a new phase of growth and freed it
from its slowed pace of progress. The major impactsof the reforms pertinent to the stock market
and forex market are discussed as follows:
Bringing in the Security Regulations (Modified) and the SEBI Act of 1992 which rendered
the legitimate power to the Securities Exchange Board of India to record and control all the
mediators in the capital market.
The Controller of Capital matters was abolished in 1992, whichused to determine the rates
and number of stocks that companies were supposed to issue in the market.
The National Stock Exchange (NSE) was launched in 1994 in the form of a computerized
share buying and selling system, which also influencedthe restructuring of the other stock
exchanges in the country.
In 1992, overseas corporate investors were allowed to invest into the equity markets of the
country. The companies were allowed to raise funds from overseas markets by issuance of
GDRs.
The rigid, old fixed exchange rate system was replaced with a new less regulated market-
driven exchange rate system.
The Sodhani Committee of 1994 suggested increased freedom to participating banks,
allowing them to fix their own trading limits & interest rates on FCNR deposits and using
derivatives products.
Relationship between Indian Stock markets with Forex rates since liberalisation
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Objectives
In the light of above discussion, our study tries to identify relation between stock market
movements & forex rate movements. Our study tries to determine whether there is any
correlation between the two indicators. We have taken data points after liberalization in our
study. We have also tried to examine relation between stocks of certain sectors with currency
movements. As Oil & gas is biggest importing sector, we have tried to determine relationship
between currency movements & stock price movements of companies in Oil & sector space
using S&P BSE Oil & Gas index. Similarly, IT & Pharma are Indias biggest exporters. So we
have tried to determine relationship between currency movements & stock price movements of
companies in IT & pharma space using S&P BSE IT index & S&P BSE healthcare index. We
have also done hypothesis testing to find if SENSEX movements & FOREX movements are
dependent or not.
Thus, our major objectives from the study are
1. To determine relation between stock market movements & forex rate movements using
correlation & hypothesis testing from the data points after liberalization
2. To find impact of forex movements on stock prices of specific sectors which have high
currency exposure
Literature Review
Financial markets are very complex & thus it is very important for investors, market players,
researchers & policy makers to understand the relationship between stock market & foreign
exchange market as both these indicators are barometers for any economy. Stock market & forex
market are most sensitive indicators of financial system.
There are various explanations given with respect to our study by different researchers. The first
one was undertaken by Franck and Young (1972) to determine forex market & stock market
dynamics. Their study showed that there are no notable interactions between stock market &
forex market. The second one is flow oriented model approach by Fischer & Dornbusch (1980)
which says that forex movements have direct relation with global competitiveness & currency
Relationship between Indian Stock markets with Forex rates since liberalisation
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movements have direct relation with balance of payment of any Country. Thus, stock prices of
various companies are affected by currency movements. Slonik (1987) undertook study to find
impact of various economic parameters including currency rates on stock market movements. He
found that currency movements do not have notable impact on stock prices. Roll (1992) carried
out research on movements of US stock market & forex market & he concluded that there exists
a positive relationship between the two variables. Abdalla and Murinde (1997) undertook co-
integration test to find the relation between Stock market movement & forex movement for
Asian Countries viz. India, Pakistan, South Korea and Philippines. The study used data points
from 1985 to 1994. They found causation runs from forex rates to stock market movements for
India, South Korea and Pakistan and found reverse causation runs for Philippines. Chow et al.
(1997) conducted research on stock market & forex markets & found no relation between both
the variables. They conducted the research again with a longer time zone and found that two
variables had positive relation.
Nieh and Lee (2001) also concluded that there is no notable long-run relationship between stock
market movements and forex movements in G-7 Countries (Canada, France, Italy, US, UK,
J apan, France). Bhattacharya and Mukherjee (2003) in their research concluded that no notable
relationship exists between stock market movement & forex movements. Apte (2001) conducted
the same research on Indian stock market & USD-INR movements from 1991 to 2000 &
concluded that spillover from forex market to stock market exists (but not the reverse). Yamini
Karmarkar and G Kawadia undertook research to find relationship between rupee & dollar rate
movements & Indian stock market movements. Five composite indices and spectral indices were
also examined for the year 2000. They concluded that forex rate movements have high
correlation with the stock prices.
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 5
Quantitative Analysis:
Dataset for Analysis:
In order to find relationship between Indian stock market and Forex rate we have considered
monthly closing price of BSE Sensex and USD-INR exchange rate. The dataset is from October
1993 to August 2014. We have collected historical data from www.bseindia.com and
www.onada.com. We have also done analysis of Forex with respect to some major BSE indices
like S&P BSE IT, S&P BSE HEALTHCARE and S&P BSE OIL & GAS. Monthly historical
dataset for these indices were available from February 1999 on www.bseindia.com
Since oil and gas is amongst major import in India and IT services and pharmaceuticals are
among major export, we have consider above three indices.
Methodology:
1. Descriptive statistics of monthly returns of Forex, BSE Sensex, S&P BSE IT, S&P BSE
HEALTHCARE and S&P BSE OIL & GAS
2. Graphical Representation of BSE Sensex, Forex and BSE indices
3. The monthly returns on the basis of closing values of the stock indices were calculated as
below:
R
t
=(P
t
- P
t-1
) / P
t-1
*100
Where R represents returns, P is the closing value of the stock index and t is the time
Simple average of monthly returns were taken and multiplied by 12 to get yearly returns
4. Find the correlation between the following
a. Forex and BSE Sensex
b. Forex and S&P BSE IT
c. Forex and S&P BSE HEALTHCARE
d. Forex and S&P BSE OIL & GAS
5. Perform hypothesis testing to test if there is correlation between stock market and forex
rates.
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 6
Calculations:
1. Descriptive statistics of monthly returns in the long run
FOREX BSE
SENSEX
S&P BSE
IT
S&P BSE
HEALTHCARE
S&P BSE
OIL & GAS
Mean 0.0028 0.0120 0.0191 0.0159 0.0177
Median 0.0004 0.0114 0.0212 0.0233 0.0177
Std. Deviation 0.0011 0.0744 0.1234 0.0723 0.0895
Sample Variance 0.0003 0.0055 0.0152 0.0052 0.0080
Kurtosis 4.3077 0.5707 3.7783 1.2323 1.9479
Skewness 0.8988 0.0172 0.4388 -0.3949 0.1955
Range 0.1525 0.5215 1.0318 0.4667 0.6188
Minimum -0.0625 -0.2389 -0.4171 -0.2433 -0.3146
Maximum 0.0899 0.2826 0.6147 0.2234 0.3042
2. Graphical representation & interpretation:
Observations:
From Aug-93 to Aug-99, rupee depreciated by 33% but Sensex appreciated by almost
70% showing an indirect relationship.
From Aug-99 to Aug-02, rupee further depreciated and Sensex also depreciated showing
a direct relationship.
0
10
20
30
40
50
60
70
0
5000
10000
15000
20000
25000
30000
O
c
t
-
9
3
A
p
r
-
9
5
O
c
t
-
9
6
A
p
r
-
9
8
O
c
t
-
9
9
A
p
r
-
0
1
O
c
t
-
0
2
A
p
r
-
0
4
O
c
t
-
0
5
A
p
r
-
0
7
O
c
t
-
0
8
A
p
r
-
1
0
O
c
t
-
1
1
A
p
r
-
1
3
S
e
n
s
e
x
SENSEX and Forex pattern
SENSEX
Forex
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 7
From Aug-02 onwards till Oct-07, we saw a bull run in Sensex with huge inflow of FIIs
in Indian Equity markets and meanwhile money also appreciated.
When Subprime crisis occurred in 2008, FII sold their holdingsfrom Indian companies &
thus rupee depreciated with outflow of money.
After 2009, markets are recovering and we can see now a bull run being anticipated.
Observations:
From Feb-99 to Feb-02, rupee depreciated and BSE Oil & Gas also dipped showing a
direct relationship between them.
Then till feb-08 money appreciated and so did appreciate BSE Oil & Gas reaching an all-
time peak in Dec-07.
In 2008, due to subprime crisis, rupeedepreciated and even BSE Oil & Gas depreciate.
J an-09 onwards till J an-11, rupee appreciated and BSE Oil & Gas also appreciated again
showing an direct relationship.
Again from Aug13 till now rupee is appreciating and BSE Oil & Gas is also appreciating.
Thus, overall we can observe that with every rupee depreciation cycle, there is decrease
in prices of Oil & gas shares.
0
10
20
30
40
50
60
70
0
2000
4000
6000
8000
10000
12000
14000
F
e
b
-
9
9
J
u
n
-
0
0
O
c
t
-
0
1
F
e
b
-
0
3
J
u
n
-
0
4
O
c
t
-
0
5
F
e
b
-
0
7
J
u
n
-
0
8
O
c
t
-
0
9
F
e
b
-
1
1
J
u
n
-
1
2
O
c
t
-
1
3
S
&
P

B
S
E

O
i
l

a
n
d

G
a
s
BSE Oil & Gas and Forex
BSE Oil & Gas
Forex
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 8
Observations:
BSE IT and Healthcare have moved hand in hand over the years except for years 2000
when IT slumped down after y2kcrisis.
From Feb-02 to Feb-08, rupee appreciated and so did these two sectors.
Due to subprime crisis in 2008, both these sectors dipped and money too depreciated due
to outflow of money.
Both the sectors are showing good rise after 2009
3. Yearly average returns in percentage are as follows:
Particulars Yearly average return (%)
Forex 3.37%
BSE Sensex 14.38%
S&P BSE IT 22.98%
S&P BSE HEALTHCARE 19.09%
S&P BSE OIL & GAS 21.20%
0
10
20
30
40
50
60
70
0
2000
4000
6000
8000
10000
12000
14000
16000
F
e
b
-
9
9
J
u
l
-
0
0
D
e
c
-
0
1
M
a
y
-
0
3
O
c
t
-
0
4
M
a
r
-
0
6
A
u
g
-
0
7
J
a
n
-
0
9
J
u
n
-
1
0
N
o
v
-
1
1
A
p
r
-
1
3
S
&
P

B
S
E

I
n
d
i
c
e
s
BSE Indices and Forex
BSE IT
BSE Healthcare
Forex
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 9
4. Correlation and covariance of different indices with Forex
Particulars Correlation Covariance
Forex& BSE Sensex 0.605989 15263.35
Forex& S&P BSE IT 0.574597 6537.878
Forex& S&P BSE HEALTHCARE 0.707817 10069.34
Forex& S&P BSE OIL & GAS 0.256713 4980.188
5. Hypothesis Testing
Null Hypothesis: There is nocorrelation between stock market and forex rates
Alternate Hypothesis: There is correlation between stock market and forex rates
Perform hypothesis testing on closing price at the end of the year.
So sample size n =23
Following is the relationship between data points:
r =CORREL(SENSEX, FOREX) =0.602
s
r
=SQRT[(1-r
2
)/(n-2)] =0.174
t =r/s
r
=3.455
t
critical
=TINV(.05, 22) =2.07 <3.455 =t
obs
Hence, we reject null hypothesis.
Therefore there exists correlation among stock market and forex rates.
y =0.0008x +35.799
R =0.3625
0
10
20
30
40
50
60
70
0.00 5,000.00 10,000.00 15,000.00 20,000.00 25,000.00
F
o
r
e
x
Sensex
FOREX
Linear (FOREX)
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 10
Interpretations
BSE SENSEX increased at average yearly rate of 14.38% post liberalization while Indian
rupee depreciated against dollar at average yearly rate of 3.37% after liberalization.
In this paper we have found out correlation of SENSEX movements with USD-INR
movements (with post-liberalization data points). We found that there exists moderate
correlation between movements of SENSEX stocks & USD-INR.
We also examined relation of share prices of companies which have high foreign
currency exposure. We found that share price movements of pharma/healthcare sector
were highly correlated with currency movements & share price movements of IT sector
were moderately correlated with currency movements. Although Oil & gas sector shares
didnt show any significant correlation with foreign exchange movements.
Also, through hypothesis testing we concluded that SENSEX movement & FOREX
movements are correlated but correlation is weak to moderate since co-efficient of
determination(R) is low.
Relationship between Indian Stock markets with Forex rates since liberalisation
Roll no 138, 141, 142, 152 Page 11
References
www.bseindia.com
www.onada.com
http://webcache.googleusercontent.com/search?q=cache:http://www.craig.csufresno.edu/I
J B/Volumes/Volume%252012/V123-5.pdf
Research paper on Exchange rates & current account by Rudiger Dombusch &Stanley
Fischer from
http://webcache.googleusercontent.com/search?q=cache:http://www.mit.edu/~14.54/hand
outs/dornbusch80.pdf
http://www.pbr.co.in/Vol-5%20Iss-5/7.pdf
Abdalla, and V. Murinde, (1997) research paper on"ExchangeRate and Stock Price
Interactions in EmergingFinancial Markets: Evidence on India, Korea, Pakistan, and
Philippines from http://www.tandfonline.com/doi/pdf/10.1080/096031097333826
Apte P. (2001) research paper on The interrelationship between stockmarkets and the
foreign exchange market from
http://webcache.googleusercontent.com/search?q=cache:http://iimb.ac.in/research/sites/d
efault/files/wp.iimb_.169.pdf