Stock Market Is Main Pillar

Published Date: 02 Nov 2017

The purpose of this study is to examine impact of macroeconomic variables on stock market performance by using the Stock Exchange of Mauritius as a case study. The study has made use of time series quarterly data spanning from 1999 to 2007 and techniques like co-integration and error correction model are used to find both short run and long run relationships. These analyses were carried out using Eview 7 econometric software. The finding of the study indicates that lending rates and Treasury bill rate have positive impact on the stock market performance. The exchange rate is negatively related to stock market performance, which indicates that investors are affected from the exchange rate losses, as a consequence of Mauritian rupee depreciation. The most significant contribution of this study is, it concentrated on stock market performance and macroeconomic indicators in a small island like Mauritius, as major studies have focused on advanced countries.

Keywords: Macroeconomic variables; Stock Market; Time series analysis; Unit Root; Econometric Model; Mauritius.

CHAPTER 1: BACKGROUND AND OBJECTIVES

1.1 Introduction

In the recent economic setup, the part of financial system is significant to the economic planning and development of an economy. The economic growth of any nation mainly depends on the growth of its financial system (Butt, 2010). Stock market is a main pillar of the financial sector of any nation as it aids to route savings from deficit sector to surplus sector. They are often termed as barometer of any nation’s economy since they act as a mirror and reflect the change and pressure of the economy (Aman, 2010).Stock market of any nation is a true reflector of its economy (Khalid, 2012). A developed and efficient equity market aids in the development of economy and it offers investors with an array of securities with varying amount of risk, return and liquidity apart from encouraging and enhancing savings and capital generation (Mohanasundarum and Karithikeyan, 2012). Gurley and Shaw (1967) emphasized the significance of financial system in channeling savings to investment. In line of this, Shaw (1973) also stressed on the job of financial relaxation in encouraging national savings and investment, through proficient distribution of resources, and accordingly promoting economic prosperity and development.

There is general agreement among the intellectuals that stock market plays a pivotal role in the progress of an economy (Levine and Zervos, 1998; Adjasi and Biekpe, 2006; Hearn and Piesse, 2010). For example, it speeds up economic development by improving mobilization of local and international resources and encouraging investment (Bencivenga et al., 1996), aides assistance for growth oriented firms to generate capital at low rate (Marone, 2003) and decreases dependency on institutions like bank which is prone to interest rate variance as well as providing platform to channelize foreign investments (Yartey, 2008). It even provides an opportunity for venture capital companies to exit out of the business and liquidate their shares in local start-up ventures (Black and Gilson, 1999). It is considered as a vital institution of a nation and is of enormous concern to investors, shareholders and the government (Olweny and Omondi, 2011). A sustainable progression and development of an economy is possible through effective and efficient resource mobilization, hence funds should be efficiently mobilized and distributed to allow the economy to obtain optimal output and stock market plays a significant role over here (Osinubi, 2010). Raee and Talangi (2005) stressed that, presence of an efficient financial market in allocation of human resources and capitals has an important function in a prosperous economy. By tradition, globally share market has been regarded as one of the main avenues of capital attraction and investment. It enables taking action in dynamic and developing industries with regard to cooperation, gaining of more earnings from liquidity (Sajadi, 2007). As the national economy develop capital investment of self-financed offer place to intermediated finance of banking institutions and after that for raising capital the establishment of stock markets becomes an additional source (Gurley and Shaw, 1955, 1960). Demirguekunt & Levin (1996) have inferred that stock markets, development & successfulness of particular financial intermediaries add on to the development and growth of an economy. Individuals are motivated or perceive incentive to raise their current savings in the stock markets because capital market provides different & changing risk characteristics maturity periods and return.

Stock Market is the foundation of modern finance. They are the sources by which share values are ascertained to the equity capital of listed company. Share value provides shareholders with a measure of their capital and earnings, while the management of the listed companies is able to notice the outcome of their decisions as revealed in share price. The supposition that share markets efficiently generate price equilibrium creates the foundation of the concepts that trigger much of the discipline of financial economies. At a basic level, this market plays two main roles. The primary role is to offer large scale direct capital to productive divisions within a nation’s economy. The second is to offer a platform, enabling stockholders to obtain liquidity when required, or to purchase stocks without having to subscribe to fresh issues. The two roles are closely linked to each other. A large secondary market noticeably assists the primary function (Naughton, 2000). Moreover, the effectiveness of stock market development on growth can be observed in three possible ways: The first one is to increase the percentage of savings really invested, which is depended on the competence of financial system in the economy. The impacts of stock market on investment, through changes in share prices that reveal the marginal productivity of capital, should be positively associated with investment upsurge. A rise in the marginal productivity of capital is straight away connected to a rise in investment activities. The second way is to influence the private saving proportion, which is possible by enhancing the distribution of funds through information or risk pooling (Bencivenga & Smith, 1991; Greenwood & Jovanovic, 1990). The final way is to generate the social marginal productivity, which is possible as saving may go either direction.

From theoretical side, many concepts have been developed to demonstrate the passages through which the financial sector development is impacted by economic growth. While from the empirical side, rising bodies of studies at different levels - company level, industry level and national level - have revealed the robust correlation between the financial market and economic growth. The development of a financial system is very closely correlated to the complete development in a nation’s economy. Properly operating financial market attains efficiencies that offer decent and easily accessible information, lesser transaction charges and effective resource distribution thus enhances economic growth. However, many macroeconomic factors have substantial impact on a share market and its functions, growth, and part in an economy. Whereas, on the other hand, the central bank role, governmental policies and investor behavior influences the financial market development. For example, monetary policy connects with share market growth through influencing money supply, interest rates, and investment activities in shares along with the market values of shares. When an expansion monetary policy is introduced, it facilitates money supply, lowers interest rates, and increases investment in shares and market value of shares. Fiscal policy can bring out similar effect by directly through the help of interest rates and investment. At the end, the influence of individual behavior is taken through the saving percentage where the lack of financial markets in economically deprived parts, where population with low incomes simply do not save and invest at great levels (Abdelbaki, 2013).

Over past decades, the significance of stock market around the globe opened new avenue of research, into the stock market development and economic growth (Khalid, 2012). The correlation between macro-economic factors and stock market performance has been of main concern in the academic and practitioners’ literature since many decades (Adam and Tweneboah, 2008). Investors presume that economic variables and events have significant influence on stock market movement and it is evident that stock prices are derived on the basis of macroeconomic variables (Khalid, 2012). Particular important macroeconomic factors such as exchange rate, interest rate, industrial out and inflation have been debated to be the contributing factor for stock price movements (Adam and Tweneboah, 2008). It is generally believed that stock returns are somewhat predictable, by utilizing publicly accessible information about macro-economic fundamentals. However, the exact cause and impact relationship between macro-economic factors and stock market performance is arguable. The empirical research regarding impact of macro-economic variables and stock market performance is varied due to different data sets and methodologies used (Al-Jafari, Salameh, and Habbash, 2011). The Stock Exchange of Mauritius (SEM) has been in operation for more than 24 years and it was incorporated in Mauritius on 30th March, 1989. It is regulated by Financial Services Commission (FSC) under the Stock Exchange Act 1988. It is a member of the World Federation of Exchanges (WFE) and today it is one the leading Exchanges in the African Continent. It operates two markets one being the Official Market and the other being the Development and Enterprise Market (DEM). SEMDEX represents the index of all the listed ordinary shares (SEM, n.d). It is very critical for all the stakeholders, of Stock Exchange of Mauritius, to understand the determinants of a stock market performance. This research will empirically study the impact of macro- economic variables on stock market performance for Small Island like Mauritius.

1.2 Research Questions and Objectives

1.2.1 Research Questions

Certain questions may assist us to have an improved understanding of what we are expecting. Drawing from the empirical literature review and study, the dissertation will focus on the following vital questions:

What is the impact of micro-economic variables on performance of Stock price index?

What is the impact the impact of Inflation rates on performance of Stock price index?

What is the impact the impact of Lending rates on performance of Stock price index?

What is the impact the impact of Exchange rates on performance of Stock price index?

What is the impact the impact of Treasury bill rates on performance of Stock price index?

1.2.2 Research Objectives

The research objectives are as follows:

To critically examine how macro-economic variables affect the stock market performance by using the Stock Exchange of Mauritius as a case study.

To analyze the impact of Inflation rates, Lending rates, Exchange rates and Treasury bill rates on Stock Exchange of Mauritius.

To assist stakeholders of Stock Exchange of Mauritius in decision making, considering the Macro-economic variables.

To review and analyze the performance of the Stock Exchange of Mauritius.

To examine relationship between macro-economic variables and stock market performance in a small island like Mauritius.

1.3 Structure of Dissertation

All the basic requirements a research study has, such as literature review, research plan, analysis and results are part of this dissertation. Bearing in mind the objectives and questions, the researcher has planned and organized the whole work. A brief description of all the chapters is mentioned below:

Chapter 2: Literature Review

This chapter includes a detailed literature review on relationship between macroeconomic variables and the equity market. It also includes comprehensive empirical evidence on this relationship. Furthermore, it separately reviews the relationship between different variables like inflation rate, exchange rate, interest rates with the equity market. Finally, it gives an overview on performance of Stock Exchange of Mauritius.

Chapter 3: Research Plan

This chapter explains the research plan which includes research criteria, research perspectives, research design, research methodology, type of data and research ethics. It mentions the econometric model used to study the impact of macroeconomic variables on the stock market performance.

Chapter 4: Analysis and Result

In this chapter a quantitative analysis of the secondary data will be carried out and documented with the help of econometric model. Different tests like unit root test, co-integration test and error correction model will be conducted and presented with help of tables. The results will be analyzed and interpreted in this part of dissertation. It will also compare the findings with previous research work in this field.

Chapter 5: Conclusion and Recommendations

In this chapter a summary of the results will be mentioned. Recommendations for the stakeholders of the stock exchange of Mauritius will be proposed.

CHAPTER 2: LITERATURE REVIEW

2.1 Introduction

Over the years, the importance of stock market around the world opened new avenue of research, into relationship between stock market performance and it macroeconomic determinants. The correlation between macro-economic factors and stock market performance has been of main concern in the academic and practitioners’ literature since many decades. This chapter will introduce detailed literature review on relationship between macroeconomic variables and the equity market. It even gives overview on performance of Stock Exchange of Mauritius.

2.2 Relationship between macroeconomic variables and the equity market

Extensive literature are now obtainable that study the relationship between equity market returns and numerous macro-economic and industry factors in several equity markets and intervals. The relationship between stock market performance and macro-economic variables has become very significant over a period of time. Importance for this study is mostly because share market has been regarded to have a significant role in a nation’s macroeconomic development (Zakaria and Shamsuddin, 2012). Theories on finance and development have critiqued the leading neo-classical monetary theories and the counter arguments by Keynesian (McKinnon-Shaw, 1973). The neoclassical monetary growth models assume that bigger positive interest rate have a direct relation with the savings and investments. Over here, money is considered as a replacement for productive investments and real assets. While Pro Keynesian economists believes that low interest rates facilitates larger investment, income and eventually savings. McKinnon (1973) progresses a debate in favor of a harmonizing relationship between financial and physical assets contrasting to the substitutability concept by the neo-classicals in a criticism of the Keynesian theory. Paddy (1992) asserts that macro-economic and fiscal environment have an impact on securities market. Favorable macro-economic surroundings encourage the prosperity of business which drives them to a level where they can acquire securities for sustained growth. In general, performance of an economy is measured through real GDP growth rate, inflation rate, the exchange rate and fiscal position.

The earnings on shares are majorly sensitive to future expectations and fundamentals. It is evident through studies that as an outcome of financial liberalization, the equity market becomes more sensitive to both internal and external environment. The major external variables influencing the share market return would be share prices in the global economy, interest and exchange rate. It has been observed from previous literature that the relationship between share returns and macro-economic factors have gained immense attention over recent years in specific nations and macro-economic environment. The degree of earnings expected or gained from the capital invested is reliant on numerous factors. The major factors are internal conditions of the company and external environment. The internal conditions can be efficiency of management, kind of investment, type of capital required and so on, while external environment can be inflation, interest, exchange rate, price controls and political events among others (Butt, 2010).

During the valuation process, apart from the evaluation of individual firms or shares, the macro-economic and industry conditions should be taken into consideration. According to psychologists an individual’s success or failure can be affected as much by social, economic and family conditions as by inherited gifts. Extending the same concept, during the valuation of shares, the company’s economic and industry conditions should be considered (Reilly and Brown, 2006). Hence, unlike the bottom-up approach, much importance has been given to the economic and industry condition for the firm’s valuation process in the top down approach. Bottom-up approach defends that it is likely to find shares to offer greater returns irrespective of the economic and industry conditions. On the other hand, the top down approach considers that macro-economic and industry conditions majorly influence the aggregate earnings for individual shares, irrespective of the internal conditions of a company. This approach has been supported by numerous academic studies examining the impact of macro-economic factors on equity market returns. The macro-economic variables and the firm’s industry conditions affect the value of a stock and its rate of return, apart from the company’s individual characteristics and profit making potentiality. Hence, economic conditions would be considered as a priori of risk that are applicable to all firms (Ozbay, 2009).

In all probability the relationship between the two is well explained by Miller and Modigliani in year 1961 by the Dividend Discount Model compared to other theoretical stock valuation methods. In the model it is explained that current prices of a share is equivalent to the present value of all future cash flow to the equity share. Hence any economic variables which affect the expected future cash flow and required rate of return also affect the share (Adam and Tweneboah, 2008). Likewise, the volatility of share prices should also be related to the volatility of anticipated future discount rates and cash flows. As the market value of firm equity at the aggregate level is subject to the state of economic activity, it is possible that any volatility in level of uncertainty of future macro-economic environment would effect a change in share return volatility. In other term, share markets could be volatile just because actual economic activities change (Zakaria and Shamsuddin, 2012).

Numerous studies and researches are carried out to analyze the relationship of macro-economic factors on the stock market performance in US and other countries (Khalid, 2012; Humpe and Macmillan, 2009; Ratanapakorn and Sharma, 2007; Chaudhuri and Smiles, 2004; Kim, 2003; Nieh and Lee, 2001; Cheung and Ng, 1998; Fama, 1981, 1990; Nieh and Lee, 2001; Mayasmai and Koh, 2000; Kwon and Shin, 1999; Ajayi and Mougoue, 1996; Mukherjee and Naka, 1995; Dhakal, Kandil and Sharma, 1993; Abdullah and Hayworth, 1993; Bulmash and Trivoli, 1991; Chen, Roll and Ross, 1986; Fama and French, 1989; Campbell and Shiller, 1988;).

High inflation rate, huge fiscal deficits and real exchange rate over valuation are normally key indicators of macro-economic volatility, which restricts private sector savings and investment and hence affects in inefficient distribution of funds on the stock exchange and therefore resulting its performance (Agenor, 2000). Though individual share prices may be associated to company specific reasons, the normal share market index is assumed to be affected by the overall economic conditions (Hsing, 2011). Among these the interest rate and exchange rate are the ones which have impact on stock market performance as they affect directly the state of corporate activity in the nation (Kyereboah-Coleman and Agyire-Tettey, 2008). Flannery and Protopapadakis (2001) examined the impact of macro-economic factors on share market performance and they concluded that these factors remarkably measure market risk, since most changes affect cash flows and position of firms and may leave an effect on the interest rate.

A series of studies have been conducted in many countries like U.S, Europe and Japan. Several researchers have found evidence that stock performance depends on macro-economic variables like inflation rate, oil price, exchange rate, money supply, employment rate, consumer price index and the interest rate. Many investors take decisions based on these factors as they believe that these factors have impact on stock market performance. Numerous methods, techniques and models researchers have used to examine the relationship between the two (Khalid, 2012).

2.3 Empirical Evidence

SR.NO

Author

Year

Study

Country

Frequency

Period

Model of study

Findings

1

1. Wongbanpo

2. Sharma

2001

Relationship of stock returns and macroeconomic variables

Singapore, Indonesia, Thailand, Malaysia and Philippines

-

1985-1996

Hypothesized model checked through Granger, Causality, Unit root PP and ADF tests.

The study observed alliance between market returns and macroeconomic indicators for long and short run.

2

1 Norli Ali

2001

Impact of variation of Macroeconomic determinants on performance of stock prices

Malaysia

monthly

1987 -1999, 1987 -1996

Arbitrage Pricing Theory and Error Correction Model

High impact of Macroeconomic determinants has been found

3

1. Li

2002

Research on Macroeconomic determinants and the correlation between Stock and Bond returns

G-7 countries

monthly

1980-2001

Affine model and co-integration test

Macroeconomic variables showed an impact on major trends instead of monthly trends

4

1. Nishat 2. Shaheen

2005

Long run co-movement between macroeconomic factors and Stock Market index

Pakistan

-

1973-2004

Vector Error Model

The result indicates that there is causal co-movement between the economy and the stock market

5

1. Gan 2. Lee

2006

Relationship between stock market index and macroeconomic factors

New-Zealand

Monthly

1990-2003

Co-integration test, Accounting Innovation Test and Granger Causality test

Long term relationship exists between stock market prices and macro-economic factors

6

1. Brahmasrene 2. Jinanvakul

2007

Impact of Macroeconomic variables on stock returns.

Developed economies

-

1992 - 2003

Unit root, Granger Causality and integration tests

Co-integration was found between Market returns and other Major economic indicators

7

1.Anthony Kyereboah-Coleman 2.Kwame F. Agyire-Tettey

2008

Impact of macroeconomic indicators on stock market

performance

Ghana

Quarterly

1991-2005

Co-integration and the error correction model techniques

Relationship exists between these variables

8

1. Torso 2. Rjoub

2008

Co-movement between the macroeconomic variables and Stock Market Price

Istanbul

Monthly

2001- 2007

Arbitrage Pricing Theory

Macroeconomic variables have no significant impact on ISE

9

1. Emrah Ozbay

2009

Causal relationship between macroeconomic variables and stock return

Turkey

Monthly

1998- 2008

Granger causality Test

The macroeconomic variables cause the stock prices

10

1. Mohammad 2. Hussain

2009

Co-movement between the macroeconomic variables and Stock Market Price

Pakistan

Quarterly

1986- 2008

Asset valuation model and Unit root test

Information of Macroeconomic factors has effect on the stock prices

11

1. Ahmet-Büyükşalvarcı

2010

Effect of Macroeconomic factors on Stock Market

Turkey

Monthly

2003- 2010

Arbitrage Pricing Theory and multi regression model

Macroeconomic variables can lead to stock market return

12

1.Tobias Olweny 2.Kennedy Omondi

2011

THE EFFECT OF MACRO-ECONOMIC FACTORS ON STOCK RETURN VOLATILITY

Kenya

monthly

2001-2010

Exponential Generalized Autoregressive Conditional Heteroscedasticity (EGARCH) and Threshold Generalized Conditional Heteroscedasticity (TGARCH)

Macro-economic factors affects stock return volatility.

13

1.Mohamed Khaled Al-Jafari 2.Rashed Mohammed Salameh 3.Mohammad Rida Habbash

2011

Investigating the Relationship between Stock Market Returns

and Macroeconomic Variables

Developed countries and emerging markets

Monthly

2002-2008

Various models including Granger Causality test and Pedroni panel

co-integration tests

The empirical results show a significant causal

relationship between macroeconomic variables and stock prices for developed and emerging markets

14

1. Aima Khan 2. Hira Ahmad 3. Zaheer Abbas

2011

Impact of macroeconomic Factors on stock Prices

Pakistan

Monthly

2004-2009

Co-integration, Vector Error Correction Model and Variance decomposition

All variables tested except for money supply have significant impact

15

1. Muhammad Aamir 2. Muhammed Akram 3. Muhammad Shafique 4. Muhammad Atif

2011

Impact of macroeconomic indicators on stock market

performance

Pakistan

Yearly

1995-2010

Unit root test, Co-integration and Error Correction Model

Significant impact on stock market in the long and short term

16

1. Yu hsing

2011

Effects of Macroeconomic Variables on the stock market

Czech Republic

Quarterly

2002- 2010

GARCH model

Strong relation between macroeconomic variables and stock market.

17

1. Naliniprava Tripathy

2011

Relationship between Macro-economic indicators and stock market

India

Monthly

2005- 2011

Ljung-Box Q test, Breusch-Godfrey LM test, Unit Root test, Granger

Causality test

Auto correlation in the Indian stock market and macroeconomic variable

18

1. Josphat Kipkorir Kemboi 2.Daniel Kipkirong Tarus

2012

Macroeconomic Determinants of Stock Market Development

Kenya

Quarterly

2000-2009

Johansen-Julius co-integration technique

Macro-economic factors are important determinants of the

development of the Nairobi Stock market.

19

Muhammad Khalid

2012

Long-Run Relationship Between Macroeconomic Variables

and Stock Return

Pakistan

monthly

2000-2010

Co-integration

The result of correlation shows that there is no significant positive correlation among these variables

20

1. Zukarnain Zakaria 2.Sofian Shamsuddin

2012

Relationship between Stock

Market Volatility and Macroeconomics Volatility

Malaysia

monthly

2000-2010

Bi-variate and multivariate

VAR Granger Causality tests as well as through regression analysis

As a group, all macroeconomic volatilities were found nor causally or significantly related with stock

market volatility

21

1. Hasan Mohammed El-Nader 2. Ahmad Diab Alraimony

2012

The Impact of Macroeconomic Factors on Stock Market

Returns

Amman

monthly

1991- 2010

Unit root test, normality test, OLS and ARCH/ GARCH Model

Apart from RDGP all other variables have a negative role on the ASE returns

22

1. Hussain Ali Bekhet 2. Mohamed Ibrahim Mugableh

2012

Investigating Equilibrium Relationship between Macroeconomic Variables and

Stock Market Index

Malaysia

Yearly

1977- 2011

Ng and Perron (NP) bounds statistics

Macroeconomic variables are co-integrated with stock market index

23

1. Yu hsing 2. Wen-jen Hsieh

2012

IMPACTS OF MACROECONOMIC VARIABLES ON THE STOCK

MARKET INDEX

Poland

Quarterly

2001- 2010

GARCH model and ARCH model

Significant association between macroeconomic variable and stock market index.

24

1. Abdelbaki

2013

Causality relationship between Macroeconomic variables and stock market development

Bahrain

Yearly

1990- 2007

Autoregressive Distributed Lag model

The paper support the theoretical and empirical literature on Macroeconomic variables and stock market development nexus

25

1.Zeynep Iltuzer

2.Oktay Tas

2012

The Analysis of Bidirectional Causality between Stock Market Volatility and

Macroeconomic Volatility

Turkey, Czech Republic, Brazil and India

Varied frequency

Varied

Multivariate GARCH model

it is not wrong to say that there exits causal relation between macroeconomic indicators of

the countries and their stock markets, but they are specific to countries dynamics

26

1.Anokye M. Adam 2.George Tweneboah

2008

Macroeconomic Factors and Stock Market Movement

Ghana

Quarterly

1991-2006

Johansen's multivariate co-integration test

and innovation accounting techniques

There is co-integration between

macroeconomic variables identified and Stock prices in Ghana indicating long run

relationship

27

1. Bilson 2. Brailsford 3. Hooper

2001

Impact of Macroeconomic variables for emerging stock market

Emerging economies in Latin America, Asia, Europe, Middle East and Africa

monthly

1985-1997

Principal component analysis and multifactor models including integration and correlation

The explanatory power of Macroeconomic variables for market returns is not high although they explain to some extent

Table : Empirical Evidence

Source: Various sources specified in the table

2.4 Relationship between inflation and Equity Market

The rate of increase in a price index is known as inflation rate (for instance, a consumer price index). It determines the rate of change in percentage for the price level over a period of time (Olweny and Omondi, 2011). Mishkin (2003) suggested that the rate of decline in the purchasing power of money and inflation rate is almost same. It has been observed that savings and investment has been majorly influenced by inflation rate, through different sources. Normally, unexpected inflation disturbs the planning prospect of economic divisions. It decreases the real interest rate keeping all other variables constant. From the saving perspective, inflation has adverse effect on savings since it decreases the real interest rate and the interest rates have a positive effect on savings. Highly volatile inflation rate increases uncertainties in regards to future pricing and investments. Individual choose to invest in physical assets, if they find high amount of uncertainty in investment due to pricing instruments. Moreover, it has the characteristics of changing investment portfolios to short term mechanism as the investors are not able to forecast the future. Investors prefer to participate in short term investment instead of long term due to the high uncertainty in the inflationary conditions. This will obviously influence the need for long term investments and the profitability of participating in long term ventures (Kyereboah-Coleman and Agyire-Tettey, 2008). Rising inflation rate tends to raise the cost of living and a need of investment decreases while the consumption needs increases. This certainly affects the need for market instruments which causes decline in the size of stock traded. Hence, inflation is expected to have a negative effect on the stock market performance (Adam and Tweneboah; Kyereboah-Coleman and Agyire-Tettey, 2008). Even the monetary policy reacts to the rise in the inflation rate with stringent economic policies, as they affect the nominal risk free interest rate. DeFina (1991) contends that nominal agreements that prohibit the sudden adjustment of the company’s sales and overall costs avert cash flow to grow at the similar pace as the inflation rate. Therefore, a negative correlation is expected inflation and stock market returns. On the contrary, Yartey (2008) found no significant relationship between these two.

There has been great study on the relationship between inflation rate and equity market, which resulted into large number of literature on the connection between these two factors. From the economic point of view, theories advocates relationship between these variables. Even though there are numerous studies on the relation between these factors, no general consensus has been gained whether the link is positive or negative. The causal relation between equity market performance and inflation rate is also ambiguous. The study has no general consensus on whether the causality moves from inflation rate to equity market performance or from equity market performance to inflation rate or whether bi-directional causality exists (Eita, 2012).

There was a general belief, until 1970s, that inflation rate affects equity market returns positively or at least non-negatively. This assumption was made on Fisher’s (1930) theory that real returns on equity market are not affected by inflation expectations. Accordingly two factors were considered to be positively related, which lead to assumption that stocks are hedge against inflation rate. Only after the late 1970s, it was discovered and believed that this relationship can also be majorly negative. The negative relationship was well justified by Fama (1981). A negative correlation between equity market performance and inflation rate specify that equity market is not hedge against inflationary conditions. It was reported that in USA, shares have been weak hedges against inflation (Jaffe and Mandelker, 1977; Linter, 1973; Oudet, 1973; Bodie, 1976; Nelson, 1976). Geske and Roll (1983) suggested a negative link between equity market return and inflation rate. Rise in inflation rate has been estimated to hike the nominal risk-free interest rate, which in turn will increase the discount rate used in stock valuation process. The impact of greater discount rate will be leveled, if cash flows rise at the same rate. On the other hand, a negative impact will be experienced, if contracts are nominal and cannot restore quickly. Even, the experimental evidence advocates that high and volatile inflation rates increase the uncertainty in inflationary conditions and hence lower stock value. Additional study also backs the hypothesis that equity returns are negatively associated to both unexpected and expected inflationary conditions. Caporale and Jung (1997) reported a non-existence of negative correlation between these two variables. On the other hand, Chatrath et al., (1997) and Adrangi et al., (1999) documented partial support to the hypothesis that inflation rate and equity market returns are negatively correlated in the developing countries like India, Chile and Peru. Further Salameh (1997) found that there is no relationship between inflation rate and share prices in Jordan. Another study by Joo (2000) tested whether monetary policy is responsible for the negative correlation between these two variables. His observation concluded that around thirty percent of the witnessed negative correlation is due to the monetary revolutions. Many researchers made use of consumer price index as substitute variable to inflation rate, in their studies. Consumer price index was frequently used to show the products and prices about the overall public. Furthermore, Patra and Poshakwale (2006) observed that short run and long run equilibrium relationships prevailed between the inflation rate and equity market prices for shares listed at Stock exchange of Athens. While, Zoicas and Fat (2008) documented that inflationary conditions has headed to the estimation of considerable relationships to the volatility of equity market. Another research by Suliaman et al., (2009) also reported that entire sale price index is positively and majorly linked to equity prices. Likewise, Antonio and Francisco (2009) carried out a research on the short run reaction of everyday share prices on the Spanish stock market to the declaration of inflation related news at the industrial level. It was reported that a positive and drastic reaction of share returns was observed in the event of bad news (i.e. the overall inflation rate greater than estimated one) in crisis, and also in the event of good news (i.e. a negative inflation news) in non-economic crisis. Durai and Bhaduri (2009) examined the relation between equity returns, output and inflation rate for the post deregulation period in India with the help of wavelet method. Its result indicated that there is a significant negative correlation between real equity return and inflation rate in the short and medium run.

2.5 Relationship between Exchange rate and Equity Market

Exchange rate is the value of one currency in regards to the other currency. It can also be described as the worth of foreign currency in regards to host currency (Khan, Ahmad and Abbas, 2011). Exchange rate as a reflector of a currency volatility is monetary factor that influence prices of shares similar to inflation factor. Devaluation of the domestic currency affects the import by making it expensive in contrast to export. Consequently, importing firms raise overall production cost and due to competitiveness of the market all the cost cannot be transferred on to the customers. This affects the overall firm’s earnings, which ultimately affects the share prices (Adam and Tweneboah, 2008). Adler and Dumas (1984) contended that even companies whose all functions are domestic may be influenced by exchange rates, if currency changes affect their input and output prices. While Luetherman (1991) observed that devaluation of the domestic currencies do not give local firms competitive advantage as contended in previous work. Likewise, Solnik (1987) reported that exchange rate movement does not affect the development and growth of share prices. Numerous researches related to relationship between exchange rates and share prices are carried out. The studies on the relationship between these two variables have been carried out in two general groups. The first group examined the impact of equity market on the market directly and finds the link between fluctuations of these two variables. The other group examined the impact of exchange rate on the equity market (Fathi, Samadi and Kahyani, 2011). A rise in demand for export sales may occur, if there is devaluation in domestic currency making exporting goods cheaper. Therefore, the export company value would be benefited from devaluation in domestic currency. In contrast, the domestic currency appreciation would cause a decline in foreign demand of exporting company’s goods, which would affect the profitability of the company and consequently its share prices. However, in case of importing company the relativity of the company value to exchange rate changes is exactly the reverse. Importing company’s value would increase and decrease as the domestic currency appreciates and depreciates, respectively (Al-Jafari and Salameh, 2011). Trade effect has displayed this to affect the share prices (Geske and Roll, 1983). Foreign currency and credit have financial prices in terms of exchange rates and interest, respectively. Interest and exchange rates majorly influence the prices, cost, financial positions, and resource distribution and production levels. Eventually, movement in these reflects in stock values – a reflector of stock market performance. For example, investors would prefer to invest in equity market for better returns, if the interest on demand and saving deposits are lowered considering the factors such as transaction charges, risk level and so on constant. This will certainly raise the demand and stock values of affected stocks on the stock market and hence affecting its performance. The concept of investing in dollars also becomes widespread in an environment of relentless exchange rate devaluation. This turns away capital that could be invested on the exchange into assets such as foreign currencies which is non-functioning. Real exchange rate devaluation could lead into fund flight hence affecting the local economy by depriving it from probable investable financial resources (Kyereboah-Coleman and Agyire-Tettey, 2008).

Exchange rate as a macro-economic variable has gathered lot of attention in financial economics field in developed and emerging countries due to its effects in the financial markets, especially the capital market. Contradicting inferences were detected between equity market performance and exchange rate movement - Adjasi et al (2008) documented devaluation of domestic currency causes rise in share market prices in the long run, while Choi et al (1995) observed that exchange rate movements didn’t influence equity market returns at all. Jorion (1990) documented considerable relationship between equity returns and the real US dollar exchange rate for US MNCs for the period 1971 to 1987. In contrast, Soenen and Hennigar (1988) found that effective US dollar exchange rate adversely influenced the US equity market index for the period 1980 to 1986. On other hand, Aggarwal (1981) observed positive relationship between revaluation of the United States dollar and share prices. Mukherjee and Naka (1995) also observed positive relationship between these two variables for Japan and Indonesia both being large exporters.

Granger et al., (2000) made use of Bayesian Vector auto-regression model to study the correlation between share prices and exchange rates for 9 Asian nations and reported mixed outcomes. After the study, their results suggested that there is no correlation among the exchange rate and share prices for countries like Japan and Indonesia. On the contrary, they indicated that exchange rate influence share prices in Korea, although share prices affected exchange rates in other Asian countries i.e. Taiwan, Thailand, Hong Kong and Malaysia. Patra and Poshakwale (2006) observed through their empirical studies that no short-run or long-run equilibrium relation exists between these two variables. Even, Ming-Shiun et al., (2007) carried out study on the dynamic relationships between these two variables for 7 East Asian countries, which included Thailand, Taiwan, Japan, Korea, Malaysia, Hong-Kong and Singapore for the year 1988 to 1998.

From the study it was observed that before the 1997 Asian financial crisis, a major causal relationship between exchange rates and share prices existed for Malaysia, Japan, Thailand and Hong-Kong. In case of Korea, Singapore and Hong-Kong same relationship was found between share market and exchange rates. Apart from the period of Asian crisis, a causal relationship between foreign exchange market and equity prices were seen for all the nations except for Malaysia. In further study, Abugri (2008) found that the equity market return was greatly influenced by exchange rate movement. Griffin et al (2001) showed that there was a positive effect on the electronic sector in U.S. Kandir (2008) carried out an empirical study on Turkey with the goal of finding the linkage between the two variables. With the help of multiple regression models, the outcomes indicated that exchange rate seem to have a positive linkage with equity portfolio performance. Jefferis and Okeahalam (2000) reported for South Africa, the equity market is positively affected by the exchange rate. The same results were found by studies carried out by Phylaktis & Ravazzolo, 2000; Hsing, 2011; Granger et al., 2000; Abdalla & Murinde, 1997; Cheng’ et al., 2011; Aggarwal, (1981); and Apte, 2001. Aubgri (2008) studied the relationship between stock returns and exchange rate for emerging markets like Brazil, Mexico, Argentina and Chile. The relationship between these variables was negative for Brazil and Mexico, while Argentina and Chile did not respond significantly. Adam and Tweneboah (2008) examined the relationship between these variables in Ghana and found negative relationship between stock market returns and exchange rate.

2.6 Relationship between Interest rate and Equity Market

The interest rate is the most important macro-economic variable influencing the equity market. It is the cost of capital, which is one of the major factors affecting production. Even for the valuation process it is been used as a discount factor. Hence, they affect directly the cost, profit and Net present value of the future cash flows of a company. The numerator and denominator of the valuation process are largely affected by higher interest rates (Erdugan, 2012). The correlation between share prices and interest rates is extensively studied. Opportunity cost of carrying money will rise as there is increase in interest rate and individual holds interest bearing securities as substitute for stocks thereby causing fall in share prices (Adam and Tweneboah). T-bills are the arguable debts allotted by the government of a country and are backed up by its non-risky feature with maturity period of 1 or less than 1 year. Interest rates are the cost loaner receives for lending money to the borrower and the cost borrower bears for borrowing it from the loaner (Khan, Ahmad and Abbas, 2011). Investors are motivated to buy more government instruments in case of high T-bill rates. T-bills thus are likely to compete with shares and bonds as an alternative resource for investors. The estimated association between T-bill rates and share prices is thus negative. According to the Dividend Discount Model, as the interest rate increase, the stock price and required rate of return which are inversely related would decrease. Gan et al (2006) contended that opportunity costs of carrying money increases with rise in interest rate, and the set off caused by possessing other interest bearing securities would cause a decline in stock price.

Fiscal deficits make government interfere in the financial markets with much lucrative options that would force out shares. A rise in government borrowing by offering T-bills may cause an impact on the share market as investors re-adjust their portfolio balances. Lower T-bill rates instigate shift of local capital from the money market to the share market (Pilbeam, 1992). Long lasting and large fiscal deficits along with issuance of high yielding but less risky government offerings like the T-bill, negatively affect the bonds and shares issued by private companies for long term funds. In this study, it has been found that T-bill rate affects share market performance similar to impact of interest rate on demand and saving deposits (Kyereboah-Coleman and Agyire-Tettey, 2008). French et al. (1987), in theory found inverse relationship between long and short term interest rate and share returns. Other empirical studies found evidence indicating Treasury bill movement comprise information significant to the estimation of share prices (Doukas, 1989; Kandir, 2008; Tandon and Urich, 1987; Johnson and Jensen, 1993). These studies suggested, Treasury bill yield movements are significant to investors as they are indicators of future economic performance.

The influence of nominal interest rate on share prices is also estimated to be adverse; the degree of real economic activity is supposed to have positive influence on future cash flows and hence will influence share prices to move in the same direction (Fama, 1990). Maghyereh (2003) observed that nominal interest rates are seen in share prices in the Jordanian equity market. While, Melina (2005) inferred that a unidirectional causal relationship exists between the interest rates and the common index of Athens stock market, with direction from the interest rates to the common index of Athens share market. Even, Uddin and Alam (2007) studied the linkage between stock prices and interest rates, stock prices and movement in interest rates, movement of stock prices and interest rates and movement of stocks and movement of interest rates for Dhaka stock market. They observed that interest rates are inversely related to stock prices and movement of interest rates have major inverse relationship with stock prices movement. Zocias and Fat (2008) in their study on return series behavior for the Bucharest Stock Exchange index, reported weak relationship between interest rates and equity market index. Likewise, Alam and Uddin (2009) analyzed the impacts of interest rates on share market and their study documented relationship between interest rates and share market index for 15 developed and developing nations; Spain, Australia, Germany, Mexico, Bangladesh, Canada, Venezuela, Chile, Colombia, Italy, South Africa, Jamaica, Japan, Malaysia and the Philippine. The Equity market performance stationary is examined and the results show that none of these equity markets are efficient in weak form. It is also observed that for all countries interest rates have substantial relationships with stock prices and for 6 nations, it is evident that movements of interest rates have major inverse relationship with movement of stock prices. Hence, if the interest rate is well managed for these nations, it will be the great advantage of these nations’ equity market through demand pull method of more participants in equity market and supply push method of more extensional capital of firms. Even, Suliaman et al., (2009) observed that interest rates in Pakistan are majorly influencing equity prices. Chen et al (1986) specified that interest rate affects the stock return positively. Kandir (2008) examined the Turkish market and observed a positive relationship between these two variables. Kim and Moreno (1994) studied the relationship between bank loans and stock prices. They observed a strong positive relationship between stock prices movement and bank lending rate for Japan for period 1970 to 1993.

2.7 Overview and Performance of Stock Exchange of Mauritius

SEM was incorporated 24 years back on 30th of March, 1989 under the Stock Exchange Act 1988 and is regulated by FSC. Since 2008, it has become a public company and today it is one of prominent exchanges in African continent. It functions two markets one being the Official Market and the other being the Development and Enterprise Market (DEM). The Official Market has a market capitalization of approximately USD 5.7 billion as on 31st December 2012 and a listing of 41 companies. While, DEM currently have 47 companies listed with a market capitalization of approximately USD 1.4 billion as on 31st December 2012. SEMDEX, SEM7, SEMTRI are different indices of SEM. SEMDEX represents index of all the ordinary shares while SEM-7 includes the 7 biggest eligible stocks of the Official List, calculated in terms of market capitalization (SEM, n.d). The IPO market is considered as a vital source for raising capital and for the growth of the private sector. With the introduction of government’s privatization program, the IPO market gained even more importance. According to some studies the market is efficient in the weak form (Bundoo, 2007). As per the study by Magnusson and Wydick (2002) the SEM clears both Random Walk I and II models of market efficiency. It is also been observed that SEM is at par with developing share markets in Asia and Latin America. In the year 1994, Stock Exchange of Mauritius was accessible for foreign investors, suggesting that they did not need approval to invest in shares except the investment relates to kind of Management control of Mauritian firm or for acquiring more than fifteen percentages in a sugar company (Wbiconpro, n.d). There are no constraints on repatriation of fund, dividends and interests (USEmbassy, n. d.). The introduction of Central Depository System has enabled quick, efficient clearing and settlement of transactions and also reduced inherent risks in the procedure (Africansea, n.d.). Since beginning, efforts have been taken to make sure that the SEM stays at the lead of Institutional reform and growth while rendering quality services to its participants and contributing for the growth of financial sector in Mauritius.

YEAR

No. of Listed companies

Market Capitalisation (Rs)

Annual Turnover in (Rs)

Market Capitalization/ GDP %

P/E ratio

Dividend Yield %

1999

43

41,731,973,736

1,978,180,320

38.73

8.98

5.03

2000

42

37,034,909,667

2,045,247,037

31.1

6.4

6.73

2001

40

32,147,404,156

3,292,410,159

24.33

5.91

8.3

2002

40

38,641,073,426

1,722,521,587

26.99

5.33

9.83

2003

39

51,229,930,441

2,989,174,317

32.55

7.43

5.74

2004

40

67,033,922,981

2,819,024,443

38.19

9.93

4.85

2005

41

80,038,466,322

4,547,982,065

43.18

7.98

4.64

2006

41

116,981,444,907

5,992,247,910

56.96

11.95

3.66

2007

41

173,094,638,415

11,825,521,416

74.93

13.2

2.8

Table : Stock Exchange of Mauritius: Market Highlights

Source: SEM Factbook, 2012 [1] 

Table 2 depicts market performance from year 1999 to 2007. During this period SEM has shown a major rise and an incredible growth rate in market capitalization. However, there are no major changes in number of listed companies. In year 2007, there were in total forty one companies listed on SEMDEX having a market capitalization of MRU 173,094,638,415 and priced at MRU 1852. There was a phenomenal rise in market capitalization and the price level in year 2006 and 2007. The percentage change in annual rate in SEM has been incremental. The P/E ratios and dividend yield is comparatively low and considering that the SEM is an extremely small market by international standards. Again for year 2007 the P/E ratio was quiet significant at 11.95, whereas it experienced lowest dividend yield for that year. The SEM shows low levels of trading activity although it has a descent rise in annual turnover. The market capitalization compared to GDP was significant in this period.

Graph : Stock Market Indicators for SEM

Source: SEM Factbook, 2012 [2] 

CHAPTER 3: RESEARCH PLAN

3.1 Introduction

The aim of this research work is to study of the impact of macro- economic variables on stock market performance, taking special reference of Stock exchange of Mauritius. This part of the research work will give a brief idea about the research plan. It will focus on the research methods and type of data sources used for the research. The initial chapter listed research questions which will allow the researcher to accomplish the research objectives and thus the aim of this study. This chapter will also specify the model that will be used to check the impact of independent variables on the dependent variables.

3.2 Research Criteria

The researcher would consider the validity, authenticity, reliability, generalizability and transparency of data and use relevant data and methods for answering the research questions and would draw some general conclusions from the research.

3.3 Research Perspectives

This research is a study of impact of macro-economic variables on the stock market performance considering small economy like Mauritius. The research conducted will primarily focus on secondary data and with the help of macro-econometric model, the impact will be traced. There are three different research perspectives that and this research will have the nature of positivist approach, which suggests that social world and natural world can be studied in a similar way. Also my research will have quantitative approach. Certainly quantitative approach gives objective and unprejudiced outcomes that have not been affected by the researcher. This approach focuses on numerical outcomes and tries to avoid the influence of human element.

3.4 Research Design

Research design is a complete master plan of the research process, from the theoretical groundwork to the collection, analysis and interpretation of the data. The primary role of research design is to make sure that required data in accordance with the problem at hand is gathered meticulously and economically. It also assists the researcher to decide which research methods would be appropriate for the specific study. This study used explanatory survey research in the pursuit to answer the puzzle on the impact of macroeconomic variables that on stock market performance in the Stock Exchange of Mauritius which has been of major concern. The explanatory survey research was used for rigorous study and in-depth research into the macroeconomic variables to achieve the objective of the study. The study will carry out empirical research by using a dependent variable that is the stock market index and different independent macro-economic variables. The research will be a time series analysis where the researcher will make use of quarterly data in a continuous series for particular time period. The empirical research used particular software Eviews 7 for quantitative analysis.

3.5 Research Methods

Conceptual model:

This research will totally rely on secondary data. The researcher has used the macro-econometric model proposed by Kyereboah-Coleman and Agyire-Tettey (2008), which is a modified version of Omole and Falokun (1996). This will allow the researcher to empirically analyze the impact of macro-economic variable on the performance of the share market index. Variables which are considered important for Stock Exchange of Mauritius are included in this model. Thus, the empirical model is as follows:

Semdext = α0 + α1CPIt + α2Exchratet + α3Lenratet+ α4TBt + εt, (1)

where,

Semdex - represents the stock price index

CPI – Proxy for inflation rate

Exchrate – the MUR-US dollar Exchange rate

Lenrate – the lending rate

TB – 91 days treasure bill

α’s – the coefficients of the variables

ε – the error term.

The researcher has taken the logs of the variables in the equation (1) which enables to carry a partial elasticity analysis, thus allowing to measure the impact of a change. The estimable equation (2) is as follows:

LSemdext = α0 + α1LCPIt + α2LExchratet + α3LLenratet+ α4LTBt + εt, (2)

Type of Data

Secondary Data

The different types of data available for empirical study are time series, cross section and panel data (Gujarati, 2003). This research will make use of time series quarterly data spanning from the first quarter of 1999 to the last quarter of 2007, thus enabling use of 36 data points, enough for effective regression analysis and the variables are considered in their natural logarithm form. SEM suffered worst period in 2008 – 2009 due the global financial crisis. It was considered as a period of extreme uncertainty, high fluctuations and unparalleled pressure for the financial world. The Mauritius official market suffered a loss of approximately 45 percentages in its value between 15th September 2008 and 3rd March 2009. The time series data till last quarter of 2007 has been considered, so as to avoid the influence of global financial crisis on the findings and results of the study and to majorly focus on the independent variables. The data will be obtained from different sources. Stock market performance for Mauritius is measured by Semdex price. Daily closing values of the SEMDEX price index are obtained from Stock Exchange of Mauritius. Consumer Price Index is used as a proxy for inflation rate and 91 days Treasury bill is considered to represent the saving interest rate. Data on Interest rates, Exchange rates, Lending rates and 91 days Treasury bill rates is obtained from Bank of Mauritius and Central Statistics Office, Mauritius. The stock exchange performance variable is collected from SEM.

Explanatory Variables

Measured by

Symbol

Stock Market performance

Semdex Price Index

SEMDEX

Inflation Rate

Consumer Price Index

EPI

Exchange Rate

MUR- US dollar Exchange Rate

EXCHRATE

Lending Rate

Bank of Mauritius lending rate

LENRATE

Savings Interest Rate

91 days Treasury Bill

TB

Table : Measurement of Explanatory Variables

3.6. Research Ethics

3.6.1 Ethical consideration

The researcher has followed each and every detail of the Coventry’s Ethical guidelines, taking all the efforts to conduct research ethically, to acknowledge other’s help, to avoid harm to anyone and to conduct the research to the highest standards of moral conduct. The researcher has ensured that all his examination of secondary data is original. All secondary used are gathered from the most authentic and reliable sources such Central Statistics Office and Bank of Mauritius. The researcher has also ensured that the analysis and findings are carried on the basis of honesty and unprejudiced perspective.

3.6.2 Plagiarism

The researcher has acquired a strong understanding of the act of plagiarism and realized how to avoid it. The researcher has acknowledged the contribution, for the information used from other sources, by using proper in text citations and references at the end of the research. Harvard style of referencing and in text citations has been used. The researcher confirms and promises that this dissertation is his own honest and sincere work.

CHAPTER FOUR: RESULTS AND ANALYSIS

LSEMDEX

LCPI

LEXCHRATE

LLENRATE

LTB

Mean

6.379266

4.752035

3.365995

2.204227

2.113623

Median

6.195535

4.779533

3.378542

2.304084

2.195000

Maximum

7.524135

4.933034

3.509304

2.540026

2.543176

Minimum

5.831648

4.406719

3.230449

1.556037

1.488400

Std. Dev.

0.478011

0.143763

0.076662

0.276908

0.304777

Skewness

0.827663

-1.076838

-0.212200

-0.884738

-0.376296

Kurtosis

2.575669

3.484119

2.261138

2.758989

2.119199

Jarque-Bera

4.380238

7.309038

1.089048

4.783700

2.013307

Probability

0.111903

0.02