The effect of macroeconomic variables on stock market is a matter of focus for economists since a long time. Macroeconomic variables and the stock market volatility play a key role in forecasting and determining the position of an economy in the future. In this study, the impact of one of the macroeconomic variables, the foreign exchange rate on the Indian Stock Market prices (NSE Index of NIFTY 50) is studied. Exchange rate and stock market index relationship is considered to be one of the important factors which is used to forecast the growth or business cycle of any economy. This dynamic linkage between exchange rate and stock market has been analysed considering 18 years of data (from Aug 2010 to Aug 2018) on exchange rate(US$) and stock market index related to Indian Economy. The main focus of this paper is to find out whether the impact of exchange rate fluctuation on stock market volatility to predict the economic scenario in India and to see whether it is accordance to the literature review or not.
The Stock market is defined as the financial markets and exchanges where equities or stocks of publicly held companies, bonds and other classes of securities are issued or traded, The trading may take place either through the exchanges or over the counter markets. Stock market is the most important component of a free market economy, because it gives companies the required capital in exchange of giving traders a part ownership in the company whose stocks they invest in.
The Foreign Exchange Market (Forex) is an international decentralized market in which participants can buy, sell, exchange, and speculate on currencies. This involves buying, selling & exchanging currencies at present or determined rates.
Stock market plays a very pivotal role for every country in the context of economic development. The connection between a country’s stock market and its foreign exchange market has been a subject of importance for a long time. The magnitude and nature of the relationship between stock prices and exchange rates have implications for a number of crucial issues in international finance.
There are many macroeconomic factors which affect the stock market. Some of them are Broad Money, Call Money Rate, Exchange Rate, Foreign Exchange Reserve, Foreign Institutional Investors, Interest Rates, Crude Oil Price Index of Industrial Production, Inflation Rate, Gross Fiscal Deficit, Trade Balance etc.
The Asian crisis of 1997-98, where a sequence of currency devaluations caused stock market declines, gives evidence for a dynamic linkage between stock prices and exchange rates. During the crisis, it was seen that the emerging markets collapsed due to substantial depreciation of exchange rates (in terms of US$) as well as dramatic fall in the prices of stocks.
Stock market return is one of the most important factors for the management and the shareholders of any organizations. Exchange rate and stock market price are related with each other either directly or indirectly, because today the world is turning into a global village as a result of trade liberalization and globalization.
THEORITICAL RELATION BETWEEN EXCHANGE RATES AND STOCK PRICES
Exchange rates will have an impact on stock market prices because they have an impact on the trade balance and the competitiveness of domestic products, thereby affecting output and real income. Since stock prices are an estimate of the present value of the future income, exchange rate fluctuations bring about stock price fluctuations. Therefore, one approach claims that there is a positive relation between the exchange rate and stock prices with direction of causation running from exchange rates to stock prices. Another alternative approach claims that the direction of causation runs from stock prices to exchange rate. The inflows and outflows of foreign funds in the stock market affect the demand and supply of the dollar. When the market is trending upward, the increasing inflow of foreign funds will cause the demand of the currency to increase, thereby causing it to appreciate against the dollar. Conversely, when the market is falling, the increase in demand for dollar by outflow of foreign portfolio will cause the currency to depreciate.
DATA AND METHODOLOGY
In this paper, the data sample consists of the closing prices of the NSE index of NIFTY50 as the representative of the Indian stock market prices. The data for Stock market prices and the exchange rate (in terms of rupee per US$) has been taken from August24,2010 to August 24,2018
All the data has been obtained from investing.com
Since stock prices and exchange rates are given in terms of different units, it is not possible to study the effect of one on another. We have thus normalised both the data using the formula
Normalised value of the variable= (Original value in the series – minimum value of the series) ÷ (maximum value of the series – minimum value of the series)
Since we are analysing the effect of exchange rate on stock prices, the dependent variable is taken to be the normalised values of the stock market denoted byY. The normalised values of the exchange rates are taken to be the independent variable denoted by X.
The regression equation is