European Journal of Scientific Research

ISSN 1450-216X Vol.38 No.1 (2009), pp.96-103

© EuroJournals Publishing, Inc. 2009
http://www.eurojournals.com/ejsr.htm

Impact of Macroeconomics Variables on Stock

Prices: Emperical Evidance in Case of KSE
(Karachi Stock Exchange)

Sulaiman D. Mohammad
Associate professor, Federal Urdu University of Arts, Science and Technology, Karachi
E-mail: Suliaman1959@gmail.com

Adnan Hussain
M.Phil Fellow, Applied Economics Research Centre, University of Karachi
E-mail: adnanaerc@gmail.com

M. Anwar Jalil
M.Phil Fellow, Applied Economics Research Centre, University of Karachi
E-mail: majalilonline@yahoo.com

Adnan Ali
M.Phil, Fellow, Applied Economics Research Centre, University of Karachi
E-mail: adnanaliabbasi@hotmail.com

Abstract

The purpose behind this study is to explore the correlation among the
macroeconomics variables and share prices of KSE (Karachi Stock Exchange) in context of
Pakistan. The study consider several quarterly data for different macroeconomics variables
are as foreign exchange reserve, foreign exchange rate, industrial production index (IPI),
whole sale price index (WPI), gross fixed capital formation (GFCF) and broad money M2.
These variables are obtained from the period 1986-2008. The result shows that after the
reforms in 1991 the influence of foreign exchange rate and foreign exchange reserve
significantly affect the stock prices, while other variables like IPI and GFCF are
insignificantly affect stock prices. The result also highlighted the internal factors of firm
like increase in production and capital formation insignificant while external factor like M2
and foreign exchange affect positively. The study will be very helpful for national policy
makers, researchers and corporate managers.

Keywords: Stock prices, Macroeconomics variables

Introduction
In modern economy the role of stock exchange is very important. It can be very helpful to diversify the
domestic funds and channels into productive investment, however to perform this important task it is
very necessary that stock market have significant relationship with the macroeconomics variables.
Nowadays capital market became a key element of modern market based economy. They transfer the
long term funds from savers to borrowers of capital which is very essential for economic development.
Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in
Case of KSE (Karachi Stock Exchange) 97

Economic growth and prosperity is possible only when capital market works efficiently. After the
globalization international capital markets are integrated rapidly. This integration has positive affects
on economic growth, reducing the risk and especially contagion impact on financial crises.
The EMH (efficient market hypothesis) suggests that all the necessary or relevant information
to investors about profit maximizing and the macroeconomics variables fall the possibility of earning
supernormal profit. Therefore the stock prices are fully reflecting the current position of
macroeconomics variables. (Chong and Koh 2003).
The portfolio managers and investment advisors are not able to help the investors to earn
supernormal profit continually. If EMH is continually follow in stock market the role of stock
brokerage firms diminishes gradually.
Stock market plays the vital role to transfer of funds from capital borrowers to capital investors
which is very essential for economic growth. In other words the stock market is very significant to
speed up economic growth through increasing liquidity of financial assets and diversification of global
risk easier for investors to make a wiser investment decision. (Agrawalla 2006). A well performing
stock exchange is very helpful for economic activity through growth and saving, efficient allocation of
investment and attracting FDI (foreign direct investment). The stock market gives confidence to savers
by providing domestic house- holds having invest able funds, innovation in financial instruments,
which diversify their risk and better sharing in investment projects (Agrawalla 2006).

II. History of KSE (Karachi Stock Market)

Since the independence (1947) a number of problems have been stood in the way of economic growth
and development in Pakistan. In which included social, economic and political problems such as
increasing population, bureaucratic problem, policy inconsistency, violence and political instability.
Economic problems include unproductive tax rate, delicate custom duties which adversely affect
foreign investment. Pakistan government strategic approach is also towards closed the economy.
As discussed that Pakistan has been faced socio and political problems. In 1991 economic
reforms were taken to resolve these problems. The most important reforms were to liberalize the stock
markets for foreign investors and allowing first time in the history of Pakistan foreign direct and
indirect investment landing. These reforms had positive impact on stock market index.
Karachi stock exchange (KSE) is the largest and most dynamic stock exchange in Pakistan. The
share of KSE is about 70 percent of total stock transition. On October 1, 2004, there are 663 companies
were registered or listed in KSE. The market capitalizations were $23.23 billion. Pakistan foreign
investment and industrial export is rapidly grown. Pakistan foreign exchange reserves reached $12.327
billion in 2003-04. Nowadays our all stock markets traded on international market. SECP (Security and
exchange commission of Pakistan) has permitted foreign and local brokerage houses to make joint
ventures which give the newfound interest in the Pakistan stock markets.
In Pakistan, Karachi Stock Exchange is a leading stock exchange. It was stated the “Best
Performing Stock Market of the World for the year 2002”. The KSE 100 Index reached at 5315.82 on
1st October 2004. KSE has been ranked for three years of being one of the Best Performing Markets of
the world as ranked by “Business Week” which is an international magazine. As well as a leading US
newspaper, “USA Today” mentioned Karachi Stock Exchange as one of the best performing stock
exchange in rest of the world.
Karachi stock exchange attained a major landmark when KSE-100 index had reached at the
psychological level of 15500 for the first time in the history and later on reached at 15737.32 on 20
April 2008 but due to recent financial crises KSE declined to 9000 because of larger foreign capital
outflows. Around 654 companies were listed at KSE with market capitalization of US $ 33.81 billion
on September 25 2009.
98 Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

Literature Review
Dr. Nishat (2004) evaluates long term association among macroeconomic variables, stock prices and
employed money supply, CPI, IPI, and foreign exchange rate as explanatory variable. The result shows
that there are causal relationships among the stock price and macroeconomics variables. The data used
in this study from 1974 to 2004. Most of the time series data is nonstationary therefore unit root
technique is used to make data into stationary. The result also indicates that industrial production is
significantly affects to macroeconomic variables. Nishat used Karachi stock exchange 100 index price
from 1974 to 2004. Grange causality test is used to find the correlation among the variables the result
of granger causality shows that interest rate is not granger cause by stock price.
Shahid Ahmed (2003) empirically investigated on SENSEX index price affects due to real and
financial sector performance in Indian economy, the data has been chosen from the period 1997 to
2007. The study consists variables export and foreign exchange rate and foreign direct investment.
Granger causality test is used to find out the causal relationship between the variables. All the variables
are Granger cause to stock prices. Speculation in the market was analysis with the help of AR (Auto
Regressive) which was highly significant according to the result.
Fazal Hussain and Tariq Masood (2001) used variables investment, GDP and consumption
employing granger causality test to define the relationship among the selected variables and stock
prices, finding shows at two lags of all variables are highly significantly effect on stock prices. Robert
D. gay (2008) evaluated the association among stock prices and macro economics variables in cases of
China, India, Brazil and Russia which are emerging economies of the world using Oil price, exchange
rate, and moving average lags values as explanatory variables employing MA (Moving Average)
method with OLS (Ordinary least square) and found insignificant results which postulate inefficiency
in market. Finally they concluded that in emerging economies the domestic factors influence more than
external factors i.e. exchange rate and oil prices.
Dr. Aftab (2000) examines the association between monetary and fiscal policy of Pakistan to
equities market and the result of his analysis is significant. The result shows that fiscal and monetary
policy could change market capitalization by liquidity and equity which can significantly effect the
market capitalization and stock prices in case of Pakistan from the period 1993 to 1998. Liaquat Ali
and Nadeem Ahmed (2008) used data from 1971 to 2006 and try to find out the relationship of
economic growth with stock market prices and study shows that there are dynamics association
between stock prices and economic growth employing DF-GLS test first time in case of Pakistan.
M. Shahbaz (2006) investigated the association between stock prices and rate of inflation using
ARDL approach for dynamics analysis. Result of this study depicts that stock hedges are not in favor
of inflation in long run as well as in short run and found that black economy effects long run and short
run prices of the stock. The study used variables CPI, (inflation) and share of black economy the
sample size of the study is 1971-2006.
Safail Sharma (2007) used interest rate, exchange rate and reserve, industrial production index,
monetary growth and inflation as independent variables with AR and MA to nullify the effects of non
stationary in the variables. The result shows that lags values are highly connected with current share
prices which recommend the speculation in market. Exchange rate and reserve, industrial production
index and monetary growth are significantly associated. The study took data set from 1986 to 2004.
Desislava Dimintrova (2005) used multivariate model and try to find out link among stock
prices, exchange rate and economics policy (fiscal and monetary policy). The study defines the interest
parity condition affects on stock prices. The result shows that ambiguous affects of deprecation on
stock prices.
Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in
Case of KSE (Karachi Stock Exchange) 99

IV. Econometrics Methodology and Data Base

4.1. Data Base
The assets valuation model and pricing of macroeconomics variables
• Stock prices and foreign exchange rate and reserve: the positive relation between foreign
exchange and stock price is found. FDI is increased if there is liberalization of stock market
prevailed in any economy which may cause to increase FDI and raise stock prices.
λ = ∑ π + Ψ / r + δ = ps
Where λ = is total gain which equal to price of share
π = net dividend / profit
ψ = capital gain
r = real interest rate
δ = Risk premium
ps = price of shares
• As stock market is liberalized it can cause to reduce the risk premium and increase competitions
in stock market ultimately stock prices have been increased. As foreign exchange currency
inflows resulting increases in supply which can cause to appreciate local currency consequently
prices of share increase and that improve foreign exchange reserves which cause to appreciate
exchange rate while other factors remain constant.
• Stock prices and interest rate: increase in interest rate cause to increase opportunity cost of
holding money which can cause to change portfolio diversification between stock and interest
bearing securities as a result stock prices fall. Another reason for falling stock prices is that when
interest rate increases it can cause to raise cost of production which deteriorate companies profit
and dividend results reduce the prices of shares.
• Stock market and money supply: increase in money supply cause to increase in inflation therefore
people maintained there real cash balances consequently they sell shares and other assets which
cause to decline the share prices but on the other hand increase in monetary growth reduces the
interest rate which cause to reduce cost of capital and increase earning of corporation.
• Industrial production index and stock prices: the IPI and stock prices are positively related
because increase in IPI cause to increase in production of industrial sector which cause to
increase the profit of industries and corporations. As dividends increase resulting share prices
raise therefore it is found positive association between IPI and share price according to economic
theory.
• Gross fixed capital formation and share price: gross fixed capital formation is defined as fixed
assets accumulation. Assets accumulation are increased by bonds financing and equity financing,
if corporations want to finance assets they float their shares in stock market as a result supply of
shares increase which cause to decline share prices. On the other hand when assets financing is
increased by purchasing of bonds consequently firms/corporations credit become worthiness.
Economic theory suggests that increase in Gross fixed capital formation cause to decline share
prices in short run but in long run production is increased which cause to raise share prices.
LSP= β1 + β2 LEXERS+ β3LRER+ β4 LGFCF+ β5LIIP+ β6 LIR+ β7 LM2 + β8 LWPI+ε (1)
All the variables are taken in a form of monthly data. The data is taken from IFS (International
Financial Statistics) from various issues and Economic Survey of Pakistan. The sample size of data is
taken from the period 1987-2007. The logic behind of it that the sample period 1987-2008 and 1991
the era of reforms of financial sector and liberalization of stock markets in Pakistan.
100 Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

4.2. Econometrics Methodology

The study consists time series data for econometrics analysis so several preliminary statistical steps
must be taken. The steps included descriptive statistics, unit root, and Auto Regressive Integrated
Moving Average (ARIMA) model testing. The nature of time series data found non stationary in many
cases therefore it is necessary to check stationary of the data. Stationary is defined as mean and
variance of the data is zero and constant respectively. The ADF (Augmented Dicky Fuller) test is used
to analyze the stationary of variables. The model of ADF is used as follow
r = α + ∑ βrt − j + at + ρrt −1 + η
(2)
Here null hypothesis is non stationary and alternative hypothesis is stationary. To check
stationary of all the macroeconomic variables by ARIMA to change them into stationary.

V. Result Analysis
The empirical result or evidence provided by the various studies mentioned in the section of review
literature shows that macroeconomics variables have strong effect the stock market. On the other hand
Karachi stock market is declared to be inefficient collaborator with respect to the most
macroeconomics variables. If market is ineffective with respect to information then it has essential to
analysis the statistical inconsistency of the variables. As shown in table no. 1

Table 1: Statistical Discrepancy

SP EXCRES EXR GFCF IIP IR M2 WPI

Mean 127.6368 3553.989 39.89068 110574.6 105.5122 8.030114 400084.3 81.3842
Median 103.56 1322 39.765 89578.5 92.29 7.89 395424 84.305
maximum 299.21 14435 64.15 396551 232 15.42 1043700 164.25
minimum 34.57 213 15.98 17259 52.52 1.05 69875.9 27.94
Std. Dev. 78.14981 4217.17 16.81541 88349.3 43.29091 3.050957 280527.7 38.89997
Skewness 0.972571 1.163066 0.019702 1.241375 1.104169 0.175299 0.411707 0.274529
Kurtosis 2.73852 2.669788 1.386929 4.173968 3.264533 2.924647 2.089966 1.960819
Jarque-Bera 14.12381 20.23975 9.546355 27.65491 18.13803 0.471524 5.522628 5.064995
probablity 0.000857 0.00004 0.008453 0.000001 0.000115 0.789969 0.063209 0.07946
observation 88 88 88 88 88 88 88 88

As mentioned in above table no.1 that all the variables are positively skewed which show that
they are asymmetrical. Kurtosis values of all variables also show that the data is not normally
distributed because values of kurtosis are deviated from 3. So the descriptive statistics shows that the
values are not normally distributed about its mean and variance. It is said that no randomness in the
data therefore, being sensitive to speculation shows periodical changes. This indicated that individual
investors can earn considerably higher rate of profit from the Karachi Stock Market. Hence the results
of descriptive statistics raise the issue the inefficiency of market. The funds and investment in market
are not allocated to the productive sector of the economy.
The result of unit roots test suggested that data/variables are not stationary at level except gross
fixed capital formation other wise all variables are non stationary at level but they are stationary at first
difference level. The value is 5% level significant of first difference level. ADF method is used to find
out stationary of data as suggested in section 5 of this paper.
Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in
Case of KSE (Karachi Stock Exchange) 101

Table 2: Unit root test / Augmented Dicky Fuller test

Variables At level At first difference

Share price -1.426297 -3.923520*
Gross fixed capital formation 3.311289 -5.618675*
Foreign exchange reserve -1.335140 -4.189409*
Interest rate -1.647429 -9.058792*
Industrial index of production 1.797305 -13.81579*
Whole sale price index (wpi) -1.621632 -4.723153*
M2 (Broad Money) -0.978078 -6.420688*
Foreign Exchange rate -0.250161 -4.120358*

Table 3: Dependent Variable: SP

Variable Coefficient Std. Error t-Statistic Prob.

C 462.2149 729.6082 0.633511 0.5281
AR(2) 0.983048* 0.035285 27.85994 0.0000
MA(1) 0.983110* 0.012342 79.65724 0.0000
Significance level at 5%

As evident from table-3 Karachi stock share prices are autoregressive of order 2 and highly
significant, moving average is also very highly significance shows that prices are highly seasonal. Thus
studying the impact of macroeconomics variables lagged prices of Karachi stock exchange are also
taken as independent variables.

Table 4: Dependent Variable: SP

Variable Coefficient Std. Error t-Statistic Prob.

C 50.93326 47.72902 1.067134 0.2893
EXCRES 0.004599** 0.002749 1.673216 0.0984
EXR -2.645900* 1.125605 -2.156000 0.0356
GFCF -0.000134 9.09E-05 -1.471965 0.1452
IIP 0.151023** 0.086775 1.740394 0.0858
IR -1.242176* 0.595195 -2.087007 0.0402
M2 -3.59E-05* 1.86E-05 -1.931914 0.0571
WPI 2.411239* 0.813718 2.963239 0.0041
AR(2) 0.820881* 0.075523 10.86930 0.0000
MA(1) 0.989783* 0.001822 543.0924 0.0000
*Significance level at 5% **significance level at 10%

Further analysis also reported in table-4 exhibits foreign exchange rate is highly significance at
4% level. It is found that negative relationship with KSE which shows that foreign institutions’
investment has been significant factor affecting the stock market prices, as foreign investment
increases results foreign exchange reserves also increases thus exchange reserve is positively related
with stock price at 10% significance level. IPI is also significance at 9% level which suggested that as
industrial production increases consequently stock prices increase. Interest rate is negatively related
with stock prices as interest rate increases as a result stock prices fall down which is defined in section
4.1. Interest rate is significantly effect at 4% level. M2 is negatively related with stock prices and
significant at 6% level.
102 Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

VI. Conclusion
The result of this study pointed out that changes in macroeconomics variables are not trading rule by
investors to gain continually supernormal profits in the stock exchange market. The result of AR
(Autoregressive) and MA (Moving Average) suggest that current as well as past knowledge about the
development of variables are also incorporate with share prices. Thus, the investors are not able to
generate supernormal profit using the available information.
The main objective of this research paper is to study the association between macroeconomics
variables and Karachi stock market’s shares prices. For this purpose the quarterly data of foreign
exchange rate, foreign exchange reserve, gross fixed capital formation, M2, Call Money Rate (interest
rate proxy), Industrial production index and whole sales price index (proxy of inflation) have been
chosen. The result shows that exchange rate and exchange reserve highly affect the stock prices. It has
been observed since the liberalization in 1991 of stock markets in Pakistan has largely increased stock
prices in Pakistan. The empirical result also suggests that IR and M2 is also significant and negatively
effect to stock prices. However, few variables like IPI and GFCF neglect able effect to stock prices
thus result suggested that increase in capital formation by firms and increase in industrial production
do not affect stock prices.

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