International Journal of Policy Sciences and Law

Volume 1, Issue 4

International Journal of Policy Sciences and Law

Volume 1, Issue 4

Impact of Exchange Rate, Interest Rate and

Inflation on Indian Stock Market
Mahima Jejani1 and Tushar Jejani 2

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1
B.A. Hons. Economics, Kirori Mal College, University of Delhi, India
2
BMS, Shaheed Sukhdev College of Business Studies, University of Delhi, India

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Abstract
This paper will analyse the impacts of macroeconomic variables such as foreign
exchange rates (Dollar, Euro, Pound), Inflation rate and the Interest rate on India stock
Indices such as Sensex and Nifty 50. Here we have considered data of the last 29 years from
1991-2019 from various sources. The focus will be on finding the relationship between
macroeconomic variables such as foreign exchange rates, inflation rates, and interest rates
on India Stock Indices through coefficient, regression and ANOVA analysis.
Keywords: Indian Stock Indices, Exchange rates, Inflation, Interest rates

1.0 Introduction
The stock market plays a crucial role in the context of economic development in
India. To observe the impact of various independent factors such as Indian currency
fluctuation (in context with USD, Euro and Pound), Interest rate and Inflation on the Indian
Stock Indices like Bombay stock exchange and national stock exchange. The study has been
conducted from the period of 1991 to 2019(Forecast) and by calculating the regression
analysis to check the relationship between the independent and dependent factors.

Interest Rate - Sum of the amount of interest due per quarter/year, as a proportion of
the amount lent, borrowed or deposited. Principal sum, the interest rate, the compounding
frequency, and the length of time over which it is lent deposited or borrowed are the factors
on which total interest on an amount lent or borrowed depends. One of the factors that affect
stock prices is expected earnings which, in turn, is affected by interest rates as companies
operate with some borrowings in their balance sheet. If the repo rate continues to go up,
banks will raise loan rates, sooner or later. This will lead to higher loan repayment costs for
corporates. Rising costs reduce the net profit, which reflects in stock prices. This is applied to
equity stocks in aggregate, it translates to a negative impact. Hence, when the interest rate
cycle is on an upward trend, equities are unlikely to give high returns. The reverse happens
when interest rates are cut. After studying the relationship between macroeconomic variables,
we find that the independent variable Interest rate has a lesser impact on the indices than what
inflation has on the indices wherein they have an even lesser impact on Sensex.
Exchange Rate - And the exchange rate is the value of one nation's currency that is
exchanged with the currency of another nation or economic zone. After studying the
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relationship between these two macroeconomic variables we find a strong relationship
between them. This study objective is to learn the dynamics, feature manipulation and effects
of variation. The review is set to find the overtone between the currency fluctuation and
indices. The researchers extracted the data from BSE and NSE from 1991 to 2019 (Forecast).
Inflation - Inflation can be defined in numerous ways but the ap test way which
defines inflation is it is the increase in the overall average price level of the products/services
and not an increase in any particular product/services. The most widely reported measure of
inflation in India after 2014 (Governor - Raghuram Rajan) is the consumer price index (CPI)
which measures the changes in the average prices of consumer goods and services. Kevin and
Solman explain that inflation may be either demand-pull inflation or cost-push inflation.
Demand-pull inflation is caused by persistent rises in aggregate demand thus the firms
responding by raising prices and partly by increasing output. After studying the relationship
between macroeconomic variables, we find that the independent factor Inflation has a very
weak relationship with the dependent factor Nifty 50 and Sensex.

1.1 The objective of the Study

1. To study the trend of the macro-economic variables like exchange rate, inflation,
Interest rate and Indian stock Indices between the period of 1991-2019.
2. To know the relationship between the independent variables like interest rates,
inflation and exchange rates (Dollar, Euro, Pound) and dependent variables Indian
stock indices (Sensex, Nifty50).
3. To understand the fluctuation in the stock market and its volatility.

2.0 Theoretical Review

2.1 Interest Rates
In India, the Reserve Bank of India (RBI) is India’s central banking institution that
decides the interest rate after looking into the condition and requirement of the economy of
the nation. After studying the data of the period 1991-2019 We have seen that there is a
negative correlation between interest rates and Indian stock indices. Interest rate is the cost of
borrowing for the borrowers so if the interest rate increases the expectation of the borrower
from the stock market also increases as the rising interest rate regime, the cost of borrowing
increases and profitability is affected.
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In India, the stock market and rates are inversely related (Negative Correlation) i.e.
related. When Interest is higher the value of the equity reduces and also increases the FD
more favourable. Inversive when the interest rate is lower than it will give a boost to the stock
market.

Graph 1: Interest rates from the period 1991-2019

Graph 2: Percentage Change in Nifty and Percentage change in Interest rate

(1991-2019)

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Graph 3: Percentage Change in Sensex and Percentage change in Interest rate
(1991-2019)

2.2 Exchange Rates

The exchange rate shows the relation between one country’s currency with the other
country currencies. Factors which affect the stock market the most are Foreign Direct
Investment (FDI) and Foreign Institutional Investors (FII), as we have observed at the time of
budget presented by Nirmala Sitharaman when FII have pulled off 1.2 Billion US Dollar due
to the income tax surcharge on the superrich investors. In the union budget, the government
proposed to increase income tax surcharge on the super-rich which would also include
non-corporate foreign entities. The research and data show the strong correlation between the
Indian indices and foreign exchange (Dollar, Pound, Euro) wherein Indian indices have the
strongest positive correlation with the Euro and pound being the least. The country where
technological advancements are present in their economy when the currency depreciates will
lead to lesser FDI inflows whereas in developing countries like India where there is a
restriction on technological advancement, whenever currency depreciates it promotes more
FDI and FII in the country.
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To test the relationship between the Stock market (Nifty 50 Sensex) and foreign
exchange rate (Dollar, Euro, Pound) we have taken the 29 years of data from 1991 to 2019
that give us the impression that there is a strong positive relationship between the exchange
rate and stock market which means that if the exchange rate increases then the stock market
also increases and vice-versa.

Graph 4: Exchange Rate (INR-Dollar) from the period of 1991-2019

The graphs show the trend of USD and INR since 1991. This Graph shows the
fluctuation between the USD and INR as between 1991-2000 the exchange between both
currencies, In 1991 1$=22INR whereas in 2000 it was 1$=45INR which states that the rate
was between 22INR to 45INR. In 2000-2010 USD-INR rate was between 45INR to 46INR.
In this period the fluctuation between the USD-INR was least in the past 3 decades. In the
current decade, the range of exchange rate was between 46INR to 72INR which makes the
current decade the most volatile decade in terms of the exchange rate between USD-INR.

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Graph 5: Exchange Rate (Euro-INR) from the period of 1991-2019

The graphs show the trend of EURO and INR since 1991. This Graph shows the fluctuation
between the EURO and INR as between 1991-2000 the exchange between both currencies, In
1991 1 EURO = 35 INR whereas in 2000 it was 1 EURO = 42 INR which states that the rate
was between 35 INR to 42 INR in this period the fluctuation between the EURO-INR was
least in the past 3 decades. In 2000-2010 EURO - INR rate was between 43 INR to 60 INR.
In the current decade, the range of exchange rate was between 60 INR to 80 INR which
makes the current decade the most volatile decade in terms of the exchange rate between
EURO-INR.

Graph 6: Exchange Rate (Pound-INR)from the period of 1991-2019

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The graphs show the trend of Pound and INR since 1991. This Graph shows the fluctuation
between the Pound and INR as between 1991-2000 the exchange between both currencies, in
1991 1 Pound =48INR whereas in 2000 it was 1 Pound =68INR which states that the rate was
between 48INR to 68INR. In 2000-2010 Pound -INR rate was between 67INR to 70INR in
this period the fluctuation between the Pound -INR was the least in the past 3 decades. In the
current decade, the range of exchange rate was between 69INR to 90INR which makes the
current decade the most volatile decade in terms of the exchange rate between Pound-INR.

2.3 Inflation
Inflation can be defined in numerous ways but the ap test way which defines inflation
is it is the increase in the overall average price level of the products/services and not an
increase in any particular product/services. Any unexpected rise in the inflation, CPI in India,
is considered worrisome for the corporates as it takes several months for them to pass on
higher input costs to consumers. Even customers feel the pinch when goods and services
become pricier. They also tend to hold less liquid money in hand in such a scenario, as
inflation eats away most of their savings and also the investors with less cash holding in their
hand tend to invest less in the stock market during such periods. They also get confused since
the impact is likely to affect the economy and stock prices, however not at the same rate.
Sometimes any rise in inflation is also considered good as it can help in stimulating growth in
developed countries which is seen in countries like the US. But it can also impact profits of
the corporates through higher input costs as firms stop hiring a greater number of employees.
It's therefore much required for an investor to make wise decisions during periods of high
inflation. After studying the data of the period 1991-2019 of inflation and testing the
secondary data, we have seen a moderate negative correlation between inflation and the
Indian stock market. In which Inflation affects less to Sensex compared to Nifty. Inflation and
the Indian Stock market is in inverse relation if inflation increases, the stock market decreases
and vice-versa.

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Graph 7: Inflation (%) from the period of 1991-2019

The graphs show the trend of inflation in 1991. This Graph shows the fluctuation in inflation
from 1991-2000. The inflation in the country varies year to year. In 1991 in Indian Inflation =
10.24% whereas in 2000 it was 4.41% which states that the rate was between 10.24% to
4.41%. In 2000-2010 inflation rate was between 4.22%-8.47%, In this period the fluctuation
between the Pound -INR was the least in the past 3 decades. In the current decade, the range
of exchange rate was between 10.34% to 4.85% which makes the current decade the most
volatile decade in terms of inflation rate in the country.

3.0 Data Analysis and Interpretation

3.1.1 Interest Rate
Interest rate and Nifty (Anova)
Table: 1 ANOVA Table between Interest Rate and Nifty
Sources of Degree of Sum of Mean Significance
variation Freedom square Square F F
17349254.5 17349254.5 1.288815 0.26624419
Between Samples 1 3 3 1 4
363457777. 13461399.1
Within Samples 27 9 8
380807032.
Total 28 4
The Table value is equal to 4.2100 whereas the calculated value is equal to 1.288
Interpretation of the table
H0: There is no significant relationship between the interest rate and Nifty
H1: There is a significant relationship between the interest rate and nifty
The table value is more than the calculated value so the null hypothesis is accepted.
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3.1.2 Interest rate and Sensex (ANOVA)
Table: 2 ANOVA Table between Interest Rate and Sensex
D
f SS MS F Significance F
Regression 1 142899453.2 142899453.2 1.110829848 0.301242488
2
Residual 7 3473335940 128642071.9
2
Total 8 3616235393
The table value is equal to 4.2100 whereas the calculated value is equal to 1.11
Interpretation of the table
H0: There is no significant relationship between the interest rate and Sensex
H1: There is a significant relationship between the interest rate and Sensex
The table value is more than the calculated value so the null hypothesis is accepted.

3.1.3 Correlation Between interest rate and Nifty, Sensex

Table:3 Correlation Between interest rate and Nifty, Sensex
Correlation between the interest rate and Nifty -0.213445955
Correlation between the interest rate and Sensex -0.198786523
Interpretation of Carrel Pearson Correlation:
● The Correlation between the interest rate and the Indian stock market is negatively
moderate.
● Negatively moderate means that the interest rate does not affect Nifty and Sensex.
● The direction of the movement of both the variable is inverse

Graph 8: Percentage Change in the interest rate and Nifty

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Graph 9: Percentage Change in the interest rate and Sensex

3.2 Exchange Rate

3.2.1 Dollar and Sensex
Table: 4 ANOVA Table between Dollar and Sensex
Significance
Sources of variation Degree of Freedom Sum of square Mean Square F
F
685.7
Regression 1.00 366380404.02 366380404.02 0 0.00
Residual 27.00 14426628.41 534319.57
Total 28.00 380807032.43
The table value is equal to 4.2100 whereas the calculated value is equal to 685.70
Interpretation of the table
H0: There is no significant relationship between the dollar and Sensex
H1: There is a significant relationship between the dollar and Sensex
The table value is less than the calculated value so the null hypothesis is rejected.

3.2.2 Dollar and Nifty

Table: 5 ANOVA Table between Euro and Sensex
df SS MS F Significance F
Regression 1.00 327488902.03 327488902.03 165.84 0.00
Residual 27.00 53318130.40 1974745.57
Total 28.00 380807032.43
The table value is equal to 4.2100 whereas the calculated value is equal to 165.84
Interpretation of the table
H0: There is no significant relationship between the dollar and Nifty
H1: There is a significant relationship between the dollar and Nifty
The table value is less than the calculated value so the null hypothesis is rejected.
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3.3.3 Correlation Between Dollar and Nifty, Sensex
Table 6: Correlation Between Dollar and Nifty, Sensex
Correlation Between dollar and Nifty 0.877604
Correlation Between dollar and Sensex 0.876914
Interpretation of Carrel Pearson Correlation:
● The Correlation between the Dollar and the Indian stock market is Positive and
strong.
● The direction of the movement of both variables is the same. 0.877 and .876

3.3 Pound and Sensex

Table: 7 ANOVA Table between Dollar and Sensex
df SS MS F Significance F
Regression 1 2127372976 2127372976 38.57916599 1.21497E-06
Residual 27 1488862418 55143052.5
Total 28 3616235393
The table value is equal to 4.2100 whereas the calculated value is equal to 38.57
Interpretation of the table
H0: There is no significant relationship between the Pound and Sensex
H1: There is a significant relationship between the Pound and Sensex
The table value is less than the calculated value so the null hypothesis is rejected.

3.3.1 Pound and Nifty

Table: 8 ANOVA Table between Pound and Nifty
df SS MS F Significance F
Regression 1.00 232431970.00 232431970.00 42.30 0.00
Residual 27.00 148375062.43 5495372.68
Total 28.00 380807032.43
The table value is equal to 4.2100 whereas the calculated value is equal to 42.30
Interpretation of the table
H0: There is no significant relationship between the Pound and Sensex
H1: There is a significant relationship between the Pound and Sensex
The table value is less than the calculated value so the null hypothesis is rejected.

3.3.2 Correlation Between Pound and Nifty, Sensex

Table: 9 Correlation Between Pound and Nifty, Sensex
Correlation Between Pound and Nifty 0.78126
Correlation Between Pound and Sensex 0.766997

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Interpretation of Carrel Pearson Correlation:
● The Correlation between the Pound and the Indian stock market is Positive and
strong.
● The direction of the movement of both variables is the same.

3.4 Euro and Sensex

Table: 10 ANOVA Table between Euro and Sensex
df SS MS F Significance F
Regression 1 3054443997 3054443997 146.7982395 1.9906E-12
2
Residual 7 561791396.1 20807088.74
2
Total 8 3616235393
The table value is equal to 4.2100 whereas the calculated value is equal to 146.79
Interpretation of the table
H0: There is no significant relationship between the Euro and Sensex
H1: There is a significant relationship between the Euro and Sensex
The table value is less than the calculated value so the null hypothesis is rejected.

3.4.1 Euro and Nifty

Table: 11 ANOVA Table between Euro and Nifty
df SS MS F Significance F
Regression 1.00 327488902.03 327488902.03 165.84 0.00
Residual 27.00 53318130.40 1974745.57
Total 28.00 380807032.43
The table value is equal to 4.2100 whereas the calculated value is equal to 165.84
Interpretation of the table
H0: There is no significant relationship between the Euro and Sensex
H1: There is a significant relationship between the Euro and Sensex
The table value is less than the calculated value so the null hypothesis is rejected.

3.4.2 Correlation Between Euro and Nifty, Sensex

Table: 12 Correlation Between Euro and Nifty, Sensex
Correlation Between Euro and Nifty 0.927354564
Correlation Between Euro and Sensex 0.919047033

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Interpretation of Carrel Pearson Correlation:
● The Correlation between the Euro and Indian stock market is Positive and strong.
● The direction of the movement of both variables is the same.

3.5 Inflation
Table: 13 ANOVA Table between Inflation and Nifty
df SS MS F Significance F
Regression 1 18588942.16 18588942.16 1.385633274 0.249416944
2
Residual 7 362218090.3 13415484.83
2
Total 8 380807032.4
The table value is equal to 4.2100 whereas the calculated value is equal to 1.385
Interpretation of the table
H0: There is no significant relationship between Inflation and Nifty
H1: There is a significant relationship between Inflation and Nifty
The table value is less than the calculated value so the null hypothesis is accepted.

Table: 14 ANOVA Table between Inflation and Sensex

df SS MS F Significance F
Regression 1 205390216.8 205390216.8 1.625853877 0.213140797
2
Residual 7 3410845177 126327599.1
2
Total 8 3616235393
The table value is equal to 4.2100 whereas the calculated value is equal to 1.625
Interpretation of the table
H0: There is no significant relationship between Inflation and Sensex
H1: There is a significant relationship between Inflation and Sensex
The table value is less than the calculated value so the null hypothesis is accepted.

3.5.1 Correlation Between Inflation and Nifty, Sensex

Table: 15 Correlation Between Inflation and Nifty, Sensex
Correlation Between Inflation and Nifty -0.22094026
Correlation Between Inflation and Sensex -0.23832057
Interpretation of Carrel Pearson Correlation:
● The Correlation between Inflation and the Indian stock market is negative and weak.
● The direction of the movement of both the variables is inverse in relation.

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4.0 Findings
● The relationship between inflation and the stock market is weak and inverse in a
relationship whereas its effects are nifty more than Sensex.
● Relationship between the Interest rate and stock market (Nifty, Sensex) and inverse in
a relationship whereas its effects Sensex more than nifty.
● Relationship between the Exchange rate and stock market (Nifty, Sensex)
▪ Pound and stock market are strong and direct in relationship
▪ The dollar and the stock market are having a strong and direct relationship
▪ Euro and stock market are having a strong and positive relationship
▪ Euro is relatively stronger than other currencies
▪ Exchange rate and stock market price are interconnected directly or indirectly,
because today, the world is turning into a global village due to trade liberalization
and globalization.

5.0 Study of Scope

● Knowing about the more economic variables that have a strong relationship with the
Indian Stock market
● Why the Euro affects more than the dollar and pound
● Knowing about the relationship between nifty and Sensex

6.0 Table
Interest
Year Dollar Euro Pound Rate Inflation GDP Nifty Sensex
1991 22.74 34.48 40.1 15.85 13.88% 1.06% 407.49 1908.85
1992 25.92 43.73 45.48 19.57% 11.88% 5.48% 826.16 2615.37
1993 30.49 38.71 45.73 14.42% 6.31% 4.75% 669.45 3346.06
1994 31.37 39.78 48.01 6.99% 10.24% 6.66% 1318.56 3926.90
1995 32.43 44.93 51.17 9.40% 10.22% 7.57% 935.04 3110.49
1996 35.43 45.38 55.25 17.73% 8.98% 7.55% 1132.05 3085.20
1997 36.31 43.57 59.44 7.84% 7.25% 4.05% 1059.80 3658.98
1998 41.26 50.37 68.33 8.69% 13.17% 6.18% 1188.10 3055.41
1999 43.06 50.73 69.66 7.83% 4.84% 8.85% 1044.45 5005.82
2000 44.94 42.32 67.99 8.87% 4.02% 8.00% 1818.15 3972.12
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2001 47.19 42.25 67.92 9.15% 3.77% 4.15% 1422.95 3262.33

2002 48.61 45.92 72.85 7.16% 4.31% 5.39% 1205.95 3377.28

2003 46.58 52.61 76.05 5.89% 3.81% 3.88% 1914.40 5838.96

2004 45.32 56.3 80.96 4.62% 3.77% 7.97% 2088.45 6602.69

2005 44.1 54.81 80.15 4.65% 4.25% 7.05% 2857.00 9397.93

2006 44.31 56.84 83.36 5.60% 5.79% 9.48% 4046.85 13786.91

2007 41.35 56.42 82.73 7.22% 6.39% 9.57% 6185.40 20286.99

2008 43.51 63.31 79.97 6.07% 8.32% 9.32% 6357.10 964.31

2009 48.41 67.36 74.56 5.50% 0.83% 6.72% 5221.85 17464.81

2010 45.73 60.59 70.65 5.00% 10.83% 8.59% 6338.50 20509.09

2011 46.67 64.89 74.77 6.50% 8.87% 8.91% 6181.05 15454.92

2012 53.44 68.6 84.41 8.00% 9.30% 6.69% 5965.15 19426.71

2013 56.57 77.93 91.6 7.75% 10.92% 4.47% 6415.25 21170.68

2014 62.33 81.04 100.4 8.00% 6.37% 4.47% 8626.95 27499.42

2015 62.97 71.02 98 7.75% 5.88% 8.15% 9119.20 26117.54

2016 66.46 74.37 90.72 6.50% 4.97% 7.11% 8968.70 26626.46

2017 67.79 73.53 87.56 6.00% 2.49% 6.68% 10552.40 34056.83

2018 70.09 85.8 88.33 6.50% 4.85% 6.81% 11760.20 36068.33

2019 * 71.44 78.48 87.8 5.40% 7.54% 5.81% 12103.05 37384.99

7.0 Conclusion
After studying the data from the period of 1991 to 2019 of dependent variables like
Nifty and Sensex and independent variables like exchange rate (Dollar, Pound, Euro), Interest
rate and Inflation rate. It was found that the correlation between the exchange rates and
Indian indices is direct/Positive and very strong in which Euro is the strongest amongst them
(Dollars, Euro, Pound) whereas Interest Rate and Inflation have a weak and inverse/negative
relationship with the Indian Stock Market (Nifty and Sensex). Correlation between the dollar
with Nifty and Sensex is 0.877 and .876; Pound with Nifty and Sensex is .78 and .76 whereas
Euro has the strongest correlation with the Nifty and Sensex is .92 and .91.
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