Causality Between Stock Market and Macro-Economic Indicators in India-An Empirical Analysis

The stock market index of any country has got unprecedented importance in recent days as it is highly sensitive and responsive to the internal and external macroeconomic factors. The present study evaluates the relationship between the stock market index and the various macroeconomic indicators viz., inflation, exchange rate, foreign institutional investments (FII), index of industrial production and money supply and how they impacts the stock market in India over the period April 2005 to December 2015. The Vector Error Correction Model (VECM) is used to evaluate the results. The major findings of the study are; there exists long run bi-directional causality between the inflation (CPI), money supply (MS) and exchange rate (ER) in India, unidirectional causality between BSE SENSEX (BS), index of industrial production (IIP) and net foreign institutional investments (FII) with inflation (CPI), money supply (MS) and exchange rate (ER) in the long run. In the short run, there exists bidirectional causality between the inflation (CPI), index of industrial production (IIP) and money supply (MS), a unidirectional causality between the BSE SENSEX (BS) and exchange rate (ER) from BS to ER, money supply (MS) and exchange rate (ER) from MS to ER, money supply (MS) and net foreign institutional investments (FII) from MS to FII and between the index of industrial production (IIP) and net foreign institutional investments (FII) from IIP to FII. The macroeconomic indicators effect transmission mechanism impacting stock market is also presented in the study.