Factors Affecting Indian Stock Market

Any event that takes place in the economy has an impact on the stock

Market . For the convenience of study we have selected 10 factors . They

are as follows :-

 Inflation effect on the stock market .

 Recession effect on the stock market.

 Effect of Crude Oil Prices on the stock market.

 Impact of Foreign Institutional Investment on stock market.

 Announce effect on stock market.

 Impact of Euro Debt Crisis on stock market.

 Impact of High Fiscal Deficits on stock market.

 Impact of Stock Market Scams on stock market.

  Impact of Index of Industrial Production on stock market.

 Impact of Corporate Governance on stock market

Inflation effect on the stock market

In economics , inflation is a rise in the general level of prices of goods

and services in an economy over a period of time . When the general price

level rises , each unit of currency buys fewer goods and services .

Consequently , inflation also reflects an erosion in the purchasing power of

money – a loss of real value in the internal medium of exchange and unit

of account in the economy . A chief measure of price inflation is the

inflation rate , the annualized percentage change in a general price index

( normally the Consumer Price Index ) over time .

Inflation effects on an economy are various kinds and can be

simultaneously positive and negative . Negative effects of inflation include a

decrease in the real value of money and other monetary items over time ,

uncertainty over future inflation may discourage investment and savings , and

high inflation may lead to shortages of goods Sellers begin

hoarding of goods in anticipation of rise in prices of such goods . Positive

effects include ensuring central banks can adjust nominal interest rates

( intended to mitigate recessions ) , and encouraging investment in non –

monetary capital projects .

Recession effect on the stock market

A period of general economic decline ; typically defined as a decline

in GDP for two or more consecutive quarters . A recession is typically

accompanied by a drop in the stock market , an increase in unemployment ,

and a decline in the housing market . A recession is generally

considered less ever than a depression , and if a recession continues long

enough it is often classified as a depression .

What causes it ?
An economy which grows over a period of time tends to slow down the

growth as a part of the normal economic cycle . An economy typically

expands for 6 – 10 years and tends to go into a recession for about six

months to 2 years .

A recession normally takes place when consumers lose confidence in the

growth of the economy and spend less .

This leads to a decreased demand for goods and services , which in turn

leads to a decrease in production , lay – offs and a sharp rise in

unemployment .

Investors spend less as they fear stocks values will fall and thus stock

markets fall on negative sentiment .

Stock markets and recession

The economy and the stock market are closely related . The stock markets

reflect the buoyancy of the economy . In the US , a recession is yet to be

declared by the Bureau of Economic Analysis , but investors are a worried

lot . The Indian stock markets also crashed due to a slowdown in the US
economy . The Sensex crashed by nearly 13 percent in just two trading

sessions in January . The markets bounced back after the US Federation cut

interest rates . However , stock prices are now at a low in India with

little cheer coming to investors .

Effect of Crude Oil Prices on the stock market

Oil is one of the most precious commodities on earth and is available only

in limited amounts . Crude oil is the basic form of oil which is used

to extract other useful form of oils like petroleum , diesel , jet – fuel after

refining . Companies involved in oil production are exploration and

production ( E & P ) companies ( back – end ) and refining and marketing

companies ( front – end ) . In India , ONGC and Oil India are the leading

front - end players while IOC , HPCL , BPCL and Reliance are major back –

end players .

Why Oil price rise ?

 • Weak dollar leads to oil price increase . As oil exporting nations get

money in terms of dollar for their oil , their profits decreases as dollar

becomes weak . So , to protect their margins , they increase oil cost .

• The prices of crude oil are determined by the demand and supply

gaps .

• Higher growth in developing countries like India and China increases

demand for oil thereby leading to a price rise .

• War between an oil exporting nation and an oil importing nation

( like

US and Iran ) .

• Weather ( hurricanes ) which can shut – down refineries .

Impact of oil price rise on economy

Rising oil prices can affect the world economy significantly . Points

mentioned below highlight the relationship between oil prices and economy :

• With rising oil prices , there is an increase in the cost of production

of goods and services in the economy putting pressures on profit

margins of the companies . Companies pass this input cost increase to

consumers .

• Higher oil prices lead to inflation , increased input costs , reduced

other demands ( as people have less free money after spending on costly

items ) . Tax revenues fall and budget deficit increases due to rigidity in

government expenditure , which drives up interest rates .

• Higher oil prices mean oil importing countries will have to spend

more money on oil . They have less money to spend in their own

country for expediting growth .

• Interest rates generally rise with increase in oil prices . Government

has less money to spend because of oil price rise . So , government will

borrow money from capital market there by reducing the amount of free

money in the market and hence increasing the interest rates . Higher

interest rates lead to reduced growth . Consumer start saving more . As

interest rates rise , money start flowing from stock markets to bond

markets such as fixed deposits as they provide higher and safe returns .

• Oil prices have significant impact on financial markets . Initially stock

market rises in tandem with oil prices as it is the economic growth

which is creating more demand for oil in the first place . Because of this

increased demand , oil prices are increasing ( sometimes they increase

because of just speculation which is a dangerous situation and a warning

signal ) . But if oil prices keep on increasing and sustain at higher values

for a longer period of times , it will have detrimental effects on the

economy . Eventually markets realize this impact and corrects . Higher the

oil price increase and longer the higher prices are sustained , the bigger

the macro economic impact .

Impact of Foreign Institutional Investment (FIIs) on stock market

FIIs are companies registered outside India . In the past four years there has

been more than $ 41 trillion worth of FII funds invested in India . This has

been one of the major reasons on the bull market witnessing unprecedented

growth with the BSE Sensex rising 221% in absolute terms in this span .

The present downfall of the market too is influenced as these FIIs are

taking out some of their invested money . Though there is a lot of value in

this market and fundamentally there is a lot of upside in it . For long - term

value investors , there is little worry but short term traders are

adversely getting affected by the role of FIIs that are playing at the present.

Investors should not be panic and should remain invested in sectors where

underlying earnings growth has little to do with financial markets or global

economy .

It is always good to keep an eye on what the big movers are doing and

plan individual strategy accordingly . There are several reasons on FIIs

selling , but there are three predominant factors that are cited as being

largely responsible .

1. The swings in the market forced several FIIs to withdraw from India and

invest their dollars in other emerging markets . Some of the other markets

include Uruguay , Russia , the Ukraine , and several other former Soviet

countries . Though there have been swing’s in the past too but FII response

this time was different because of margin pressures back home as even they

have to provide regular returns to their investors .

2. The Indian markets are not seen as a good short – term bet any more .

India is seen as a good investment for the medium to long term . FIIs seem

to fear the pace of growth and the fundamentals of the markets .

3. Most FIIs are looking at corporate governance and execution abilities ,

which could be significant drivers in creating a strong portfolio of Indian

stocks . Recent action taken by the market regulator indicates that the Indian
government would like to moderate the inflow of FII money .

Though valuations are very attractive on a selective basis , but stock picking

has to be done based on evaluation of business fundamentals . The subprime

issue and problems in the credit markets have raised concerns about

potential growth slowdown in the US and Europe . The fear of a slowdown

is likely continue to weigh on markets average FII redemptions in India

have been lower than in other Asian economics . FIIs do get affected by it .

India is among the economies less sensitive to a deceleration in US growth

and one should not be perturbed by FII flows in either direction . One need

not worry much about the volatility of the market as it is influenced by

temporary factors but the Indian story is still strong . Markets cannot go in

one direction all the times ( upwards ) which it was going . Volatility is too

good for the market as it helps in keeping the economy cycle moving and

it will again help the values of the stocks at a fair price for investments to

again keep flowing and so will the FIIs too .

Announcement effect on stock market

Just as it was recovering , IT major Satyam Computer Service’s explosive

revelations send the market on a southward spiral . Satyam’s shares plunged

77.69% in a single trading session on 7 January 2009 , as chairman

Ramalinga Raju resigned after announcing during trading hours that the

company’s accounts were inflated . The shocking revelation of the

accounting fraud , estimated at about Rs 7000 crore , sent the BSE 30- share

Sensex tumbling 7.25% on that day .

Satyam’s disclosures raised concerns of corporate governance and accounting

integrity of Indian companies . Realty and infrastructure shares tumbled on

market perception that a number of firms in these sectors do not strictly

follow good corporate governance practices . The BSE Realty index tanked

30.2% in the fortnight .

Impact of Euro Debt Crisis on stock market

In early 2010 , fears of a sovereign debt crisis , the 2010 Euro

Crisis developed concerning some European states , including European

Union members Portugal , Ireland , Italy , Greece , Spain ( sometimes

collectively referred to with the acronym PIGS ) , and Belgium . This led to

a crisis of confidence as well as the widening of bond yield spreads and

risk insurance on credit default swaps between these countries and other

EU members , most importantly Germany .

Concern about rising government deficits and debt levels across the globe

together with a wave of downgrading of European government debt created

alarm in financial markets . In 2010 the debt crisis was mostly centered on

events in Greece , where there was concern about the rising cost of

financing government debt . On 2 May 2010 , the Eurozone countries and

the International Monetary Fund agreed to a €110 billion loan for Greece ,

conditional on the implementation of harsh Greek austerity measures . On 9

May 2010 , Europe's Finance Ministers approved a comprehensive rescue

package worth almost a trillion dollars aimed at ensuring financial stability

across Europe by creating the European Financial Stability Facility .

Impact of High Fiscal Deficits on stock market

Fiscal deficit is an economic phenomenon , where the Government's total

expenditure surpasses the revenue generated . It is the difference between the

government's total receipts ( excluding borrowing ) and total expenditure .

Fiscal deficit gives the signal to the government about the total borrowing

requirements from all sources .

Components of fiscal deficit

The primary component of fiscal deficit includes revenue deficit and capital

expenditure .

Revenue deficit : It is an economic phenomenon , where the net amount

received fails to meet the predicted net amount to be received .

Capital expenditure : It is the fund used by an establishment to produce

physical assets like property , equipments or industrial buildings . Capital

expenditure is made by the establishment to consistently maintain the

operational activities .

In India , the fiscal deficit is financed by obtaining funds from

Reserve Bank of India , called deficit financing . The fiscal deficit is also

financed by obtaining funds from the money market ( primarily from banks).

Impact of Stock Market Scams on stock market

Harshad Mehta was an Indian stockbroker and is alleged to have

engineered the rise in the BSE stock exchange in the year 1992 . Exploiting

several loopholes in the banking system , Harshad and his associates

siphoned off funds from inter - bank transactions and bought shares heavily

at a premium across many segments , triggering a rise in the Sensex . When

the scheme was exposed , the banks started demanding the money back ,

causing the collapse . He was later charged with 72 criminal offenses and

more than 600 civil action suits were filed against him . He died in 2002

with many litigations still pending against him .

Impact of Index Industrial Production on stock market

Index of Industrial Production ( IIP ) in simplest terms is an index which

details out the growth of various sectors in an economy . E.g. Indian IIP

will focus on sectors like mining , electricity , manufacturing and general .

Also base year needs to be decided on the basis of which all the index

figures would be arrived at . In case of India the base year has been fixed

at 1993 - 94 hence the same would be equivalent to 100 points but now it

changed its based year to 2004 – 2005 .

Index of Industrial Production ( IIP ) is an abstract number , the magnitude

of which represents the status of production in the industrial sector for a

given period of time as compared to a reference period of time .

As the structure of the industrial sector changes over time , it became

necessary to revise the base year of the IIP periodically to capture the

changing composition of industrial production and emergence of new

products and services so as to measure the real growth of industrial sector

( UNSO recommends quinquennial revision of the base year of IIP ) . After

1937 , the successive revised base years were 1946 , 1951 , 1956 , 1960 ,

1970 , 1980 – 81 and 1993 – 94 . Initially it was covering 15 industries

comprising three broad categories : mining , manufacturing and electricity .

The scope of the index was restricted to mining and manufacturing sectors

consisting of 20 industries with 35 items , when the base year was shifted

to 1946 by Economic Adviser , Ministry of Commerce & Industry and it

was called Interim Index of Industrial Production . This index was

discontinued in April 1956 due to certain shortcomings and was replaced by

the revised index with 1951 as the base year covering 88 items , broadly
categorized as mining and quarrying ( 2 ) , manufacturing ( 17 ) and

electricity ( 1 ) compiled by CSO . The items in this index were classified

according to the International Standard Industrial Classification ( ISIC ) 1948

of all economic activities .

The index is computed using the weighted arithmetic mean of quantity

relatives with weights being allotted to various items in proportion to value

added by manufacture in the base year by using Laspeyre's formula :

I = ∑ ( Wi Ri ) / ∑ Wi .

Where I is the index , Ri is the production relative of the ith item for the

month in question and Wi is the weight allotted to it .

Impact of Corporate Governance on stock market

A country’s economic condition depends largely on the performance of the

financial market . A strong financial market is the backbone for the

economic development of the country . Financial markets have significantly

developed in the last decades throughout industrialized countries .

Governments throughout the world have become aware of the importance of

corporate governance for the efficient performance of the stock market . In

the last few years’ corporate governance has become an important issue

throughout the world . A market that has sound corporate governance proves

to be very efficient . An efficient market in turn attracts more investment

and increased transaction thus increasing market capitalization and liquidity .

Although economies are becoming increasingly global , firms with

international operations are still subject to the principles and practice of

national corporate governance . It has been rightfully seen that a firm’s

valuation does not only depend on the profitability or the growth prospects

embedded in its business model , but also on the effectiveness of control

mechanisms , which ensure that investors’ funds are not wasted in value

decreasing projects . Investors’ however are encouraged to invest in sound ,

orderly and transparent markets .