investment article

8/6/2019 Investment Article

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Running head: IMPACT OF FOREIGN RESERVES ON KSE 1

Impact of Foreign Reserves on KSE Market Capitalization: A Study during 2001 2009

Shabbir Hussain

University of Central Punjab


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IMPACT OF FOREIGN RESERVES ON KSE 2

Abstract

This paper explains the relationship between foreign exchange reserves of Pakistan and KSE

market capitalization on the basis of quarterly gathered data from fiscal year 2001 to 2009. Both

of the variables under consideration are very important because foreign exchange reserve is one

out of the major supports to stable the value of home currency against foreign currencies and

market capitalization shows the overall investment in stock market. This study uses simple linear

regression model to measure the relationship between these two important variables. Results of

this study show that there is positive (not significant positive) relationship between variables.

The results show that foreign exchange reserves of Pakistan have a positive impact on KSE

Stock Market that is the principal stock market of Pakistan.


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Foreign Exchange Reserves

Foreign exchange is the currency of other countries and Foreign Reserves mean deposits

of international currencies held by a central bank. Foreign reserves allow governments to keep

their currencies stable, reserves are used as a tool of exchange rate and monetary policy, it

facilitate for the payment of external debt and liabilities, it act as a defense against unexpected

emergencies and economic shocks.

To know about the relationship of foreign reserves with stock market is important

because of above reasons and because international reserves accumulation has been the preferred

policy

recently adopted by developing economies to achieve financial

stability. The aim of this

policy is to increase liquidity andthus reduce the risk of suffering a speculative attack. (Cruz &

Walters, June 2008).

Foreign reserves can be enhanced by storing more and more international currency and

this can be done through three ways, by increasing exports, by foreign remittance and by taking

official grants or loans. If foreign reserves are increasing due to exports and remittances then the

growth of reserves is positive but if it is increasing with the help of loans then growth will be

negative. This research is not concerned with the positive or negative growth, this research

examines only the foreign reserves held by central bank and their impact on stock market

capitalization.

Market Capitalization

Market capitalization represents the aggregate value of a company or stock. It is obtained

by multiplying the number of shares outstanding by their current price per share then by adding

all the values, we get aggregate market capitalization. For example, if XYZ company has

200,000 shares outstanding with a share price of $25 per share then the market capitalization is


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200,000 x $25 = $5,000,000. KSE market capitalization represents the aggregate value of whole

market, in this way by measuring KSE-All shares market capitalization we can measure the

overall performance of Karachi stock exchange.

Objective

The purpose of this research is to know about the impact of foreign exchange reserves of

Pakistan on KSE market capitalization on the basis of previous behavior of both variables with

each other.

Problem Statement

The main focus of this study is to link the foreign exchange reserves of Pakistan with its

Stock Markets to see a clear picture about them as it affects many other variables.

Significance

Significance of this research work is to provide the considered necessary information that

will guide the stock brokers, agents, planners, government policy makers to make decision about

the stocks and stock markets of Pakistan especially about KSE by looking at the trend of foreign

exchange reserves of Pakistan. The research will also try to add value for executives, directors,

researchers and other students to know about the foreign reserves and stock markets of Pakistan.

Literature Review

In the following there are some studies related to this topic that has been conducted prior

by other researchers.

Hussain et al. (2009) analyzed the Impact of Macroeconomics Variables on Stock

Prices: Empirical Evidence in Case of KSE they consider the quarterly data of severa l

economic variables such as foreign exchange rate, foreign exchange reserve, industrial

production index, whole sale price index, gross fixed capital formation, and broad money M2 ,


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these variables are obtain from 1986 to 2008 period. The results shows that after the reforms in

1991 the influence of foreign exchange rate and reserve effects significantly to stock market

whiles other variables like IIP and GFCF are not effects significantly to stock prices. This result

also shows that internal factors of firms like increase production and capital formation not

effects significantly while external factors like exchange rate and reserve are effects

significantly the stock prices.

Nishat and Shaheen analyze long-term equilibrium relationships between a group of

macroeconomic variables and the Karachi Stock Exchange Index. The macroeconomic variables

are represented by the industrial production index, the consumer price index, M1, and the value

of an investment earning the money market rate. They used vector error correction model to

explore such relationships during 1973 to 2004. Their results indicate a "causal" relationship

between the stock market and the economy and show that industrial production is the largest

positive determinant of Pakistani stock prices, while inflation is the largest negative determinant

of stock prices in Pakistan. They found that macroeconomic variables Granger-caused stock

price movements, the reverse causality was observed in case of industrial production and stock

prices. Furthermore, he found that statistically significant lag lengths between fluctuations in the

stock market and changes in the real economy are relatively short (Nishat & Shaheen, 2004).

Bhattacharya et al. conduct a case study to analyze Causal Relationship between Stock

Market and Exchange Rate, Foreign Exchange Reserves and Value of Trade Balance. They

used methodology of Granger non-causality recently proposed by Toda and Yamamoto (1995)

for the sample period April 1990 to March 2001. In this study, the Bombay BSE Sensitive Index

was used as a proxy for the Indian stock market. The three important macroeconomic variables

included in the study are real effective exchange rate, foreign exchange reserves and trade


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balance. The analysis reveals interesting results in the context of the Indian stock market,

particularly with respect to exchange rate, foreign exchange reserves and trade balance. The

results suggest that there is no causal linkage between stock prices and the three variables under

consideration (Bhattacharya & Mukherjee, 2001) .

Dimitrova analyzed the relationship between stock prices and exchange rates using

multivariate model. He focuses on the stock markets of United States and the United Kingdom

over the period January 1990 through August 2004. This study developed the hypothesis that

there is a link between the foreign exchange and stock markets. The researcher asserted that

relationship is positive when stock prices are the lead variable and likely to negative when

exchange rates are the lead variable (Dimitrova, August 2005).

Sohail et al. conducted a research on LSE, the intention of this study was to examine

long-run and short-run relationships between Lahore Stock Exchange and macroeconomic

variables in Pakistan. Monthly data from December 2002 to June 2008 was used in this study.

The results revealed that there was a negative impact of consumer price index on stock returns,

while, industrial production index, real effective exchange rate, money supply had a significant

positive effect on the stock returns in the long-run (Sohail & Hussain, winter 2009).

Robert Gay conducted study to investigate the time-series relationship between stock

market index prices and the macroeconomic variables of exchange rate and oil price for Brazil,

Russia, India, and China (BRIC) using the Box-Jenkins ARIMA model. But no significant

relationship was found between respective exchange rate and oil price on the stock market index

prices of either BRIC country and also there was no significant relationship found between

present and past stock market returns (Gay, March 2008).


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Data explanation and Methodology

Dependent Variable

KSE Market capitalization is dependent variable in this study and simply picked up from

the Economic Surveys of Pakistan and from the reports of State Bank of Pakistan at the end of

quarter month from the fiscal year 2001 to 2009.

Independent Variable

A foreign exchange reserve of Pakistan is independent variable in this research and

calculated by following equation.

R = SDR + Fc + Nostro + TLR

Where:

R = Foreign exchange reserves

SDR= Special drawing rights held by SBP

Fc = Foreign Currency held by SBP

Nostro = Accounts of SBP in foreign countries in foreign currencies.

TLR = Total liquid reserves

Methodology

To examine the relationship between the foreign reserves and KSE market capitalization

following simple linear regression model has been tested.

Y = 0 + 1 X1 +


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Where:

Y = KSE market capitalization in billion Rs.

0 = Y intercept

1= Slope of the line

X1 = Foreign Exchange Reserves in million US $

= Error variable

Table 1

Model Summary

Model R R Square

Adjusted R

Square

Std. Error of

the Estimate

1 .680a .463 .440 903.87372

Table 2

Anova

Model

Sum of

Squares df Mean Square F Sig.

1 Regression 1.687E7 1 1.687E7 20.651 .000a

Residual 1.961E7 24 816987.693

Total 3.648E7 25


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Table 3Coefficients

Model

Unstandardized

Coefficients

Standardized

Coefficients

t Sig.B Std. Error Beta

1 (Constant) -1227.564 810.346 -1.515 .143

Reserves .303 .067 .680 4.544 .000

Note. The data are adapted from the SPSS software output

After analysis results show that the value of co-efficient of correlation (R) is equal to

0.680 which shows that there is positive (not significant positive) relationship between market

capitalization and foreign exchange reserves, as it is looking in the following graph.

This graph shows that an increase in foreign reserves also reflecting in KSE market

capitalization but not too much.

0

5000

10000

15000

20000

25000

1 3 5 7 9 11 13 15 17 19 21 23 25

Reserves (US $

Million)

KSE Market

Capitalization (Rs.

Billion)


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The results show that the value of co-efficient of determination (R2) is equal to 0.463

which shows that 46.3% of the variation in the KSE market capitalization is explained by the

variation in the foreign exchange reserves. The remaining 53.7% is unexplained. The value of

Anova table is significant (.000) which shows that the model is overall good fit.

The value of Regression constant or intercept is -1227.56 this is the average market

capitalization without independent variable. Here it shows that the average value of market

capitalization is negative (below the X-axis line) with the value of 1227.56 billion Rs. when

foreign exchange reserves are zero.

The value of Regression co-efficient or slope is equal to 0.303 which shows that the KSE

market capitalization will increase by 0.303 billion Rs. for an increase of one million $ increase

in foreign exchange reserves of Pakistan.

Conclusion

Results of this study show that there is positive (not significant) relationship between the

foreign exchange reserves and KSE market capitalization. The results show that 46.3% of the

variation in the KSE market capitalization is explained by the variation in the foreign exchange

reserves. The results of this study also match with the result of other researchers like Suliaman et

al. conduct study to measure the impact of macroeconomic variables on stock prices and write

that there is positive relation between foreign reserves and stock prices in Pakistan. In other

countries there are different results like in India there is no relation between these variables as

showed by one researcher, but this study shows the facts about the stock market of Pakistan.


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References

Bhattacharya, B., & Mukherjee, J. (2001). Causal Relationship Between Stock Market And

Exchange Rate, Foreign Exchange Reserves and Value Of Trade Balance: A Case Study

For India.

Bloomsbury Information Ltd. (2009). Dictionary. Retrieved February 18, 2010, from Q Finance:

http://www.qfinance.com/dictionary/foreign-currency-reserves

Cruz, M., & Walters, B. (June 2008). Is the Acculmulation of International Reserves good for

Development. Cambridge Journal of Economics .

Dimitrova, D. (August 2005). The Relationship between Exchange Rates and Stock Prices -

Studied in Multivariate Model.Issues in Political Economy, 14.

Elizabeth. (2006). the oxford dictionary of Phrase and Fable. Retrieved February 10, 2010, from

Encyclopedia: http://www.encyclopedia.com/doc/1O214-StockExchange.html

Encyclopedia. (2009). The Oxford PocketDictionary ofCurrent English. Retrieved February 14,

2010, from Encyclopedia website: http://www.encyclopedia.com/doc/1O999-

foreignexchange.html

Gay, R. D. (March 2008). Effect of Macroeconomic Variables on Stock Market Rturns for Four

Emerging Economies - Brazil, Russia, India and China.International Business &

Economics Research Jornal, 7.

Gulf News. (2008).Investment. Retrieved March 15, 2010, from gulfnews website:

http://gulfnews.com/business/investment/pakistan-emerges-a-market-winner-1.97437


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Hussain, D. I. (2009). Why does Pakistna have ato accumulate foreign reserves?

Karachi Stock Exchange guarantee Limited. (2009). introduction. Retrieved February 2010, from

Kararchi Stock Exchange website:

http://www.kse.com.pk/aboutus/introduction.php?id=7&sid=7.01

Karachi Stock Exchange. (2009). introduction. Retrieved February 2009, from Kararchi Stock

Exchange website: http://www.kse.com.pk

Minitry of Finance Islamabad, Govt of Pakistan. (n.d.). Capital Markets.Economic Survey of

Pakistan . Islamabad, Pakistan: Govt of Pakistan.

Mohammad, S. D., Hussain, A., & Ali, A. (2009). Impact of Macroeconomics Variables on

Stock Prices - Emperical Evidance in Case of KSE.European Journal of Scientific

Research, 38 no. 1, 96-103.

Nishat, D. M., & Shaheen, R. (2004). Macro-Economic Factors and Pakistani Equity Market.

Reilly, F. K., & Brown, K. C. (September 2005).Investment Analysis and Portfolio Management

(Eitghth ed.).

Sohail, N., & Hussain, Z. (winter 2009). Long Run and Short Run Relationship between Macro

Economic Variables and Stock Prices in Pakistan - The case of Lahore Stock Exchange.

Pakistan Economic and Social Review, 47, 183-198.

SPSS software. (2007, September 13). Regression analysis.

State Bank of Pakistan. (2010, January). Foreign Reserves. Lahore, Pakistan: State Bank of

Pakistan.


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Table 4

Chronologically arranged data of Reserves and KSE MarketCapitalization

Fiscal year Quarter Month KSE Market

Capitalization End of

month (Rs. Billion)

Reserves

(US $ Million)

2001-2002 December 2001 292.9 4867

June 2002 407.6 6398

2002-2003 December 2002 458.3 9170

2003-2004 December 2003 922.0 11839

March 2004 1346.1 12279

June 2004 1357.5 12324

2004-2005 September 2004 1425.8 12222

December 2004 1696.1 12141

March 2005 2114.8 12854

June 2005 2067.7 12421

2005-2006 September 2005 2329.7 12016

December 2005 2709.5 11707

March 2006 3218.5 12635

June 2006 2801.0 13302

2006-2007 September 2006 2,874.7 12570

December 2006 2,738.4 13204

March 2007 3,065.8 14246

June 2007 4,019.4 16558


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2007-2008 September 2007 4,050.0 16730

December 2007 4,329.9 15264

March 2008 4,622.9 12812

June 2008 3,777.7 11342

2008-2009 September 2008 2,847.3 7397

December 2008 1,858.7 9719

March 2009 2,057.1 10379

June 2009 2120.7 12036

*(Minitry of Finance Islamabad, Govt of Pakistan)

* (State Bank of Pakistan, 2010)

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