News of Inflation and Effect on Stock Prices in India

In any economy, changes in inflation rate influence almost all economic activities directly or indirectly. In the economic theory, it is understood that low and stable inflation is desired as a key objective of economic policy. On the contrary, high inflation is widely believed to hold back economic growth and is contrary to social justice. Thus the relationship between inflation and economic growth and relationship between inflation and corporate performances has been an interesting issue for the researchers. There is also relation between corporate fundamentals and stock prices. In this context, the intention of this study is to investigate the impact of the inflation rate on stock market in India during the period 1993 to 2013. The Johansen's cointegration test suggests that there exist significant negative long-run co-movement between the rate of inflation and stock prices in India. The result of vector error correction model indicates that in short-run the inflation rate negatively affects the Indian stock market, and, the Granger Causality test reveals that the inflation rate causes the stock market movement in India. The variance decomposition analysis reveals that both the Indian stock markets are strongly exogenous in the sense that shocks to inflation rate explain only a small portion of the forecast variance error of the market indices. Finally, from the impulse response function analysis it is noticed that a positive shock on inflation rate has a negative and persistent effect on Indian stock markets