Impact of changes in Oil Price on Indian Stock Market

Impact of changes in Oil Price on Indian Stock Market Virendra Pratap Rai FMS, BHU Varanasi - 221005 E mail: [email protected]

Palash Bairagi FMS, BHU Varanasi - 221005 E mail: [email protected]

Abstract - The purpose of this present paper is to contribute to the literature on stock markets and energy prices by studying the impact of oil price changes on Indian stock market returns. The study employed various statistical tools like trend analysis, correlation analysis and regression based modelling in order to try and establish a relationship between Crude Oil Prices and Indian Stock Market based on available past data. The span of this study includes data of Crude Oil Price (Brent Crude) and Indian Stock Market Index (BSE Sensex) for last 10 years (2003-12) in monthly Time Series format. As the above mentioned period (i.e. 2003-12) has witnessed various turmoils and changes in both Indian and World economy, namely the Global Recession (2008), Iraq War (2003), Arab Spring (2011), Iran Nuclear Crisis (2007), etc. Among the four last three had a significant impact on Oil Prices as they have caused political instability to major oil producing nations of the Middle East like Iraq, Iran, Libya, Bahrain, etc. Consequently, the period experienced marked fluctuations in global crude oil prices and thus, would prove to be significant for our study. The findings of the study indicate that oil prices generally follow economic principles of supply and demand in the long run. Also there exists a weak but significant relationship between oil price changes and returns on Indian stock market (BSE Sensex).

billion worth crude oil and products in 2012-13 and Oil imports account for 34 per cent of the total import bill and a dollar increase per barrel raises trade deficit by $900 million (Ranjan, 01/08/2013). Thus, a rise in crude oil prices affect Indian Economy in a significant manner as the country has to produce about $1 trillion of GDP to sustain its huge population and to do so it requires about 2.5 million barrels of oil/day which is 6.5% of world’s total oil demand (Sharma, Singh et. al. 2012).

Keywords: Oil price, BSE-Sensex, India.

INTRODUCTION Crude Oil price is one of the most significant macroeconomic variables which affect the cost of production directly or indirectly, thus, affecting the future cash flows and profits of companies. Recent years especially after Gulf War (1990-91) and Iraq War (2003) had resulted sharp swings in oil prices, with oil price reaching as high as $148/bbl, followed by an equal dramatic fall in prices. Despite the fact that, based on previous research, oil price changes seem to affect equity prices in a negative manner, a deeper analysis should be done as regard the different impacts on oil exporting and on oil importing countries. In the OPEC countries and in other oil exporter countries the effect of increases in oil prices should be positive, whereas for the oil importing countries like India the impact should be negative (Asteriou, Dimitras & Lendewig, 2013). As India is a net importer of crude oil so its economy is highly sensitive to oil prices shocks in the international crude oil market. India imported $156.97

As oil prices increases cost of production and in turn affecting the required expected rate of return from the business. Since, current stock price of a company reflects the discounted future cash flows from the business, as specified by the Dividend Discount Model for Stock Valuation (Value of Stock = Dividend per share/(Discount Rate-Dividend Growth Rate)). Thus, theoretically, a rise/fall in oil price influences the required discount rate for arriving at Present Value of Future Cash Flows of a listed company which reflects in its current share price. Rising oil prices are often indicative of inflationary pressures which central banks can control by raising interest rates. Higher interest rates make bonds look more attractive than stocks leading to a fall in stock prices. The overall impact of rising oil prices on stock prices depends of course on whether a company is a consumer or producer of oil and oil related products. Since there are more companies in the world that consume oil than produce oil, the overall impact of rising oil prices on stock markets is expected to be negative (Basher & Sadorsky, 2006). Thus, this study would try to empirically test this relationship between changes in crude oil prices (Brent Crude) and its impact on Indian Stock Market (i.e. BSE Sensex). LITERATURE REVIEW The trend in crude oil Market has reignited interest in the macro-economic factors that have a strong impact over equity returns and volatility in the equity market. Several studies have explore this aspect among them are Chittedi (2011) who have investigated long-run relationship between oil Price and Stock prices in India for the period April 2000 to June 2011. The Author applied Autoregressive distributed lag. The finding suggested that the volatility of stock price in India have a significant impact on the volatility of oil prices and the macro-economic factors

Proceedings of Manegma – 2014 : ISBN No – 978 – 81 – 929306 – 0 – 2

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that have a strong impact over equity returns and volatility in the equity markets.

stock price returns in emerging markets although the exact relationship depend upon the data frequency.

Imarhiabel (2010) applied vector-error correlation modeling to study the impact of oil prices on stock prices of selected major oil producing and consuming countries(Mexico, Russia, Saudi Arabia, India, China and the US) with nominal exchange rate as additional determinant. The result showed that in all countries Variance decomposition and impulse response tests confirm existence of oil prices and exchange rates influences over stock prices.

Hale and Chang (2011) titled the impact of oil price fluctuation on stock markets in Developed and emerging economies. Suggested that the fluctuations in oil price on stock market is not so statistically significant although the presumption of oil price –stock price relationship seen some reasonable area of Japan.

Onos (2010) assessed the differences of the impact of oil price futures in stock markets or companies expected earnings among BRIC’s and also an unprecedented oil price increases from 1990 to 2010. The finding indicated real oil price for India and industrial production with constants and trend for Brazil cannot be rejected. The existence of a unitroot in their levels while on the other hand Null hypothesis (Ho) was rejected real stock price of the unit –root of 1% level in all cases. Consequently, the author believed that real stock returns responded positive to some of the oil price indicators with statistically Significance for China, India, Russia where as no Significant response was observed in the Brazilian real stock returns. Masih, Peter and Mello (2010) analyzed the relationship between oil prices shocks and the Macro-economic variables by using modern time series techniques in a cointegrating framework. The findings suggested that the financial crises did not affect on the stochastic trend between ip, op, rvol and rsr. In addition the author believed that the oil price movements significantly affect the stock markets and analysis indicates that real stock returns are the main channel of Short-run adjustment to long-run equilibrium. (Industrial production as ip, real stock returns as rsr, interest rates as r, oil prices as op, and oil price volatility as rvol). Impact of crude oil prices in Indian economy growth and the relationship between oil price and inflation was studied by Sharma et.al. (2012) and analyzed the trend in oil price and the factors that affect the crude oil prices. Lis, NeBler, and Retzmann (2007) investigated the impact of oil prices is different on the overall Market and automotive companies. In addition showed the differences in sensitivity among the continents taking Germany, USA and Japan in to account where result pictured a link between the Crude oil price and the share price of cars producing companies in every period as well as every portfolio. Basher and Sadorsky (2006) examined the impact of oil price changes on a large set of emerging stock market returns and found regression for unconditional and conditional models for the relationship between risk returns differences and result showed that oil price risk impacts

Roselee, Samad, Fazilah, Bhat and Sonal (2009) examined the effect of oil price movements on the stock price of oil and gas companies in three different market (US, India & UK) and found that some co-integration between oil stocks, oil prices, interest rates, industrial production and the stock index and there is a significant short-run as well as long-run relationship between them which concluded that these variables have co-integrating relationship. Asteriou, Dimitras, Lendewig (2013) assessed the differences in the impact of oil price fluctuations on oil importing countries and on oil exporting countries. The result of the study showed that the oil price interact with the stock markets in a stronger manner than with the interest rates in the short –run as well as in the long-run . Furthermore, the significance of this impacts is higher on oil importing countries than on oil exporting countries. Finally the fluctuation in oil price might present different affects among different countries and a possible explanation for this can be the degree of development of the countries. The World Economic Outlook contained an extensive discussion of the potential impact of higher Prices where IMF Research department approved by Mussa (2000), on the topic “The impact of higher oil prices on the Global economy.” The researcher suggested some recent development and outlook in oil Markets & impacts on global economy and concluded that ¼ of the GDP from global oil importers to oil exporters would be a sustained oil price increase of that size & imply a permanent transfer. Christensen (2011) analyzed the impact of oil Price Shocks on Stock Markets where the author investigated linear, nonlinear & asymmetric oil price shocks, where he found that all individual countries dependency on oil will have great impact on the response of the real stock returns. Papaetrou (2001) studied the dynamic linkage between crude oil price and employment in Greece using industrial production and industrial employment as alternative measures of economic activity. His study was modelled in a cointegrated VAR framework and extends out by looking at the generalised variance decomposition and impulse response functions. Eika and Magnussen (2000) examined the effects of the high oil prices on the Norwegian economy in the first half of the 1980s. They utilized two large scale macroeconomic


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models i.e. NIGEM and KVARTS on high oil prices from 1979 to 1985. The results showed that the higher oil price had a rather persistent effect on the trading partners of Norway, which lowered the demand for Norwegian export goods and it also resulted in an increase in interest rate.

analysed and then the results of correlation and regression analysis would be evaluated over the course of this paper. 1.

Trend Analysis of Oil Prices (Brent Crude).

Hamilton (2003) investigated the nonlinear relation between oil price changes and GDP growth in the US economy. He found strong evidence supporting a nonlinear relationship between the two factors. Further results showed that an increase in oil price has a greater impact than oil price decreases, and oil prices are not much of use for forecasting of the GDP. Huang et al. (1996) provided an evidence in favor of causality effects from oil futures prices to stock prices while O'Neill et al. (2008) found that oil price increases lead to reduced stock returns in the United States, the United Kingdom and France. Objectives The research study aims to fulfil following major objectives: 1. 2.

To study the fluctuations in Crude Oil price (Brent Crude) in the last ten years (2003-12). To evaluate the impact of Crude Oil price on Indian Stock market.

Hypothesis H0 = There is no significant impact of changes in oil prices on BSE Sensex returns. RESEARCH METHODOLOGY The study was empirical in nature and the total population consisted of all the global Oil Markets and various stock exchanges functioning today. Out of which only Brent Crude is selected as reference for oil price and the study is limited to Indian stock market represented by BSE Sensex. The time frame for the study was ten years beginning from 2003 till end of 2012. The sampling elements for the study were Oil price and its impact on BSE Sensex. Purposive sampling was used to complete the study and the data was collected from secondary sources through official website of NSE, BSE, Index Mundi and Yahoo Finance.

Previous economic researches indicate that the fundamentals of supply and demand in the oil market are important to understand the short-run and long-run fluctuations. In particular, these fundamental changes allow more pricing information for investors/producers to decide which investments are profitable. Moreover, the primary source of oil price fluctuations are not from financial speculation but from oil supply, oil demand, or precautionary oil demand— expected oil supply disruptions, such as the concern about a disturbance in Iran’s oil production can lead to significantly different economic effects. Although historically there are several oil price spikes from oil supply disturbances, these disruptions are typically shortlived because of production changes around the globe to profit from price changes. However, aggregate demand shocks, such as from China and India during the 2000s, last longer. In the research, it was found that various historic global events like US subprime crisis and the following global recession had a negative effect on oil prices as the total fuel demand came down as a result of reduced production during recessionary phase. The same is indicated by sudden steep decline in oil prices in middle of 2008 after a preceding period of almost continuous rise. Similarly, global socio-political events like Iraq war (2003), Arab Spring (2011-), etc. resulted in speculative as well as real threats in possible decline in global oil production, thus, pushing the oil prices upwards in international markets.

Tools for Data Analysis a. b. c.

Trend Analysis Correlation Regression Analysis RESULTS AND DISCUSSIONS

As per the framed objectives for the study, first the trend graph for the fluctuations in oil prices would be


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2.

Correlation Correlations sensex

Pearson Correlatio n Sig. (1tailed) N

sensex

oil_prices

1.000

.194

oil_prices

.194

1.000

sensex oil_prices sensex oil_prices

. .017 119 119

.017 . 119 119

There exists a weak but significant correlation (r=0.194, n=119, p