Relationship Between Stock Exchange and Growth

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Correlation Between Stock Exchange and Economic Growth

This paper examines the correlation between capital market and economic growth in Pakistan using a regression function. Using annual data from 1999 to 2009, examining the relationship of the variables used in the analysis. The results show that the capital market development is positively correlated with economic growth, with feed-back effect, but the strongest link is from economic growth to capital market, suggesting that capital market follows economic growth, economic growth determining financial institutions to change and develop. Key words: correlation; economic growth; capital market

The Pakistani stock market comprises of three exchanges, namely Karachi stock exchange, Lahore stock exchange and Islamabad stock exchange. For the purpose of this study we will focus exclusively on Karachi stock exchange (KSE), which is the main exchange of the country. A stock exchange is a place to regulate and perform the activities of stock (equity) market. It is considered as a “barometer” of the economy, because of its immediate and visible reaction on the news and transactions of economic importance. Capital market and monetary policy are closely interrelated as they are determined jointly by the supply of money, interest rates and liquidity position. One cannot ignore the monetary side effects in survey of capital market behaviour and forecasting. The linkage between the macro economic targets and financial and material growth in the different sectors of stock exchange is indispensable for a balanced economic growth. Harmonization between the rules and regulations developed by the Securities and Exchange Commission of Pakistan (SECP), the State Bank of Pakistan (SBP) and the Central Board of Revenue (CBR) are also required to determine the balanced strategies regarding the reinvestment of corporate profits (retained earnings) for modernization and expansion, dividend payments, treatment of the sick units and placing of the companies on default counters at the stock exchanges. (Government of Pakistan) Capital markets are key elements of a modern, market-based economic system as they serve as the channel for flow of long term financial resources from the savers of capital to the borrowers of capital. Efficient capital markets are hence essential for economic growth and prosperity. The Karachi stock market showed lackluster performance as its index decreased by 25.7 percent in terms of local currency owing to deterioration in domestic macroeconomic conditions and political upheaval and slumped to 36.5 percent in terms of USD compared to 23.5 percent rise in the same period last year. (Government of Pakistan, 2008) The Pakistan financial system displays all the classic characteristics of an emerging market: market capitalisation amounts to only 5.5% of GNP; less than 0.3% of the population are shareholders, resources mobilised through the capital market are insignificant compared to that through the banking system, and equities account for about 4% of the assets of the financial system.The pricing of both equity and debenture capital is administratively set by the Government. (Khambata & Khambata, 2005) Prime Minister Syed Yosuf Raza Gilani said the stock market plays a vital role in the national economy and the stock exchange is a primary indicator for the micro economic stability. He said the stock exchange has shown an impressive performance that has provided ample investment opportunity for the local as well as international investors. (Sana News, 2009) Fiscal year 2007-08 proved to be a tough year for the domestic stock exchange. Many factors played key role in eroding the investors’ confidence. These factors include: (i) political instability, (ii) adverse law and order situation, (iii) deteriorating security environment in tribal areas, (iv)downgrading of Pakistan’s rating by S&P and...
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