MP A R
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The Stock Market and the Economy in Pakistan
Fazal Husain and Tariq Mahmood
Pakistan Institute of Development Economics
Online at http://mpra.ub.uni-muenchen.de/4215/ MPRA Paper No. 4215, posted 24. July 2007
The Pakistan Development Review 40 : 2 (Summer 2001) pp. 107–114
The Stock Market and the Economy in Pakistan
FAZAL HUSAIN and TARIQ MAHMOOD
This paper re-examines the causal relationship between stock prices and macro variables like consumption expenditure, investment spending, and economic activity (measured by GDP) in Pakistan. Using annual data from 1959-60 to 1998-99 and applying cointegration and error correction analysis, the paper indicates the presence of long-run relationship between stock prices and macro variables. Regarding the cause and effect relationship, the analysis indicates a one-way causation from macro variables to stock prices, implying that in Pakistan fluctuations in macro variables cause changes in stock prices. The findings suggest that the stock market in Pakistan is not that developed to play its due role in influencing aggregate demand. A disturbing feature of the stock market in Pakistan is that it cannot be characterised as the leading indicator of economic activity. In the absence of other strong indicators, shooting up of stock prices may indicate a speculative bubble.
I. INTRODUCTION The stock market plays an important role in the economy by mobilising domestic resources and channelling them to productive investment. This implies that it must have a significant relationship with the economy. The relationship can be seen, in general, in two ways. The first relationship views the stock market as the leading indicator of the economic activity in the country, whereas the second focuses on the possible impact the stock market may have on aggregate demand, particularly through aggregate consumption and investment. In other words, whether changes in stock market cause fluctuations in macroeconomic variables, like Consumption Expenditures, Investment Spending, Gross Domestic Product (GDP), Index of Industrial Production (IIP), etc., or are caused by these variables is an interesting issue to be examined. The former case implies that stock market leads economic activity, whereas the latter suggests that it lags economic activity. The knowledge of the relationship between stock prices and macro variables is now becoming more important in the case of developing countries in view of the various economic reforms taking place there. From the beginning of the 1990s, a number of Fazal Husain and Tariq Mahmood are Senior Research Economist and Research Economist, respectively, at the Pakistan Institute of Development Economics, Islamabad. Authors’ Note: We are grateful to Dr Abdul Qayyum, Dr A. R. Kemal, and Dr Faiz Bilquees for their valuable comments and suggestions on an earlier draft of the paper.
Husain and Mahmood
measures have been taken for economic liberalisation, privatisation, relaxation of foreign exchange controls, and in particular the opening of the stock markets to international investors. These measures have resulted in significant improvements in the size and depth of stock markets in developing nations and they are beginning to play their due role. The empirical evidence regarding the direction of causality between stock prices and macro variables is not conclusive. For example, a unidirectional causality from stock prices to consumption expenditures is observed by Nishat and Saghir (1991) in Pakistan and Ahmed (1999) in Bangladesh, whereas Mookerjee (1988) observes the opposite case in India. Similarly, Mookerjee (1988) and Ahmed (1999) report a unidirectional causality from stock prices to investment spending for India and Bangladesh respectively, whereas the opposite case is reported by Nishat and Saghir (1991) for Pakistan. Regarding causal relation between stock prices and economic activity,...
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