Impact of fundamental economic variable-exchange rate on the profitability and value of Indian stocks listed in the national stock exchange

Abstract

In this project, we intend to explore the relation between the profitability and value of Indian stocks listed in the National Stock Exchange and fundamental macroeconomic variable, i.e., exchange rates over the period 1995-2014. The corporate sector plays a crucial role in the growth of industries and commerce of an economy. In recent times, anecdotally, it appears that corporations are increasingly prone to macro-economic shocks such as cyclicality of demand, geo-political changes, and externalities of the international economic environment. Investors in these corporations would benefit considerably from an assessment of the nature of the macroeconomic determinants of firm profitability and the magnitude of these effects. Since the early 1990s, the Indian economy has delivered strong economic growth; however in the last 4-5 years, we have a considerable slowdown. Hence, an important question is what has caused this slowdown. Is it deterioration of firms performance, or greater exposure to macro-economic shocks? The goal of this project is to test whether the economic fundamentals and its changes correlate with macroeconomic changes and whether the market perceives the same when taking a decision. The study used annual data from 1995 to the present to investigate the relationship between NSE stocks and the chosen macroeconomic variable-the exchange rate. We also surveyed the prior literature on this topic. Research on US firms by Bodnar and Weintrop (Year 1997) discusses that valuation of US firms by market is more heavily dependent on their foreign income rather than their domestic incomes. They also conjectured that change in exchange rate wasn t the reason for a heavier association coefficient for foreign income over firm s valuation. Further, Dominiquez and Tesar (year 2005) in their study of US firms have surmised that exchange rates do have an implication on the firm s value. In our study, we have tried to study the importance of domestic and international revenue growth to overall revenue growth of Indian firms (listed in NSE) and the relevance of exchange rate impact on Indian firms by examining the associations between annual stock performance (in terms of market capitalisation) and changes in firms' domestic and real foreign incomes. For 1730 companies and 20 year observations between 1995 and 2014, we hypothesized that both foreign and domestic revenues changes have significant positive associations with domestic sales growth having more weightage than the real export revenues growth; however, the persistence of export sales growth is found to be as significant as the persistence of domestic sales growth which is different to what was perceived in the US market in the earlier literature. Further, since both domestic and export sales growth had equivalence in predicting the overall sales growth of company, we anticipated that market capitalisation of the Indian firms would pay equal weightages to domestic and export sales growth as well. Interestingly, it is not so and market is skewed as it provides lesser importance to export sales growth when compared to domestic sales growth. Also, we looked into the predictability of profitability, its relation with the scale of change of imports and exports and the impact of exchange rates on the expenditures of firms in India. Certain interesting facts were revealed which are embellished in Section 3 of this report