Relationship Between Exchange Rate and Stock Prices in India – An Empirical Analysis By Golaka C Nath* and G P Samanta** Abstract: The dynamic linkage between exchange rate and stock prices has been subjected to extensive research for over a decade and attracted considerable attention from researchers worldwide during the Asian crisis of 1997-98. The issue is also important from the viewpoint of recent large cross-boarder movement of funds. In India the issue is also gaining importance in the liberalization era. With this background, the present study examines the causal relationship between returns in stock market and forex market in India. Using daily data from March 1993 to December 2002, we found that causal link is generally absent though in recent years there has been strong causal influence from stock market return to forex market return. The results, however, are tentative and we need further in-depth research to identify the causes and consequences of the findings.

January 2003

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Manager, NSEIL, Bandra-Complex, Bandra (East), Mumbai – 400 051 ** Assistant Adviser, RBI, DESACS, C-8, Bandra-Kurla Complex, Bandra (East), Mumbai – 400 051 The views expressed in the paper are those of the authours’ and not necessarily of the organizations they belong to.

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Introduction The Asian crisis of 1997-98 has made a strong pitch for dynamic linkage between stock prices and exchange rates. During the crisis period, the world has noticed that the emerging markets collapsed due to substantial depreciation of exchange rates (in terms of US$) as well as dramatic fall in the stock prices. This has become important again from the view point of large cross border movement of funds due to portfolio investment and not due to actual trade flows, though trade flows have some impact on stock prices of the companies whose main sources of revenue comes from foreign exchange. In