1

Impact of macroeconomic variables on economic indicators:

An Empirical Study of India and Sri Lanka
(Gurvinder Singh)
1.Introduction

Over thirty years the relationship between macroeconomic variables and stock market prices has
been an attractive subject for both financial and macro economists. Although there are a number
of studies that investigate the link between macroeconomic variables and stock market, both the
academics and the practitioners have not arrived at a consensus on the direction of the causality
among these variables, which remained as a source of ambiguity.An efficient capital market is
one in which security prices adjust rapidly to the arrival of new information and, therefore, the
current prices of securities reflect all information about the security. What this means, in simple
terms, is that no investor should be able to employ readily available information in order to
predict stock price movements quickly enough so as to make a profit through trading shares.

For the past three decades evidence that key macroeconomic variables help predict the time
series of stock returns has accumulated in direct contradiction to the conclusions drawn by the
EMH. The onslaught against the conclusions drawn from the EMH includes early studies by
Fama and Schwert (1977) and Jaffe and Mandelker (1976), all affirming that macroeconomic
variables influence stock returns. Again Chen, Roll and Ross (1986), having first illustrated that
economic forces affect discount rates, the ability of firms to generate cash flows, and future
dividend payouts, provided the basis for the belief that a long-term equilibrium existed between
stock prices and macroeconomic variables. More recently, Granger (1986) proposed to
determine the existence of long-term equilibrium among selected variables through cointegration
analysis, paving the way for a (by now) preferred approach to examining the economic variables-
stock markets relationship. A set of time-series variables are cointegrated if they are integrated of
the same order and a linear combination of them is stationary. Such linear combinations would
then point to the existence of a long-term relationship between the variables. An advantage of
cointegration analysis is that through building an error-correction model (ECM), the dynamic co-
movement among variables and the adjustment process toward long-term equilibrium can be
examined, Maysami et al (2004).

More recently, Granger (1986) and Johansen and Juselius (1990) proposed to determine the
existence of long-term equilibrium among selected variables through cointegration analysis,
paving the way for a (by now) preferred approach to examining the economic variables-stock
markets relationship. A set of time-series variables are cointegrated if they are integrated of the
same order and a linear combination of them is stationary. Such linear combinations would then
point to the existence of a long-term relationship between the variables. An advantage of
cointegration analysis is that through building an error-correction model (ECM), the dynamic co-
movement among variables and the adjustment process toward long-term equilibrium can be
examined.
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Despite the importance of previous studies, until now the majority of research considers
developed countries financial markets, which are efficient enough and do not suffer from the
inefficiency problems in less developed countries. Considering this matter, the subject of
financial markets in developing countries still needs lengthy analysis and more research
attention.

2.Objectives
The study aims to achieve the following objectives:
1. To study the pattern of CPI, WPI, GDP, GNI and Rate of interest in India and Sri Lanka
for the year 2002-2009
2. To study the impact of macroeconomic variable on GDP growth of the Indian and Sri
Lankan economy.
3. To comparatively analyze the impact of macro-economic variable on GDP growth in
India viz-a-viz Sri Lanka

3.Literature Review
For number of years, there has been an extensive debate in the literature assessing the influence
of macroeconomics variables on the stock return. The economic theory, in explaining this
interrelationship, suggests that stock prices should reflect expectations about futures corporate
performance. Corporate profits on the other hand generally may reflect the level of countrys
economic activities. Thus, if stock prices accurately reflect the underlying fundamentals, then the
stock prices should be employed as leading indicators of future economic activity. However, if
economic activities reflect the movement of stock prices, the results then should be the opposite,
i.e economic activities should lead stock price. Therefore, the causal relations and dynamics
interactions among economics factors and stock prices are important in the formulation of
nations macroeconomic policy. According to Oberuc (2004), the economic factors which,
usually associated with stock prices movement and being considered greatly by researchers are
dividend yield, industrial production, interest rate, term spread, default spread, inflation,
exchange rates, money supply, GNP or GDP and previous stock returns, among others.

Emerging stock markets have been identified as being at least partially segmented from global
capital markets. In direct contradiction to the conclusions drawn by the EMH, evidence that key
macroeconomic variables help predict the time series of stock returns has accumulated for nearly
30 years.

Numerous studies have investigates the relationship between stock returns, interest rates,
inflation and real activity (see, inter alia, Fama (1981, 1990), James et al. (1985), Fama and
Schwert (1977), Geske and Roll (1983), Mandelker and Tandon (1985), Hendrys (1986), Chen,
Roll and Ross(1986), Darrat and Mukherjee (1987), Fama and French (1989) , Asprem
(1989),Martinez & Rubio, 1989, Schwert, 1989,Schwert (1990), Ferson and Harvey (1991), Lee
(1992), Mukherjee and Naka (1995), Chatrath et al. (1997), Naka A., Mukherjee T. and Tufte D.
3

(1998), Ibrahim (1999) , Gjerde & Saettem, 1999, Wongbangpo and Sharma (2002), , and
Vuyyuri (2005).
[
Now we divide the whole work of the researchers on macroeconomic variables in different parts
on the basis of stock markets, tests and conclusions.

Fama (1981) focuses upon the correlation between stock returns and expected and unexpected
inflation in the U.S., showing that the observed negative relation is a proxy effect for more
fundamental relationships between stock returns and real activity. James et al. (1985) finds
strong links between stock returns, real activity and money. Investigating the stock return-
inflation relation for the U.S., U.K., Canada and German. Fama and Schwert (1977) estimate the
extent to which various assets were hedges against the expected and unexpected components of
the inflation rate during the 19531971 period. They finds that U.S. government bonds and bills
were a complete hedge against expected inflation, and private residential real estate was a
complete hedge against both expected and unexpected inflation. Geske and Roll (1983) offers a
supplementary explanation suggesting that stock prices signal changes in expected inflation
because money supply responds to changes in expected real activity. Mandelker and Tandon
(1985) tests whether the negative relationship between real stock returns and inflation in the
United States is in fact proxying for a positive relationship between stock returns and real
activity variables in six major industrial countries over 19661979. Hendrys (1986) approach
which allows making inferences to the short-run relationship between macroeconomic variables
as well as the long-run adjustment to equilibrium, they analysed the influence of interest rate,
inflation, money supply, exchange rate and real activity, along with a dummy variable to capture
the impact of the 1997 Asian financial crisis. Chen, Roll and Ross (1986), having first illustrated
that economic forces affect discount rates, the ability of firms to generate cash flows, and future
dividend payouts, provided the basis for the belief that a long-term equilibrium existed between
stock prices and macroeconomic variables. Darrat and Mukherjee (1987) finds a significant
causal (lagged) relationship between stock returns and some selected macro variables, including
money supply, implying market inefficiency in the semi-strong sense on the Indian data over
19481984. Fama and French (1989) finds that expected returns on common stocks and long-
term bonds contain a term or maturity premium that has a clear business-cycle pattern (low near
peaks, high near troughs). Expected returns also contain a risk premium that is related to longer-
term aspects of business conditions. The variation through time in this premium is stronger for
low-grade bonds than for high-grade bonds and stronger for stocks than for bonds. The general
message is that expected returns are lower when economic conditions are strong and higher when
conditions are weak. Asprem (1989) investigates the relationship between stock indices, asset
portfolios and macroeconomic variables in ten European countries. It is shown that employment,
imports, inflation and interest rates are inversely related to stock prices. Expectations about
future real activity, measures for money and the U.S. yield curve are positively related to stock
prices. Schwert, 1989 in analyzes the relation of stock volatility with real and nominal
macroeconomic volatility, economic activity, financial leverage, and stock trading activity using
monthly data from 1857 to 1987. Ferson and Harvey (1991) provides an analysis of the
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predictable components of monthly common stock and bond portfolio return. Most of the
predictability is associated with sensitivity to economic variables in a rational asset pricing
model with multiple betas. The stock market risk premium is the most important for capturing
predictable variation of the stock portfolios, while premiums associated with interest rate risks
capture predictability of the bond returns. Time variation in the premium for beta risk is more
important than changes in the betas. Lee (1992) investigates causal relations and dynamic
interactions among asset returns, real activity, and inflation in the postwar United States. Major
findings are (1) stock returns appear Granger-causally prior and help explain real activity, (2)
with interest rates in the VAR, stock returns explain little variation in inflation, although interest
rates explain a substantial fraction of the variation in inflation, and (3) inflation explains little
variation in real activity. Mukherjee and Naka (1995) investigates whether cointegration exists
between the Tokyo Stock Exchange index and six Japanese macroeconomic variables, namely
the exchange rate, money supply, inflation, industrial production, long-term government bond
rate, and call money rate. They find that a cointegrating relation indeed exists and that stock
prices contribute to this relation. Chatrath et al. (1997) investigates a negative relationship
between stock market returns and inflationary trends has been widely documented for developed
economies in Europe and North America. This study provides similar evidence for India. Naka
A., Mukherjee T. and Tufte D. (1998) analyze relationships among selected macroeconomic
variables and the Indian stock market. They find that three long-term equilibrium relationships
exist among these variables. These results suggest that domestic inflation is the most severe
deterrent to Indian stock market performance, and domestic output growth is its predominant
driving force. After accounting for macroeconomic factors, the Indian market still appears to be
drawn downward by a residual negative trend. Ibrahim (1999) investigates the dynamic
interactions between seven macroeconomic variables and the stock prices for an emerging
market, Malaysia. The results strongly suggest informational inefficiency in the Malaysian
market. The bivariate analysis suggests cointegration between the stock prices and three
macroeconomic variables - consumer prices, credit aggregates and official reserves. From
bivariate error-correction models, we note the reactions of the stock prices to deviations from the
long run equilibrium. Gjerde & Saettem, 1999 investigates to what extent important results on
relations among stock returns and macroeconomic factors from major markets are valid in a
small, open economy. Wongbangpo and Sharma (2002) investigates the role of select
macroeconomic variables, i.e., GNP, the consumer price index, the money supply, the interest
rate, and the exchange rate on the stock prices in five ASEAN countries (Indonesia, Malaysia,
Philippines, Singapore, and Thailand). They observe long and short term relationships between
stock prices and these macroeconomic variables. Vuyyuri (2005) investigates the cointegration
relationship and the causality between the financial and the real sectors of the Indian economy
using monthly observations from 1992 through December 2002.

Different methods of data analysis have been put into use by the researchers in their studies
about the effect of macroeconomic variables on economy in the case of India, Sri Lanka, U.S.,
U.K., Canada, Germany, Netherland, Switzerland, European countries and ASEAN countries
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with each other or with country(s) from the other parts of the world. Grangers Causality Model,
Cointegration techniques (particularly Johansens Model), VECM and Vector Auto Regression
Model are the prominent ones that have been used to analyze the data about the effect of
macroeconomic variables on economy. However, a number of researches have used only one or
at the most two methods to analyze the data.
Grangers causality model has also been used very extensively by the researchers. Darrat and
Mukherjee (1987) , Wongbangpo and Sharma (2002), Ibrahim (1999), Vuyyuri (2005) applying
Granger-type causality. Ibrahim (1999), Wongbangpo and Sharma (2002) Cheung and Ng
(1998), Vuyyuri (2005), Johansen, S. & Juselius, K. 1990 using the Johansen cointegration
technique using cointegration. Ferson and Harvey (1991) using rational asset pricing model with
multiple betas. James et al. (1985) ,Lee (1992), Gjerde & Saettem, 1999 Using a multivariate
vector autoregression (VAR) approach, uses a VARMA approach. Mukherjee and Naka (1995),
Naka A., Mukherjee T. and Tufte D. (1998) use Johansen's (1991) vector error correction model
(VECM) .Chatrath et al. (1997) using heteroscedasticity and autocorrelation corrected models.
The current study contributes to the literature in numerous ways. First, this is the study
concentrating on the economy India and Sri Lanka; and studies the linkages within these rather
than with the developed world. Secondly, it uses a combination of the various methods used
empirically to analyze the data.

4.Research Methodology

In this study monthly data from 2002 onwards to 2009 has been used in case of all the variables
like, GDP (Gross Domestic Product), GNI (Gross National Income), wholesale price index
(WPI), consumer price index (CPI), exchange rates, bank rates and balance of payments. The
major source of data of all the above macro economic variables is International Monetary Fund
on-line data source. Index Numbers (2000=100) is used as the base index for the whole research
data. We filled the missing values by taking the average of two of the preceding cases and two of
the succeeding cases.
Data have been analyzed using econometric tools. The analysis of econometrics can be
performed on a series of stationary nature. In order to check whether or not the series are
stationary, we prepare the line graph for each of the series. Further, we perform the Augmented
Dickey-Fuller test under the unit root test to finally confirm whether or not the series are
stationary. For the basic understanding of Unit root testing, we may look at the following
equation
yt = yt1 + xt'o + ct , (1.1)
where xt are optional exogenous regressors which may consist of constant, or a constant and
trend, and o are parameters to be estimated, and the ct are assumed to be white noise. If || 1 ,
y is a nonstationary series and the variance of y increases with time and approaches infinity. If
||< 1 , y is a (trend-)stationary series. Thus, we evaluate the hypothesis of (trend-) stationarity
by testing whether the absolute value of || is strictly less than one.
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The Standard Dickey-Fuller test is carried out by estimating equation (1.2) after subtracting yt-1
from both sides of the equation.
Ayt = o y t-1 + xt'o + ct, (1.2)
where o = - 1. The null and alternative hypotheses may be written as,

H0 : o = 0
H1: o < 0 (1.3)
In order to make the series stationary, we take the log of the three series and arrive at the daily
return of the three series. All the remaining analysis is performed at the daily return (log of the
series) of WPI, CPI and Exchange rates.

At the stationary log series of the three stock exchanges, we perform the Grangers causality
model in order to observe (i) whether the LOG of WPI granger causes the LOG of Exchange rate
and/or at CPI; (ii) whether the LOG of Exchange rate granger causes the return at LOG of CPI
and/or at LOG of WPI; and (iii) whether the LOG of CPI granger causes the LOG of WPI and/or
at Exchange Rate.

The Granger (1969) approach to the question of whether x causes y is to see how much of the
current y can be explained by past values of y and then to see whether adding lagged values of x
can improve the explanation. y is said to be Granger-caused by x if x helps in the prediction of y
, or equivalently if the coefficients on the lagged x s are statistically significant. It is pertinent to
note that two-way causation is frequently the case; x Granger causes y and y Granger causes x. It
is important to note that the statement x Granger causes y does not imply that y is the effect or
the result of x. Granger causality measures precedence and information content but does not by
itself indicate causality in the more common use of the term. In Grangers Causality, there are
bivariate regressions of the under-mentioned form
yt = o0 + o1 yt-1 + + ol yt-l + |1 xt-1 + + |l xt-l + ct
xt = o0 + o1 xt-1 + + ol xt-l + |1 yt-1 + + |l yt-l + t (1.4)

for all possible pairs of (x, y) series in the group. In equation (1.4), we take lags ranging from 1
to l. In Grangers model, one can pick a lag length, l that corresponds to reasonable beliefs about
the longest time over which one of the variables could help predict the other. The reported F-
statistics are the Wald statistics for the joint hypothesis:
|1 = |2 = = |t = 0 (1.5)

for each equation. The null hypothesis is that x does not Granger-cause y in the first regression
and that y does not Granger-cause x in the second regression.

We follow the application of Grangers causality with the Vector Auto Regression (VAR)
Model. The Vector Auto Regression (VAR) is commonly used for forecasting systems of
interrelated time series and for analyzing the dynamic impact of random disturbances on the
system of variables. The VAR approach sidesteps the need for structural modeling by treating
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every endogenous variable in the system as a function of the lagged values of all of the
endogenous variables in the system. The mathematical representation of a VAR is:
yt = A1 y t-1 + + Ap y t-p + Bxt + ct (1.6)
where yt is a k vector of endogenous variables, xt is a d vector of exogenous variables, A1,
, Ap and B are matrices of coefficients to be estimated, and ct is a vector of innovations
that may be contemporaneously correlated but are uncorrelated with their own lagged values and
uncorrelated with all of the right-hand side variables.

Finally, we apply the Variance Decomposition Analysis in order to finally quantify the extent
upto which the three indices are influenced by each other. While impulse response functions
trace the effects of a shock to one endogenous variable on to the other variables in the VAR,
variance decomposition separates the variation in an endogenous variable into the component
shocks to the VAR. Thus, the variance decomposition provides information about the relative
importance of each random innovation in affecting the variables in the VAR.

5.Results of the Study
5.1 Descriptive Statistics and Correlation matrix of Indian yearly data
Table 5.1
Mean Median Min. Max. Variance Std.Dev. Coef.
Var.
Skewness Kurtosis
Exchange
Rates
45.40 45.31 41.35 48.61 6 2.46 5.4240 -0.168645 -0.47373
Bank
Rates
6.03 6.00 6.00 6.25 0 0.09 1.4655 2.828427 8.00000

WPI
130.63 129.40 107.50 154.55 289 17.01 13.021
0
0.176321 -1.19579

CPI
129.58 125.05 108.20 164.36 371 19.26 14.859
8
0.835715 -0.12527

GDP
40485.45 38579.55 24545.60 61641.80 172467608 13132.69 32.438
1
0.449978 -1.00381

GNI
40437.96 38300.15 24378.70 61386.40 178127021 13346.42 33.004
7
0.452074 -1.11894
Balance
of
Payments
-1383.60 -1155.10 -3439.50 -244.20 1233016 1110.41 -
80.255
3
-0.952124 0.17422

From the above table in which descriptive values of all the variables have been calculated shows
that standard deviation is very high in case of GNI comparative to others which portrays nothing
but that it is dispersed around its mean value by 13346.42 i.e., there is high volatility in its
values. From the skewness measure we found that exchange rates and balance of payment is
negatively skewed while bank rates are more positively skewed compared to other variables. In
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case of kurtosis, all variables are negatively skewed except bank rates and balance of payments.
Next step is to check out the correlation between the variables in consideration in this study.
.Table 5.2

Exchange
Rates
Bank
Rates
WPI CPI GDP GNI Balance of
Payments
Exchange Rates 1.00 0.53 -0.30 -0.11 -0.22 -0.23 0.33
Bank Rates 0.53 1.00 -0.55 -0.45 -0.49 -0.49 0.41
WPI -0.30 -0.55 1.00 0.97 0.99 0.99 -0.94
CPI -0.11 -0.45 0.97 1.00 0.99 0.99 -0.89
GDP -0.22 -0.49 0.99 0.99 1.00 1.00 -0.92
GNI -0.23 -0.49 0.99 0.99 1.00 1.00 -0.93
Balance of Payments 0.33 0.41 -0.94 -0.89 -0.92 -0.93 1.00

In the table 5.2 there is a positive correlation between Exchange rates - Bank rates, Exchange
rates-Balance of payments, Bank rates - Balance of payments, W.P.I. - C.P.I., WPI - G.D.P.,
WPI-GNI, CPI - GDP and CPI-GNI.
In the same table there is a negative correlation between Exchange rates - WPI, Exchange rates -
CPI, Exchange rates-GDP, Exchange rates GNI, Bank Rates -WPI, Bank Rates -CPI, Bank
Rates GDP, Bank Rates GNI, WPI - Balance of Payments, CPI - Balance of Payments.
Balance of payments - GDP and Balance of payments - GNI. In table highlighted values are
significant at 0.05 level of significance.
When GDP is Dependent Variable
Table 5.3
Coefficients
a

Model Unstandardized Coefficients Standardized
Coefficients
t Sig.
B Std. Error Beta
1 (Constant) -5371.526 22912.473 -.234 .853
Exchange Rates -7.066 82.443 -.001 -.086 .946
Bank Rates 568.306 1987.636 .004 .286 .823
WPI 23.592 105.386 .031 .224 .860
CPI -16.876 102.537 -.025 -.165 .896
GNI 1.079 .254 1.097 4.244 .147
Balance of Payments 1.298 .263 .110 4.928 .127
a. Dependent Variable: GDP

From table 5.3, we can formulate the regression equation Y= a + bX, where in Y is the
dependent variable (GDP) and X is the independent variable (Exchange rates, Bank rates, WPI,
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CPI, GNI and Balance of Payments). Hence, we arrive at the regression equation GDP = -
5371.526 + (-7.066) Exchange Rates + (568.306) Bank Rates + (23.592) WPI + (-16.876)CPI +
(1.079) GNI + (1.298) Balance of Payments. Using this regression equation to the entire series
we find out the predicted values of GDP for the given values of independent variables. These
values shall be presented later in this section.
Table 5.4
ANOVA
b

Model Sum of
Squares
df Mean Square F Sig.
1 Regression 1.207E9 6 2.012E8 5542.540 .010
a

Residual 36302.156 1 36302.156

Total 1.207E9 7

a. Predictors: (Constant), Balance of Payments, Exchange rates, Bank Rates, CPI, WPI, GNI
b. Dependent Variable: GDP

Table 5.4 shows the anova table in which we find the sum of squares, mean square, f statistic and
level of significance for regression equation as also for the residuals. The first important value
that we can look at is the level of significance the value of which is found to be 0.010. This value
is significant at 5% level of significance. Looking at the sum of squares, we find that the
regression equation accounts for a major proportion of the values of the dependent variable
(GDP). The detailed values of GDP at every level of independent variables are presented in the
table 5.5 below.
Table 5.5
Predicted & Residual Values

Observe
d - Value
Predicte
d - Value
Residua
l
Standar
d - Pred.
v.
Standard
-
Residual
Std.Err. -
Pred.Val
Mahalanobi
s -
Distance
Deleted -
Residual
Cook's -
Distance
2002 24545.60 24545.60 0.000 -1.21377 0.000000 190.5313 6.125000
2003 27546.20 27534.31 11.887 -0.98619 0.062387 190.1600 6.097747 3053.2 36.5404
2004 31494.10 31614.09 -119.986 -0.67553 -0.629746 148.0050 3.348946 -302.6 0.2174
2005 35867.40 35723.53 143.867 -0.36261 0.755085 124.9178 2.133947 252.3 0.1077
2006 41291.70 41294.22 -2.523 0.06159 -0.013244 190.5145 6.123771 -14374.9 813.1068
2007 47234.00 47256.65 -22.652 0.51561 -0.118890 189.1799 6.026056 -1602.6 9.9639
2008 54262.80 54283.76 -20.961 1.05070 -0.110013 189.3746 6.040268 -1731.7 11.6576
2009 61641.80 61631.43 10.371 1.61020 0.054433 190.2488 6.104265 3501.2 48.0961
Min. 24545.60 24545.60 -119.986 -1.21377 -0.629746 124.9178 2.133947 -14374.9 0.1077
Max. 61641.80 61631.43 143.867 1.61020 0.755085 190.5313 6.125000 3501.2 813.1068
Mean 40485.45 40485.45 0.000 0.00000 0.000001 176.6165 5.250000 -1600.7 131.3843
Median 38579.55 38508.88 -1.262 -0.15051 -0.006622 189.7673 6.069008 -302.6 11.6576
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From table 5.5, we find that the predicted values in most of the cases are quite near to the 1% of
the observed values except one case of year 2004, which indicates that there is a significant
impact of the independent variables on the GDP. Besides presenting the predicted values of the
series, table 5.5 also presents the residual value, standardized predicted value, standard error of
the predicted value, Mahalanobis distance, deleted residual, and Cooks distance.
When GNI is Dependent Variable
Table 5.6
Coefficients
a

Model Unstandardized Coefficients Standardized Coefficients t Sig.
B Std. Error Beta
1 (Constant) 526.488 21214.056

.025 .984
Exchange Rates -5.809 74.386 -.001 -.078 .950
Bank Rates -198.429 1853.503 -.001 -.107 .932
WPI -1.903 97.361 -.002 -.020 .988
CPI 34.711 87.036 .050 .399 .758
Balance of Payments -1.149 .325 -.096 -
3.540
.175
GDP .878 .207 .864 4.244 .147
a. Dependent Variable: GNI
From table 5.6, we can formulate the regression equation Y= a + bX, where in Y is the
dependent variable (GNI) and X is the independent variable (Exchange rates, Bank rates, WPI,
CPI, GDP and Balance of Payments). Hence, we arrive at the regression equation GDP =
526.488 + (-5.809) Exchange Rates + (-198.429) Bank Rates + (-1.903) WPI + (34.711) CPI +
(-1.149) Balance of Payments + (.878) GDP. Using this regression equation to the entire series
we find out the predicted values of GDP for the given values of independent variables. These
values shall be presented later in this section in the table 5.7
Table 5.7
ANOVA
Model Sum of Squares df Mean Square F Sig.
1 Regression 1.247E9 6 2.078E8 7040.431 .009
a

Residual 29516.652 1 29516.652

Total 1.247E9 7

a. Predictors: (Constant), GDP, Exchange Rates, Bank Rates, Balance of Payments, WPI, CPI
b. Dependent Variable: GNI

Table 5.7 shows the anova table in which we find the sum of squares, mean square, f statistic and
level of significance for regression equation as also for the residuals. The first important value
that we can look at is the level of significance the value of which is found to be 0.009. This value
is significant at 5% level of significance. Looking at the sum of squares, we find that the
11

regression equation accounts for a major proportion of the values of the dependent variable
(GNI). The detailed values of GNI at every level of independent variables are presented in the
table 5.8 below.
Table 5.8

Predicted & Residual Values

Observed
- Value
Predicted
- Value
Residual
Standard -
Pred. v.
Standard -
Residual
Std.Err. -
Pred.Val
Mahalano
bis -
Distance
Deleted -
Residual
Cook's -
Distance
2002 24378.70 24378.70 0.000 -1.20328 0.000000 171.8041 6.125000
2003 27339.10 27336.82 2.279 -0.98163 0.013267 171.7890 6.123767 12938.99 810.3730
2004 31270.30 31185.56 84.742 -0.69326 0.493249 149.4505 4.421945 348.31 0.4443
2005 35606.30 35749.23 -142.926 -0.35131 -0.831911 95.3332 1.280356 -206.51 0.0636
2006 40994.00 40966.63 27.367 0.03961 0.159293 169.6106 5.947396 1078.64 5.4881
2007 46995.60 46970.22 25.379 0.48944 0.147720 169.9197 5.972288 1163.32 6.4070
2008 55533.30 55515.84 17.461 1.12975 0.101633 170.9147 6.052714 1690.88 13.6948
2009 61386.40 61400.70 -14.297 1.57068 -0.083216 171.2083 6.076534 -2064.93 20.4940
Min. 24378.70 24378.70 -142.926 -1.20328 -0.831911 95.3332 1.280356 -2064.93 0.0636
Max. 61386.40 61400.70 84.742 1.57068 0.493249 171.8041 6.125000 12938.99 810.3730
Mean 40437.96 40437.96 0.001 -0.00000 0.000004 158.7538 5.250000 2135.53 122.4235
Medi
an
38300.15 38357.93 9.870 -0.15585 0.057450 170.4172 6.012501 1078.64 6.4070

From table 5.8, we find that the predicted values in all cases are quite near to the 1% of the
observed values from year 2002 to 2009, which indicates that there is a significant impact of the
independent variables on the GNI. Besides presenting the predicted values of the series, table 5.8
also presents the residual value, standardized predicted value, standard error of the predicted
value, Mahalanobis distance, deleted residual, and Cooks distance.
For performing the econometric analysis, it is very essential for the researcher to make sure that
the series under reference are stationary. In order to make the series stationary, we take log of the
three series on which the further analysis shall be performed. In this way, three new variables are
created and we assign those, names LOGExchange, LOGWPI and LOGCPI which denote the
LOG of Exchange rate, WPI and CPI respectively. Going further in the paper, we shall discuss
the linkages between the logs of exchange rate, WPI and CPI

Table 5.9 presents the descriptive statistics of the series of LOGExchange, LOGWPI and
LOGCPI



12


Table 5.9
Descriptive statistics of the Exchange rates, WPI and CPI















Table 5.9 shows that the mean at the Exchange rates, WPI and CPI happens to be 45.4384,
130.7451 and 133.9192 respectively. Since there are a total of 96 observations for a period of 8
years. The value of median is highest in the case of WPI than the CPI and Exchange rates which
are 128.9000, 127.5890 and 45.5355 respectively. The variance and standard deviation in the
case of CPI is higher than the WPI and Exchange rate which shows that the volatility is more in
CPI than the others. In Figure 1 to 4 present the line graphs of the LOG of WPI, LOG of CPI and
LOG of Exchange rate of India. While the return on WPI, CPI and Exchange Rates are
individually presented in figures 1 to 3, figure 4 presents common line graphs for the three macro
economic variables under study.

5.2 Stationarity and Causality Analysis of Indian Monthly data

After all these statistics stationarity tests are carried out on the variables because to apply
Granger causality, first the series have to be made stationary. Augmented Dickey Fuller (ADF))
test have been done and after the application of these tests all the series have been found
stationary at various significance levels.





LOGExchange LOGWPI LOGCPI
Valid N 96 96 96
Mean 45.4384 130.7451 133.9192
Median 45.5355 128.9000 127.5890
Frequency 1 2 5
Minimum 39.3740 104.7800 113.8000
Maximum 51.2290 161.8180 184.6630
Variance 7.5766 266.5260 311.2582
Std.Dev. 2.75256 16.32562 17.64251
Coef.Var. 6.05778 12.48660 13.17400
Skewness -0.456286 0.217605 1.302944
Kurtosis -0.29634 -1.07108 0.94365
13


Figure 1

-.04
-.03
-.02
-.01
.00
.01
.02
.03
.04
.05
10 20 30 40 50 60 70 80 90
LOGWPI



Figure 2

-.16
-.12
-.08
-.04
.00
.04
.08
10 20 30 40 50 60 70 80 90
LOGCPI

14


Figure 3

-.12
-.08
-.04
.00
.04
.08
.12
10 20 30 40 50 60 70 80 90
LOGXCHNG


Figure 4

-.16
-.12
-.08
-.04
.00
.04
.08
.12
10 20 30 40 50 60 70 80 90
LOGCPI LOGWPI LOGXCHNG

Figures 1 to 4 demonstrate the value of the three macro economic variables. It is indicated from
the figures that values at all the three macro economic variables are stationary in nature. In order
to further check the stationarity of the three series, we perform the Unit Root Test in order to
further confirm the same.
15


The unit-root test is performed on the three series in order to test the null hypothesis that the
series has a unit root. The findings of the unit-root test and the augmented Dickey- Fuller test are
shown below in the following tables.


Table 5.10
Unit root test on LOG exchange


Variable Coefficient Std. Error t-Statistic Prob.
LOGXCHNG_NA(-1) -0.991078 0.104187 -9.512455 0.0000
C -0.000457 0.002292 -0.199305 0.8425
R-squared 0.495854 Mean dependent var -6.41E-05
Adjusted R-squared 0.490374 S.D. dependent var 0.031124
S.E. of regression 0.022219 Akaike info criterion -4.754684
Sum squared resid 0.045419 Schwarz criterion -4.700571
Log likelihood 225.4701 Hannan-Quinn criter. -4.732826
F-statistic 90.48679 Durbin-Watson stat 1.999856
Prob(F-statistic) 0.000000


By the way of unit-root test, the null hypothesis that series Log of Exchange Rates has a unit-root
is tested. Probability value of less than 0.05 in above table shows that the Null hypothesis is
rejected and the variable does not have a unit-root, which confirms that the series is stationary.
Hence, the econometric models can now be applied on the series.

Table 5.11
Unit root test on LOG CPI

Variable Coefficient Std.
Error
t-Statistic Prob.
LOGCPI_NA(-1) -0.954503 0.104062 -9.172398 0.0000
C 0.004433 0.001739 2.549087 0.0125
R-squared 0.477667 Mean dependent var 8.68E-05
Adjusted R-squared 0.471990 S.D. dependent var 0.022325
S.E. of regression 0.016223 Akaike info criterion -5.383769
Sum squared resid 0.024212 Schwarz criterion -5.329657
Log likelihood 255.0372 Hannan-Quinn criter. -5.361912
F-statistic 84.13288 Durbin-Watson stat 1.999738
Prob(F-statistic) 0.000000
The probability value of unit-root test in table 5.11 points towards the fact that the null
hypothesis can be rejected at 0.05 level of significance. It implies that the LOG of CPI of India is
also a stationary one. Hence, the econometric models can now be applied on the series.
16


Table 5.12
Unit root test on LOG WPI

Variable Coefficient Std. Error t-Statistic Prob.
LOGWPI_NA(-1) -0.931885 0.104279 -8.936453 0.0000
C 0.004203 0.001063 3.954774 0.0002
R-squared 0.464681 Mean dependent var -0.000105
Adjusted R-
squared
0.458862 S.D. dependent var 0.012484
S.E. of regression 0.009184 Akaike info criterion -6.521737
Sum squared resid 0.007759 Schwarz criterion -6.467624
Log likelihood 308.5216 Hannan-Quinn criter. -6.499879
F-statistic 79.86019 Durbin-Watson stat 2.015654
Prob(F-statistic) 0.000000
The probability value of unit-root test in table 5.12 points towards the fact that the null
hypothesis can be rejected at 0.05 level of significance. It implies that the LOG of WPI of India
is also a stationary one.

Table 5.13
Granger Causality test on India monthly data

Pairwise Granger Causality Tests
Date: 03/11/11 Time: 16:09
Sample: 1 95
Lags: 2


Null Hypothesis: Obs F-Statistic Prob.


LOGXCHNG_NA does not Granger Cause LOGCPI_NA 93 0.01602 0.9841
LOGCPI_NA does not Granger Cause LOGXCHNG_NA 1.42415 0.2462


LOGWPI_NA does not Granger Cause LOGCPI_NA 93 0.19801 0.8207
LOGCPI_NA does not Granger Cause LOGWPI_NA 0.53034 0.5903


LOGWPI_NA does not Granger Cause LOGXCHNG_NA 93 0.66470 0.5170
LOGXCHNG_NA does not Granger Cause LOGWPI_NA 1.11568 0.3323


Table 5.13 presents the results about the application of Grangers Causality model to the WPI,
CPI and Exchange Rates of India. Null hypothesis in the case of Grangers causality model is
that A does not granger cause B. On those lines, table 6 tests the hypotheses about the three
variables in pairs. The results show that the probability value for the hypotheses Exchange rate
does not Granger Cause LOGCPI and LOGCPI does not Granger Cause LOGEXCHNG is
more than 0.05 which means that in both the cases null hypotheses can be accepted. And the
same results are observed in the case of LOGWPI & LOGCPI and LOGWPI & LOGEXCHNG.
17


Now we apply the Vector Auto Regression (VAR) model on the series under reference in order
to further confirm the results produced by the Grangers Causality model.

In table 5.14, we present the application of Vector Auto Regression (VAR) Model at the three
stock exchanges.

Table 5.14
Vector Auto Regression test on Indias monthly data

LOGCPI_NA LOGWPI_NA LOGXCHNG_NA
LOGCPI_NA(-1) 0.037950 -0.049043 0.129684
(0.10903) (0.05984) (0.14649)
[ 0.34807] [-0.81950] [ 0.88525]
LOGCPI_NA(-2) -0.007443 -0.032575 0.179728
(0.11010) (0.06043) (0.14793)
[-0.06760] [-0.53905] [ 1.21497]
LOGWPI_NA(-1) 0.058476 0.059458 -0.100699
(0.19499) (0.10703) (0.26199)
[ 0.29989] [ 0.55554] [-0.38435]
LOGWPI_NA(-2) 0.098758 0.201064 0.237570
(0.19686) (0.10805) (0.26450)
[ 0.50167] [ 1.86082] [ 0.89818]
LOGXCHNG_NA(-1) 0.006020 -0.000821 0.000317
(0.07947) (0.04362) (0.10678)
[ 0.07576] [-0.01883] [ 0.00296]
LOGXCHNG_NA(-2) 0.008605 -0.063557 -0.042913
(0.07894) (0.04333) (0.10606)
[ 0.10901] [-1.46688] [-0.40460]
C 0.003794 0.003678 -0.002482
(0.00217) (0.00119) (0.00292)
[ 1.74748] [ 3.08648] [-0.85084]


R-squared 0.006754 0.068391 0.042170
Adj. R-squared -0.062543 0.003395 -0.024656
Sum sq. resids 0.024099 0.007260 0.043505
S.E. equation 0.016740 0.009188 0.022492
F-statistic 0.097459 1.052240 0.631044
Log likelihood 252.0453 307.8332 224.5760
Akaike AIC -5.269790 -6.469531 -4.679054
Schwarz SC -5.079165 -6.278906 -4.488429
Mean dependent 0.004641 0.004503 -0.000476
S.D. dependent 0.016239 0.009204 0.022219
Determinant resid covariance (dof adj.) 1.16E-11
Determinant resid covariance 9.16E-12
Log likelihood 785.9715
Akaike information criterion -16.45100
Schwarz criterion -15.87912

18

By the application of VAR Model, we observe that the integration of macroeconomic variables
with the other can be established if the p-value is more than 1.96. Table 5.14 shows that the
LOGCPI at the lag of 1 and 2, does not have any influence on LOGCPI, LOGWPI and
LOGEXCHNG.. Similarly, LOGWPI at a lag of 1 and 2 does not have any influences on the
LOGCPI, LOGWPI and LOGXHNG. In LOGXCHNG, the table reveals that LOGXCHNG at a
lag of 1 and 2 does not have any effect on the LOGCPI, LOGWPI and LOGXCHNG.
Table 5.15
Variance Decomposition on Indias monthly data

Variance Decomposition of LOGCPI_NA:
Period S.E. LOGCPI_NA LOGWPI_NA LOGXCHNG_NA
1 0.016740 100.0000 0.000000 0.000000
2 0.016764 99.88856 0.104968 0.006467
3 0.016793 99.54793 0.431889 0.020176
4 0.016795 99.53270 0.444589 0.022712
5 0.016797 99.50979 0.458547 0.031663
6 0.016797 99.50889 0.459146 0.031967
7 0.016797 99.50841 0.459344 0.032243
8 0.016797 99.50839 0.459348 0.032259
9 0.016797 99.50839 0.459348 0.032264
10 0.016797 99.50839 0.459348 0.032264
Variance Decomposition of LOGWPI_NA:
Period S.E. LOGCPI_NA LOGWPI_NA LOGXCHNG_NA
1 0.009188 2.360903 97.63910 0.000000
2 0.009233 2.975686 97.02392 0.000397
3 0.009505 2.963575 94.76938 2.267042
4 0.009513 3.076295 94.64900 2.274704
5 0.009523 3.178698 94.48968 2.331623
6 0.009523 3.184630 94.48252 2.332855
7 0.009523 3.187336 94.47914 2.333527
8 0.009523 3.187458 94.47900 2.333538
9 0.009523 3.187478 94.47899 2.333537
10 0.009523 3.187478 94.47899 2.333537
Variance Decomposition of
LOGXCHNG_NA:

Period S.E. LOGCPI_NA LOGWPI_NA LOGXCHNG_NA
1 0.022492 0.051339 0.818124 99.13054
2 0.022602 0.856645 0.973590 98.16977
3 0.022984 3.134815 1.764871 95.10031
4 0.022986 3.135866 1.773601 95.09053
5 0.022993 3.142175 1.818193 95.03963
6 0.022994 3.142716 1.819371 95.03791
7 0.022994 3.143564 1.820026 95.03641
8 0.022994 3.143676 1.820051 95.03627
9 0.022994 3.143726 1.820051 95.03622
10 0.022994 3.143729 1.820050 95.03622
Cholesky Ordering: LOGCPI_NA
LOGWPI_NA LOGXCHNG_NA


19

Finally, the Variance Decomposition Analysis of the three macro economic variables is
presented in the table 5.15. The table decomposes the values at the three macro economic
variables for a period ranging from 1 to 10.
The Variance Decomposition Analysis as presented in table 5.15. It implies that on LOGCPI, the
impact of other two macro economic variables is negligible. Rather the LOGCPI itself with the
lag of 1 through 10 impacts the LOGCPI in the current period. However, the table reveals that in
the case of LOGWPI, there is visible impact of LOGCPI for periods 1 to 10 and LOGEXCHNG
for the periods 2 to 10. In LOG WPI the impact on LOGCPI is more than the LOGEXCHNG. In
the case of LOGEXCHNG, there is also visible impact of LOGCPI and LOGWPI for the periods
of 2 to 10. The impact is more in the case of LOGCP than the LOGWPI. Variance
Decomposition Analysis shows that the macro economic variables under study are not much
influenced by each other.
5.3 Descriptive Statistics and Correlation matrix of Sri Lanka yearly data
Table 5.16
Mean Median Minimu
m
Maximu
m
Variance Std.
Dev.
Coef.
Var.
Skewnes
s
Kurtosis
Exchange
Rates
104 103 96 115 4.685914E+01 7 6.5846 0.39081 -1.01195
Bank Rates 15 15 15 18 1.125000E+00 1 6.8986 2.82843 8.00000

WPI
187 169 124 277 3.691617E+03 61 32.449
9
0.57728 -1.41353

CPI
181 168 125 258 2.644244E+03 51 28.416
3
0.62302 -1.21344

GDP
29694
08
269573
1
1636037 4825085 1.432158E+12 119672
8
40.301
9
0.54621 -1.24436

GNI
29279
48
266049
5
1611994 4769271 1.377908E+12 117384
3
40.091
0
0.54585 -1.21101
Balance of
Payments
-
27901
7
-266482 -603649 -106481 2.685934E+10 163888 -
58.737
8
-1.04250 1.26959

From the above table in which descriptive values of all the variables have been calculated shows
that standard deviation is very high in case of Balance of Payments comparative to others which
portrays nothing but that it is dispersed around its mean value by 163888 i.e., there is high
volatility in its values. From the skewness measure we found that only balance of payment is
negatively skewed while bank rates are more positively skewed compared to other variables. In
case of kurtosis, all variables are negatively skewed except bank rates and balance of payments.
Next step is to check out the correlation between the variables in consideration in this study.


20

Table 5.17
Correlations
Exchange
Rates
Bank Rates WPI CPI GDP GNI Balance of
Payments
Exchange Rates 1.00 -0.49 0.92 0.93 0.95 0.95 -0.71
Bank Rates -0.49 1.00 -0.42 -0.44 -0.45 -0.45 0.43
WPI 0.92 -0.42 1.00 0.99 0.99 0.99 -0.88
CPI 0.93 -0.44 0.99 1.00 1.00 1.00 -0.84
GDP 0.95 -0.45 0.99 1.00 1.00 1.00 -0.82
GNI 0.95 -0.45 0.99 1.00 1.00 1.00 -0.81
Balance of Payments -0.71 0.43 -0.88 -0.84 -0.82 -0.81 1.00

In the table 5.17 there is a positive correlation between Exchange rates -WPI, Exchange rates-
CPI, Exchange rates-GDP, Exchange rates- GNI, Bank rates - Balance of payments, W.P.I. -
C.P.I., WPI - G.D.P. and WPI-GNI
In the same table there is a negative correlation between Exchange rates Balance of Payments,
Exchange rates Bank Rates, Bank Rates -WPI, Bank Rates -CPI, Bank Rates GDP, Bank
Rates GNI, WPI - Balance of Payments, CPI - Balance of Payments, GDP-Balance of
payments and GNI-Balance of payments. In table highlighted values are significant at 0.05 level
of significance.
GDP as a Dependent variable
Table 5.18
Coefficients
a

Model Unstandardized Coefficients Standardized
Coefficients
t Sig.
B Std. Error Beta
1 (Constant) -199957.986 227360.801 -.879 .541
xchnge -203.156 1830.257 -.001 -.111 .930
Bank Rates 4508.881 1747.712 .004 2.580 .235
WPI -854.678 599.947 -.043 -1.425 .390
CPI 3164.948 1370.841 .136 2.309 .260
GNI .911 .046 .893 19.712 .032
Balance of Payments -.151 .040 -.021 -3.750 .166
a. Dependent Variable: GDP
21

From table 5.18, we can formulate the regression equation Y= a + bX, where in Y is the
dependent variable (GDP) and X is the independent variable (Exchange rates, Bank rates,
WPI, CPI, GNI and Balance of Payments). Hence, we arrive at the regression equation GDP =
-199957.986 + (-203.156) Exchange Rates + (4508.881) Bank Rates + (-854.678) WPI +
(3164.948) CPI + (0.911) GNI + (-0.151) Balance of Payments. Using this regression
equation to the entire series we find out the predicted values of GDP for the given values of
independent variables. These values shall be presented later in this section in the table 5.19
Table 4.19
ANOVA
b

Model Sum of Squares df Mean Square F Sig.
1 Regression 1.003E13 6 1.671E12 185498.790 .002
a

Residual 9007333.846 1 9007333.846
Total 1.003E13 7
a. Predictors: (Constant), Balance of Payments, Bank Rates, Exchange Rate, CPI, WPI, GNI
b. Dependent Variable: GDP
Table 5.19 shows the anova table in which we find the sum of squares, mean square, f statistic
and level of significance for regression equation as also for the residuals. The first important
value that we can look at is the level of significance the value of which is found to be 0.002. This
value is significant at 5% level of significance. Looking at the sum of squares, we find that the
regression equation accounts for a major proportion of the values of the dependent variable
(GDP). The detailed values of GDP at every level of independent variables are presented in the
table 5.20 below.
Table 5.20
Predicted & Residual Values

Observe
d - Value
Predicte
d - Value
Residua
l
Standard
- Pred. v.
Standard -
Residual
Std.Err. -
Pred.Val
Mahalanobi
s - Distance
Deleted -
Residual
Cook's -
Distance
2002 1636037 1636037 0.00 -1.11418 0.000000 3001.222 6.125000
2003 1822468 1821307 1161.25 -0.95937 0.386926 2767.444 5.076953 7756.1 0.81125
2004 2090841 2090140 701.13 -0.73473 0.233613 2918.166 5.742926 12845.3 2.47412
2005 2452782 2455375 -2592.75 -0.42953 -0.863898 1511.789 0.901169 -3474.3 0.04858
2006 2938680 2938186 493.75 -0.02609 0.164516 2960.339 5.935589 18247.3 5.13798
2007 3578688 3578949 -261.25 0.50934 -0.087048 2989.837 6.071993 -34500.4 18.73507
2008 4410682 4410364 318.00 1.20408 0.105957 2984.350 6.046515 28362.1 12.61490
2009 4825085 4824905 180.00 1.55048 0.059976 2995.827 6.099854 50108.3 39.67971
Min. 1636037 1636037 -2592.75 -1.11418 -0.863898 1511.789 0.901169 -34500.4 0.04858
Max. 4825085 4824905 1161.25 1.55048 0.386926 3001.222 6.125000 50108.3 39.67971
Mean 2969408 2969408 0.02 0.00000 0.000005 2766.122 5.250000 11334.9 11.35737
22

Medi
an
2695731 2696781 249.00 -0.22781 0.082966 2972.344 5.991052 12845.3 5.13798

From table 5.20, we find that the predicted values in all cases are quite near to the 1% of the
observed values from year 2002 to 2009, which indicates that there is a significant impact of the
independent variables on the GDP. Besides presenting the predicted values of the series, table
5.20 also presents the residual value, standardized predicted value, standard error of the predicted
value, Mahalanobis distance, deleted residual, and Cooks distance.
GNI as a dependent variable
Table 4.21
Coefficients
a

Model Unstandardized Coefficients Standardized
Coefficients
t Sig.
B Std. Error Beta
1 (Constant) 206911.824 259697.553 .797 .572
Exchange Rates 318.889 1994.159 .002 .160 .899
Bank Rates -4890.749 2050.417 -.004 -2.385 .253
WPI 910.217 694.910 .047 1.310 .415
CPI -3392.804 1672.082 -.149 -2.029 .292
GDP 1.095 .056 1.117 19.712 .032
Balance of Payments .164 .050 .023 3.299 .187
a. Dependent Variable: GNI

From table 5.21, we can formulate the regression equation Y= a + bX, where in Y is the
dependent variable (GNI) and X is the independent variable (Exchange rates, Bank rates, WPI,
CPI, GDP and Balance of Payments). Hence, we arrive at the regression equation GDP =
206911.82 + (318.889) Exchange Rates+ (-4890.749)Bank Rates + (910.217)WPI + (-3392.804)
CPI+ (0.164) Balance of Payments + (1.095) GDP. Using this regression equation to the entire
series we find out the predicted values of GDP for the given values of independent variables.
These values shall be presented later in this section in the table 5.22
Table 5.22
ANOVA
b

Model Sum of
Squares
df Mean Square F Sig.
1 Regression 9.645E12 6 1.608E12 148397.650 .002
a

Residual 1.083E7 1 1.083E7
Total 9.645E12 7
a. Predictors: (Constant), Balance of Payments, Bank Rates, Exchange Rates, CPI, WPI, GDP
b. Dependent Variable: GNI

Table 5.22 shows the anova table in which we find the sum of squares, mean square, f statistic
and level of significance for regression equation as also for the residuals. The first important
23

value that we can look at is the level of significance the value of which is found to be 0.002. This
value is significant at 5% level of significance. Looking at the sum of squares, we find that the
regression equation accounts for a major proportion of the values of the dependent variable
(GNI). The detailed values of GNI at every level of independent variables are presented in the
table 5.23 below.
Table 5.23
Predicted & Residual Values

Observe
d -
Value
Predicted -
Value
Residual
Standard -
Pred. v.
Standard -
Residual
Std.Err. -
Pred.Val
Mahalanobi
s -
Distance
Deleted -
Residual
Cook's -
Distance
2002 1611994 1611994 0.00 -1.12107 0.000000 3291.318 6.125000
2003 1805933 1807137 -1204.38 -0.95482 -0.365925 3063.022 5.187599 -8993.6 0.92383
2004 2070109 2071006 -896.50 -0.73003 -0.272383 3166.860 5.605616 -12082.6 1.78238
2005 2422733 2419899 2833.75 -0.43281 0.860977 1674.103 0.936018 3822.8 0.04986
2006 2898256 2898750 -494.00 -0.02487 -0.150092 3254.051 5.967379 -21938.7 6.20429
2007 3539634 3539288 346.25 0.52080 0.105201 3273.043 6.047486 31268.5 12.75083
2008 4305650 4306024 -373.50 1.17399 -0.113480 3270.067 6.034900 -29017.7 10.96132
2009 4769271 4769483 -212.00 1.56881 -0.064412 3284.493 6.096002 -51176.1 34.39450
Min. 1611994 1611994 -1204.38 -1.12107 -0.365925 1674.103 0.936018 -51176.1 0.04986
Max. 4769271 4769483 2833.75 1.56881 0.860977 3291.318 6.125000 31268.5 34.39450
Mean 2927948 2927948 -0.05 -0.00000 -0.000014 3034.620 5.250000 -12588.2 9.58100
Medi
an
2660495 2659325 -292.75 -0.22884 -0.088946 3262.059 6.001139 -12082.6 6.20429

From table 5.23, we find that the predicted values in all cases are quite near to the 1% of the
observed values from year 2002 to 2009, which indicates that there is a significant impact of the
independent variables on the GNI. Besides presenting the predicted values of the series, table
5.23 also presents the residual value, standardized predicted value, standard error of the predicted
value, Mahalanobis distance, deleted residual, and Cooks distance.
5.4 Stationarity and Causality Analysis of Indian Monthly data
Table 5.24
Exchange
Rates
WPI CPI
Valid N 96 96 96
Mean 103.9292 184.4419 186.0590
Median 102.7625 168.3500 167.2500
Mode 114.2580 233.5400 Multiple
Frequency 2 4 2
Minimum 93.3830 120.3540 129.6000
Maximum 116.9210 294.7000 277.6590
Variance 43.077 3036.495 2224.671
24

Std. Deviation 6.56329 55.10440 47.16642
Coef. Of variance 6.31516 29.87630 25.35025
Skewness 0.263307 0.529218 0.525176
Kurtosis -1.18682 -1.10259 -1.27886
As we did in the case of Indias data same as that Figure 5 to 8 present the line graphs of the
values of WPI, CPI and Exchange rates of Sri Lanka. While the return on WPI, CPI and
Exchange Rates are individually presented in figures 5 to 7, figure 8 presents common line
graphs for the three macro economic variables under study.
Figure 5

-.30
-.25
-.20
-.15
-.10
-.05
.00
.05
.10
.15
10 20 30 40 50 60 70 80 90
LOGWPI


Figure 6

-.16
-.12
-.08
-.04
.00
.04
.08
10 20 30 40 50 60 70 80 90
DCPI


Figure 7
25


-.06
-.04
-.02
.00
.02
.04
10 20 30 40 50 60 70 80 90
LOGEXCHNG


Figure 8

-.30
-.25
-.20
-.15
-.10
-.05
.00
.05
.10
.15
10 20 30 40 50 60 70 80 90
LOGCPI LOGEXCHNG LOGWPI


Figures 5 to 8 demonstrate the value of the three macro economic variables. It is indicated from
the figures that values at all the three macro economic variables are stationary in nature. In order
to further check the stationarity of the three series, we perform the Unit Root Test in order to
further confirm the same.

The unit-root test is performed on the three series in order to test the null hypothesis that the
series has a unit root. The findings of the unit-root test and the augmented Dickey-Fuller test are
shown below in Table 5.25

Table 5.25
26

Unit Root test on CPI

Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LOGCPI_NA)
Method: Least Squares
Date: 03/23/11 Time: 10:55
Sample (adjusted): 3 95
Included observations: 93 after adjustments


Variable Coefficient Std. Error t-Statistic Prob.


LOGCPI_NA(-1) -0.983429 0.125938 -7.808820 0.0000
D(LOGCPI_NA(-1)) 0.274317 0.101332 2.707104 0.0081
C 0.007146 0.002562 2.789463 0.0064


R-squared 0.432031 Mean dependent var 7.74E-05
Adjusted R-squared 0.419410 S.D. dependent var 0.030323
S.E. of regression 0.023105 Akaike info criterion -4.665803
Sum squared resid 0.048046 Schwarz criterion -4.584106
Log likelihood 219.9598 Hannan-Quinn criter. -4.632816
F-statistic 34.22974 Durbin-Watson stat 2.100575
Prob(F-statistic) 0.000000

The probability value of unit-root test in table 5.25 points towards the fact that the null
hypothesis can be rejected at 0.05 level of significance. It implies that LOG of CPI of Sri Lanka
is also a stationary one. Hence, the econometric models can now be applied on the series..

Table 5.26
Unit root test on WPI



Variable Coefficient Std. Error t-Statistic Prob.


LOGWPI_NA(-1) -1.212027 0.101879 -11.89667 0.0000
C 0.008339 0.003974 2.098294 0.0386


R-squared 0.606048 Mean dependent var 1.35E-05
Adjusted R-squared 0.601766 S.D. dependent var 0.060103
S.E. of regression 0.037929 Akaike info criterion -3.685174
Sum squared resid 0.132349 Schwarz criterion -3.631061
Log likelihood 175.2032 Hannan-Quinn criter. -3.663316
F-statistic 141.5308 Durbin-Watson stat 1.991122
Prob(F-statistic) 0.000000


The probability value of unit-root test in table 5.26 points towards the fact that the null
hypothesis can be rejected at 0.05 level of significance. It implies that the LOG of WPI of Sri
Lanka is also a stationary one. Hence, the econometric models can now be applied on the series..


Table 5.27
27

Unit Root Test on Exchange Rates



Variable Coefficient Std. Error t-Statistic Prob.


LOGEXCHNG_NA(-1) -0.792874 0.102070 -7.767954 0.0000
C 0.001687 0.001031 1.637207 0.1050


R-squared 0.396092 Mean dependent var -3.30E-05
Adjusted R-squared 0.389528 S.D. dependent var 0.012489
S.E. of regression 0.009758 Akaike info criterion -6.400354
Sum squared resid 0.008761 Schwarz criterion -6.346242
Log likelihood 302.8167 Hannan-Quinn criter. -6.378497
F-statistic 60.34111 Durbin-Watson stat 1.969786
Prob(F-statistic) 0.000000

The probability value of unit-root test in table 5.27, points towards the fact that the null
hypothesis can be rejected at 0.05 level of significance. It implies that the LOG of Exchange
Rate of Sri Lanka is also a stationary one. Hence, the econometric models can now be applied on
the series.
Table 5.28
Granger Causality test on Sri Lanka monthly data

Lags: 2


Null Hypothesis: Obs F-Statistic Prob.


LOGEXCHNG_NA does not Granger Cause LOGCPI_NA 93 0.86114 0.4262
LOGCPI_NA does not Granger Cause LOGEXCHNG_NA 0.08428 0.9193


LOGWPI_NA does not Granger Cause LOGCPI_NA 93 2.11268 0.1270
LOGCPI_NA does not Granger Cause LOGWPI_NA 0.49521 0.6111


LOGWPI_NA does not Granger Cause LOGEXCHNG_NA 93 1.12065 0.3307
LOGEXCHNG_NA does not Granger Cause LOGWPI_NA 1.07596 0.3454

Table 5.28 presents the results about the application of Grangers Causality model to the WPI,
CPI and Exchange Rates of India. Null hypothesis in the case of Grangers causality model is
that A does not granger cause B. On those lines, table 5.28 tests the hypotheses about the
three variables in pairs. The results show that the probability value for the hypotheses Exchange
rate does not Granger Cause LOGCPI and LOGCPI does not Granger Cause LOGEXCHNG is
more than 0.05 which means that in both the cases null hypotheses can be accepted. And the
same results are observed in the case of LOGWPI & LOGCPI and LOGWPI & LOGEXCHNG.

Now we apply the Vector Auto Regression (VAR) model on the series under reference in order
to further confirm the results produced by the Grangers Causality model.

In table 5.29, we present the application of Vector Auto Regression (VAR) Model at the three
stock exchanges.
Table 5.29
28

Vector Auto Regression test on Sri Lankas monthly data

Vector Autoregression Estimates
Date: 03/11/11 Time: 16:30
Sample (adjusted): 3 95
Included observations: 93 after adjustments
Standard errors in ( ) & t-statistics in [ ]


LOGCPI_NA LOGEXCHNG_NA LOGWPI_NA


LOGCPI_NA(-1) 0.276479 0.015195 0.141757
(0.10083) (0.04376) (0.17074)
[ 2.74199] [ 0.34725] [ 0.83027]

LOGCPI_NA(-2) -0.296388 0.018369 -0.041587
(0.10047) (0.04360) (0.17012)
[-2.95002] [ 0.42132] [-0.24445]

LOGEXCHNG_NA(-1) 0.369838 0.201905 0.165298
(0.24486) (0.10626) (0.41462)
[ 1.51039] [ 1.90010] [ 0.39868]

LOGEXCHNG_NA(-2) -0.160170 -0.036185 0.493158
(0.24607) (0.10678) (0.41666)
[-0.65092] [-0.33886] [ 1.18360]

LOGWPI_NA(-1) 0.069514 -0.032033 -0.222476
(0.06317) (0.02741) (0.10696)
[ 1.10047] [-1.16856] [-2.07999]

LOGWPI_NA(-2) 0.133537 -0.034492 0.014252
(0.06327) (0.02746) (0.10713)
[ 2.11064] [-1.25627] [ 0.13303]

C 0.005549 0.001896 0.006310
(0.00265) (0.00115) (0.00449)
[ 2.09272] [ 1.64751] [ 1.40530]


R-squared 0.186419 0.073080 0.076002
Adj. R-squared 0.129657 0.008411 0.011537
Sum sq. resids 0.044597 0.008399 0.127867
S.E. equation 0.022772 0.009882 0.038559
F-statistic 3.284250 1.130059 1.178971
Log likelihood 223.4234 301.0607 174.4440
Akaike AIC -4.654267 -6.323886 -3.600946
Schwarz SC -4.463642 -6.133260 -3.410320
Mean dependent 0.007250 0.002034 0.007032
S.D. dependent 0.024410 0.009924 0.038784

Determinant resid covariance (dof adj.) 7.47E-11
Determinant resid covariance 5.91E-11
Log likelihood 699.2882
Akaike information criterion -14.58684
Schwarz criterion -14.01497
29


By the application of VAR Model, we observe that the integration of macroeconomic variables
with the other can be established if the p-value is more than 1.96. Table 5.29 shows that the
LOGCPI at the lag of 1 and 2, does not have any influence on LOGWPI and LOGEXCHNG.
However, it influences the returns at LOGCPI in period 0. Similarly, LOGEXCHNG at a lag of 1
and 2 does not have any influences on the LOGCPI, LOGWPI and LOGEXHNG. In LOGWPI at
the lag 1 does not have any influence on LOGCPI and LOGEXCHNG but it influences the return
at LOGWPI in period 0. In LOGWPI at lag 2 LOGWPI have influence on LOGCPI but it does
not influence LOGEXCHNG and LOGWPI.
Table 5.30
Variance Decomposition on Sri Lankas monthly data

Variance Decomposition of LOGCPI_NA:
Period S.E. LOGCPI_NA LOGEXCHNG_NA LOGWPI_NA
1 0.022772 100.0000 0.000000 0.000000
2 0.024161 96.51089 2.261100 1.228008
3 0.025031 93.01309 2.117113 4.869802
4 0.025200 92.95173 2.168757 4.879512
5 0.025229 92.76467 2.180776 5.054553
6 0.025245 92.75595 2.185437 5.058613
7 0.025246 92.75185 2.185334 5.062813
8 0.025247 92.74894 2.186027 5.065036
9 0.025247 92.74892 2.186094 5.064990
10 0.025247 92.74873 2.186116 5.065150
Variance Decomposition of
LOGEXCHNG_NA:

Period S.E. LOGCPI_NA LOGEXCHNG_NA LOGWPI_NA
1 0.009882 0.544881 99.45512 0.000000
2 0.010166 0.697640 97.82953 1.472829
3 0.010253 0.856835 96.17923 2.963936
4 0.010256 0.857207 96.16613 2.976659
5 0.010260 0.867678 96.15021 2.982117
6 0.010260 0.870224 96.14645 2.983325
7 0.010260 0.870247 96.14643 2.983320
8 0.010260 0.870455 96.14619 2.983358
9 0.010260 0.870466 96.14618 2.983358
10 0.010260 0.870471 96.14617 2.983359
Variance Decomposition of LOGWPI_N
Period S.E. LOGCPI_NA LOGEXCHNG_NA LOGWPI_NA
1 0.038559 0.225725 0.001937 99.77234
2 0.039644 0.763915 0.178602 99.05748
3 0.040088 0.749457 1.943572 97.30697
4 0.040104 0.766544 1.947060 97.28640
5 0.040110 0.767313 1.946547 97.28614
6 0.040110 0.768456 1.946880 97.28466
7 0.040110 0.768456 1.947305 97.28424
8 0.040110 0.768561 1.947306 97.28413
9 0.040110 0.768578 1.947306 97.28412
10 0.040110 0.768580 1.947308 97.28411
30

Cholesky Ordering: LOGCPI_NA
LOGEXCHNG_NA LOGWPI_NA


Finally, the Variance Decomposition Analysis of the three macro economic variables is
presented in the table 5.30. The table decomposes the values at the three macro economic
variables for a period ranging from 1 to 10.

The Variance Decomposition Analysis as presented in table 5.30. It implies that on LOGCPI, the
impact of other two macro economic variables is visible. The impact is near about constant in the
LOG of Exchange rate but in LOG of WPI impact increases step by step than the previous one.
However, the table reveals that in the case of LOGEXCHNG, there is visible impact of LOGWPI
for periods 2 to 10 and no impact on LOGCPI. In the case of LOGWPI, there is also visible
impact of LOGEXCHNG for the periods of 3 to 10. Variance Decomposition Analysis shows
that the macro economic variables under study are not much influenced by each other.

Conclusion
The aim of this research is to find out the impact of macroeconomic variables on GDP growth
and study the pattern of CPI, WPI, GDP, GNI and Rate of interest in India and Sri Lanka. To
solve this basic purpose monthly data was used from 2002 to 2009 of both of the countries and
the basic and believed to be indicator variables were used and studied and analyzed by first
applying the basic statistical tools like correlation and descriptive statistical tools and finally
regression, unit root test, Granger causality, VAR and Variance decomposition models.
The application of Unit-root test (Augmented Dickey-Fuller test) reveals that the null hypothesis
can be rejected at 0.05 level of significance. It implies that the series of WPI, CPI and Exchange
rates of India and Sri Lanka are stationary. Grangers Causality Model when applied to the three
series indicates that probability value for the hypotheses Exchange rate does not Granger Cause
LOGCPI and LOGCPI does not Granger Cause LOGEXCHNG in Indian data and the
probability value for the hypotheses Exchange rate does not Granger Cause LOGCPI and
LOGCPI does not Granger Cause LOGEXCHNG is more than 0.05 which means that in both
the cases null hypotheses can be accepted. And the same results are observed in the case of Sri
Lankas data. None of the other variables happen to Granger cause any of the other variables
under study. The application of the VAR model implies that the LOGCPI at the lag of 1 and 2,
does not have any influence on LOGCPI, LOGWPI and LOGEXCHNG. Similarly, LOGWPI at
a lag of 1 and 2 does not have any influence on the LOGCPI, LOGWPI and LOGXHNG. In
LOGXCHNG, the table reveals that LOGXCHNG at a lag of 1 and 2 does not have any effect on
the LOGCPI, LOGWPI and LOGXCHNG in Indian data and in the case of Sri Lankas data
Vector Auto regression (VAR) model implies that LOGCPI at the lag of 1 and 2, does not have
any influence on LOGWPI and LOGEXCHNG.. However, it influences the returns at LOGCPI
in period 0.Similarly, LOGEXCHNG at a lag of 1 and 2 does not have any influences on the
LOGCPI, LOGWPI and LOGEXHNG. In LOGWPI at the lag 1 does not have any influence on
31

LOGCPI and LOGEXCHNG but it influences the return at LOGWPI in period 0. In LOGWPI at
lag 2 LOGWPI have influence on LOGCPI but it does not influence LOGEXCHNG and
LOGWPI. The Variance Decomposition Analysis implies that on LOGCPI, the impact of other
two macro economic variables is negligible. Rather the LOGCPI itself with the lag of 1 through
10 impacts the LOGCPI in the current period. However, in the case of LOGWPI, there is visible
impact of LOGCPI for periods 1 to 10 and LOGEXCHNG for the periods 2 to 10. In LOG WPI
the impact on LOGCPI is more than the LOGEXCHNG. In the case of LOGEXCHNG, there is
also visible impact of LOGCPI and LOGWPI for the periods of 2 to 10. The impact is more in
the case of LOGCP than the LOGWPI. In case of Sri Lanka data it implies that on LOGCPI, the
impact of other two macro economic variables is visible. The impact is near about constant in the
LOG of Exchange rate but in LOG of WPI impact increases step by step than the previous one.
However, the table reveals that in the case of LOGEXCHNG, there is visible impact of LOGWPI
for periods 2 to 10 and no impact on LOGCPI. In the case of LOGWPI, there is also visible
impact of LOGEXCHNG for the periods of 3 to 10.

After applying all the models on the data of both the countries the results do not lead us to any
clear-cut conclusion because the results from all the models are different. Granger model and
VAR model indicates that LOGCPI, LOGWPI and LOGEXCHNG does not have any influence
on each other in the case of both of the countries but the Variance decomposition model shows
visible impact of macroeconomic variables on each other in some of the cases in Indian and Sri
Lankan data which is mention above.














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