Does the inflation rate affect the performance of the stock market ...

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M. Omran, J. Pointon Emerging Markets Reiew 2 2001 263279
stock markets. This paper focuses upon Egypt as an important example of a
successful economic experiment within the Middle East region. Since inflation has
tended to have a negative impact on stock market performance, such economic
policies have benefited the stock markets. Many academic investigations into the
impact of inflation have concentrated upon the effects on returns to investors. It
should be mentioned that the market index in Egypt was established in late 1993.
This means that to analyze statistically the impact on returns is not sensible for
such a short period of time. However, other aspects of stock market performance,
such as market activity and liquidity have been neglected. Yet, it is particularly
important for policy-makers to look at market activity and liquidity, since these
give indicators of the market’s attraction as a channel for investment and a source
of finance for businesses
When Egypt started its economic reform program by late 1990, the inflation rate
had been targeted to be under control in order to create an attractive environment
for investment. With regard to this program, Egypt has witnessed major and radical
changes in its economic climate. The aim of this program was to increase the
growth rate of the economy. This objective is not likely to be achieved without
increasing the level of investment. In turn, this investment can be obtained through
creating a strong stock exchange market that is capable of attracting local and
foreign investment. In fact, it was vital for the Egyptian economy to depress the
high inflation rate in the first stage of the economic reform program period. In
turn, the government chose to restrict the demand for goods and services by
putting the inflation rate under control in the short-term, since the other alternative,
which represented an increase in the supply of goods and services, usually,
needs a long time. In light of this, the Egyptian government introduced treasury
bills in 1991 followed by treasury bonds Ž 510 years.
in 1995. In the meantime, the
rates of interest liberalized and real interest rates became positive, and in turn, all
these procedures helped in absorbing the level of liquidity. As a conclusion, the
liquidity growth declined from over 27% in 19901991 to only 8.7% in 19971998
Ž Central Bank of Egypt 1998 ..
On the other hand, the decline in the budget deficit, combined with a relatively
stable exchange rate, assisted in decreasing the rate of inflation.
This paper will focus upon examining the impact of the inflation rate on the
stock market activity and liquidity in Egypt. In turn, we will consider previous
empirical studies on inflation and stock prices and returns, the background
literature, the hypotheses, and the data set and then move on to set out the
methodology based on co-integration analysis. The results of the analysis will then
follow, before the summary and conclusions.
2. Literature review
The impact of inflation on the Egyptian stock market does not appear to have
been the subject of prior study. However, Omran and Pointon Ž 2000.
examined the
cost of capital in Egypt based on a sample of 109 companies, although their