eBusiness Weekly
Blessing Nyatanga
The Zimbabwe Stock Exchange is an avenue for efficient capital mobilisation and allocation through domestic and foreign portfolio investment in listed entities.
In Zimbabwe’s financial system, there are two interest rates, the lending rate which is the cost of capital or borrowing and the deposit rate which is the rate of return on savings.
Various financial models and economic theories have long attempted to establish and investigate the relationship between interest rates and stock market performance.
Empirical studies have shown that the relationship between interest rates and the stock market is dynamic and patterns of interactions remain unclear. They vary with the level of the country’s economic development.
Several studies have been done on how stock market development affects economic growth and how stock market development impacts the financial development process.
However, none of these studies have highlighted how changes in interest rates affect the behaviour of stock market investors, especially from a Zimbabwean perspective hence the need to establish the relationship between interest rate shifts and stock market performance.
Economists are of the opinion that the stock exchange is a vehicle for providing liquidity in the economy, promoting efficient capital allocation. Stock markets and interest rates influence economic growth because of their direct relationship with savings and investments in the economy.
The interest rate plays a great role in portfolio determination. According to the desired portfolio allocation theory, investors want to maximise their returns in the short run and the interest rate will determine their portfolio allocation between capital markets and money markets.
When the interest rate is low and inflation is on the rise, investors will seek safe custody on the capital markets. How such movement of capital between money and capital markets affects the performance of the stock market remains a grey area that has not been touched especially in the context of Zimbabwe’s financial markets.
This article will seek to determine how changes in interest rates affect the performance of Zimbabwe’s stock market.
Empirical evidence shows that interest rates have a significant impact on the performance of stock markets.
Stock markets are classified as high-risk instruments hence the negative relationship with interest rates as compared to money markets which are less risky and positively correlated to interest rate.
According to the McKinnon-Shaw hypothesis, the investment function is negatively correlated with the interest rate. They defined interest rate as the cost of capital hence when the cost of capital is low the firms have access to cheap credit leading to profitability, when firms are profitable their share price increases hence investment in the firms because of investor expectations on dividend and share price growth.
Stock markets and money markets are close substitutes, with the interest rate being the rate of return for money. When there is a low-interest rate investors will move to stock markets in search of higher returns resulting in better stock market performance.
Investor sentiment and expectations affect stock markets. When investors expect changes in government policy with emphasis on the fiscal and monetary policy, the information is fully reflected in share prices, for example expansionary monetary policy leads to improved stock market performance because of the provision of low-interest rates.
Industry performance has a major effect on stock market performance because portfolio allocation theory states that investors will tend to invest in profitable sectors where there is a provision for higher dividends.
Industry performance affects stock market performance because firms in the same sector are affected by the same market conditions.
In the long run, a negative relationship exists between the real rate and stock market performance. This is explained by the exposition that high real rates do not proffer any incentive for stock market investment while lower real rates attract stock market performance.
The Government should adopt an expansionary monetary policy in an attempt to enhance stock market performance.
It has been ascertained that a significant negative relationship exists between the interest rate and the stock market hence lowering interest rates will lead to the stimulation of stock market performance and an increase in money supply stimulates stock market performance.
The Reserve Bank of Zimbabwe has control over all the domestic factors which are the interest rate, money supply, and inflation however, the exchange rate is a global factor so the authorities lack autonomy in influencing the exchange rate.
The Government through the central bank should adopt a policy framework that stimulates domestic and foreign investment on the ZSE and this encompasses low-interest rates, moderate inflation, sustainable growth of money supply, and a stable exchange rate.
Blessing Nyatanga holds a Bachelor’s Degree in Banking and Investment Management from National University of Science and Technology.0784909184/[email protected]
