6 Vol. 6.

3 (2012) The Dyke

Zimbabwe Industrial Equity Index Determinants in the Multiple

Currency Regime

*Chikoko L and 1Samu A

*Department of Banking and Finance
Midlands State University
Gweru, Zimbabwe

1
Community Development Trust Prospect
Harare, Zimbabwe

Abstract
The objective of this paper is to determine the sensitivity of the Zimbabwean Industrial equity index to
fluctuations in macroeconomic variables. The research used an explanatory research design, through
quantitative analysis employed on historical monthly time series from March 2009 to December 2011.
Empirical results point to the existence of a long-run relationship between Zimbabwe Stock Exchange
(ZSE) performance and interest rates, oil prices and the manufacturing index. Interest rates and international
oil prices had a positive significant impact on the ZSE performance. However, the manufacturing index
showed a significant negative relationship with the ZSE industrial index. The findings point to the fact
that ZSE investors and potential investors should pay more attention to the trends of the aforementioned
variables for them to consistently beat the market in the multiple currency era. Qualitative factors that are
not incorporated in the study should be considered in making investment decisions, since the aforementioned
variables are reported to account for only 67.09 percent of the variations in ZSE performance. Overally, the
model exhibited that macroeconomic variables have a significant long run relationship with the ZSE
performance; hence they are the leading indicators of the stock market performance.

Key Words: Zimbabwe Stock Exchange, Industrial Equity Index, Performance, Sensitivity

1 Introduction
The stock exchange has been perceived by many as the backbone of most
contemporary economies, serving a critical need of raising capital funds for companies
at a reasonably low cost as compared to other sources of finance such as borrowing.
The Zimbabwe Stock Exchange (ZSE) has become very important as an investment
vehicle for both local and international investors especially after the introduction of
the Economic Structural Adjustment Program (ESAP) in 1991 when borrowing
rates increased to levels above 100%, (Sunde and Sanderson, 2009).
The Dyke Vol. 6.3 (2012) 7

The Zimbabwean dollar lost its power as a legal tender in late 2008 at the height of
macro-economic instability and hyperinflation which peaked at 231million percent
in July 2008, (RBZ, 2008). The ZSE had become the epicentre of economic
destruction as it allowed some stock brokers to falsely bid up stock prices when in
fact the same stock brokers had absolutely no money to pay for the shares. The
end result was that some counters grew by, as high as 2 million percent in a single
day (Techfin Research, 2009). Figure 1. depicts the trend followed by the industrial
index from the period 1999 to 2008.

10000000

9000000
8000000
Industrial Index

7000000
x
e
d 6000000
n
Il
ai 5000000
trs
u 4000000
d
n
I
3000000
2000000
1000000
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Year

Figure 1: Zimbabwe Industrial Index Trends

Source: Techfin Research (2009)

There was a steady rise of the industrial index from 1999-2005. In 2006, Zimbabwe
experiencing problems of high inflation with the industrial index rising sharply.
Inflation rates galloped during the period 2007 and 2008 and this caused the ZSE
industrial index to astronomically reach high levels. In this case inflation played a
profound role in determining the stock market returns.

In 2009, the government of Zimbabwe introduced a multiple currency regime. The use
of the multiple currencies and the suspension of the Zimbabwean dollar from the
monetary system resulted in curing the problem of hyperinflation which stabilised the
 8 Vol. 6.3 (2012) The Dyke

economy. Regardless of this, stock values were not revalued to match the current value
of the prevailing currency. This led to investors being sceptical of whether to invest or
withdraw investments. The resulting effect has been the ZSE performance dropping
considerably. The ZSE has not been performing well compared to the international
stock exchanges such as the Johannesburg Stock Exchange, All Share and the Standard
& Poor 500. The question therefore is whether macroeconomic variables had a bearing
on the ZSE performance in the multiple currency system. It is against this background
that the main objective of the study is to determine the sensitivity of the Zimbabwean
industrial equity index to fluctuations in macroeconomic variables.

Literature Review

There are many theories and models that predict an association between
macroeconomic variables and stock market returns. Theories and models that
predict an association between macroeconomic variables and stock market
performance are given below.

(i) The Dividend Discount Model (DDM)

The Dividend Discount Model (DDM), proposed by Gordon (1962), predicts
that the price of a share of common stock is the present value of all future
cash flows (dividends) that it is expected to provide over an infinite time
horizon. Mathematically, this relationship can be represented as follows:
Dt
Pj " ....................................................................... (i)
k!g
Where: Pj - is the price of common stock j, Dt - is the dividend during
period t, k - is the required rate of return on stock j,
After simplification, equation (i) decomposes to:
D1
Pj " ...................................................................... (ii)
k!g
Where: D1 - is the dividend in period 1 and g - is the constant growth
rate of dividends.

Equation (ii) denotes that the share price depends on future dividends (D1)
and the required rate of return (k) on that share.

Any macroeconomic variable that may have an influence on future dividends

or the required rate of return (discount rate) should have an influence on
the share price. The model is applicable especially in the case of ZSE when
the multiple currency system was introduced in 2009.
The Dyke Vol. 6.3 (2012) 9

To the best interest of researcher‘s knowledge, The stocks held during that time
were not revalued to match the current value of the prevailing currency , hence all
the stocks lost their values significantly. Therefore the investors were sceptical of
whether to invest or withdraw their investments. This contributed to the poor
performance of the ZSE and this confirms the idea that any economic variable,
(such as foreign exchange) which impact future cash flows and the required returns,
is expected to influence stock market performance. Miller and Modigliani (1961)
supported this school of thought that the determinants of share prices are the required
rate of return and expected cash flows suggesting that economic factors that influence
the expected future cash flow and required rate of return also affect the share price.
This assertion lends weight to the idea that macroeconomic variables are the major
determinants of stock market performance.

(ii) The Arbitrage Pricing Theory (APT)

The Arbitrage Pricing Theory (APT), which was developed by Ross (1976), contends
that returns on an individual stock will depend upon a variety of variables in an
economy. It is built on the premise that investors take advantage of arbitrage
opportunities, though they are short-lived. This means that the return of any asset
can be written as follows:
R i " E i $ # ............................................................................ (iii)

Where: Ri - is the total return on asset i, Ei - is the expected return component and
µ - is the unexpected return component.
The surprise in return (µ) comes from market-wide (m) and firm specific (å) sources,
such that equation (iii) can be rewritten as:
Ri " E i $ m $ % i ........................................................................ (iv)

The market-wide risk (m) under the APT is measured by economic fundamentals
and can therefore be decomposed to specific economic factors as follows:
Ri " E i $ ( ' i1( i $ ' i 2& 2 $ ........ $ ' ik & k ) $ % i .............................. (v)

For i =1-N
Where: âik - Reaction in asset is return to movement in a common factor, ók
– multiple factors expected to have an impact on the returns of all assets
(economic fundamentals) and N - number of assets.

The APT essentially seeks to measure the risk premium attached to various factors
that influence the returns on assets, whether they are significant or whether they
are priced into stock market returns. While the APT focuses on individual security
10 Vol. 6.3 (2012) The Dyke

returns, it may also be used in an aggregate stock market framework, where a

change in macroeconomic variables could be seen as reflecting a change in an
underlying risk factor regarding future returns. This theory is relevant to the case
of ZSE as the macroeconomic environment gradually stabilised after the
introduction of the multiple currency system in the economy. Macroeconomic
variables such as inflation dropped to a single digit and as a result, national output
improved among other things. It is apparent that the current multiple currency
era presented investors with minimum risk regarding future stock returns.
Therefore economic variables are essential in determining stock market
performance as they are the ones that influence future stock returns.

(iii) The Efficient Market Hypothesis (EMH)

The Efficient Market Hypothesis (EMH) championed by Fama (1970) in particular
the semi-strong form efficiency which states that stock prices must contain all
relevant information including publicly available information, has important
implications for policy makers and the stock broking industry alike. Policy makers
should feel free to conduct national macroeconomic policies without the fear of
influencing capital formation and the stock trade process. However, this is contrary
to what happened on the ZSE as the mere announcement of the immediate use of
multiple currency system affected the market‘s future stock returns significantly
and ultimately the performance.

Moreover, economic theory suggests that stock prices should reflect expectations
about future corporate performance, and corporate profits generally reflect the
level of economic activities. If stock prices accurately reflect the underlying
fundamentals, then the stock prices should be employed as leading indicators of
future economic activities, and not the other way around. As for the effect of
macroeconomic variables on stock market performance, the EMH suggests that
competition among the profit-maximizing investors in an efficient market, will
ensure that all the relevant information currently known attract changes in
macroeconomic variables are fully reflected in current stock prices, so that investors
will not be able to earn abnormal profits through prediction of the stock market
movements. Empirically, studies investigating the relationship between
macroeconomic variables and stock returns have been carried out in a number of
stock markets using varying types of datasets. However, the results are not
conclusive. Some of the studies are outlined below.

Maysami et al (2004) studied the relationship between macroeconomic variables

and stock market indices for Singapore for the period January 1989 to December
The Dyke Vol. 6.3 (2012) 11

2001. The researcher used the Vector Error Correction Model (VECM) to test the
relationship between macroeconomic variables and the various sector indices. The
results from the study confirmed that stock returns were positively and
significantly related to the industrial production index. The general conclusion
held was that the Singapore Stock Market and the equities property index formed
significant relationships with many macroeconomic variables. The research
supports the theory that macroeconomic variables are the driving forces towards
stock market performance.

The effects of macroeconomic variables on stock returns were also examined by

Buyuksalvara (2010) in relation to the Turkish Stock Exchange Market. The study
embraced seven macroeconomic variables (consumer price index, money market
interest rate, and industrial production index, among others). A multiple
regression model was designed to test the relationship between the Turkish Stock
Market Index (Istanbul Stock Exchange Index (ISE) returns and seven
macroeconomic factors. The results of the study indicated that interest rate,
industrial production index, oil price and foreign exchange rate have a negative
effect on ISE index returns while money supply positively influenced ISE Index
returns. On the other hand, inflation rate and gold price did not appear to have
any significant effect on ISE index returns.

In their study, Sohail and Hussain (2009) investigated the long-run and short-run
relationship between macroeconomic variables and stock prices in Pakistan Lahore
Stock Exchange using monthly data for the period December 2002 to June 2008.
The results revealed that there was a negative impact of consumer price index on
stock returns, while industrial index, real effective exchange rate and money supply
had a significant positive effect on the stock returns in the long run. The results are
in line with the assertion that inflation, industrial performance and foreign exchange
can determine stock returns. In Zimbabwe, prior to dollarization, inflation and foreign
exchange rate fluctuations played a major role in eroding stock returns.

Frimpong (2011) examined the speed of adjustment of stock prices to

macroeconomic information for the case of Ghanaian Stock Exchange using
monthly Databank Stock Index (DSI) from November 1990 to December 2007.
The researcher used the Granger causality test to show unidirectional causality
from macroeconomic information with exchange rate being the slowest. The
researcher also argued that the speed of adjustment of exchange rate reflects the
behaviour of foreign investors. This confirms the theory that macroeconomic
variables determine stock market performance.
12 Vol. 6.3 (2012) The Dyke

Scholars investigated the long run equilibrium relationship between the major
stock indices of Singapore and United States and selected macroeconomic
variables by means of time series data for the period January 1982 to December
2002. The results suggested that Singapore‘s stock prices generally displayed a
long- run equilibrium relationship with interest rate and money supply (M1)
but the same type of relationship did not hold for the United States. To capture
the short-run dynamics of the evolving relationship between stock indices and
macroeconomic variables, they applied the same methodology for different
subsets of data covering shorter time periods.

Njanike et al (2009) assessed the factors that influenced the Zimbabwe Stock
Exchange’s performance from 2002 to 2007. The study sought to identify and define
the major drivers of the bourse during this period and use them to guide an investor
on the ZSE or any other stock exchange in a developing economy. High inflation
rates as documented by various researchers e.g proved to have a positive relationship
with the stock market performance. From the research conducted, it shows that
there is much credit given to the inflationary influence among others. Interest
rates showed a significant impact on the price fluctuation on the ZSE had it has an
effect of reducing or increasing price of stocks. The ZSE was also affected by
information announcements and other various activities taking place. This included
political news, monetary and fiscal policies that saw the stock market reacting to
such. This is in line with the assertions of the EMH.

Acikalin et al (2008) looked at the relationship between returns in Istanbul Stock

Exchange (ISE) and macroeconomic variables of Turkish economy. The researchers
employed the Cointegration tests and vector error correction model (VECM) on a
quarterly data set and found a long-term stable relationship between ISE and four
macroeconomic variables namely, GDP, exchange rate, interest rate, and current
account balance. They then carried causality test and found a unidirectional
relationship between macro-indicators and ISE index. This is consistent with the
existing literature which demostrates that; changes in GDP, foreign exchange rate
and current account balance have an effect on stock returns. However, contrary to
expectations, changes in the stock market index proved to affect interest rates.

Methodology

The research uses an explanatory research design, through quantitative analysis

employed on historical monthly time series from March 2009 to December
2011. The researcher employed econometric procedures to estimate the resultant
The Dyke Vol. 6.3 (2012) 13

equation for the dependent variables. A linear regression model was used. The
econometric views package was used to estimate the equation.

Model Specification
Adam and Tweneboah (2008) in the study on the effects of macroeconomic variables
on stock market movement in Ghana employed a model of the following form:
LDSI t " ' 0 $ ' 1 LCPI t $ ' 2 LXR t $ ' 3 LTB t $ ' 4 LFDI t $ % t
Where: LDSI is the log of Databank Stock Index,
LCPI is the log of Consumer Price Index,
LFDI is the log of Net Foreign Direct Investment Inflows,
LXR is the log of Exchange Rate,
LTB is the log of Interest Rate.
åt is the error term

The above model has been modified by replacing the net foreign direct investment
inflows with the manufacturing index and international oil price. Apart from that,
the consumer price index was removed as it involved some negative values in the
multiple currency regime of which there were no natural logarithmic values for
negative numbers. The estimation of the relationship is expressed in natural
logarithms. The model that is used to explain the determinants of ZSE performance
in the multiple currency regime is specified as follows:

LZII t " ' 0 $ ' 1LIrt $ ' 2 LOPt $ ' 3 LMI t $ % t

Where LZII t - is the natural log of stock market price in period t and the
industrial index is
the proxy for the ZSE performance,
LIr t - is the natural log of interest rate in period t and monthly
negotiable certificate of deposit (NCDs) is used as proxy for interest rate,
LOPt - is the natural log of international crude oil price in period t,
LMI t - is the natural log of the manufacturing index and is a proxy
for economic growth,
% t - is the error term during period t, is assumed to be normally
distributed with zero mean and constant variance.
Where â0, â1, â2 and â3 are estimation parameters and â0 is the intercept.
A priori conditions: â0>0, â1<0, â2<0 and â3>0.

Empirical Results
Stationarity and Cointegration Test Results.
The unit root tests were undertaken to ascertain the level of stationarity for each of
14 Vol. 6.3 (2012) The Dyke

the variables in the model using the Augmented Dickey- Fuller (ADF) test. The
results are presented in Table 1 below:

Table 1: Summary of Unit Root Tests Results

Va riable ADF test statistic Critical values Order of integra tion

1% -2.6756
LZII -6.438333*** 5% -1.9574 I(1)
10% -1.6238
1% -2.6756
LIR -4.621112*** 5% -1 .9574 I(1)
10% -1.6238
1% -2.6756
LOP -4.219017*** 5% -1 .9574 I(1)
10% -1.6238
1% -2.6756
LMI -7.697146*** 5% -1.9574 I(1)
10% -1.6238
1% -2.6700
Res idual b -6.221392*** 5% -1 .9566 I(0)
10% -1 .6235

Note: *** indicates statistical significance at 1 percent.

These results confirm the generally held wisdom that most economic time series
are difference stationary. Therefore in the case of industrial index, interest rate, oil
price and manufacturing index, H0 must not be rejected.

Cointegration Tests

Cointegration means that despite the fact that the series are individually
nonstationary, a linear combination of two or more time series can be stationary.
In general, if Yt is I(d) and Xt is also I(d), where d is the same value, these time series
are said to be cointegrated. However, the researcher still proceeded to carry out
cointegration test employing the Engle-Granger‘s residual based unit root test to
The Dyke Vol. 6.3 (2012) 15

verify this. The residuals from the cointegrating equation were found to be
stationary at level, confirming that the time series are cointegrated. This implies
that the coefficients of the cointegrating equation can be interpreted as the long
run coefficients, measuring the long run relationship between the variables. In
effect, there exists a long run relationship between industrial index, interest rate,
oil price and manufacturing index under the study.

Table 2: Summary of Regression Results

Variable Coefficient S td. Error T-statistics Probab ility

L Irt 0.293812 0 .119178 2.465314 0.002

L OPt 0.719591 0 .180708 3.932077 0.0007

L Mlt -0.888651 0 .268280 -3.31 2399 0.0035

C 4.344306 0 .965190 4.500987 0.002

R2 = 0.670868 F Statistic = 13.58865

Adjusted R2 = 0.621498 Prob (F-statistic) = 0.000046
DW statistic = 2.038993 T- statistic from the tables is 1.725

The t-statistic of 1.725 is the critical value for the t-ratios and was extracted
from Tables at 5 percent level of significant and 20 as degrees of freedom. The
decision rule is to reject the null hypothesis that the variable is insignificant if
its t-statistic is greater than the critical value from tables. Since all the t-statistic
values are greater than the critical value, it can be concluded that all the variables
including the intercept are significant at 5% level. The estimated model is:

LZII t " 4.344306077 $ 0.2938120665 LIrt $ 0.7195913902 LOPt ! 0.8886507517 LMI t

Where LZIIt is the natural logarithm of the industrial index
LIrt is the natural logarithm of interest rate
LOPt is the natural logarithm of international oil price
LMIt is the natural logarithm of manufacturing index
16 Vol. 6.3 (2012) The Dyke

A coefficient of determination (R2) of 0.670868 means that around 67% of the

variations in industrial index, a proxy for ZSE performance are determined by the
explanatory variables in the model and about 33% are accounted for by the residual.
Whereas, the adjusted R2 of 62.1498% shows the percentage of the ZSE performance
which is still explained by the explanatory variables even if the degrees of freedom
are taken into consideration. The model in question has an F-statistic of 13.58865,
hence the model specified, is therefore a good fit. All the explanatory variables
were found to be significant even using the t-statistic from the tables.

The exogenous variable or the autonomous component of 4.344306077 shows the

returns on riskless assets which investors can invest in such as treasury bills. This
means that if there is zero impact from the macroeconomic variables investors
could still enjoy returns from zero risk assets. The findings of this research renders
the constant term useful since it has a statistically significant t-statistic of 4.500987.
The coefficients of the natural logarithms are interpreted as elasticities and they
show the degree of responsiveness or sensitivity. Interest rate is significantly positively
related to industrial index, a proxy for ZSE performance. The coefficient of
0.2938120655 implies that a proportionate rise in interest rate will cause
0.2938120655 proportionate change in ZSE stock prices. This means that as interest
rates rises, investors tend to invest more in stocks, causing stock prices to rise. The
t-statistic results of 2.465314 shows that interest rates were positively significant in
determining ZSE performance. This means that the null hypothesis that interest
rate does not determine ZSE market performance must be rejected. Again, the
sign of coefficient (â3>0) is contrary to theory. Wong et al (2005) found that interest
rates in Singapore moved in tandem with stock prices, but the pattern was not
observed after the Asian crisis of 1997. This might explain what happened to
Zimbabwe after the 2008 economic crisis.

The coefficient of oil price was found to be statistically significant and positive.
Although contrary to theory, this means that in Zimbabwe, oil is an important
factor in determining production costs of firms. However, in theory, increase in oil
prices will be beneficial to oil-exporting countries and as such a positive relationship
between stock and oil prices is expected in such countries. On the other hand, oil-
importing countries (like Zimbabwe) are expected to experience a negative
relationship between stock and oil prices. The findings documented in this study
were contrary to theory. A study found a negative relationship between oil price
and stock market performance for the case of Turkey.

An interesting finding is the relationship observed between the manufacturing

index (a proxy for economic growth) and industrial index (a proxy for ZSE
The Dyke Vol. 6.3 (2012) 17

performance). The effect of the manufacturing index on ZSE performance is

statistically significant as expected, but with an unexpected sign. It had a coefficient
of -0.8886507517 implying that a proportionate rise in the manufacturing index
would lead to 0.8886507517 proportionate fall in the ZSE performance which is
contrary to existing theory.

Conclusions and Recommendations

Interest rate, international oil price and the manufacturing index (a proxy for
economic growth) were found to be significant in determining the ZSE
performance.Macroeconomic variables such as interest rates, international oil prices
and the manufacturing index (a proxy for economic growth) have a long run linear
and significant relationship between macroeconomic variables and the ZSE
performance. During the period under study, interest rates and international oil
prices proved to have a positive and significant association with the industrial index,
a proxy for ZSE performance.The manufacturing index exhibited a significantly
negative relationship with the industrial index. The aforementioned variables
account for 67.09 percent of the variations in ZSE performance, hence investors
should also consider other risk factors not discussed in the study when making
their investment decisions.

The significance of interest rates in determining the ZSE performance shows that
interest rates are an effective policy instrument. Low interest rates regimes entail
increased profitability due to decreased cost of servicing loans. This will lead to
enhanced productivity by companies, resulting in increased profit expectations of
investors. :This in turn leads to an upward movement of the expected stock
market returns and therefore stock market performance.

If the government intends to increase the level of investments on the stock

exchange, it can make use of the interest rate since they is no time lag on the
response of investors to changes in interest rates. Interest rates on the local bourse
can be used as a tool for decision making with more certainty by investors because
of the relationship that was found to exist. Low interest rates in the absence of
inflationary pressures make stock market investments more profitable in
comparison to the money market investments. Governments should continuously
review their interest regimes so that they promote savings and investments.

The manufacturing sector was estimated to have grown by 10.2% in 2009 and the
sector was projected to post a lower growth of 4.5% in 2010 (RBZ, 2010). However,
18 Vol. 6.3 (2012) The Dyke

the growth of the manufacturing sector shows the growth potential of the whole
economy. Therefore, the growth of the manufacturing sector can be enhanced through
duty reduction on capital equipment, access to lines of credit, stabilisation of the
macroeconomic environment which fosters long term planning and a sustainable
power supply. An improvement in the manufacturing sector performance would
ensure an increased level of investment on the ZSE through an increase in liquidity.

The government should provide an enabling environment for investment. Investors

should always be on the watch for monetary policy changes because the impact of
the monetary transmission mechanisms are significant and necessary quick
portfolio changes are needed to curb for losses. Again, the ZSE as an organization
should make strategies that will encourage strong form efficiency by ensuring
that stock prices reflect all the available information at all times. This will eliminate
the spirit of arbitrage and speculation on the part of investors since stock markets
will now be reflective of the actual economic activity.

Finally, investors who are interested in investing on the ZSE should pay more
attention to the trend followed by the interest rates, manufacturing index and
international oil prices. Since the aforesaid variables account for 67.09 percent of
the variations in ZSE returns, investors should also consider other risk factors not
discussed in the study when making their investment decisions.

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