Interlinkages Between Stock Market Volatility, Balance Of Payments, And Foreign Exchange Reserves: An Empirical Study

Abstract

The present study analyzes the dynamic interrelationship between stock market volatility, BoP movement, and FER in the context of emerging economies, with a focus on India. Considering that financial markets and external sector variables are deeply interlinked, this paper investigates how fluctuations in the stock market influence the country's external balance and reserve management. Adopting quarterly time-series data from 2010 to 2024, the study uses advanced econometric models such as the Johansen Co-integration Test, VECM, and Granger Causality Test to capture the long-run equilibrium along with the short-run dynamic relationship among the variables. The results show the presence of a significant long-run co-integrating relationship among SMV, BoP, and FER, indicating that over time these variables move together to attain a stable equilibrium. The VECM results confirm the long-term stability since the deviations from equilibrium are corrected gradually. The causality from stock market volatility to foreign exchange reserves is bidirectional, meaning the fluctuation in the financial markets affects the level of reserve, while the adequacy of reserve impacts market confidence. BoP exerts a unidirectional causal impact on FER, reflecting its stabilizing role in maintaining external balance. This paper, therefore, suggests that macro-financial coordination between monetary and capital market regulators is immensely required to attain sustainable external stability along with investor confidence. In this respect, the effective policy synchronization, robust reserve management, and sound capital flow regulation may help in mitigating the volatility-induced shocks and, hence, enhancing the resilience of emerging economies like India.