Economic Analysis
Economic Analysis is a study of the general economics factors that go into an evaluation of the security's value. The stock market is an integral part of the economy. when the level of the economy. When the level of the economic activity is low, stock price are low, and when the level of the economic activity is high, stock prices are high, reflecting a booming outlook for the sales and profits of the firms. an analysis of the macroeconomic environment is essential to understand the behavior of stocks prices. the commonly analyzed macroeconomic factors are as follows:
- Gross Domestic Product (GDP)
- Savings And Investment
- Inflation
- Interest rates
- Budget and Fiscal Deficit
- Tax Structure
- Balance of payment
- Foreign Direct Investment
- Investment by Foreign institutional investors
- International Economic Conditions
- Business Cycle and investor psychology
- monsoon and Agriculture
- infrastructure facilities
- demographic factor
Gross Domestic Product (GDP)
The GDP represents the aggregate monetary value of goods and services produced in the economy during a specified period. Although GDP is usually calculated on an annual basis, quarterly estimates are also available. the common equation for the calculation of GDP is
GDP = Consumption + Investment + Exports - Imports
The growth rate of GDP points out the prospectus for the industrial sectors and the return investors can expect from the investment in shares. A decline in the GDP indicates a Potential economic slowdown. A high GDP growth rate is Advantageous to the stock Market.
The 1990s Marked the initiation of the rise of the Indian GDP growth rate with the opening up of Indian Markets to foreign direct investments (FDI) and FIIs. Real GDP growth at factors cost increased to 8.5% in 2010-11 from 8% in 2009-10. According to the RBI Annual Report (2010-11) the real GDP growth rate increased for the second successive year after the global crisis induced a sharp slowdown in 2008-09.
Savings and Investment
It is obvious that growth requires investment, which in turn, requires a considerable amount of domestic savings. growth in savings naturally leads to more investments. High capital investment means possibility of more production, more demand and supply, better prices in the future and consequently, higher business profits and a positive outlook for the stock market. Savings are distributed over different assets like equity, savings, deposits, mutual funds units, real estate, and bullion. the primary market is a channel through which the savings of investors are made available to corporate bodies. Over the years, household and private corporate savings have increased and, in turn, the gross domestic investment has also increased.
Inflation
A simple explanation of inflation is that it refers to a situation where too much money is chasing too few goods. Inflation indicates a rise in the price of goods and services. along with growth of GDP in the economy, if the inflation rate also increases, then the real rate of GDP would be very low. inflation and stock markets have a very close relationship. If there is inflation, the stock market is adversely affected. The price of the stock is directly related to the performance of the company. Inflation typically results in the following:
- High Raw material cost
- non availability of cheap credit due to rise in interest rates
- low earnings
Interest Rate
Interest rates have a direct impact on the economy. The base rate of banks affects the cost of borrowed funds. The base rate is the minimum rate of interest at which banks lend to anyone. it is the floor rate below which the RBI will not allow banks to lend. The bank rate range for scheduled commercial banks for march 2011 was as follows:
- Public Sector Banks - 8.20 - 9.50%
- Private Sector Banks - 8.20- 10.00%
- Foreign Banks - 6.25 - 11.75%
A decrease in the interest rate implies low cost of finance for the firms and more profitability. More money is available at a low interest rate to brokers who do business with borrowed money. Availability of affordable funds encourages speculation and a rise in the price of shares.
An increase in lending rates affects negatively firms which depends on the banks for their working capital and growth requirements.
Budget and Fiscal Deficit
the budget drafts provides a detailed account of government revenues and expenditures. A deficit budget nay be lead to high rate of inflation and adversely affect the cost of production. A surplus budget may be result in deflation. A balanced budget is highly favorable to the stock market.
Fiscal deficit is the difference between the government's total receipts and total expenditure.
Fiscal Deficit = Total Expenditure (revenue + capital) - (revenue receipts + non debt capital receipts).
if the capital expenditure in total expenditure is high and a deficit occurs, it is healthy sign. Capital expenditure augment the productive capacity of the economy.
Tax Expenditure
Every year in March, the business community eagerly awaits the statements from the government regarding the tax policy. Concession and incentives given to a particular industry encourages investments in that particular industry. the finance minister introduced tax exemptions for the stock market investments in the union budget (2012-13) to attract retail investors to the stock market.
Balance of Payments
The Balance of Payments is the record of a country's money receipts from abroad and payments to foreign countries. The difference between receipts and payments may be a surplus or a deficit. Balance of payments is the measure of the strength of the rupees on the external account. if the deficit increases, the rupee value may depreciate against other currencies, thereby affecting the cost of imports. Industries involved in the exports and imports are markedly affected by changes on the foreign exchange rate. The volatility of the foreign exchange rate affects the investments of the foreign institutional investors in the Indian stock market. A favorable balance of payments has a positive effects of the stock market.
Foreign Direct Investment
According to the International Monetary fund (IMF), the definition of foreign direct investment includes different elements, namely, equity capital, reinvested earnings of foreign companies, inter company debt transactions, short term and long term loans, financial leasing, trade credits, investments made by foreign venture capital investors, and so on. FDIs help in the upgrading of technology, skills, and managerial capabilities and bring much needed capital in the economy. They also help in providing employment opportunities. Inflow of capital helps the economy grow and has a positive impact on the stock Market.
Investment By Foreign Institutional Investors (FIIs)
FIIs are considered to be the main drivers of the stock market. Outflows of FIIs investment affect the stock market negatively. According to a report in the times of India , net investment by FIIs in the stock market in 2011-12 were the lowest of the past three years, and stood at Rs.47935 crores. The stock Market barometer Sensex lost 2041 points or 10% in fiscal 2011-12. The index finished at 17404.20 points on 30 March.
Considering the importance of FIIs Investments, in January 2012, the government announced its decision to allow qualified foreign investors (QFIs) to invest directly in the Indian equity Market, in August 2011 the government allowed foreign investors to invest directly to the extent of $13 Billion in equity and debt Schemes of mutual funds.
International Economics Conditions
worldwide economies are not independent but interdependent. The boom or depression in one country is affects other countries and the stock market too. For Example, the sub prime crisis in the U.S. bankruptcy, and a 29% drop down in the Dow Jones and Nasdaq had an impact on the Indian economy. IT industries financial sectors, real estate, the automobile industry, investment banking, and others industries faced heavy losses. Further the global recession results in the pulling of FII funds from the Indian stock market. The Sensex plunged and Became highly volatile in 2008.
Business Cycle and Investors Psychology
During a boom, economic activity is at its peak, and the growth of industry and GDP are prominent. Companies record high turnover and profits. They Engage in Expansion plans, mergers, and acquisition. This leads to investors Optimism. Retail Investors big and small, are enthusiastic about the market and are willing to invest. the market reaches new high.
Some of the companies may fail to fulfill the goals and as their profit margins fall, the next phase of the trade cycle, a recession sets in. Economic growth declines, and there is an economic slowdown. the stock market reacts with a fall in price and volume of stock. Fear grips the market. The recession slips into depression. It results in additional fall in growth rates and increase in unemployment. The investors becomes pessimistic about the market. Panic prevails, and the stock market reaches a low level.
After a while the economy slowly begins to recover. Some entrepreneurs begins to realizes the things cannot get any worse and start investing in the business . The recovery starts. In the stock market, the mood changes to hope and caution. Once again, the cycle goes on.
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