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Module-7
Session-13
Economic Analysis I
Outline
Fundamental Analysis
Macroeconomic Variables
Demand and Supply Shocks
Monetary and Fiscal Policy
Fundamental Analysis
For estimating the price of a stock, the security analyst must forecast the earnings and cash flows that can
be expected from the firm. This is primarily known as fundamental analysis. The performance of a
particular stock or company is affected rather determined by numerous factors associated with
economy, industry and the company itself. That is why fundamental analysis is also known as economyindustry-company [EIC] analysis. Module 7 is devoted to economic analysis. Subsequent modules deal
with industry and company analysis.
Economic Analysis
A particular firm or company is a micro unit of the economy as a whole. Fluctuations in security markets
are related to changes in expectations for the aggregate economy. Prospects of the firms are tied to those
of the broader economy even that of international economy. For some firms, macroeconomic and industry
circumstances might have a greater influence on profits and cash flows that the firms relative
performance within its industry.
Global Economy: The economic analysis should start from the global economy. Since the economies are
interrelated thus the firms across economies, the international economy can affect a firms prospects. It
affects the price competition it faces from competitors, or the profits it makes on investments abroad. At a
particular point of time, there can be variations in the economic performance across countries. Similarly,
political risks can be of greater magnitude in other countries compared to domestic political environment.
Fluctuations in currency exchange rate also affect the performance of companies. Figure 13.1 depicts the
real GDP growth of developed and emerging economies. One can see that trend is not always similar and
the pattern in rate of growth is also different. The emerging economies show higher growth in comparison
to developed economies. One need not be surprised about attraction of investors towards emerging
economies. If explored further, different countries in a particular group [emerging or developed] would
also show varied GDP growth and pattern.
Figure: 13.1: Real GDP Growth Developed Vs. Emerging Economies
Gross Domestic Product: Measure of the economys total production of goods and services.
Growth in GDP reflects opportunities for a firm to increase its revenue by selling more products
or services.
Industrial Growth Rate: Although part of GDP growth, industry growth rates indicates the activity
in manufacturing sector of the economy.
Monsoon and Agriculture: For agrarian economies these two factors are pertinent. Several
industries also depend on agriculture for inputs. Level of monsoon indicates the likely
performance of agriculture sector.
Employment and Capacity Utilization: The employment of labour as well as other factors of
production [like machine capacity] indicates the level of economic activity in the country.
Price Level and Inflation: The general level of price rise is known as inflation. When demand for
products and services are higher than the productive capacity, there can be high inflation. The
governments and monetary regulators like Reserve Bank of India try to draw a balance between
inflation, growth and unemployment.
Interest Rates: Sectors like consumer durables, automobiles and housing are highly sensitive to
interest rates. High interest rates also reduce the present value of investment.
Budget Deficit: This is the difference between government spending and revenues. The shortfall
is taken care by government borrowing. Government borrowing can impact interest rates as well
as restrict the private sector borrowings from market.
Sentiment: Depending upon the level of confidence of consumers in future income levels, they
will like to spend more in future which in turn affects the confidence of producers. Accordingly
producers plan their investment activity.
Figure 13.2 shows the trend in GDP in India vs. BSE Sensex. One can see that from 2002-03 till 2007-08,
BSE Sensex has moved in tandem with GDP.
18000
6,000,000
16000
5,000,000
14000
12000
4,000,000
10000
3,000,000
8000
2,000,000
6000
4000
1,000,000
2000
BSE Sensex
BSE Sensex
Analysing Macro Economy - Demand and Supply Shocks: The different factors that affect the macro
economy can broadly be considered as demand and supply shocks. Demand shocks are the events that
affect the demand for goods and services in the economy. Demand shocks are characterized by aggregate
output moving in the same direction as interest rates and inflation. For example, reduction in tax rates can
increase the disposable income of the consumers. This is expected to increase the demand for products
and services, which in turn can lead to increase in inflation. The events that influence production capacity
and costs are known as supply shocks. Supply shocks are usually characterized by aggregate output
moving in the opposite direction of inflation and interest rates. Natural calamity can adversely affect the
production in the economy, thus reducing the aggregate output and increase in the cost of production and
output. Consumers will not be willing to purchase the outputs at higher prices. Overall GDP is likely to
fall. Some of the examples of demand and supply shocks are given below. Analysts need to identify
industries based on the demand and supply conditions and devise the switching strategy [from one
industry to another]
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Demand Shocks
Reduction in Tax rates
Increase in money supply
Increases in government spending
Supply Shocks
Natural calamity
Changes in educational level of workforce
Changes in the wage rates
Changes in the price of imported oil
Economic Analysis
Industry Analysis
Company Analysis
Q.2.: What are the key domestic economic variables to be considered for economic analysis?
Ans.: The following domestic economic variables need to be considered for economic analysis.
Q.3.: What is meant by demand shocks and what are different methods of demand shocks?
Ans.: Demand Shocks: an event that affects the demand for goods and services in the economy. Demand
shocks are characterized by aggregate output moving in the same direction as interest rates and inflation.
Different methods of demand shocks are:
Q.4.: What is meant by demand shocks and what are different methods of demand shocks?
Supply Shocks are events that influence production capacity and costs. Supply shocks are usually
characterized by aggregate output moving in the opposite direction of inflation and interest rates. Some of
the examples of supply shocks are:
Natural calamity
Changes in educational level of workforce
Changes in the wage rates
Changes in the price of imported oil