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Parth Verma I The Valuation School

CHAPTER 5

ECONOMIC ANALYSIS

Learning objectives

• Principles of. Macro & Micro economics.

• Sources of data / information of economic variable for carrying
out economic analysis
• Role of economic analysis.

Economics :

The core fundamental of economics is human action, behaviour, choices of human & how
we interact with each other to benefit ourselves as well as the society.

Tradeoffs is the cost of making one decision over another.

Let's understand the micro and macro economics now :-

5.1. BASIC PRINCIPLES OF MICRO ECONOMICS

• It deals with the behaviour of individuals making decision about goods & services.

• And how economy is impacted by the behaviour of the individual consumers & producers.

• It's philosophy is that the prices & production of goods & services depends on consumer
demand.

• It deals with Theory of Firm

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For maximising profits, firms / individuals uses different strategies
 • Importance of Microeconomics :

It deals in understanding " Free Market Economy " It helps to determine

the changes in the
Market where prices of goods and services are
economy by observing
determined by the open market and consumers.
the individuals and
firms behaviour with
Producers produces what they want and
respect to prices.
consumer consumes what they wish to.

5.2. BASIC PRINCIPLES OF MACRO ECONOMICS

• It deals with the overall economy including consumers, producers, businesses & govt
behaviour.

• The factors include unemployment rate, GDP, Inflation, saving , investment rates, etc.

• These are affected by changes in public policies.

• 2 major influence

Government Central bank ( RBI )

• Decision of government = Fiscal policy

Action of Central Bank = Monetary Policy

• Importance of macroeconomic :

Helps in understanding Consumption, various Macroeconomy

sources of income, aspect of import/export, models helps govt &
savings, investment in domestic production, central bank to form
an economy exchange rates, etc. economic policies

Parth Verma The Valuation School

 Parth Verma The Valuation School

5.3. INTRODUCTION TO VARIOUS MACROECONOMIC VARIABLES

• Government in Central Bank always want economic stability & high growth but
economics has its cycle of BOOMS & BUSTS.

• Economics is a broad subject , so read about it from additional sources as we are

sticking to the Exam course only.

5.3.1. NATIONAL INCOME

• It has a total market value of goods & services produced by a country / nation.

• It includes

Gross Domestic Product ( GDP ). Gross National Product (GNP )

• It is measured by 3 methods

Product Method Income Method Expenditure Method

• It is calculated by • It is calculated by • It is calculated

combined values of asking incomes earned by adding the
fiscal goods and by 4 types of total spending's /
services from individuals namely, consumptions of
different sectors like Employees goods & services.
agriculture , industry Professionals • It includes
& other during a Entrepreneurs imports &
specific period. exports also.
Investors
• Consumers are
• Final products = divided into 3
during a specific period
Consumed / Used by categories:
consumers. Individual
Corporate
• Products sectors Government
deals in sector wise.
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Parth Verma The Valuation School
Use of NATIONAL ECONOMIC STATISTICS

• Levels of economic welfare & growth

Reveals the overall performance of the country

It includes per capital incomes which is more accurate measure of standard of living
in a country

High per capital income High Standard of living & vice - versa.

• Distribution of incomes among constituents of the economy

Different Methods of calculating national income provides various insights of

distribution of national incomes.

example : Product method shoes the service sector as the primary contributor to
GDP with 60% contribution

• Support to Fiscal & Monetary Policies

It helps policy makers to make correct decisions.

It acts as a valuable guide to them.

5.3.2. SAVINGS AND INVESTMENT

• Savings Investment

• Savings needs to be channelised into productive avenues called investments.

• Government focus on converting savings into investments for economic growth.

• 3 types of savings

Personal Savings (ind) Corporate savings Public savings (govt)

 5.3.3. INFLATION

• Increase in price of goods & services which leads to decrease in purchasing power
over a course of times is called as inflation.

• It is measured in 2 ways : -
. Wholesale price Index (WPI)
. Consumer Price Index (CPI)

• It is caused by

DEMAND PULL FACTOR COST PULL INFLATION

Demand increases but supply remains When prices of goods & services increases
constant / decrease. because of increase in production cost, I.e., raw
materials and so on or increase in money to spend
by consumers.

• Interest and Inflation:

When inflation is high, then RBI hikes interest rates to control high inflation
and,
when inflation is low, then RBI Cuts down the interest rates.

5.3.4. UNEMPLOYMEN T RATE

If unemployment rate = high,

it shows slowdown in the economy & vice - Versa.

Parth Verma The Valuation School

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Parth Verma The Valuation School

5.3.5. FDI & FPI

• Foreign capital flows in 2 ways

FOREIGN DIRECT INVESTMENT FOREIGN PORTFOLIO INVESTMENT

(which is active form) ( which is passive form )

• active and long terms including • passive & short term without
participation in management. participation in management.

• Advantages : • It is called hot money that posses

risk because they can their money
Bring capital to the country anytime.
Job creation
New technology,skills & product
services.

5.3.6. FISCAL POLICIES & ITS IMPACT ON ECONOMY

. It determines the government revenues and expenses plans and also the spending and
taxation plan.

. It is an important aspect because the change in fiscal policy impacts the overall economy.

. Fiscal deficit : expenditure > Revenue.

. High fiscal rate + High borrowing results in high interest rates which is dangerous.

. Current account balance = Receipts - Payments

. Account Surplus : Receipts > Payments

Account deficit : Receipts < Payments

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. High current account deficit (CAD) causes Nations currency to weaken

. Capital inflows in the form of FDI and portfolio inflows balance the CAD and
protect currency.

. Expenditure is funded by government through multiple ways

P/L measures BS measures

Income from operations Borrowing

Taxation Sales of asset
Interest
Dividend income

. Government tries to balance between its inflow and outflow based on its actions,
fiscal policy is categorised as

Neutral fiscal policy

- government income and expenditure are in balance

- no major changes in fiscal policy.

Expansionary Fiscal Policy

- government spending > income

- it is used during recessions slow moving economy

Contractionary Fiscal Policy

- government spending < income

- It is used for debt repayment or asset buying.

Parth Verma The Valuation School

 Parth Verma The Valuation School

5.3.7 MONETARY POLICIES AND THEIR IMPACT ON ECONOMY

It is controlled by the Central Bank.

It deals with money supply, inflation, interest rates for economic growth and price
stability.

Expansionary Monetary Policy:

- Increase money supply and,

- Decrease Interest rates which result in pushing the economy up.

Contractionary Monetary Policy

- Reduction/ slow increase in Money supply and,

- Increase in Interest rates result in cooling down the heated economy

Central bank controls

- Repo Rate :
Rate at which Central Bank (RBI) gives money/ loan to other commercial bank

-Reverse Repo Rate:

Rate at which other commercial banks give money/loan to the central bank (RBI)

Cash Reserve Ratio (CRR)

The amount of money commercial banks needs to deposit in the central bank without
gaining any interest is called Cash Reserve.
In percentage, it is called Cash Reserve Ratio.
It take minimum (%) of total deposit.

( This is done because banks apna sara cash loan k form mein customer ko na Dede
because of interest gains)

Statutory Liquidity Ratio (SLR)

Minimum % of total deposits which commercial banks have to hold in the form of cash
equivalents such as gold & government securities.
 Parth Verma The Valuation School

5.3.8. INTERNATIONAL TRADE, EXCHANGE RATE AND TRADE DEFICIT

• It refers to the total trade of country with all other countries.

• Balance of Payment shows the transaction of a country with rest of the world. It is
divided into 2 accounts :-
Current account (transaction like import / export )
Capital account ( transaction of capital flow like FDI, FII, etc )

• If imports > exports, then current account deficit.

• If imports < exports, then current account surplus.

• Both current and capital (surplus / deficit ) together makes the balance of payment
number of a country.

• If current account is deficit then we need capital account is surplus or reduce

foreign currency reserves.

• Exchange rates refer to the value of one unit of a currency wrt other currencies.

5.3.9. GLOBALISATION

It is the ability of the individual or firm to produce & sell goods anywhere in the world.

Positives Negatives

1. Better resource allocation 1. Inequality in wealth increase.

2. Integration of developing economies 2. High competition

results in creating nephew opportunity to
learn & grow. 3. Dependency problem increases as one
part of the world affect other parts as
3. Beneficial for end consumers. well
5.4 ROLE OF ECONOMIC ANALYSIS IN FUNDAMENTAL ANALYSIS

• Fundamental focus area is on how much the business is likely to grow or shrink in
future.

• Economic analysis focus on the factors affecting external environment to understand

the direction of economy f its impact on businesses.

• GDP growth, monetary & fiscal policies , interest rates , inflation and other factors
helps in economic analysis.

5.5 SECULAR, CYCLICAL & SEASONAL TRENDS

Economic trends are classifies into 3 trends

Secular (long term). Cyclical ( Temporary). Seasonal (Predictable)

5.5.1. SECULAR TREND

• It is the long term change occurring in the economy.

• Caused by change in technology, culture, demography or consumer preference.

• Ex : Digitalisation of office results in increase in spending on digital products &

paper per consumption decreases.

Parth Verma The Valuation School

 Parth Verma The Valuation School
5.5.2. CYCLICAL TRENDS

• Temporary trends that reverses over a period of time.

• 3 types of cyclical trends are

Economic cycle. Commodity cycle. Inventory cycle

ECONOMIC CYCLE

• It refers to the process where an economy expands and contracts repeatedly.

• It has 4 phases :- Recovery:

Now again after recession when things are in
control like easy availability of money and
decrease in prices, consumers start spending.

Expansion:
Increase consumption of
good & services, high
income, low interest
rate, high demand for
products.

This all cumulatively

results in booming of
economy.
Booming - reaches
peaks.

Slow down:
Recession:
Now high prices & interest starts to decrease
the consumption and the economy starts to Low capacity utilisation leads to layoffs,
cool down. Lower capacity utilisation is seen. decrease in expansion plans, income,
consumption

The length of the phase are unpredictable. Economic cycle helps in getting the info about sales,
volume and prices.
 Parth Verma I The Valuation School

COMMODITY CYCLE

• Commodity usually follows economic cycles.

• During expansions, prices increase of commodity.

During recessions, prices decrease of commodity.

• Some times commodity cycle also behave independently from the economic cycle.
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• When commodity prices ↑ then production capacity .

And at some point when too many suppliers increase the capacity, gradually the
prices of commodity come down and thus cycle goes on.

INVENTORY CYCLE

• Short time cycles within commodity cycles.

• It occurs from changes / adjustments made in the inventories level made by suppliers
and customers.

• This causes price fluctuations.

• Inventory cycle helps in understanding the demand and prices for a public input /
output.

5.5.3. SEASONAL TRENDS

• Highly predictable fluctuations in production as well as in consumption.

• Eg : Agriculture contribution in GDP is high during harvest period.

• Analyst use seasonally adjusted growth rate or YOY consumption growth comparison to
understand the trend.
.5.6. SOURCES OF INFORMATION FOR ECONOMIC ANALYSIS

• Government Websites.

• Websites of regulators like RBI, SBI, Ministry of Finance (MOF), etc.

• Published economic research report.

• Economic Survey.

Parth Verma The Valuation School