Economic Analysis

1Microeconomics

Economics studies choices under scarcity, assuming people are rational and face trade-offs. Microeconomics looks at individuals and firms: how consumers decide what to buy at given prices, how their choices shape supply, demand and prices, and the theory of the firm (how firms choose inputs, output and prices to maximise profit). Its premise is that prices and production are driven by consumer demand. It explains how prices are set and how goods are distributed under different market structures.

Remember

• Micro = individuals and firms; prices and output.

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2Macroeconomics

Macroeconomics studies the whole economy: aggregate supply and demand, GDP, unemployment, price levels and inflation, savings and investment. These are shaped by public policy from the government (fiscal policy) and the central bank (monetary policy). John Maynard Keynes's General Theory of Employment, Interest and Money transformed macroeconomic thinking.

Uses: understanding the general state of the economy (production, consumption, prices, growth, quality of life); the drivers of income, savings, investment and employment; designing policy for stable long-run growth; international trade, the balance of payments and exchange rates; and links between economies.

Remember

• Two big policy makers: government and central bank.

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3National income

Policy makers aim for low unemployment, stable low inflation and steady growth, but economies still go through booms and busts, and not every variable can be controlled (RBI rate rises in 2011 to 2013 did not tame inflation because food prices stayed high).

• GDP: market value of goods and services produced within the country, whoever owns the producer.
• GNP: value produced by the country's residents, wherever they are.
• GNP − GDP = net factor income from abroad (NFIA) (income earned by residents abroad minus income paid to non-residents).

Three ways to measure GDP:

• Product (output) method: the value of final goods and services (not intermediate goods), sector by sector: agriculture, industry and services.
• Income method: add up incomes: wages and salaries, professional fees, profits (including undistributed profits), interest and rent.
• Expenditure method: private consumption + government spending + gross capital formation + net exports (exports − imports).

The three give similar results. Uses: measuring welfare and growth (per capita income = national income ÷ population is the better measure of living standards, since population may grow faster than income); showing how income is distributed and which sectors contribute most (services are about 60% of India's GDP at factor cost); and guiding policy.

Remember

• GDP = within borders; GNP = by residents.
• Expenditure: C + G + I + (X − M).

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4Savings and investment

Savings = income − expenses, for individuals (personal), companies (corporate, i.e. undistributed profits) and government (public, rarely positive). Personal plus corporate = private savings; all three = national savings. Savings are not investment until channelled into productive uses through financial instruments (equity, bonds, G-secs). Governments and central banks build efficient markets (wide choice, ease, simplicity, safety, low cost, transparency) to aid this. Higher savings and higher conversion into investment are good for an economy.

Remember

• National savings = personal + corporate + public.

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5Inflation and interest rates

Inflation is a general rise in prices that erodes the purchasing power of money: ₹1,000 kept in a drawer buys less a year later.

• Demand-pull inflation: demand exceeds supply.
• Cost-push inflation: input costs rise.

India measures inflation at the wholesale level (WPI) and the retail level (CPI), using baskets of goods.

Higher inflation needs higher interest rates to encourage saving; more saving means less consumption, and higher rates raise the cost of capital and slow investment and growth. Rate-sensitive sectors such as real estate and autos, which rely on loans, are hit hardest. Inflation also cuts discretionary income, reducing demand broadly.

Remember

• WPI = wholesale; CPI = retail.
• High rates hurt loan-funded purchases most.

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6Unemployment, FDI and FPI

The unemployment rate is the share of people willing and able to work who have no job. It rises in slowdowns and falls in expansions; more jobs mean more income and spending.

Foreign capital comes as:

• FDI (active): investors take part in management and decisions. Benefits beyond capital: jobs, technology, managerial skills, new products. Long-term and stable.
• FPI (passive): investment in equity or bonds without management involvement, subject to holding limits. Seen as hot money that can leave quickly and create systemic risk.

Remember

• FDI: stable, brings skills. FPI: hot money.

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7Fiscal policy

Fiscal policy covers the government's revenue (mainly taxes) and spending (education, health, defence, police, interest, administration, welfare), which affect demand, supply, savings, investment and activity.

• Fiscal deficit: budgeted spending above revenue, usually expressed as a % of GDP, bridged by market borrowing. A large deficit raises borrowing, pushes up interest rates and crowds out companies, hurting growth.
• Funding sources: revenue receipts (direct and indirect taxes, interest, dividends from PSUs) and capital receipts (domestic and foreign borrowing, disinvestment).
• Neutral policy: income and spending balanced. Expansionary: spend more, tax less (in slowdowns; creates deficits). Contractionary: spend less, tax more (when the economy overheats; aims for surplus).

The current account of the balance of payments records recurring receipts and payments (trade, interest, dividends, transfers). A high current account deficit (CAD) weakens the currency, makes imports and capital goods dearer, lowers creditworthiness and raises foreign borrowing costs; a weaker currency does help exports. Strong FDI and portfolio inflows can offset a CAD and protect the currency.

Remember

• Big fiscal deficit → higher rates → slower growth.
• Expansionary: more spending, lower taxes.

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8Monetary policy

Monetary policy, run by the central bank, manages money supply, inflation and interest rates for growth with price stability. Expansionary policy raises money supply and cuts rates; contractionary policy slows money supply and raises rates.

Tools:

• Repo rate: the rate at which the central bank lends to banks against securities (short term).
• Reverse repo rate: the rate at which it borrows from banks against securities.
• Bank rate: its rate for lending to banks without collateral, for longer or emergency needs.
• Cash reserve ratio (CRR): minimum share of deposits banks must hold as cash with the central bank.
• Statutory liquidity ratio (SLR): minimum share of deposits held in liquid assets such as gold and government securities.

There is no sure formula: the same action may work differently in different economies, and fixing one problem can create another (stimulus can raise inflation; tightening can slow growth and raise unemployment).

Remember

• Repo: central bank lends. Reverse repo: central bank borrows.

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9International trade and the balance of payments

The balance of payments (BoP) records a country's transactions with the rest of the world. In the older format: the current account (exports and imports of goods and services) and the capital account (FDI, FII, loans, grants). Imports above exports mean a current account deficit; ideally the two accounts offset each other.

Under the IMF's BPM6 format: the current account is much the same; the capital account now covers non-produced, non-financial assets (patents, rights, land, natural resources) and capital transfers; and the financial account holds FDI, portfolio flows, derivatives, debt flows and reserve assets. Current + capital + financial accounts + errors and omissions = change in reserves.

Persistent current account deficits need capital account (financial account) surpluses, or else reserves fall; either way, confidence can weaken and the currency depreciate.

Remember

• BPM6: FDI and FPI sit in the financial account.

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10Globalisation

Globalisation means producing and selling anywhere, with people and capital flowing to where they earn the best returns. Countries choose whether to open up.

Positives: best global allocation of resources; developing economies learn and gain access to products and technology; competition spurs innovation and keeps prices down; more cultural choice.

Negatives: survival of the fittest, as jobs move to the most competitive countries; contagion (the 2008 US credit crisis spread worldwide); early advantage to developed countries, which negotiate hard, so developing countries need strong political will; and erosion of local culture, which ESG thinking shows can become a business issue too.

Remember

• Biggest risk of integration: problems spread across borders.

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11Using economic analysis in research

A business's growth depends on its execution and its environment. Economic analysis shows how the environment is moving:

• GDP growth shows the state of the economy;
• monetary and fiscal policy show whether policy will support growth;
• interest rates, inflation, public spending and the fiscal deficit signal where policy is heading.

If the economy is shrinking, low inflation suggests the central bank has room to cut rates, and a manageable fiscal deficit suggests room to raise public spending. The analyst then works out how this trajectory will affect the specific industry.

Remember

• Low inflation = room for rate cuts. Low deficit = room for spending.

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12Secular, cyclical and seasonal trends

• Secular trends: long-term shifts in what is consumed or how it is produced, roughly every 7 to 10 years, driven by technology, culture, demography and preferences. Example: office digitalisation cutting paper and ink use while raising spending on digital products.
• Cyclical trends: medium-term swings in quantity, which reverse and recur over about 2 to 6 years.
• Seasonal trends: highly predictable annual patterns tied to weather or farming.

Economic cycle, four phases:

1. Expansion (boom): rising income, low rates and confidence drive consumption, production and jobs; firms expand capacity; borrowing pushes rates up and inflation rises near the peak.
2. Slowdown: high prices and rates and tighter policy slow the rate of growth; capacity utilisation falls.
3. Recession: expansion plans are cut, layoffs begin, income and consumption fall, confidence drops, people save more; interest rates and inflation fall.
4. Recovery: low inflation lets the central bank ease; spending picks up and expansion returns.

Phase lengths are unpredictable, but the cycle helps forecast medium-term volumes and prices.

Commodity cycle: usually follows the economic cycle (prices up in expansion, down in recession) but can be independent. High prices draw new capacity, prices fall, high-cost producers shut, supply shrinks and prices rise again.

Inventory cycle: short cycles within a commodity cycle, caused by stock adjustments: customers with big inventories cut purchases (prices fall); cautious customers caught short must buy urgently (prices rise). In April 2020, a crude glut at Oklahoma sent futures to about $20 and briefly negative; by June 2020 they were back near $40.

Seasonality: agricultural GDP peaks around harvests. Analysts use seasonally adjusted growth or year-on-year comparisons (same quarter last year) to strip it out.

Remember

• Secular 7 to 10 years; cyclical 2 to 6 years; seasonal annual.
• Compare a quarter with the same quarter last year.

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13Sources of economic information

Key sources: government websites; regulators and ministries such as SEBI, RBI and the Ministry of Finance; published economic research reports; and the Economic Survey.

Remember

• The Economic Survey is a core source.