Saturday, June 14

Economic Analysis & How to Select an Industry

Economic Analysis

No person can work and live in isolation. External forces are constantly influencing an individual's actions and affecting him. Similarly, no industry or company can exist in isolation. It may have splendid managers and a tremendous product. However, its sales and its costs are affected by factors, some of which are beyond its control - the world economy, price inflation, taxes and a host of others. It is important, therefore, to have an appreciation of the politicoeconomic factors that affect an industry and a company.
A stable political environment is necessary for steady, balanced growth.
It is imperative for investment managers and analysts to carry out an industry analysis from time to time in order to be aware of the polito-economic environment and their effects on the investments.

Let us analyse a few important factors in Economis Analysis or rather an Industrt Analysis.
Foreign Exchange Reserves
A country needs foreign exchange reserves to meet its commitments, pay for its imports and service foreign debts. Without foreign exchange, a country would not be able to import materials or goods for its development and there is also a loss of international confidence in such a country. However, neither huge deficit of forex reserves nor excessive surplus reserves are desirable.
Foreign Exchange Risk
This is a real risk and one must be cognizant of the effect of a revaluation or devaluation of the currency either in the home country or in the country the company deals in. Devaluation in the home country would make the company's products more attractive in other countries. It would also make imports more expensive and if a company is dependent on imports, margins can get reduced. On the other hand, a devaluation in the country to which one exports would make the company's products more expensive and this can adversely impact sales. A method by which foreign exchange risks can be hedged is by entering into forward contracts, i.e. advance purchase or sale of foreign exchange thereby crystallizing the exposure. In India our currency has been appreciating against the dollar. Thus, the threat investors or recipients of dollars face is that the rupees that they finally receive are less than that they expected. This is an about turn from the situation earlier. As a consequence many have begun quoting in rupees.
Restrictive Practices
Restrictive practices or cartels imposed by countries can affect companies and industries. The United States of America has restrictions regarding the imports of a variety of articles such as textiles. Licenses are given and amounts that may be imported from companies and countries are clearly detailed. Similarly, India has a number of restrictions on what may be imported and at what rate of duty.
Foreign Debt and the Balance of Trade
Foreign debt, especially if it is very large, can be a tremendous burden on an economy. India pays around
$ 5 billion a year in principal repayments and interest payments. This is no small sum. This has been the price the country has had to pay due to our imports being far in excess of exports and an adverse balance of payments. A permanent solution will result only when the inflow of foreign currency exceeds the outflow and it is on account of this that tourism, exports and exchange earning/saving industries are encouraged.
Inflation
Inflation has an enormous effect in the economy. Within the country it erodes purchasing power. As a consequence, demand falls. If the rate of inflation in the country from which a company imports is high then the cost of production in that country will automatically go up. This might reduce the cost competitiveness of the product finally manufactured. Conversely, if the rate of inflation in the country to which one exports is high, the products become more attractive resulting in increased sales. The USA and Europe have fairly low inflation rates (below 2%). In India, inflation has been rising steadily in recent times. It is currently estimated between 7% and 8%. Thus growth rate of the country is being questioned of late. Low inflation within a country indicates stability and domestic companies and industries prosper at such times.
Interest Rates
A low interest rate stimulates investment and industry. Conversely, high interest rates result in higher cost of production and lower consumption. When the cost of money is high, a company's competitiveness decreases. In India, the government, through the Reserve Bank, has been successful in regulating interest rates. Increasing competition among banks has also helped.
Taxation
The level of taxation in a country has a direct effect on the economy. If tax rates are low, people have more disposable income. In addition they have an incentive to work harder and earn more and an incentive to invest. This is good for the economy. While the tax rates may go up, collection will decline. This is why there it has been argued that the rates in India must be lowered.
Government Policy
Government policy has a direct impact on the economy. A government that is perceived to be proindustry will attract investment.
Domestic Savings and its Utilization
If utilized productively, domestic savings can accelerate economic growth. India has one of the largest rates of savings (22%). In USA, it is only 2% whereas in Japan it is as high as 23%. Japan's growth was on account of its domestic savings invested profitably and efficiently. Investment from savings leads to greater consumption in the future.
Infrastructure
The development of an economy is dependent on its infrastructure. Industry needs electricity to manufacture and roads to transport goods. Bad infrastructure leads to inefficiencies, poor productivity, wastage and delays.
Budgetary Deficit
A budgetary deficit occurs when governmental expenditure exceeds its income. Expenditure stimulates the economy by creating jobs and stimulating demand. However, this can also lead to deficit financing and inflation. Both these, if not checked, can result in spiraling prices. To control and cut deficits governments normally cut governmental expenditure. This would also result in a fall in money supply and a consequent fall in demand which will check inflation.
Employment
High employment is required to achieve a good growth in national income. As the population growth is faster than the economic growth unemployment is increasing. This is not good for the economy.
Monsoons
The Indian economy is an agrarian one and it is therefore extremely dependent on the monsoon. Economic activity often omes to a stand still in late March and early April as people wait to see whether the monsoon is likely to be good or not.

Selecting an Industry

When choosing an industry, it would be prudent for the investor to bear in mind or determine the following details:
1. Invest in an industry at the growth stage.
2. The faster the growth of a company or industry, the better. Indian software industry, for example, was growing at a rate of more than 50 per cent per annum at the dawn of the new millennium. Recently Real Estate was growing at a great pace.
3. It is safer to invest in industries that are not subject to governmental controls and are globally competitive.
4. Cyclical industries should be avoided if possible unless one is investing in them at the time the industry is prospering.
5. Export oriented industries are presently in a favorable position due to various incentives and government encouragement. On the other hand, import substitution companies are presently not doing very well due to relaxations and lower duties on imports. 6. It is important to check whether an industry is right for investment at a particular time. There are sunrise and sunset industries. There are capital intensive and labour intensive industries. Each industry goes through a life cycle. Investments should be at the growth stage of an industry and disinvestments at the maturity or stagnation stage before decline sets in

Ref: www.Sharekhan.com

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