Some Economic Events and Their Impact On The Market

Summary

To be successful in the stock market, you not only have to watch the results of the company, but you also have to keep an eye on the events that affect the market. There are many financial and non-financial events that have an impact on the market. In this chapter, we will look at some such incidents.

Monetary Policy ie Monetary Policy

Reserve Bank of India i.e. RBI (RBI) controls the supply of money in the market by bringing monetary policy and for this, it uses interest rates. RBI modifies interest rates, which increases or decreases the supply of cash. RBI is the central bank of India, the central bank of every country in the world determines the interest rates.

While fixing interest rates, the RBI also has to see that there is a balance between growth and inflation.

If interest rates remain high, it will be difficult for companies to take loans and if they do not get loans, then companies will not expand. This way the economy will slow down.

On the other hand, if interest rates remain low, it will be easier to get loans, which means more cash in the hands of the companies and also in the hands of the customers. When people have more money in their hands, they will spend more. To take advantage of this, sellers of goods increase their prices. An increase in the price can lead to inflationary conditions in the market.

To maintain this balance of growth and inflation, RBI fixes interest rates only after considering some things. If these rates are not balanced, then the economy may go into trouble. The RBI rates you should keep an eye on are:

Repo Rate – When banks want a loan, they take a loan from RBI. The rate at which RBI lends to banks is called the repo rate. If the repo rate is high, it will be costly to borrow and fewer loans will be taken. This can slow down the pace of development. At present, the repo rate in India is 8%. Banks do not like to increase the repo rate by the Reserve Bank of India i.e. RBI.

Reverse Repo Rate – Reverse Repo Rate is the interest rate at which RBI borrows from banks. When the Reserve Bank of India takes loans from banks, the banks happily give loans because they know that the RBI will not default, it will not happen that the RBI does not repay the loan, while at the time of lending to companies or corporates. The risk of default remains. But when banks give loans to the Reserve Bank of India, the supply of cash in the market decreases. This makes it difficult for companies to get loans. A high reverse repo rate is not considered good for the economy as it makes it difficult for companies to get loans. At present, the reverse repo rate in India is 7%.

Cash Reserve Ratio (CRR) – Every bank has to keep some cash with RBI. How much this amount will be, depends on how much is the CRR i.e. Cash Reserve Ratio, if the cash reserve ratio is high, then more cash goes out of the market to the RBI. This is not considered good for the economy.

RBI considers changes in these rates every 2 months. The stock market monitors this meeting and its decisions. Rate sensitive ie stocks affected by interest rates are affected by this decision of RBI, these include sectors like banking sector, automobile sector, housing finance and real estate.

Inflation

Inflation is the continuous increase in the price of goods and services. When inflation is high, the buying power of the rupee decreases, i.e. less than every rupee can be bought for goods or services. If nothing else has changed in the country and onion prices have increased from Rs 15 to Rs 20, inflation is believed to be the reason. Inflation is a common phenomenon but a high inflation rate is not considered good. This puts pressure on the economy. The government always tries that the rate of inflation should not exceed a certain limit. An index is used to measure inflation, depending on the percentage increase or decrease in that index, inflation is said to be going up or down.

There are two types of indexes that measure inflation – Wholesale Price Index (WPI) and Consumer Price Index (CPI).

Wholesale Price Index (WPI) – Wholesale Price Index refers to the change in price at the wholesale level. It tracks the price at which one entity or company sells goods to another entity or company. This index does not track the price received by the consumer. The Wholesale Price Index (WPI) is an easy way to measure inflation in the wholesale market. But this does not reflect the inflation that is for the consumer.

At the time of writing this chapter, the WPI for May 2014 was 6.01%.

Consumer Price Index (CPI/CPI)- The Consumer Price Index or CPI tracks the price changes in the retail market. For a customer or for the common man, only the CPI or Consumer Price Index is important. A lot of calculations have to be done to measure the Consumer Price Index as consumption is divided into rural and urban and many more such categories. Each such category has its own index and all these indexes are combined to form a Consumer Price Index (CPI).

The Consumer Price Index contains a lot of information. It is a very important index to know the condition of the economy. At the national level, the Ministry of Statistics and Program Implementation releases the CPI numbers in the second week of every month.

The Consumer Price Index for the month of May 2014 was 8.28%. Its inflation for the last one year is given in this table.

As you can see, CPI inflation has come down from its November 2013 high of 11.16%. The biggest challenge for the RBI i.e. Reserve Bank of India is how to strike a balance between inflation and interest rates. Low-interest rates increase inflation and high-interest rates prevent inflation from rising.

Index of Industrial Production-IIP

The Industrial Production Rate (IIP) tells how the industrial sector of the country is performing in the short term. IIP data is also released every month along with inflation data. This data is also released by the Ministry of Statistics and Program Implementation. As the name suggests, IIP refers to the output of an industry sector in the country. In IIP, production is measured on the basis of a certain scale. At present, 2004–05 production in India is considered as a benchmark. This scale is called the base year.

About 15 types of industries provide their production data to the ministry. The ministry collects these data and prepares the IIP index and releases it. If IIP increases, it is believed that there is a good environment for the industry in the country as production has increased. Both the market and the economy consider it good. A decrease in IIP is not considered good. It is considered a sign that the country does not have a good production environment and is considered bad for both the economy and the market.

Overall, an increase in IIP is a good sign for the economy and a fall in it is considered a bad sign. As industrialization is increasing in India, the importance of IIP is also increasing.

The lowering of IIP puts pressure on RBI i.e. Reserve Bank to reduce interest rates.

The graph below shows the change in IIP in the last 1 year.

Purchasing Managers Index/ PMI

Purchasing Managers’ Index (PMI) is an index that measures business activities in the manufacturing and service sectors. This index is created on the basis of a survey. In this, opinion is taken from people who usually buy goods for companies. These people give their assessment on what has changed in this month as compared to last month. A separate survey is conducted for the production sector and a separate survey for the service sector. Later, an index is prepared by combining the surveys of both sectors. This survey usually inquires about new orders, production, business expectations, and employment.

The PMI figure is usually around 50. Above 50 it is considered that the economy is growing. If the figure is below 50 it is considered that the economy is in decline. A figure of 50 means that there has been no change in the economy.

Budget

Budget is an event in which the finance ministry discusses the economic condition of the country in detail. On behalf of the Ministry of Finance, the Finance Minister places the budget in front of the country. Many types of policy decisions and economic reforms are announced in the budget speech, which have a direct impact on the industries and the market. That is why the budget is considered an important event of the economy.

Let us try to understand this a little better. In the 2014 budget, it was expected that the duty on cigarettes would increase further. As expected, it happened and the Finance Minister announced to increase the duty on cigarettes. Because of this, the prices of cigarettes went up. The effect of rising cigarette prices would be:

• Some people will stop smoking cigarettes because of rising cigarette prices (although it can be debated whether this is true). Because of this, the profits of a cigarette maker like ITC will be reduced. People will sell ITC shares in case the company’s profit decreases.
• If people sell the shares of ITC then the market will come down because ITC has a lot of weight in the market index.

In fact, after the announcement of a duty hike in the budget, ITC’s stock fell by 3.5%.

A budget is an annual event. It is offered in the month of February. Sometimes there may be some delay in the formation of a new government.

Announcement of financial results of companies (Corporate Earnings Announcement)

The announcement of the company’s trading results is perhaps the biggest event on which the stock market reacts immediately. Every company listed in the stock market has to present its business results every third month i.e. every quarter. During these quarterly results, companies give all the information related to their business in detail like…

• How much revenue did the company make?
• How did the company manage its expenses?
• How much money did the company pay as taxes and interest rates?
• How much profit did the company make in the quarter?

Apart from this, some companies also tell how their business is expected to be in the coming few quarters, it is also called corporate guidance.

Infosys Limited is the first blue-chip company to present its results every quarter. Infosys always gives corporate guidance as well. All the market players listen very carefully to Infosys results and its guidance as it has a huge impact on the overall market.

Every quarter when the company announces its results, the market traders compare those results with their estimates. These market projections are called market estimates or market expectations.

If the company’s results are better than the market forecast, then the company’s stock will go up. Similarly, if the company’s results are less than the market estimates, then the stock falls.

If the results remain close to the market estimates, then the share price may not change much as the market players feel that the company has not given any such news which will increase the enthusiasm of the investors.

Highlights of this chapter

• Both the market and the stock react to economic events. Market people should be able to understand these events and their consequences.
• Monetary policy is a very important event related to the economy. Rates of Repo, Reverse Repo, CRR etc. are reviewed in this policy. New rates are also announced when needed.
• Interest rates and inflation are related to each other. If interest rates go up, inflation is low, and if interest rates go down, inflation can rise.
• Inflation data is released every month by the Ministry of Statistics and Program Implementation. As a customer you should focus on CPI.
• IIP measures industrial output. A rise in IIP makes the market happy, and a fall in IIP causes disappointment in the market.
• The mood of the business is measured on the basis of the PMI survey. A PMI number above 50 is considered good and a PMI number below 50 is considered bad.
• A budget is an important event in which policy decisions and economic reforms are announced. Both the market and the stock react sharply to the budget announcements.
• Corporate results are presented every quarter. The stock fluctuates when the company’s results and market expectations are not the same.