NISM Series XV Research Analyst Study Notes - Chapter V: Economic Analysis (Part 2)

This is Part Two of the comprehensive study notes for Chapter V: Economic Analysis, designed for candidates preparing for the NISM Series XV Research Analyst Certification Examination. This part completes the chapter, covering foreign capital, fiscal and monetary policies, international trade, globalisation, and economic trends, based strictly on the official study notes.

1. Foreign Capital Flows: FDI vs. FPI

Foreign capital flows are a key driver of growth in developing economies, entering a country in either active or passive forms.

A. Foreign Direct Investment (FDI)

• Nature: FDI represents an active form of foreign capital investment.
• Characteristics: It is long-term in nature and considered highly stable money.
• Benefits: FDI is welcomed by developing economies because it brings multiple benefits beyond capital, such as technology transfer, skill development, and employment.

B. Foreign Portfolio Investment (FPI)

• Nature: FPI represents a passive form of foreign capital investment.
• Characteristics: It is often referred to as "hot money".
• Risks: Portfolio investors can pull their money out of the country at any time, which can create systemic risk for the host economy.

2. Fiscal Policies and Government Deficits

Fiscal policy refers to the measures and decisions of the Government concerning its revenues and expenses. It directly influences aggregate demand, supply, savings, investment, and overall economic activity.

Key Fiscal Formulas (Simple Line Format)

• Fiscal Deficit = Government Expenditure > Government Revenue (Occurs when expenditure exceeds revenue).
• Current Account Balance = Receipts - Payments.

Three Types of Fiscal Policies

The stance of a government's budget can be classified into three categories:

1. Neutral Fiscal Policy

   • Government Income = Government Expenditure.
   • It has a neutral effect on aggregate economic activity.

2. Expansionary Fiscal Policy

   • Government Income < Government Expenditure.
   • The government spends more than it earns to stimulate aggregate demand and boost the economy.

3. Contractionary Fiscal Policy

   • Government Income > Government Expenditure.
   • The government runs a surplus, spending less than its income, to cool down a heated economy.

3. Monetary Policies and Central Bank Actions

Monetary policies are administered by the country's Central Bank. They manage the money supply, interest rates, and inflation to promote sustainable economic growth and price stability.

A. Expansionary Monetary Policy

• Objective: Used to push economic growth up during a slowdown.
• Mechanism: Involves a steep increase in the money supply and a reduction in interest rates to encourage borrowing and spending.

B. Contractionary Monetary Policy

• Objective: Intended to cool down a heated or inflationary economy.
• Mechanism: Involves a reduction in the money supply (or slowing its growth rate) and an increase in interest rates to curb excessive borrowing and spending.

4. International Trade, Exchange Rates, and Deficits

Core Definitions

• International Trade: Refers to the total trade (exports and imports) that a country conducts with all other nations in the world.
• Exchange Rate: Refers to the value of one unit of a currency with respect to other currencies.

Trade Balance Dynamics

• Current Account Deficit: Occurs when a country's imports are more than its exports.
• Current Account Surplus: Occurs when a country's exports are more than its imports.

5. Globalisation and Economic Trends

Globalisation

Globalisation is defined as the ability of individuals and firms to produce anything anywhere and sell anything anywhere across the world. It allows resources, specifically people and capital, to flow to places where they produce and earn the best returns.

Positives and Negatives of Globalisation

The impact of globalisation presents distinct advantages and structural trade-offs:

• Positives:
  • Best allocation of global resources.
  • Integration of world economies.
  • Highly beneficial for end customers (due to lower prices and more choices).
  • Greater access to foreign cultures.
• Negatives:
  • Increase in inequality of income distribution.
  • High level of competition for domestic business entities.
  • Interlinked economies easily pass on financial risks from one to another.

Economic Trends

Economic activity and data are analysed through three distinct types of trends:

1. Secular Trends
   • Definition: Long-term trends that cause structural displacement in the production or consumption of goods and services.
   • Drivers: Driven by disruptions caused by changes in technology, culture, demography, regulations, and consumer preferences.
   • Example: The digitalisation of office space.
2. Cyclical Trends
   • Definition: Fluctuations that correspond to broader economic business cycles (recessions and expansions).
   • Level: Typically observed at the aggregate macroeconomic cycle level.
3. Seasonal Trends
   • Definition: Highly predictable, short-term fluctuations in the quantity of goods and services produced or consumed.
   • Cause: Arise due to seasonal changes, holidays, or specific times of the year.

6. The Role of Economic Analysis in Fundamental Analysis

Economic analysis forms the foundation of the top-down fundamental analysis framework. Its primary functions include:

• External Environment Mapping: It helps analysts understand what is happening in the external environment and how those changes are likely to affect a particular business.
• GDP Growth Tracking: Studying the GDP growth rate helps analysts understand the overall direction and health of the country's economy.
• Policy Alignment: Understanding monetary and fiscal policies reveals whether public policies support further business growth or pose regulatory headwinds.
• Forward-Looking Indicators: Tracking key metrics such as interest rates, inflation, public expenditure, and the fiscal deficit helps analysts forecast the future direction of government and central bank policies.

7. Key Takeaways and Technical Terms

• FDI: Active, stable, long-term foreign capital that brings technological and operational benefits to a country.
• FPI: Passive, short-term "hot money" portfolio investments that carry capital flight and systemic risks.
• Fiscal Deficit: The gap when government expenses exceed its tax and non-tax revenues.
• Monetary Policy: Central-bank-led adjustments of interest rates and money supply to target inflation and economic growth.
• Current Account Deficit: An economic condition where a nation's total imports of goods and services exceed its exports.
• Globalisation: The borderless integration of markets, resources, and capital across countries.
• Secular Trend: A permanent, long-term shift in technology, demography, or consumer habits.
• Cyclical Trend: Medium-term economic expansions and contractions.
• Seasonal Trend: Predictable calendar-based swings in business activity.