Cyclical and Non-cyclical stocks: How do they differ?

The best offense is a good defense. Just like in military combat or football, investors also need a good offense and defense strategy. In other words, you need to use more than one strategy in order to succeed. As a serious investor, there are many different ways you can do this. You can invest in a variety of stocks, cash, and other securities, you can also diversify your portfolio by investing in securities across various sectors and markets or you can invest in stocks that are at different growth and value levels.

Implementing the right strategy requires a good knowledge of the global economy and how the markets work- if you don’t have a good understanding of this, making decisions become incredibly difficult. As we all know, the economy goes through different business cycles and while we can’t predict the outcome of the cycles we can alter our decisions to keep up with the ever-changing landscape. This changing environment also provides a great way for investors to mix up their portfolio, namely with investing in cyclical and non-cyclical industries.

What are cyclical stocks?

As the name suggests, cyclical stocks are those that move in the direction of the market. That is when the economy is doing well, the stocks go up and when there is a downturn in the economy, the value of the stock goes down too. These stocks are more closely aligned with the broader economy and are more prone to economic activity.

For many investors, the movement of stock in cyclical industries provides a great opportunity to earn revenue on the stock by buying when there is a downturn and selling when there is an upward trend. For a novice investor, this may seem like a fool-proof strategy but be cautious, as it is almost impossible to tell when there will be a downturn in the market.

Cyclical industries usually may include durable goods (that last for a long time into the future), non-durable goods (that have a short shelf life) and services like automobile, construction, and travel.

When the economy is doing good and the people are earning well, they may spend a lot of money on buying a new car, constructing their new house or even plan fancy off-shore travels. However, when there is a downturn in the economy, people may prefer to hold these expenses for another year or two.

Around 75 percent of the stocks listed in the stock exchange are cyclical and follow the market trends. A few examples include Ferrari NV (RACE), Alibaba Group Holding Ltd. (BABA) and Royal Caribbean Cruises Ltd. (RCL).

What are non-cyclical stocks?

While cyclical industries may seem like a good investment, every good offense needs a defense, hence, it is important to balance out your portfolio with non-cyclical or defensive stocks. During a boom, people splurge on goods and services such as travel and cars. But during a slump, people stop spending on purchases that they don’t consider a basic necessity, instead they focus their spending money on food, water, and shelter.

non cyclical industry

During an economic recession or depression, the revenue and cash-flows and share price of non-cyclical companies continue to do well because they are industries that produce the basic needs of life that people will continue to consume.

In addition to basic needs, non-cyclical stocks also include those goods that are addictive such as tobacco or alcohol which can put ethical investors in a tricky situation as these industries do well even during a slump and reduces the number of industries that they can invest in.

Defensive stocks include goods and services in industries that are not affected by market fluctuations such as utilities, food, and medicines. It is basically any good or service that people will buy whether or not the economy is doing well. A few examples of defensive stock companies include Kraft Heinz Company (KHC), Johnson and Johnson (JNJ) and Sysco Corporation (SYY).

Bonus: The top-down strategy

There are two main investing strategies in the market, the top-down approach, and the bottom-up approach. The top-down approach involves looking at the economy as a whole and picking stocks that do well during certain economic conditions. This strategy requires the investor to have a good understanding of the macroeconomy along with its various sectors and industries to know what industry will perform well during the different business cycles. They also need to assess the inflexion points in the economy, that is when a certain stock price is expected to go up or down. For cyclical and non-cyclical stocks, top-down is the most commonly used strategy.

The bottom-up approach, on the other hand, involves looking at the stock individually and making investment decisions based on independent parameters.

When using the top-down approach, there are many indicators that investors can use to study the market. The first and most obvious metric is the GDP (Gross Domestic Product). This is the total value of all the goods and services produced in the economy and gives us a good understanding of the overall economic health.

Another great indicator is the ‘Purchasing Manager’s Index (PMI). This is a survey conducted among the purchasing managers in different sectors and industries in the economy. The PMI provides the investor with information on how the businesses are currently performing and which direction the economy is headed.

A third metric is the Consumer Price Index (CPI). This will give an investor insight into the changing price levels of goods and services in the economy and is a reflection of the state of the economy.

The top-down strategy is considered successful when the cyclical and defensive stocks are in perfect correlation with each other. A 100% correlation would mean that the stocks move in synch with each other while a -100% correlation means that the stocks are still in sync but move in the opposite direction.

During the 2008 recession, luxury goods such as Ford cars faced a huge decline in the value of their stock as people stopped spending on expensive items when the economy was down but at the same time, the stock for beverages such as Coco-Cola continued to do well as people spent money on this regardless of the business cycle.

Also read:

Conclusion

It is important for every investor to have a balanced and diversified portfolio with both cyclical and non-cyclical stocks.

Cyclical stocks include more luxury goods and hence a provide a higher return than non-cyclical stocks. However, the investor needs to study the market carefully and have a good tolerance for risk. Defensive stocks are safer investments but provide lower returns but are better for investors looking for safe investments Remember low risk, low return.

Micro vs Macro Economics cover

Micro vs Macro Economics -What’s the Difference?

Economics is the study of how humans use limited resources (land, labor, capital and enterprise) to manufacture goods and services and satisfy their unlimited needs and distribute it among themselves. It is divided into two broad branches, microeconomics and macroeconomics.

Each branch has its own policies and regulations relating to different sectors such as agriculture, labor market and the government. Microeconomics is the study of the behavior of an individual, firm or household in the market while macroeconomics is the study of the economy as a whole- that is, the individuals, households and firms collectively.

What is Microeconomics?

Microeconomics was first introduced by the economist Adam Smith and is the study of the economy at a lower level, it is commonly termed the ‘bottom-up’ approach. This branch of economics focuses on how decisions made by people and organizations can affect the economy as a whole. As individuals, we make numerous decisions everyday from what clothes to wear to what food to eat. These decisions are made by the different agents in the economy and serve as the basis for microeconomists to study how they affect supply and demand and ultimately the economy as a whole.

Tools such as supply, demand, consumer behavior, spending and purchasing power of people are used by economists to build models that they base their learnings on, one such model is the supply and demand curve. By understanding the buying and spending habits of people, economists come up with various theories to understand relationships between different elements and how these small parts fit into the larger picture.

However, in the real world, things are different and cannot always be represented through a model. Hence some economists study subsets of microeconomics such as human behavior which is the actions taken by an individual when making a decision and the behavioral model which uses disciplines such as psychology and sociology to understand how people make decisions.

Since microeconomics is the study of the economy at a lower level, many people use it as a starting point for learning economics. The theories used in microeconomics are then used to study the economy at a larger scale- also known as macroeconomics.

Also read: What is Top Down and Bottom Up approach in stock investing?

What is Macroeconomics?

While microeconomics is a bottom-up approach, macroeconomics is considered a top-down approach as it is the study of the economy on a larger scale. Prior to 1929, many economists only studied microeconomics (people’s individual decisions) however after the crash of 1929 (aka the great depression), many economists were unable to explain its cause. They found that there were forces in the economy, which based on people’s decisions, could have a positive and negative impact. In addition to looking at individual decisions, it was also important to look at the big picture.

Macroeconomics is the study of larger issues affecting the economy such as economic growth, unemployment, trade, inflation, recessions and how decisions made by the government can affect the economy. For example, the Central Bank creates their interest rate policies based on the macroeconomic conditions in the country and around the world.

John Maynard Keynes is considered the founding father of Macroeconomics and his understanding of the subject was largely influenced by the Great Depression. During the 1930s Keynes wrote an essay titled The General Theory of Employment, Interest and Money where he outlined the broad principles of Macroeconomics that led to the development of Keynesian economics. Keynesian economics are macroeconomic theories about how during a recession, in the short run, the output is influenced by the aggregate demand in the economy. Milton Freidman another pioneer of macroeconomics used monetary policy to explain the reasons for the depression.

Micro vs Macro Economics -The key differences

micro vs macro economics big picture-min

As mentioned earlier, microeconomics is the study of individual and household decisions and the issues they face. This could be analyzing the demand for a certain good or service and how this affects the production levels of a company. It could also be the study of effects of certain regulations on a business.

While macroeconomics is the study of the economy as a whole. This involves looking at the gross domestic product (GDP) of the economy, the unemployment rates and the effects of inflation, deflation and monetary policy. For example, they may look at how an increase in taxes can affect the economy using the GDP, national income and inflation rate as a metric rather than individual factors.

Microeconomics is useful for determining the prices of goods and services in the economy along with the costs of the factors of production (land, labor, capital) while macroeconomics helps maintain price stability and creates policy to resolve problems dealing with unemployment, inflation and deflation.

However, both micro and macroeconomics come with their limitations. For example, the study of microeconomics assumes that there is full employment in the economy. This can lead to unrealistic theories as this is never true. In macroeconomics, there is a fallacy of composition where economists assume that what is true for an individual is true for the economy as a whole. However, in the real world, the aggregate factors may not be true for individuals too.

Micro and macroeconomics are interlinked

By definition, microeconomics and macroeconomics cover completely different aspects of the economy and while this is true, the two fields are similar and also interdependent on each other.

When dealing with inflation, many people think of it as a macroeconomic theory as it deals with interest rate and monetary policy. However, inflation is an important part of microeconomics because as inflation raises the prices of goods and services, it reduces the purchasing power that affects many individuals and businesses in the economy. Like inflation, government reforms such as minimum wage and tax rates have large implications in microeconomics.

Another similarity in microeconomics is the distribution of the limited resources. Microeconomics studies how the resources are distributed among individuals while macroeconomics studies how they are distributed among groups that consist of individuals.

Also read: How Does The Stock Market Affect The Economy?

Conclusion:

Although micro and macroeconomics affect different levels of the economy and cover different policies, they are in fact two sides of the same coin and often overlap each other. The most important distinction is their approach to the economy. Microeconomics is ‘bottom-up’ and macroeconomics is ‘top-down.’

Petrol, Diesel price history in India

A brief study of Petrol & Diesel price history in India

Crude Oil. You definitely have heard of this word, right? Crude oil is a naturally occurring unrefined petroleum product. It consists of organic materials and hydrocarbons. When the crude oil is refined, first it is heated until it starts boiling. Then, the boiling liquid is separated into various liquids and gases. These liquids are further utilized in making petrol, diesel, paraffin, and other petroleum products.

The products and by-products of crude oil are used in direct or indirect consumption by the end users. They are also used in manufacturing several commodities by a wide range of industries. Crude oil is also traded in the commodity market like gold, silver, etc. This results in the global price of crude oil to fluctuate. In India, only one-fifth of the crude oil requirements are met from domestic production. Therefore, we are heavily dependent on the US, African, and Middle East countries to support our nation’s demand for petrol and diesel.

How the prices of diesel and petrol are determined?

The Oil Marketing Companies or OMCs take crude oil to the refinery houses to generate petrol, diesel, kerosene and other products. After that, they dispose those products to the dealers of the same. In India, 90% of the share of oil marketing is owned by Indian oil corporation Ltd (IOCL), Bharat petroleum corporation ltd (BPCL) and Hindustan petroleum corporation ltd (HPCL).

Here is the exact process of how the price determination of diesel and petrol takes place in India.

First, an OMC imports crude oil from an oil producing nation like UAE. The cost and freight are the initial costs incurred on the same. Import charges (plus insurance charges, losses due to transportation and port fees) are further added to the same. Next, the Government of India adds Customs Duty on such crude oil, after which they are carried to the refinery houses.

The refineries charge Refinery Transfer Charge for their work. After that, such refined oil is sold to the dealers by the OMC at Depot Price after incurring inland freight on the same. So the total desired price is the result of all the Cost & Freight charges, Import charges, Refinery Transfer Price, Inland Freight, OMC’s Marketing costs, and Profit margin.

In addition, the Central Government of India adds Excise Duty on the Depot Price and the State Governments add State VAT on the same. Further, the dealers also add their commission which is calculated on the basis of per liter. So, after adding all the costs and taxes, we get the Retail Price that a consumer pays for buying a liter of petrol or diesel.

If you compare the prices of diesel and petrol in the South Asian nations, you would find that the prices in India are always the highest. This is because our Government regulates the prices by imposing taxes. Ironically, when you would see the prices of the crude oil dropping, Indian government increases the Excise Duty and State VAT to not let the retail prices of diesel and petrol fall. On the other hand, when the prices of crude oil rises, here the Government doesn’t reduce the said taxes so that the prices of the fuels in the nation don’t undergo fluctuations.

Besides, there is no doubt in stating that the prices of diesel and petrol would vary from one state to another in India due to differences in commission pattern of OMCs and transportation charges.

Petrol & Diesel price history in India

Now, let us have a look at the price history of diesel and petrol in India over the last few years. Given below is a table which shows the petrol prices per liter in the four metropolitan cities in India. 

Petrol Price history in India:

Date Chennai Mumbai Kolkata Delhi
05-11-2018 81.61 84.06 80.47 78.56
29-10-2018 82.86 85.24 81.63 79.75
29-09-2018 86.7 90.75 85.21 83.4
29-08-2018 81.22 85.6 81.11 78.18
29-07-2018 79.11 83.61 79.05 76.16
29-06-2018 78.4 83.06 78.23 75.55

As you can see from the above table, generally the petrol prices have been on the higher side in Mumbai. However, Delhi witnessed the most reasonable petrol prices in the last few months of 2018. 

Further, here is the historical petrol price movement in the big four metropolitan cities in India.

Date Chennai Mumbai Kolkata Delhi
29-05-2018 81.43 86.24 81.06 78.43
16-05-2017 68.26 76.55 68.21 65.32
17-05-2016 62.47 66.12 66.44 63.02
16-05-2015 69.45 74.12 73.76 66.29
07-06-2014 74.71 80.11 79.36 71.51
23-05-2013 65.9 71.13 70.35 63.09
24-05-2012 77.53 78.57 77.88 73.18
15-05-2011 67.22 68.33 67.71 63.37
01-04-2010 52.13 52.2 51.67 47.93
27-02-2010 51.59 51.68 51.15 47.43
02-07-2009 48.58 48.76 48.25 44.72
29-01-2009 44.24 44.55 44.05 40.62
24-05-2008 49.64 50.54 48.98 45.56
16-05-2007 47.44 48.38 46.86 42.85
10-06-2006 51.83 53.5 51.07 47.51
05-06-2006 51.83 53.5 51.07 47.51
20-06-2005 44.26 45.93 43.79 40.49
16-04-2003 35.48 37.25 34 32.49

When you look at the longer time period shown by the above table, the picture looks similar as well. Anyways, one comparable takeaway is that, in every metropolitan city, the petrol price has consistently gone up at the same rate in the last one and half decades. (Note: You can find the latest prices of petrol in India here).

crude oil price

Diesel Price history in India:

Now, let us talk about the historical prices of diesel per liter in India. Here is a short-term view of diesel prices in the four Indian metropolitan cities:

Date Chennai Mumbai Kolkata Delhi
05-11-2018 77.34 76.67 75.02 73.16
29-10-2018 78.08 77.4 75.7 73.85
29-09-2018 78.91 79.23 76.48 74.63
29-08-2018 73.69 74.05 72.6 69.75
29-07-2018 71.41 71.79 70.37 67.62
29-06-2018 71.12 71.49 69.93 67.38

The table given above shows that in the last few months of 2018, the diesel prices first have gone up and then they showed consolidation at the beginning of November.

Next, here is the long-term diesel price history in India. If you look at the table shared below, it is easily understood that the diesel prices in the said four Indian cities have actually witnessed consistently rising prices in the last fifteen years.

Date Chennai Mumbai Kolkata Delhi
29-05-2018 73.18 73.79 71.86 69.31
16-05-2017 58.07 60.47 57.23 54.9
17-05-2016 53.09 56.81 54.1 51.67
16-05-2015 55.74 59.86 56.85 52.28
07-06-2014 61.12 65.84 61.97 57.28
23-05-2013 52.92 57.17 53.97 49.69
24-05-2012 43.95 45.28 43.74 40.91
15-05-2011 43.8 45.84 43.57 41.12
01-04-2010 38.05 39.88 37.99 38.1
27-02-2010 37.78 39.6 37.73 35.47
02-07-2009 34.98 36.7 35.03 32.87
29-01-2009 32.82 34.45 33.21 30.86
24-05-2008 34.44 36.12 33.96 31.8
16-05-2007 33.3 34.94 32.87 30.25
10-06-2006 35.51 39.96 34.96 32.47
05-06-2006 35.95 39.96 34.96 32.47
20-06-2005 31.51 35.2 30.8 28.45
16-04-2003 23.55 26.7 23.51 21.12

Quick Note: You can find the latest price of diesel in India here.

diesel price

Difference between prices of Petrol & Diesel in India:

Below is a table shared for your reference which shows the price gap in diesel and petrol in the Indian metro cities during the mid of the year 2016.

City Diesel Price /Liter Petrol Price /Liter Price Gap
Chennai Rs 55.82 Rs 62 Rs 6.18 / Litre
Mumbai Rs 59.6 Rs 67.11 Rs 7.51 / Litre
Kolkata Rs 56.48 Rs 66.03 Rs 9.55 / Litre
New Delhi Rs 54.28 Rs 62.51 Rs 8.23 / Litre

Further, here is another table that would give you an idea of the price gap with regard to diesel and petrol during as of November 2018.

Date Diesel Price /Liter Petrol Price /Liter Price Gap
Chennai Rs 74.99 Rs 78.88 Rs 3.89 / Litre
Mumbai Rs 74.34 Rs 81.50 Rs 7.16 / Litre
Kolkata Rs 72.83 Rs 77.93 Rs 5.1 / Litre
New Delhi Rs 70.97 Rs 75.97 Rs 5 / Litre

From the above tables, it can be clearly noticed how substantially the price gap has been narrowed down within the period of around two years.

Consequences of petrol and diesel price hike

As you might have observed from the above tables, the fuel price in India has undergone a significant hike over the last multiple years. So, what does it imply? Does it mean that the overall cost of living in India has gone up too? If you look back in 2018, the rate of consumer inflation in India was around 4.75%

When the price of fuel increases, in general, it narrows down the gap between disposable income and expenditure of the consumers. It means that the consumers will try to reduce the consumption of luxury commodities like automobiles and electronic equipment in order to manage their necessities comfortably.

Hike in fuel price also has a direct adverse effect on the revenues of a few industries like tyres and fertilizers as the retail prices of their outputs shoot upwards. However, if you look at the financials of oil producing companies in India, there is no doubt in saying that they do enjoy a gala time during such period.

Further, you might think that only those companies which produce crude oil based products suffer during the fuel price bull run. But, the fact is that most of the companies in our nation (belonging to diverse industries) suffer as a result of the price hike. Even if you consider the FMCG industry, the cost of its products goes up considerably as a result of the upward movement in the prices of diesel and petrol. This happens because transportation costs go up significantly.

Now, what kind of impact can you expect to see in financial markets during fuel price hike? Well, when the price of diesel and petrol goes high, not only people will try to cut down their unnecessary expenses but they may even reduce financial investing. In order to finance their necessities, people would refrain from putting their money in the financial markets.

Therefore, will the banks have adequate funds to advance the businesses? Not really! Can the corporate organizations listed in NSE and BSE comfortably raise capital through IPO and FPO? Certainly not! Will the Asset Management Companies of Mutual Funds have an adequate corpus to pour into the market? No, my friend, they won’t have!

Also read: Rupee Depreciation: Is it a cause of concern?

Final thoughts

The hike in the global price of crude oil depends primarily on the demand-supply theory that we study in Economics. However, it also depends on other factors like the trade war, geopolitical tensions, and willingness of oil-producing countries to charge a higher price. As we had already seen earlier that hike in crude oil price results in inflation. So, to fight against the same, the Central Government charges more taxes and duties on diverse stuff. For a similar reason, the RBI also instructs the commercial banks to increase their interest rates on loans so as to squeeze money supply in the Indian economy.

Further, the price of petrol and diesel can be controlled if we lay emphasis on a few points. Firstly, price controlling mechanism has to be adopted either partially or fully. The half of Retail Prices of fuels in India consists of taxes and duties. The government (both central and state) does need to look into the matter. It would also be great if the OMCs can try to witness some of the price burdens that the ultimate consumers have to bear in our nation.

Finally, the consumption of petrol and diesel in India in terms of US Dollar is even higher than the GDPs of many small nations across the globe. And that’s why the government and the people need to consider petrol and diesel price hike in India seriously.

How Does The Government Control Inflation cover

How Does The Government Control Inflation?

We cannot minimize the explosive effects of inflation. High inflation has the ability to topple governments, ruin nations and reduce economic growth. It discourages savings and reduces the overall productivity in the country. In its creepiest form, inflation can reduce the purchasing power of people, this means the pensions and savings of people can now buy less than it did before.

In response to this, governments have many powerful tools they can use to control the rate of inflation in the economy. These policies have been discussed in detail in this article.

What is inflation?

Inflation can be described as a continuous increase in the general level of prices. In some cases, inflation can be used to encourage spending in the economy. However, this is not always the case as inflation can often get out of hand and the purchasing power of people drastically decreases. The government will then have to intervene to create balance in the economy.

Inflation can be measured using the Consumer Price Index (CPI). The bureau of labour statistics chooses close to 500,000 products from more than a 100 categories which are included into a ‘basket’. The prices of the goods are used to calculate the price index.

Effects of inflation

Inflation, depending on its severity, has the ability to disrupt economies. There is an uneven distribution of income that can affect many sectors in the economy. They are discussed as follows:  

— Effect on various economic groups- If there is low inflation in the economy, job seekers can benefit from this as increased demand will lead to a rise in employment. However, an unhealthy level of inflation can be disastrous for the economy as people pull their money out of financial institutions and their purchasing power reduces.

— Government spending- During inflation, the government, like individuals, have to pay more for wages and supplies. In order to raise more revenue the government can increase taxes but people will may have the ability to pay for them and some groups will be affected more than others.

— Savings and Investment- If inflation is on the rise, it is not a great time for savers as the decrease in the value of money reduces the value of savings. Many people move their investments to stocks and property during inflation. It is a favorable time for borrowers because the value of the money they owe reduces.

How Does The Government Control Inflation?

If the rate of inflation in the economy goes beyond a rate that is uncontrollable, the government has to intervene with policies to help stabilize the economy. Since inflation is the result of too much expenditure on the economy, the policies are created to restrict the growth of money. There are three ways the government can control the inflation- the monetary policy, the fiscal policy, and the exchange rate. They are discussed as follows.

— The Monetary Policy

Monetary policy is a tool used by the government to control the amount of money circulated in the economy. This includes paper money, coins and bank deposits held by businesses and individuals in the economy. Monetary policy uses interest rates to control the quantity of money in the economy.

— Open market operations

When there is high inflation in the economy, the amount of money created by financial institutions needs to be restricted. The Federal Reserve Bank lowers the supply of money by selling their large securities to the public, specifically to security dealers. The buyers pay for the securities by writing checks on the deposits they hold in the commercial banks. This is an effective way to control the supply of money as the deposits of the commercial banks at the Federal Reserve Bank are the legal reserve for the banks. With the sale of securities, the banks are forced to restrict their lending and security buying, therefore reducing the quantity of money in the economy.

— Increasing the reserve requirement

The reserve requirement refers to the amount of money that the commercial banks are required to have on deposit with the Federal Reserve Bank. A low reserve requirement means banks have more money to lend out which can increase the money supply. But when there is high inflation in the economy, the government increases the reserve requirement which restrains the growth of money and even reduces it.

— The rediscount rate

The rediscount rate is the rate of interest charged by the commercial banks. The commercial banks borrow from the Federal Reserve in exchange for a promissory note. In exchange, the Federal Bank increases the deposit of the bank. The rediscount rate controls the cost to banks for adding additional reserves. When inflation is high the bank increases the rediscount rate, which makes it more expensive for banks to buy reserves. This cost is usually translated to customers in the form of high interest rates on loans borrowed from commercial banks which ultimately reduces the supply of money in the economy. In order to control the supply of money in the economy with the monetary policy, the rediscount rate is used in conjunction with the reserve requirement and sale of securities.

— Fiscal policy

The Fiscal policy uses government spending and taxation to control the supply of money in the economy. The policy was designed by John Maynard Keynes who studied the relationship between aggregate spending and the amount of economic activity in society. He also claimed that government spending can be used to control aggregate demand.

— The decrease in government spending

Sending by the government constitutes a large part of the circular flow of income in the economy. During periods of high inflation, the government can reduce the spending to decrease the amount of money in circulation. In many instances, high government spending is the root cause of inflation. However, it is often hard for governments to differentiate between essential and non-essential expenditure so, the spending policy should be augmented by taxation.

— Increase in taxes

An increase in the level of taxes reduces the amount of money that people have to spend on good and services. The effect of the tax can vary with the kind of tax imposed, but any increase in tax would reduce spending in the economy. An increase in tax combined with a decrease in government spending can have a double-barrelled effect on the supply of money in the economy.

— Increase in savings

Another theory derived by Keynes was his belief in compulsory savings or deferred payments. In order to achieve this, the government should introduce public loans with a high rate of interest, attractive saving schemes and provident or pension funds. These measures lock people’s income into savings accounts for an extended period of time and are an effective way to control inflation.

Also read:

Conclusion

Inflation can have a major impact on the economy and can affect the government, investments and the purchasing power of people. A high rate of inflation for an extended period of time can lead an economy into a recession. Fortunately, the government has the ability to use the monetary and fiscal policies to help control the supply of money in the economy. When used in the conjunction, the policies can help achieve a lower rate of inflation and a more stabilized and balanced economy.

Rupee Depreciation: Is it a cause of concern?

Rupee depreciation and its impact on the economy, market and people have been in a lot of debate lately.

Last year, the exchange rate of Indian rupee to US Dollar made an all-time of Rs 74.34 on October 9, 2018. Although the currency has recovered a little since making its high and currently hovering at Rs 70.52 (as of January 9, 2019), however, people are still wondering how rupee depreciation can impact their lives.

In this post, we will understand what exactly is rupee depreciation and also analyze the impact of rupee depreciation on different industries, imports, exports, and the stock markets.

How the Rupee value is determined?

In simple words, the rupee value is determined by the forces of supply and demand in the currency market.

If the demand for Indian currency is high, Indian rupee will appreciate. This is called rupee appreciation. For example, if $1 = Rs 70 previously and later it moves to 1$ = Rs 67, then the rupee is said to be appreciating. This also means that our currency is gaining strength against the dollar.

On the other hand, if the demand is low, the currency value will depreciate. For example, if $1 =Rs 70 previously and later it moves to $1 = Rs 73, then it means that the rupee is depreciating. Here, our currency is losing strength against the dollar.

Quick Note: Although it’s easier to say that the price of a currency is determined by the forces of supply and demand, what actually drives an increase in demand or supply is a little complex and depends on multiple factors.

Some of the key determinants are inflation in the country, growth rate, interest rates, imports and exports, General macroeconomic conditions of the country, Economic Policies of a government (Fiscal Policy, Budget, Investment policy, and Foreign Trade Policies), political stability, banking capital, commodity prices etc.

Floating vs Fixed Vs Managed Rate System:

Another important concept to understand while studying the currency of a country is its rate system. It can be either fixed, floating or managed float regime.

The floating rate system is a situation in which the value of the currency is freely determined by the market through supply and demand forces and it generally fluctuates constantly.

On the other hand, if the government or RBI exercise controls and fix the exchange rate of a currency (and disallow any fluctuations according to demand and supply forces in the market), such a system is called the Fixed Rate system. It is also called the Bretton Woods system or Pegged Currency System.

However, since this mechanism does not depict the real currency strength (or weakness), most of the countries including India changed to Managed Floating Rate System where currency value is determined by competitive market forces, with intervention by the Central Govt by purchasing rupee in exchange for the foreign currency to increase money supply in the economy which leads to home currency depreciation. Vice versa, it buys foreign currency in exchange for the rupee to reduce the money supply in the economy leading to home currency appreciation.

History of Indian Rupee: A comparison of Indian Rupee Value vs US dollar 

Since October 2008, the exchange rate of INR per USD has depreciated from Rs 48.88 to Rs 70.52 – as of 9th January 2019. Here is a historical data of the exchange rate of Indian rupee per US Dollar.

Year Exchange rate
(INR per USD)
1947 3.30
1949 4.76
1966 7.50
1975 8.39
1980 7.86
1985 12.38
1990 17.01
1995 32.427
2000 43.50
2005 (Jan) 43.47
2007 (Jan) 39.42
2008 (October) 48.88
2010 (22 January) 46.21
2012 (22 June) 57.15
2014 (12 Sep) 60.95
2016(20 Jan) 68.01
2017 (28 Mar) 65.04
2018 (9 May) 64.80
2018 (Oct) 74.00

Source: Wikipedia

Exchange rate inr per dollar

(Source: Tradingeconomics.com)

What TRIGGERS the increase in demand of currency?

Rupee’s appreciation or depreciation against the dollar depends on the dynamics of demand and supply for the currencies. Besides global factors, the following factors also are instrumental in creating the demand:

  • Interest Rate: The interest rate of a country influences the demand for the currency. India with an interest rate of 6-7% would attract greater capital inflow as investors get a higher return than their earnings in the US. (with Interest rates of 2-3%). This results in rupee appreciation.
  • Inflation Rate: A country with lower inflation would have increased demand for its products by foreign buyers. Higher demand for goods & services would translate into higher demand for that currency resulting in currency appreciation.
  • Export-Import: A country exporting more than importing from other countries, would result in higher demand for that currency, causing currency appreciation.

Current Scenario of Currency in India

The Rupee is currently sharply depreciating against the dollar having breached the Rs 70 per dollar mark by the end of 2018. As per a report dated 8 Jan 2019 by Livemint –Analysts say fundamentals will aid the rupee this year.

  “Attractive real yields (net of inflation), growth momentum and robust FX reserves of $394 billion and dollar stabilization are likely to be positive for the rupee, while lower global growth and trade will eventually impact the US economy and asset markets, causing the US Federal Reserve to slow the pace of rate hikes”, -Standard Chartered Bank. (Source: Livemint)

The dollar is expected to stabilize as interest rate differentials between the US and the rest of the world peak.

how the rupee fared last year-min

(Source: Bloomberg)

What are the different impacts?

Industry impact:

Rupee Appreciation means imports turn cheaper and exports become expensive. So, it means good news for companies who are dependent on imported inputs like Petro Products and Engineering Goods as their outflows would decline.

Rupee depreciation means exports earn more. Indian IT sector is dependent on US export revenues.  The contracts with US clients are usually quoted in dollars term. Hence their inflows would increase.

rupee appreciation and depreciation impact-min

Source: Moneyworks4me.com

Stock Market impact:

Foreign investors (FIIs) stand to benefit from a rupee appreciation. Subsequently increased FII inflows could fuel a bull run in the stock market.

To explain with an example: Suppose an FII Invests Rs. 1lakh in the Indian stock market and at an exchange rate of $1 = Rs. 50. So, the amount invested is (1,00,000/50) $2000. Suppose, after 1 year, hypothetical, even if the value of the investment doesn’t appreciate or depreciate, the foreign investor will be in a position to book a profit if the exchange rate has appreciated to $1 = Rs. 40

If the investor sells his investment at the prevailing currency conversion rate, he would get (1,00,000/40)  $ 2500. So, he would book profits of $ 500 due to the rupee appreciation.

Also read: How Does The Stock Market Affect The Economy?

Fuel Shock:

In the case of a Rupee depreciation, the biggest blow to the Indian economy would be the higher outflows due to fuel becoming expensive. India imports most of its fuel requirements from the OPEC countries. This increased fuel costs would result in food inflation as transportation costs become higher. In a developing country like India, this would have disastrous consequences on the vast population.

Summary

In this post, we studied the broad framework of how the exchange rate is decided by the currency market and the factors that influence the Rupee appreciation or depreciation. We also discussed the outlook as per analyst expectations and the impact of the exchange rate fluctuation on the real economy and the stock market.

Although the impact of rupee appreciation or depreciation on individuals and industry depends on which side of the fence they are. However, broadly speaking, rupee appreciation against US dollar is an indicator of a strong, robust Indian economy.

How Does The Stock Market Affect The Economy cover 2

How Does The Stock Market Affect The Economy?

A stock is a type of security that represents an individual’s ownership in a company and a stock market is a place where an investor can buy and sell ownership of such assets.

Trading stock on a public exchange is essential for economic growth as it allows companies to raise capital through public funding, pay off debts or expand the business.

Why do we have a stock market?

The stock market exists for two main reasons, the first is to provide a company with the opportunity to raise capital that can be used to expand and grow the business.

If a company issues one million shares that can sell at $4 a share, this allows them to raise $4 million for the business. Companies find it favorable to raise capital this way so they can avoid incurring debt and paying steep interest charges.

The stock market also provides investors with the opportunity to earn a share in the company’s profit.

One way to do this is to buy stocks and earn regular dividends on its value- that is the investor earns a certain amount of money for each stock they own.

Another way is to sell the stock to buyers for a profit when the price of the stock increases. If an investor buys a share for $20 and the price eventually increases to $25, the investor can sell the stock and realize a profit of 25%.

Also read: Why do Stock Markets Exist? And Why is it So Important?

How the Stock Market affects the Economy?

The increase and decrease in stock prices can influence numerous factors in the economy such as consumer and business confidence which can, in turn, have a positive or negative impact on the economy as a whole. Alternatively, different economic conditions can affect the stock market as well.

Here are a few ways the stock market can affect the economy of a country:

Movements in the Stock Market

The movements in the individual prices of stocks give the stock market a volatile character. As stock prices move up or down, their volatility can have a positive or negative impact on consumers and businesses.

In the event of a bull market or a rise in the prices of stocks, the overall confidence in the economy increases. People’s spending also increases as they become more optimistic about the market. More investors also enter the market and this feeds into greater economic development in the nation.

When the prices of stock fall for a continuously longer period, also known as a bear market, it has a negative effect on the economy. People are pessimistic about the economic conditions and news reports on falling stock prices can often create a sense of panic. Fewer investors enter the market and people tend to invest in lower-risk assets which further depresses the state of the economy.

Also read: What is Bull and Bear market? Stock Market Basics

bull and bear market

(Image credits: 5paisa.com)

Consumption and the Wealth effect

When stock prices rise and there is a bull market, people are more confident in the market conditions, and their investment increases. They tend to spend more on expensive items such as houses and cars. This is also known as the wealth effect which is how a change in a person’s income affects their spending habits and eventually leads to growth in the economy.

In the case of a bear market or a fall in stock prices, there is a negative wealth effect. It creates an environment of uncertainty among consumers and a fall in the value of their investment portfolios decreases spending on goods and services. This affects economic growth as consumer spending is a major component of Gross Domestic Product.

A common situation of the wealth effect was during the US housing market crash of 2008, which had a large negative impact on consumers wealth.

what's the economy

(Image credits: Investopedia)

Impact on Business Investment

Apart from consumer spending, business investment is also a key indicator of economic growth.

When stock prices are high, businesses are likely to make more capital investments due to high market values. Many companies issue an IPO during this time as market optimism is high and it is a good time to raise capital through the sale of shares. There is also more mergers and acquisitions during a bull market and firms can use the value of their stock to buy out other companies. This increased investment feeds into greater economic growth.

When the stock market is bearish, it has the opposite effect on investment. Confidence in the economy decreases and businesses are no longer eager to invest in the economy. The decrease in share price makes it harder for companies to raise funding in the stock market.

Other factors

The stock market also affects the bond market and pension funds. A large part of pension funds are invested in the stock market and a decrease in the price of shares will lower the value of the fund and affect future pension payments. This can lower economic growth as people who depend on pension income will tend to save more and this lowers spending and eventually the GDP.

While a fall in share prices has a negative impact on economic growth and GDP of a nation, it has a positive effect on the bond market. When there is a depression in the stock market, people look for other assets to invest their money in such as bonds or gold. They often provide a better return on investment than shares in the stock market.

Remember, it is always important to diversify your investment portfolio and spread your risk. Don’t throw all your eggs into one basket.

The stock market and the economy are not the same

Contrary to popular belief, the stock market and the economy are two different things. The GDP of an economy and the stock market gains are incompatible and, in fact, there is little comparison between the two. The major reason for this discrepancy is the difference in the size of the two markets. The economy depends on millions of factors that can have both a positive and negative impact, while the stock market is only affected by one factor, the supply and demand of stocks.

Also read:

For investors in the stock market, it is better to err on the side of caution and focus on the fundamentals of each stock rather than on the economy as a whole. As the saying goes ‘an economist is a trained professional paid to guess wrong about the economy’.