Important Economic Factors which Affect Investment

How do performance of an economy influence a Company?

Companies are part of the industrial sector, which in turn is a part of the economy. It is thus understood that the performance of a company depends upon the performance of the economy.

Economic Factors that affect Investment

Economic Factors that affect Investment

For example, when there is a recession in the economy, the performance of the company will be far from satisfactory. On the other hand, if the economy is booming, the company will be prosperous. So, the investors are interested in studying those factors of the economy, which can influence the performance of the company whose shares they are intending to buy.

The share price of the company depends upon the performance of industry and economy. A study of the economic factors will amply reflect the future corporate earnings and the payment of dividend and interest to investors.

Important economic factors that affect investment

The following are some of the important economic factors which affect investment.

1. Agriculture

In Indian economy, an impressive performance of the agricultural sector is of paramount importance. The majority of the population in India is engaged either in agriculture or in its allied activities and agriculture contributes considerably to the growth of the Indian economy.

Some companies use agricultural raw materials as inputs, while others are suppliers of such inputs. Apart from this, it has been repeatedly observed in India that if the monsoon has been active, then the agricultural income rises. With the increasing agricultural income, the demand for industrial products and services also increases. Hence, the performance of agricultural sector has a great bearing on industrial production and corporate performance in our country.

2. Gross Domestic Product (GDP)

The gross national product or the gross domestic product (GDP) means the aggregate value of all the goods and services produced in the economy. Thus, the GDP reflects the overall performance of the economy.

Personal consumption expenditure, gross private domestic investment, government expenditure on goods and services, net export of goods and services are some of the important factors related to gross domestic product.

A healthy growth rate of the GDP reflects the over all performance of the economy. A higher growth rate brings cheers to the stock market.

3. Savings and Investment

Savings and investments represent that portion of GNP which is saved and invested. Essentially, capital formation is the function of savings and investment. Commercial banks mobilize the savings of people and make them available for productive ventures. Further, the stock market channelizes the savings of the investors into the corporate bodies.

In other words, savings of the people are distributed over various financial assets like shares, deposits, debentures, mutual fund units etc. The pattern of savings and investment of the people significantly alters the trend in stock market. A higher level of savings and investment, accelerates the pace of growth of the stock market.

4. Inflation

As we all know, inflation means the rise in prices. As Crowther puts it,

inflation is a state in which the value of money is falling as prices are rising.

As a result, higher rates of inflation erode purchasing power of consumers, thereby resulting in lower demand for products. Therefore, high rates of inflation affect the performance of companies adversely. So, an investor should carefully analyze the inflationary trend in the economy and study its impact on the performance of the company. While doing so, he must also foresee the inflationary trend that is likely to prevail for the foreseeable future.

5. Rates of interest

The rate of interest prevailing in the economy determines the cost and availability of credit to the companies. A lower interest rate means lower cost of finance for business organizations. With the declining cost of finance, the profitability of the companies increases.

On the other hand, higher rate of interest increases cost of finance which in turn, results in higher cost of production. Higher cost of production leads to lower demand of products and lower profitability. So, it is necessary on the part of the prospective investor to consider the rates of interest prevailing in the economy and carefully analyze their impact on the profitability of companies.

6. Research and technological developments

The scope of development of industry will depend upon research and technological developments that are taking place in the economy. Perhaps, the Government is the largest investor and spender of money. The amount of resources spent by a Government on technological developments significantly influences the performance of companies.

Hence, it is advisable for the investor to invest in those companies, which are making use of the technological developments supported by the Government.

7. Infrastructural facilities

Availability of adequate infrastructure is an essential pre-requisite condition for the growth of agriculture and industry in any country. Generally, infrastructure consists of adequate supply of power, roads, railways, a wide network of communication, sound banking and financial sectors, etc.

Adequate infrastructural facilities increase the performance of the companies while inadequate infrastructure leads to inefficiency, lower productivity and lower profitability. Development of infrastructure is essentially the responsibility of the Government and it has a major role to play in this regard. So, the investor, before finalizing his investment options, should carefully consider the commitment of the Government towards infrastructural development and its impact on the performance of the companies.

8. Political stability

Stable political conditions are essential for the development of the industry. Industries are an essential corollary to the development of the economy. Only a stable political system can take care of the long-term needs of the industry and foster its development. No industry can prosper when the country is passing through political instability.

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