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The economic indicators are variables designed for measuring and evaluating the macroeconomy condition of a country for the purpose of analyzing the current and future movement of the economy. They represent unavoidable risk to businesses when they eventually occur, because they are not within the control of a business entity. Hence, it is imperative for business to take cognizant of them.
The awareness and better understanding of the economic indicators will enhance the ability of a business or investor to make good investing decision or strategic planning.
There are several economic indicators depending on the agency, ministry, or entity that is producing the indices. However, some common indicators include:
This measures the total monetary value of final goods and services produced by a country within a year. GDP represents one of the vital economic indicators of a nation. It is an important measure of performance of the economy of a nation and its level of growth. It can be estimated using expenditure, income, or production methods. The GDP is a key tool designed to aid policymakers, investors, and business entities in making strategic decisions. The GDP is usually determined by the national statistical agency, such as the National Bureau of Statistics (NBS) in Nigeria, considering several parameters, and consistent with the established international standards.
This represents the total amount of goods and services produced in a country at the current market price. The current market price included the effect of inflation. The nominal GDP may be increasing year on year due to inflation, but the GDP may not be growing. As a result, nominal GDP is not appropriate measure of GDP growth rate.
This is the total goods and services produced in a country at a specified period, after adjusting for inflation. This provides a more reliable growth rate estimate since the possible effect of inflation has been adjusted. Real GDP growth rate is generally used as a measure of healthy economy. This is because an increase in real GDP demonstrates an indication that the economy is doing well (economic boom). In this case, there will be more money in circulation and in effect, companies will be hiring more labour, and employment rate will increase. But when the economy shrinks (recession), there will be a decline in real GDP, and employment level will fall.
In the determination of GDP of a country, the domestic currency is used. However, when comparing the GDP of different countries, the most important thing to do is to convert the GDP of each country with a common denominator i.e., the United States Dollar (USD), using appropriate exchange rate, including purchasing power parity.
The purchasing power parity theorem (PPPT) assumes that the exchange rate between two currencies generally depend on the relative inflation rates within the respective countries, and that the same goods should have the same price in wherever they are being traded. This is what is called the law of one price. The law of one price states that, the price of goods should be the same in every market if there are no transaction costs, trade barriers, quotas for a particular good.
PPPT can be calculated using the following formulae:
United States is the country with the largest GDP in the world with a total of $23 trillion and followed closely by China with $18 trillion, in the year 2021. Nigeria is ranked 31st in the world and the biggest economy in Africa with a GDP worth $441 billion. (WorldData, 2022).
Debt to GDP is a metric designed principally to measure the proportion of a country’s total debt to its gross domestic product (GDP). It measures the ability of a country to repay the sovereign debt owed from the total monetary value of goods and services produced within a certain period. The ability of a country to pay back its public debts as and when due will enhance its creditworthiness, leading to a good credit rating from the global rating agencies including Standards & Poor, Moody’s, and Fitch.
When a country is unable to pay its debts as they become due, it may send financial panic to domestic and global markets. By implication, the higher the debt to GDP ratio the higher the default risk (i.e., the ability to pay both the annual interest expense and the principal at maturity).
A lower debt to GDP ratio indicates a healthy financial status and a good creditworthiness to potential lender. Whereas a higher ratio shows that a country is struggling financially to repay its debt. This means that there is high propensity that the country will default in repaying the debt. In this case, lenders may not want to extend additional credit, or they may seek for higher interest rate to compensate for taken higher risk.
The World Bank carried out a study and established a threshold of 77% for debt to GDP ratio. It further states that any point above the baseline of 77% for an extended period will impair the economic growth of a country by 1.7%. In emerging markets, the threshold is 64% with additional percentage cost of 2% reduction in real growth.
Currently, Japan has the highest debt to GDP ratio of 240% relative to other countries of the world, followed by Greece with a ratio of 157%. Brunei Darussalam and Hong Kong are at the bottom of the table with 1% and 2% respectively. Nigeria debt to GDP ratio currently stands at 20%. (World Economics, 2022).
Inflation is one of the economic indicators. It represents the general increase in the prices of goods and services leading to a decline in the value of money. It is the increase in the average prices of goods and services in the economy measured in terms of changes in consumer price index (CPI). Inflation usually results in a decline in the purchasing power of money. It occurs when the supply of money is higher than goods and services available.
Basically, Inflation is caused by:
The cost-push inflation arises when there is general increase in prices as a direct consequence of increase in production costs, including direct materials, direct wages, direct expenses, and production overhead. When production costs increase, the supply of goods will decline, because manufacturer cannot produce as many goods as possible due to increasing costs. As a result, the burden of the higher cost of production will be shifted to the final consumers. Hence, the increase in prices.
Though, cost-push inflation is temporary in nature, but it has the tendency of slowing down economic growth, resulting in a fall in the standard of living of the people.
This includes:
Rise in the prices of production inputs– When the prices of production inputs such as raw material, copper, metal etc. increase, the company or manufacturer will be forced to increase the price of the final goods.
Increase in the price of commodities– If the prices of commodities such as petrol, or diesel rise, the cost of production and transportation will increase for most firms and households. Oil is considered a very important commodity in the society and that is why whenever there is increase in oil prices, the multiplier effect is always significant on the firms and final consumers.
Wages– When the cost of living becomes unbearable, workers will demand for higher wages which will invariably increase the production cost for many firms. As a result, the high cost of production will be shifted to the final consumers. On the flip side, when there is shortage of labour in the market, firms may want to increase wages to attract willing and qualified staff, thereby causing production cost to increase. This action will result in cost-push inflation.
This arises when there is increase in aggregate demand relative to aggregate supply in the economy, leading to increase in prices of goods and services. The demand-pull inflation is usually caused by the willingness of consumers to demand for more goods or services when there is relatively low supply. During the period of economic boom, the disposable income of consumers tends to increase, leading to more spending on goods and services. The increase in demand for goods and services will cause supply to fall. Therefore, there will be too much money chasing very few goods. Under this situation, the consumers will be willing and ready to pay more for the few items available.
Generally, Demand-Pull Inflation occurs when there is:
Expansionary fiscal policy is a policy designed by government to reduce tax burden on the taxpayers by adjusting tax rate downwardly or increase expenditure to increase aggregate money supply. When government increase spending, there will be more money in circulation, and this will invariably increase the discretionary income of firms and households. When this happens, the demand for goods and services will increase, which will in turn, lead to general increase in prices.
In summary:
Interest rate is the compensation for the use of funds for a specific period. It is the actual amount charged, expressed as a percentage of the principal, by a lender to a borrower for the use of funds. Interest rate represents the cost of borrowing to an entity. Several businesses including small and medium enterprises rely heavily on bank loans and other financial institutions to finance their operations.
However, central bank can reduce interest rates through government expansionary monetary policy. This will afford the banks and other financial institutions to lend more money to firms and consumers. The increase in aggregate money supply because of reduction in interest rates will lead to more spending on goods and services.
Unemployment is a vital indicator of how a particular economy is performing and a measure of improvement towards attainment of the United Nations Sustainable Development Goals #8 (Decent Work and Economic Growth). Unemployment is a situation where a capable person is actively seeking employment but unable to find work.
The number of employments generated or lost during a particular period is an indicator of macroeconomic condition which can materially impact the securities markets. When employment rate increases, it means businesses are doing well. Hence, there will be more money to spend, and demand for goods and services will increase. The increase in employment is good for businesses because it will help drive the needed growth in the economy.
However, weak economy generally produces high rate of unemployment, especially during economic downturn. In this case, when there is economic recession or inflation, cost of production tends to increase. Therefore, to minimize total overheads including salaries and wages, the low-hanging fruit for many organizations is to reduce the headcount, thereby resulting in job loss.
As a risk management strategy, it is essential for businesses, investors, or policymakers to be cognizant of various economic and industry-specific indices for strategic planning and in making good investing decisions. Your knowledge of the industry and economy, especially of the common economic indicators such as GDP, Debt to GDP, Inflation, Interest Rate, Unemployment etc. will enhance your market competitiveness and help you to avoid the risk of financial losses.
Companies should have a dedicated team responsible for monitoring the industry and regulatory environment in order to minimize exposure to economic, financial, and market risks.
At Adda, our advisory team can collaborate with you to develop a robust risk management strategy to enhance your market competitiveness. A strategy to improve performance and prevent financial losses.
At Adda, we pride ourselves with highly experienced and committed professionals willing and ready to collaborate with businesses to create value
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