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Economic Country investment Decision

Asked by Ed2008 | Apr 28, 2008 | University Level > Economics > Homework
Ed2008
Ed2008 asks:

Hello
I wonder if you can give me any advice with a class discussion I need to prepare for.
The scenario is:
I am meant to be a international fund advisor and my day to day professional life is based around the analysis of economic , political and social data in order to make investment proposals. My latest project is that I have been asked to select three countries in which to make a long term productive investment in the manufacturing sector. The client requires a diversified portfolio and so has asked me to select one country from three different GDP per capita groups: low, medium and high. The client has asked that the investments be made in countries with acceptably low risk and where the potential for medium/long term returns is high. I am given a list of countries with 3-4 countries from each per capita GDP group.
The company I work for uses a scorecard to recommend investment opportunities. The scorecard automatically assigns equal weighting to the following indicators for all of the countries (it’s a model they have given me but its web based so unfortunately I cant upload it for you to see).

•   % change real GDP
•   CPI % change
•   CPI trend
•   Budget balance
•   Deficit trend
•   Public sector debt
•   Public sector debt trend
•   Real interest rate

It is my job as a fund advisor to assign a weighting to the importance of each indicator (ie out of a max of 100% what portion would I assign to each indicator). I only have to do it once ( ie not for each per capita GDP group). The weighting I assign will then give me a ranking for each country in each sub group (ie what countries accoding to my indicator weighting will be the best for investing in).
I need to explain my logic behind why I have chosen the specific weighting for the indicators ( relating it to the fact that I am investing in the manafacturing sector).

I have some basic ideas but would really be grateful if anyone with a better understanding of economics could help me out and give me some advise as to which indicators would be more important to take into account and why ?
Thanks
Ed


etutor answers:

I have looked closely at your request and, in the absence of the model from which you are working, it is hard to advise in any detail. The key features of your task seem to me to be:

I have been asked to select three countries in which to make a long term productive investment in the manufacturing sector. The client requires a diversified portfolio and so has asked me to select one country from three different GDP per capita groups: low, medium and high. The client has asked that the investments be made in countries with acceptably low risk and where the potential for medium/long term returns is high.It is my job as a fund advisor to assign a weighting to the importance of each indicator. I need to explain my logic behind why I have chosen the specific weighting for the indicators ( relating it to the fact that I am investing in the manafacturing sector).


• % change real GDP
• CPI % change
• CPI trend
• Budget balance
• Deficit trend
• Public sector debt
• Public sector debt trend
• Real interest rate


Assuming that the above indicators are the only ones you are required to consider, then:

1. The % change in real GDP tells you little about the size of the manufacturing sector - i.e what proportion of GDP it constitutes. In advanced economies, manufacturing is declining as a % of total GDP. What is more important is the trend growth of GDP over a period of time, and also the extent to which it fluctuates. In an advanced economy, you would want relatively low fluctuations which would normally reflect strong underlying monetary and fiscal policy, a coherent inflation target and a stress upon free markets, with relatively few regulatory burdens. In less developed economies, the stability of the government and the banking system are critical.

2. CPI is of course only one measure of inflation; you would need to look at several to detect the underlying trend. High inflation countries are generally bad for investment, since governments invariably eventually apply the brakes; moreover a company's sales may suffer if it is operating in an inflationary environment, as this tends to undermine its international competitiveness. Much depends also on the SOURCE of the inflation - that caused by cost pressures is usually worse than that caused by demand pressures.

3. The trend in CPI is clearly rather more important than a single year's figures - as in 1, we are looking for something approaching price stability, which in turn implies a robust inflation target and central bank independence.

4. The budget balance is important, since in the case of a deficit, the higher the deficit the greater the need for government borrowing and the higher the interest rates that have to be offered to induce people to lend. For any highly geared manufacturing company this is a situation it would normally wish to avoid. There is also then the likelihood of future tax increases, some of which might be imposed on company profits.

5. If the above budget deficit tremd is persistent, then the cost of private sector borrowing to finance expansion will almost certainly be higher than in countries where the budget is under control. Moreover, government and the private sector could be seen to be in competition for the available funds.

6 and 7. The problem here is that the Debt has to be serviced annually. This reduces the scope for government spending on crucial infrastructure - a key issue in LDCs. Again, there is likely to be high levels of taxation (a deterrent to FDI) and possible import controls too, which could affect a company's ability to import essential energy, raw materials, components, etc. There will be further knock-on effects on domestic consumer spending if governments are committed to high taxes (and high interest rates) to service debts.

8. The real interest rate is the nominal interest rate with the effect of inflation removed. If it is positive, it is clearly a deterrent to investment for any company reliant upon borrowed funds. It will also affect cash flow if real interest rates rise and the company's existing borrowing is at variable rates. High real rates are also generally an inflationary signal, with all the problems described earlier arising.

Overall, stability is the key. Wild fluctuations in economic statistics and kneejerk and panic reactions by governments to economic problems are things that all but the most risk-loving investors will want to avoid.

I hope this is helpful.

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Eduard
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