What’s it: Macroeconomic factors refer to the macroeconomic conditions that bring both opportunities and threats to business continuity. Examples are economic growth, inflation rates, interest rates, and exchange rates.
They are parts of the external environments that expose the company’s performance. Also, companies do not have the control to influence them. They can only adapt by taking advantage of opportunities and minimizing any negative impacts of threats.
Five important macroeconomic factors
Macroeconomic factors affect the ability of companies and industries to obtain adequate rates of return and profitability. The changes can present opportunities and threats. Apart from that, their exposure also varies between companies and industries.
The five most important and frequently observed macroeconomic factors are:
- Economic growth
- Interest rate
- Currency exchange rates
- Inflation rate
- Unemployment rate
Economic growth represents changes in the economy’s output over time. The primary indicator to measure it is real GDP growth. The fluctuation from time to time is what we call the business cycle.
When the economy grows positively, we call it economic expansion. Meanwhile, the period during which economic growth is negative is referred to as an economic contraction. The contraction for more than two consecutive quarters we call an economic recession.
Economic expansion leads to a more prosperous economy. Business activity increases. The prospects for business profits, household income, and employment are improving. It has a positive impact on household spending.
Households spend more money on goods and services. As demand increases, businesses increase their production by purchasing capital equipment and recruiting new workers. As a result, the unemployment rate declines.
Long story short, economic expansion has a positive impact on most businesses. That allows them to expand their operations and earn higher profits.
Conversely, the economic contraction has led to a reduction in household spending. This condition increases competitive pressure. Economic downturns often lead to price wars, especially in mature industries.
For borrowers, the interest rate represents the cost of borrowing money. Conversely, for lenders, it represents the rate of return they require when lending money.
Interest rate exposure varies between companies. Financial companies, such as banks and pension funds, have more significant exposure than companies in the real sector.
For real sector companies, interest rates do not only affect funding costs. But, it also indirectly affects the sales of their products.
Interest rates affect consumer demand. Households often borrow money to finance goods such as houses, cars, and other expensive products. Thus, an increase in interest rates directly weakens demand. Households delay buying and applying for new loans.
Apart from sales, for companies, interest rates also impact the cost of capital and return on deposits. It affects the company’s ability to raise funds and invest in new assets.
If interest rates are low, the funding cost is also low. Businesses are borrowing more to invest in capital goods. On the other hand, businesses will receive less interest for the money they deposit in the bank.
Conversely, when interest rates are high, the funding cost becomes more expensive. They are reluctant to invest in capital goods because it is not profitable. On the other hand, they earn more interest on the money they deposit in the bank.
Currency exchange rates
Currency exchange rates represent the purchasing power of domestic currency against foreign currencies. Currency exchange rate movements have a direct impact on the competitiveness of export and import products.
For example, when the exchange rate depreciates, domestic products become cheaper for overseas buyers. Conversely, foreign products are becoming more expensive for domestic consumers.
Thus, depreciation creates opportunities for exporters to increase sales abroad. This makes domestic products more competitive (in terms of price) in foreign markets.
On the other hand, depreciation is a threat to importers. Also, it impacts increasing costs for most companies that rely on foreign raw materials and capital goods. They have to pay more.
The opposite effect applies when the exchange rate appreciates.
The inflation rate reflects changes in the prices of goods and services in general in the economy. It is not just for one or two goods and services, but for most goods and services, whether consumed by households, used by businesses, or flowing in the economy.
Inflation occurs if the price of goods and services increases. And, when prices fall, we call it deflation.
A stable and low rate of inflation is desirable. On the other hand, high and fluctuating inflation rates create uncertainty in economic decision making, both for households and businesses.
Businesses use the inflation rate for several purposes, such as setting selling prices, adjusting employee salaries, and investing.
If inflation continues to increase, the money’s purchasing power falls, so do real returns on investment. When it fluctuates, it makes the future less predictable. In such an environment, management finds it difficult to make accurate business projections.
Next, deflation also has a destabilizing effect on economic activity. Although the purchasing power of money for goods and services increases, it exposes other parts of the economy.
Deflation usually occurs during economic recessions. That is bad for companies and individuals with high levels of debt.
Deflation increases the real value of debt. As a result, households and businesses have to spend more money to repay debts, increasing the default risk.
On the other hand, falling prices make the company collect less revenue. Demand for goods and services is weak, forcing firms to cut production and labor. As a result, the unemployment rate is high, and the revenue and profit outlook worsens.
An increase in the unemployment rate worsens the prospects for household income. Household demand for goods and services weakened. As a result, the company sells fewer products and, in turn, makes less profit.
However, rising unemployment rates leave companies with more options for recruiting new workers. Because workers compete with each other for jobs, it is easier for businesses to keep wages down.
Meanwhile, when the unemployment rate is low, companies must offer higher competitive wages to attract new workers. In a situation like this, finding suitable talent is more difficult because most of them have already worked.
However, in terms of corporate income, a low unemployment rate represents an opportunity. Household income prospects are improving, as are product demand and business profits.