Thursday 3rd August, 2006

 

Inside the decline in business confidence

 
 
 
 
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Republic Bank researcher Ronald Ramkissoon, left, joins MFO’s client services manager Kimberly Philip and Republic executive director Gregory Thomson at the re-launch of the Consumer Confidence Index on July 19. Photo: Ian Gooding

By Narisha Khan

The third quarter issue of our Corporate Confidence Indices (CCI) released this week shows a decline in five of the six economic dimensions examined. Just what are the implications of these findings? This week we will explore the significance of the variables which underpin the indices and show how they impact on the economic landscape.

The primary aim of the CCI is to quantify the expectations that executives and business leaders have with respect to five variables key to understanding the current business climate in T&T: financial performance, investment, employment and the performance of the local and global economies.

It is essential for executives to keep track of the fluctuations in the outlook/expectations regarding these factors because of the significant impact that they have over existing prices, sales, incomes and other key variables.

From as early as the 1950’s economists recognised that expectations were an important determinant of economic behaviour.

The expectations examined by the CCI are important because of their often considerable influence over the current economic behaviour of households and firms and consequently on current prices and the prevailing level of economic activity.

For example, expectations of a shortage of bottled water during a hurricane can make it almost impossible to obtain any prior to the storm as people (governed by their beliefs about the future supply of the good) procure more water than they need in the expectation of a shortage.

This increased demand then increases the likelihood of a shortage, illustrating how current economic behaviour can be tied to future expectations.

Financial performance

The CCI comprises firstly a Financial Performance Index, which gives a generalised overview of the past financial performance of the firm.

Past financial performance helps shape future expectations. Overall, more executives felt that their financial performance had deteriorated over the past six months than the last quarter, as this index decreased by 25 index points.

As such we expect that executives’ financial outlook should also have deteriorated.

Financial outlook

The Financial Outlook Index measures executive opinion about the expected financial performance of their firms in the relative short term (six months) and long term (12 months) in order to determine what their level of economic activity is anticipated to be over these time periods.

In this way it is possible to gauge expectations of the future health of the macroeconomy from the point of view of decision makers. Executives can then tailor their business activities to maximise their returns in this expected economic climate.

This quarter, executives’ short run financial outlook fell by 20 index points, while their financial outlook for the long run fell by 15.

This continues the downward trend of this index since the third quarter of 2005 which is consistent with movements in the Financial Performance Index.

Executives are somewhat cautious about the financial prospects of their organisations in the coming months and have been so for some time.

This, combined with the fact that GDP growth has generally slowed in the last couple years, indicates that executives should prepare themselves to take the steps necessary to maintain their profit margins in this anticipated business climate.

Investment outlook

This index examines the outlook for planned investments in fixed and human capital in the relative short and long term.

It may, therefore, be used to anticipate the demand for capital goods (ie whether this is likely to increase or decrease at the macro level) and the associated pattern of domestic expenditure.

Since investment increases the future production capacity of the economy as a whole, the pattern of anticipated investment given by the index may serve as an indicator of future economic activity, allowing executives to take this into consideration when acting in the best interest of their firms. The outlook for both short and long term investments rose for this quarter by seven and two points respectively. This intended increase in investment contradicts what might be expected from the falling Financial Outlook Index.

In response to this decline it may seem more prudent for executives to cut back on investments in order to minimise costs over the long term and protect profits. It does appear that they are being cautious about their investment spending as the index for both time periods increased only moderately.

Employment outlook

The Employment Outlook Index explores anticipated expansion or contraction in the human resource base. This indicates the probable direction of buying power and macroeconomic activity in the near future.

For example, a general increase in employment would most likely lead to increased buying power, a rise in the demand for goods and services and growth in economic activity (although the downside of this is increasing inflation if production does not keep pace with the growth of the money supply).

On the other hand, a decrease in employment would lead to reduced buying power and less demand for goods and services, which results in lower macroeconomic activity and a dampening of the inflation rate.

The outlook for employment fell for both time periods and has been falling since the beginning of the year.

Expectations for hiring in the relative short term fell by nine index points whilst those for the long term fell by ten index points. This is consistent with the outlook for financial performance and investment.

Executives intend to spend less on expanding their HR base but are increasing capital investment or retraining current employees so that they can increase both human and capital efficiency in the long run.

Local and global economic outlook

These indices explore the overall expectations of the level of economic activity on a local and global scale. The aim is to quantify expectations about the performance of the macroeconomy.

In addition to investment, employment and micro financial health, this index examines consumption, government spending and the value of imports and exports.

The outlook for the local economy was less optimistic in this quarter. Executive expectations for the local economy in the short and long run fell by 20 and 21 index points respectively, while the Global Economic Outlook index fell by 15 and ten index points in the short and long run respectively.

Expectations for the local economy appear to be consistent with the other indices which comprise the CCI.

Theoretically, one would expect that if the outlook for financial performance and employment is less optimistic than before (even with a moderately improved outlook for investment) executives would be less optimistic about the overall performance of the local economy.

Combined with the weakened outlook for the global economy, this is then likely to feed into executive expectation for the financial prospects of their firms in the future and, by extension, the expectations for investment, employment and the current business climate.

These indices, therefore, are essential in gauging the economic outlook for T&T which can quickly evolve into economic reality.

Narisha Khan is a research analyst with the Arthur Lok Jack Graduate School of Business. She can be reached at 662-9894 ext 156 or email [email protected]

 

 

 

 

 

 

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