Its a classic error, really. And one that is repeated time and again and again. The media reported a couple of days ago the IMF World Economic Outlook (WEO) update that India should be able to grow at 6.5% in 2016-17, thereby outstripping the Chinese growth story, which should be able to clock only around 6.3%. Further, it reported with great gusto how the markets went into a tizzy. The Sensex immediately climbed 1.9% to reach 28,784 and Dalal Street celebrated yet one more day of the bull since the rates were cut by the RBI Governor on Sankranti. There was almost a tone in that whole reporting that nothing can now possibly go wrong; what the IMF has proposed, the markets have seconded. India to topple China. All in a matter of 2 years.
So what is the error, you must be thinking. Its simple. Some things don’t go together. At all. Period. Even if we see them together all the time. Like..ummm…Odie and Garfield. Harry and Sally. Economics and Finance, anyone?
I have always felt upset when the media reports economic parameters and financial markets in the same breath. We have almost always seen the financial markets dance themselves silly on the news of economic parameters like growth and unemployment. But we cannot possibly judge the economic growth story by revelling in that wild optimism that markets are known to create. For heavens’ sake, can we really allow the Sensex to corroborate the IMF forecast? How much water do the forecasts hold anyway?
Forecasting, the most imprecise branch of economics/ econometrics, is obviously the one wherein the interest of the players lies. I often go back to my favourite statement “Weather forecast for tonight: Dark” as a tongue-in-cheek reminder of whether a) a forecast is a formal way of stating the obvious and in fact doesn’t look good till it states…the obvious! and b) the basic ability of anyone to forecast anything at all is always “dark” and suspect.
Didn’t get that? Yeah, thought so. Okay, lets put it simply. The acceptability of a forecast depends on how obvious it is. So, the Modi Sarkar with its bagful of tricks (and treats, which the Obama team will bring in soon) seems to suggest to the aam mind that growth could be well on its way. Also, it is obvious that with the issues that China is facing, they will be forced to deliberately push up the rates, slow down the export rate, increase labor costs internally…hmm, they will have to slow down, right? Now, it does not take a Box and Jenkins to predict that the rates could cross over soon enough. What the market had roughly expected, the forecast stated, sealed, packed and delivered. This forecast is causing excitement, because it is stating the expected.
Second, forecasts are always the dark horses of the economic family. No matter what technique you use, no matter how deeply you understand the non-stationarity in the processes, no matter how you try to arch over the GARCH models, you are taking a view of the future based on stochastic behaviour of the past. Forecast brightness: Dark!
Hmmm…so I come back to my main point: Is the IMF forecast reliable? That’s a different question from: Is the IMF forecast acceptable? Well, now the interesting part is that there is documented proof that the WEO forecasts tend to be …biased, in certain cases and hence, buddy, before you think of buying that stock, please do take a look at this.
A number of studies have been carried out on the efficiency of the IMF WEO forecasts at a formal and informal level. A study that I found particularly interesting was “On the accuracy and efficiency of IMF forecasts: A survey and some extensions” by Hans Genberg and Andrew Martinez. Different papers seem to suggest that there is considerable scope for the forecasts to be biased.
Evidence from papers suggests that IMF growth forecasts are normally optimistic if the country is a program country (India), or is a developing economy (India) or is an Asian economy (India). There also seems to be evidence that the IMF forecasts follow political optimism cycles (India) and that forecast errors seem to be maximal if there is an issue in terms of understanding the fiscal movement of the country (India). More optimistic is the political cycle leading to expectations of low fiscal deficits, more optimistic is the forecast (India). Few papers seem to suggest that the forecast seems to be biased upwards in the short run (2016, India) and especially so in times when certain variables (like oil prices) can turn turbulent for the host country (India).
Do you want me to go on? You get the point, right? There’s way too much optimism in that IMF forecast of 6.5%, if you ask me. The only reason why I don’t have a commanding voice and an unquavering eye is the following: To expect that the IMF forecast is too optimistic for India 2016 is finally a forecast based on my observations of IMF forecast in the past! Help!
So, is it too early to celebrate? Yes. I believe that the next 6 months will give us a true picture of where we are heading. Let the Sensex and the Nifty go any which where; we need to see where the real variables move in the next 6 months. The expenditure program of the Government, fiscal deficits, GDP growth, GFCF, ICOR, employment, credit off-take, poverty ratios…these are the variables to be watched. If these move correctly, then we may have a chance of overtaking that prized opponent (if you will), China, by 2016.
In the meanwhile, let Odie, that jolly and dumb animal, be happy. Just hope Garfield doesn’t transform into Grumpy Cat.