Puzzle of Economic and Financial Forcasting and India’s long term plans

Isn’t it puzzling that although economic and financial forecasts have a terrible record, the media publishes dozens of them at the beginning of year on economic growth and how stock indices would fare at the end.

Forecasting is a more formal and well-recorded business in the US, and soit provides great examples of forecasting follies.

The consensus view in the US for 2023 was that the S&P 500 would fail; instead, it climbed 24.2 percent, and the Nasdaq 100 soared over 50 percent. The Chinese stock market was expected to rebound on post-Covid “reopening” but it sank.

The widely trumpeted prediction of US recession was wrong; its gross domestic product (GDP) rose strongly. The Federal Reserve’s interest-rate hikes were expected to slow consumer spending and business growth; instead, the economy continued to grow, the inflation rate fell and stock prices rose. On the other hand, breakthrough in artificial intelligence (Al) research started an unexpected bull market in US technology stocks.

Markets and economies are complex, emerging, adaptive systems. They are not static and hence predictions about how they will behave invariably turn out to be wrong or useless as new events set in motion a complex interplay of factors leading to unexpected outcomes. However, what if the drivers of economic growth remain in place for a longer time? Would the forecasts then be more accurate?

For instance, after a surprising lack of initiative on the economic front between 2014 and 2021 (except the knee-jerk tax cut of 2019), the Modi government has suddenly ignited several growth engines simultaneously and unleashed economic forces of change that India has seldom seen. This, perhaps, makes it easier to predict long-term outcomes as long as the stated policies remain in place and their execution matches up.

Production-linked incentives:

Launched in a small way in March 2020, the production-linked incentive (PLI) scheme aims to turn India into a manufacturing hub and reduce its reliance on imports, especially from China. The scheme offers incentives if incremental sales of locally manufactured products reach pre-set targets. It has had a limited success so far because imports of finished goods were replaced with imports of components with minimal assembly being done here.

However, every new sector beings manufacturing with the assembly (as TV manufacturing was in the 1980s) of products, and such operations also have a ripple effect.

The PLI scheme appears to be over-ambitions: We are nowhere near the six million jobs that were to be created and 2 trillion given as incentives between FY2021 and FY2027. But it is believed that Indian enterprises are more ambitions, hungry, and resourceful than they were ever before, and the scheme will boost manufacturing to some extent.

Massive capital spending:

Ever since independence, economists have complained the budgetary allocation is mostly wasted on funding revenue expenditure, primarily government salaries and interest on borrowings. No money is left for much-needed capital expenditure (capex). This suddenly changed in the 2023-24 Budget, when the government announced a stupendous capex of 10 trillion for defence, urban infrastructure, and railways (allocation of 2.40 trillion, a whopping 75 percent jump over FY2023). Energy is another sector enjoying a massive capital outlay on renewables to smartgrids to smart metering.

Cut in imports:

This is not obvious now but if capex on the PLI system, energy, and defence pays off, three of the biggest import items electronics, arms, and oil-would be cut sharply, leading to a structural change. Sectors under which the PLI scheme has been announced constitute around 40 percent of imports.

The benefits of this massive multidirectional government capex are visible. Every few days, companies are announcing orders that are multiple times their revenues. Analysts are finding it hard to keep up with the torrent of such news and updating their revenue and profit forecast. The consensus is that at least for the coming few years we have a stable and committed policy framework and hence forecasts of sustained growth are a given. This has led to a consensus about the markets heading higher. Who doesn’t know it?

Extrapolating economic fundamentals to stock market forecasting is a big leap, though. Stocks rise significantly when they are undervalued and there are positive surprises. Right now stocks are no longer undervalued and everyone in the market knows about the huge positive impact of expenditure on the railways and defence. This is why wagon manufacturer Titagarh Rail System leapt 367 per cent and Mazagon Dock Shot up 191 percent last year. As Howard Marks, legendary US investor, advised, when you are excited about something (such as the country’s or company’s future), ask yourself: Who doesn’t know that? If everyone knows, it is not a surprise and the rosy future is already reflected in the current price. Indeed, when everyone is bullish and agrees with one another, one needs to be cautious. A piece of slightly negative news can cause a serious setback.