Perils of long-term forecasting: How Goldman got it all wrong

“The only function of economic forecasting is to make astrology look respectable,” said John Kenneth Galbraith, renowned US economist. The developments over the last six-seven years prove this no doubt. Nonetheless, the forecasting industry thrives, in gloom and bloom. Fortunately for the forecasters, no one goes back to check how right or wrong they were.

Goldman Sachs, the globalfinancial services major, had released an extremely bullish report on India in November 2012.

[caption id=“attachment_1073265” align=“alignleft” width=“380”]  Goldman Sachs got it wrong on India’s GDP. AFP.[/caption]

It saw India’s GDP growth accelerating to 7.2 percent in 2014 and the value of the rupeeduring 2013-2016 at 52, 50, 51 and 52.

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Now, after the rupee’s surreal fall over the last one week to near 69 leveland GDP growth hitting a decade low of 5 percent in 2012-13, the reportreads like a piece of fiction, a fantasy.

“Three factors drive our relatively optimistic views: a decline in oilprices in real terms over the next few years, a more favorable externaldemand outlook and domestic structural reforms which can ease somesupply-side constraints,” the 2012 report said.

Interestingly, two of these factors are yet to materialise, at least until now.

Goldman Sachs said its commodities team estimated that the oil prices willdecline over the next couple of years.

Brent prices, in contrast, have risen from $108 per barrel level in November 2012 to $116 yesterday. If the US goes to war with Syria, the prices will rise again.

The structural reforms that the Indian government introduced last year have not yet yielded any major results yet.

To be fair, the report got it right, well almost, on external demand, where there is a glimmer of hope. In July, India’s exports rose 11.64 percent to $25.8 billion. But the increase came after two months of decline. Secondly, we are yet to finish a year. By the end of the year things can actually change with the appreciation of the rupee or improving export numbers.

The report failed to see the coming of the likely stimulus withdrawal in the US which is playing havoc with all emerging financial markets now.

Interestingly, it expected the capital inflows to be stronger during the forecast period.

“We expect capital inflows to be stronger through the forecast period due to easy monetary policy in the developed world, structural reforms to boost inflows and higher growth than elsewhere. Allowing greater FDI in retail, insurance, pension and aviation should aid inflows. Potential steps to increase debt inflows by deepening the corporate bond market and allowing greater foreign participation may also help. We therefore forecast a balance of payments surplus over the forecast period, driven by an improvement in both the current account and capital flows,” the report said.

Due to QE withdrawal fears, capital is in fact flowing out of India and its peers now.

The brokerage seems to have factored in an improvement in US economy but not the end of easy money that flooded the emerging markets. Ideally, there should not have been a difficulty in taking the end of the so-called quantitative easing into account because recovery and QE withdrawal have a cheek and jowl existence.

However, it is its oil price assumption that went wrong horribly, which had a cascadingeffect on all other projections.

“We expect the current account deficit to decline gradually, largely due toa lower oil deficit compensating for an increase in the non-oil trade deficit,” it said.

In contrast, the current account deficit in 2012-13 worsened to 4.8 percentof GDP and now fear is that it will get nastier. Behind the present marketmayhem is this fear.

Goldman Sachs said the CAD will be 4.3 percent in 2012, 3.6 percent in 2013,3.2 percent in 2014, 3.3 percent in 2015 and 3.1 percent in 2017.

That is not all. The brokerage also expected India’s balance of paymentposition to improve.

“An improving balance of payments and the INR being close to the lowerend ofits trading band on a real effective exchange rate basis, lead us to expectan appreciation relative to the USD over the next couple of years,” it saidin the report.

Many feel that the Indian market is a black swan event. It is a rare event where forecasting doesn’t really work. The only problem is that a name like Goldman Sachs carries a lot of weight. A lot of brokers and investors take decisions based on such reports may face losses.

Precisely because of this, the report has a caveat.

“A continuation of structural reforms is an important assumption underlyingour views. While allowing FDI in retail, the Goods and Services Tax, thedirect cash transfer of subsidies, and the dedicated freight corridor willhelp, we believe further reforms on fiscal consolidation, financialliberalization and infrastructure growth will be needed to sustain animprovement in trend growth,” the report said.

So, the blame for the wrong estimates that Goldman Sachs made, squarely falls on FinanceMinister P Chidambaram.