GDP

Forecast
and its
implicatio
ns
Agencies like IMF and World Bank
frequently revise the outlook of an
economy. They project growth
rates which rely on various
factors. The document intends to
analyze the significance of
forecast error and the various
implications of GDP forecasts

Sandeep B
1301090
PGP(2013-15)
IIM Tiruchirapalli

Submitted by Sandeep B (1301090) Page 1

GDP forecast and its implications

IMF pegs FY14 GDP growth of India at 4.25% World Bank Cuts
Developing East Asia GDP Forecasts - Bloomberg. This kind of news often
becomes headlines which put economists and the countrys governance body in
apprehensions. What is the significance of these numbers and what makes a
nation worry about these numbers? Are these projections always correct? In
business and finance and in government knowing what will happen in the
economy in the next quarter and next year is critical as an ingredient in
planning, for portfolio selection and policymaking. This demand for forecasts is
met by various professional forecasters like IMF, World Bank, RBI, Fitch and
Organisation for Economic Co-operation and Development (OECD). This process
of predicting the future of an economy using various statistical models utilizing
variables is known as Economic forecasting. Some of the significant economic
indicators involved in economic forecasting include inflation, GDP growth/decline,
employment rates and retail sales.
Gross Domestic Product (GDP) is one of the important indicators used to evaluate
the health of an economy as well as to improve a countrys standard of living.
Usually, GDP is expressed in relation to the previous year or quarter. For
instance, if GDP of an economy year-on-year is 8%, it means that it has grown
8% over the last one year.

World GDP growth forecasts

Country

Forecast
(2013)

Forecast
(2014)

Forecast
(2014)

Australia

2.00

1.06

1.00

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Brazil

2.28

2.38

1.99

China

7.50

6.50

6.00

France

1.06

0.54

0.48

Germany

2.62

1.35

0.97

Greece

-4.37

-4.80

-4.67

India

4.20

4.00

5.00

United Kingdom

1.81

0.98

1.35

USA

2.00

3.00

3.00
Source:

Tradingeconomies.com

The data given in the above table is driven by various analysts expectations and
are technically projected using an autoregressive integrated moving average
method (ARIMA). First, the past behaviour of vast amounts of historical data is
modelled and then the coefficients of econometric model are adjusted by taking
into account the analysts assessments and future expectations of an economy.
While these values may not prove to be the most accurate, Economic forecasting
remains an important decision making tool for business and governments as
they formulate financial policies and strategies. Accurate forecasts would
improve the efficiency of decision-making process.

Governments need economic forecasts for the purpose of framing a budget.

Through this, they intend to know how much revenue is likely to be available
within a given period so that the public resources can be efficiently allocated and
the essential amounts of borrowings are estimated. Macroeconomic forecasts
provide great interest to the general public only as long as they refer to future
values. Most of the forecasts rely on the historic data which demand clear
analysis of their forecast records and the statistical methods which they have
used. Granger (1996) suggests that these forecasts should be incorporated with
necessary confidence intervals based on the past performance while arriving at
the final projections.

Comparison of projections of GDP growth rate of India by

various agencies
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9
8
7
6
World Bank

IMF

Fitch
Actual value

3
2
1
0
2012

2011

AGENCY

IMF
WORLD
BANK
FITCH

2010

2012
Actu
al
Projected
Actual
3.2
4.9
3.2
3.2

6
6

2011
2010
Projecte
Projecte
d
Actual d
7.4
8.4
7.7
7.7
7.4
7.4

8
7

7.7
7.7

8.1
8

Forecast Error
As shown in the previous table, the GDP forecast of various agencies like IMF,
World Bank and Fitch may deviate from the actual forecast value. This deviation
is termed as the Forecast Error.
Forecast Error = Actual Forecast Projected value
A crucial determinant of the size of this forecast error is the forecast period.
History shows a mere association between business cycle turning points and the
size of these forecast errors. The errors were very high during the 2008 recession
period when real GDP growth was over estimated by nearly 3 percentage points
and inflation underestimated by more than 2 percentage points. Some of the
economic variables are unpredictable such as Agriculture output in a financial
year which depends on the vagaries of nature. Hence, the statements of
predictions may not hold true most of the times leading to inaccurate forecasts.
Even one percentage point of the forecast error may prove to give a difference in
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real terms of $10 billion dollars. Although perfection is the goal of forecasting, as
the future is not clear, we cannot expect the more accurate forecasts.

The various sources of forecasting errors are

The forecasts of international organisations such as IMF and World Bank

are occasionally scrutinised based on their own analysts research data.
This leads to varying growth forecasts by various rating agencies
Turning points in the business cycle the beginning and end of recessions.
The forecast errors of 2008 recession period extended till 3.5 percentage
points due to the economic uncertainty of a sudden economic downturn
Changes in productivity due to various fiscal and monetary policies
The frequent changes in the crude oil prices which largely contributes to
the spending of an economy
Forecasters may not predict disturbances like floods and other disasters,
corruption scandals and government shutdown (like recent U.S shutdown)
Use of historic data to project the future growth of an economy can very
well be inaccurate as the output is independent of historic data.

Implications of lower GDP forecasts

What the GDP forecast represents has an impact on almost everyone in
the economy. When the professional rating agencies like IMF or World Bank pegs
the growth rate of an economy, it can have a major impact on the various fiscal
and government policies and may still affect the growth of the economy. The
immediate effect of such a cut in growth forecast can result in Foreign
Institutional Investors diverting their investments and the existing investors
taking back the money from the economy and investing it elsewhere. This results
in the decrease in stock prices and the lower profits for companies. This in turn
reduces the output of an economy.
Weak economic outlook may also be due to the lower
consumption/spending of people in the country. Hence, lower GDP forecast may
lead to easing of interest rates which stimulates consumer spending. This may
actually result in the increase in money supply in the country heading towards
the positive growth.
Lower GDP may also possibly increase the value of Current Account Deficit
(CAD) which is expressed as the percentage of GDP. Higher CAD value may
trigger credit rating agencies to lower the credit rating of the country which may
lead to depreciating currency in the global market. This also leads to the increase
in interest rates of loans provided by various lenders such as World Bank and IMF
which may hinder government borrowing.

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Government can analyse the forecast reports to find out the bottlenecks
and try to overcome them by modifying the fiscal policies and thus shaping back
the economy. The forecast projections help the government allocating adequate
budgets and making reforms in the respective sectors of the country.
It is very important that an economy should be proactive in facing any
kind of economic downturn as it has been the case of the past five years such
that even in dire consequences, it could be able to bounce back. Policymakers
have credibility when the fiscal policies are believed and accepted by economic
agents. Hence, the economic and monetary policies should go hand in hand to
see positive results. Though the economic forecasts may not be accurate, an
economy should well be aware of the implications and hence give much thought
about where is it lagging in.

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