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Frontier Informal Thoughts - Tackling Uncertainty in the Economy
(2023 November marked 20 years since Frontier Research first started as an economic consultancy and investment advisory firm. Although our services have evolved over the years, there have been key principles and approaches that have guided us across these two decades. It is based off these key concepts that we work on bringing macroeconomic advisory and economic research to Sri Lanka’s boardrooms. With Sri Lanka standing at a crucial point in its post-crisis recovery, we’re writing this memo to talk about how our approach to understanding economics shapes how we view Sri Lanka’s outlook.)
In Summary
At Frontier Research, we try to give useful answers about the future as opposed to predicting it to perfection. We’re never perfect (with pandemics and wars and defaults all around, who can be?) but we think our approach takes into account the realities of the economics around us as well as the decision making requirements of those who live within this reality.
Frontier’s approach as a firm was of course set in place by our Founder-CEO, Amal Sanderatne. Across the years, Amal created a firm with a consistent and comprehensive approach that we have at times termed “The Frontier Way”. Amal was always an integral part of this approach, but the best part about how he built Frontier was that he was only ever a single part of the approach. Similarly, Frontier’s approach to research has always been about the team - diverse research and diverse perspectives, all bundled together into a few core values - independence, trust, and accessible communication. These values form the core of the worldview of the Frontier team and how we look at the economic landscape of Sri Lanka.
There are a few aspects of this reality we take within our worldview through macro intelligence, and then seek to address these with practical answers through macro analysis and advisory:
01
The future is uncertain but actionable
we answer this through our approach on ranges and probabilities
02
The future is uncertain but actionable
we answer this through our approach on ranges and probabilities
03
The future is uncertain but actionable
we answer this through our approach on ranges and probabilities
04
The future is uncertain but actionable
we answer this through our approach on ranges and probabilities
05
The future is uncertain but actionable
we answer this through our approach on ranges and probabilities
The current moment for Sri Lanka is a great example on how our approach can work. If we explore this step by step;
1. With 2024 being an election year, it is clear that the pathway forward has significant uncertainties - but we still think that businesses and investors can approach the probable outcomes directionally and take calculated decisions. Our ranges and probabilities remain wide to account for this uncertainty, but we try to give actionable insights within this.
2. That there are many “soft” aspects to the Sri Lankan story is also evident - and by avoiding a purely quantitative model driven approach, we are able to account for many of these as well. We like to think of it as “our model is our team” with a strong focus on data but a similarly strong focus on all other aspects that affect Sri Lanka’s economy as well.
Ultimately though, a reasonable portion of what we do is is partially guesswork. However, what we try is to make our guesses useful, actionable, and if they are wrong, easily correctable.
Thus the rules of the investment profession seem to require that its members describe their views about the future using high-sounding terms like 'analysis,' 'assessment,' 'projection,' 'prediction,' and 'forecast.' Rarely do we see the word 'guess.'
Howard Marks
In Detail
"The only function of economic forecasting is to make astrology look respectable."
John Kenneth Galbraith
Economics is a complex science and at many times, an obscure and often incorrect one. No further evidence is needed for this than Sri Lanka’s own story. Consider the hundreds of op-eds written in the local papers over the years, the thousands of hours of airtime given to commentators, and the millions of decisions taken in the lead-up to Sri Lanka’s economic crisis. Despite all this, it happened. Even with the benefit of hindsight, it is still sometimes a controversial topic without perfect consensus.
Living in the middle of crisis, economics can feel like a daunting cloud of worries and lies all packaged together in a series of unending storms that never even rain properly. Even outside of crisis, economists often talk of some storm or the other, never letting the sun shine for too long. They throw numbers and equations at you, they jabber on about liquidities and deficits and above all, they never give a straight answer to a question.
“Give me a one-handed Economist. All my economists say 'on one hand...', then 'but on the other...”
Harry Truman
This is even more infuriating when we look at the world we live in with so many unanswered questions that really matter. Who will be the president next year? What will next quarter’s energy tariffs be? Will interest rates keep going down? These are questions that any one would love to hear a straight answer on. Of course, economists aren’t fortunetellers, and yes, uncertainty is but a fact of life. But can’t they at least give a useful answer?
Amal’s success in setting out this framework for answering these questions was justified over the last few years. Starting from the constitutional crisis in 2018, and then moving across multiple momentous years - Easter Sunday attacks in 2019, Covid in 2020 and 2021, and the economic crisis since 2022 - Frontier’s team was able to take full ownership of talking about the wildly shifting economic landscape to our clients, and do so in a way that encapsulated the key values that Frontier built itself on - independence, trust, accessible communication, and constant change. Amal was of course, a key member of our team-driven process and his insights and contributions were highly valued. But it is a mark of his own success in building the team that he was able to be a part of the team instead of being the only member of it.
Since Amal’s passing, Frontier has continued the approach that we have been known for, and continue to engage with the economics in the same way. While our clients might have a good sense of the results of Frontier’s process, the actual process itself might not be as clear to everyone. In this memo, we’re setting out our research approach in detail so that the way we think, the way we come up with our research, and the way we engage with economics in a highly uncertain environment is laid out clearly for anyone to see.
Scenarios and ranges - Actioning an uncertain future
“We have to view the future not as an event which is predetermined and predictable or determined already, but as a range of possibilities”
Howard Marks
Economics is a complex science and at many times, an obscure and often incorrect one. No further evidence is needed for this than Sri Lanka’s own story. Consider the hundreds of op-eds written in the local papers over the years, the thousands of hours of airtime given to commentators, and the millions of decisions taken in the lead-up to Sri Lanka’s economic crisis. Despite all this, it happened. Even with the benefit of hindsight, it is still sometimes a controversial topic without perfect consensus.
Long-standing clients would know that our approach to the problem of uncertainty has been to provide probabilistic range-bound scenarios for the future. Here we give our most-likely scenario on where a particular indicator can go, which we call our “planning range”. However, we also give alternative scenarios that can play out differently, which we call our “risk mitigation range”. At some points in the past, these have admittedly been quite complex (See the attached document that shows a complicated 3-D scenario we gave in 2009!) but on the whole, we try to keep it between 3-4 relatively simple scenarios. These scenarios generally tend to have a few key factors that define them - for example, our current most likely scenario for the economy is that where the IMF programme continues with some level of delay and worries with nothing especially bad or good happening outside it.
Along with these scenarios, we generally prefer to avoid giving “single-number forecasts” and prefer to give “views ranges” instead. This allows us to account for the uncountable uncertainties that fall within our scenarios as well. Right now, even within our most likely scenarios, there can be varied smaller factors that change the specifics of what “IMF programme continuing” means. Particular policy measures, social responses, external events can all affect the economy WITHIN this scenario. We prefer to spend our time understanding the main factors that drive our scenarios as opposed to spending energy “dancing around a decimal” to try and perfect a specific number.
Despite this, there are instances where we have to give “single number forecasts” for certain practical needs of our clients. However, we recognize and communicate that the likelihood of these being precisely correct is very very low - and we don’t spend too much time trying to be perfect it. To try and account for the uncertainties, we do conduct regular reviews of such numbers and clients generally get at least a quarterly revised indication of the “forecasts”, but these are better understood as snapshot judgements as opposed to strong forecasts.
How is all this actionable? This combination of probabilistic scenarios and ranges in our view, gives a more accurate sense of what sort of outcomes are possible for the economy, even if it is not precise. We feel this allows for decisions to be taken that take into account all the realistic possibilities and not be overly affected if things don’t turn out the way we expect, and allows for the reality of uncertainty and incomplete information to be tackled nevertheless.