
Frontier Informal Thoughts - We were "wrong" about Sri Lanka in 2024
“In both economic forecasting and investment management, it’s worth noting that there’s usually someone who gets it exactly right… but it’s rarely the same person twice.”
- Howard Marks
At the start of 2024, Frontier’s overall expectation of the Sri Lankan economy was relatively clear. We told our Sri Lankan clients to plan for an economy with a recovering consumer, tightening rates, and a depreciating currency, while warning that negative risks were more likely than positive risks.
What actually happened was different. First a little gradually and then more decisively, the economy moved into our positive scenario instead of our planning ranges. Rates fell across the year, the currency appreciated, and while the consumer did start to recover in the second half, it was not as much as we expected.
Of course, given that this was in our positive scenario, it wasn’t completely outside of the bounds of possibility. Compared to giving just a single expectation, we weren’t entirely caught off guard. Forecasts are always a fickle creature. A big part of why we give scenarios and ranges is because predicting about something as complex as the economy is notoriously difficult. It is why we keep using Howard Marks’ famous quote – “you can’t predict, but you can prepare” when talking of the economy.
But at the end of the day, having a view move into a positive scenario is still different to having a planning range turn out right. What happened in 2024 that made us go “wrong”? Could we have done things better? What will we do to improve our work going forward?
What happened in 2024 and how was it different to our initial expectations?
Our initial expectations on the Sri Lankan economy were driven by a few factors. We saw the government running a stronger-than-expected primary surplus, but alongside both a recovering local consumer and credit situation. This combination alongside some technical factors on both Sri Lanka’s external and domestic debt was what led to the “fundamentals” which drove our view. Beyond this, given that 2024 was an election year that polls suggested would take an anti-incumbent turn, we also felt that market sentiment would be more likely negative than positive.
The first point we got “wrong” was where the government not just ran a stronger-than-expected primary surplus, but they overperformed our expectations massively. Sri Lanka went from our expectations of a 1.5% of GDP primary surplus (higher than the initial IMF target of 0.8%) to likely ending up closer to 4% of GDP instead. This meant that not only did the consumer not recover as much, but it also meant the technical issues in the domestic debt side were well handled. This meant weaker imports, stronger liquidity conditions, and just overall lower rates and a stronger currency.
However, despite this, until the Presidential election, markets didn’t move too dramatically different to our expectations. There were three instances where interest rates actually moved up by more than 100 bps in a relatively short period of time across 2024. Around the middle of the year, there was even some pressure on the currency, where it started a small but noticeable depreciation as well. Given that the big uncertainty of a massive election season was upcoming, this meant that we felt our overall expectations for the Sri Lankan economy were still on track.
We both overestimated and underestimated the market’s sentiment
Where things moved most decisively into the positive scenario, was in the strong and (to us) unexpected relief rally after the Presidential and Parliamentary elections. Our expectations were roughly that one of the then-opposition parties would win, but would be relatively indifferent in terms of macroeconomic policy direction. Thereby, the victory of the NPP wasn’t something we considered a potential economic “shock” (though the margin of their parliamentary victory was beyond what we expected).
However, it seems that we underestimated how worried markets had been prior to the election. Looking back, we had clearly underestimated the extent of this sentiment. Varied worries about the NPP given the Marxist past of the JVP probably led to more and more anxieties building up in markets, especially in the last few weeks before the election. Perhaps the main reason this didn’t spillover to becoming a panic was that the fundamentals had been turning more “positive”, which covered any negative moves in sentiment.
Once the NPP won and immediately moved to reassure continuity, these worries seem to have turned the other way around to result in a massive sense of relief. Along with overall fundamentals continuing to be strong, this is what probably lead to the rapid positive movements that were seen in the financial markets. We had clearly overestimated how worried markets would be AFTER the election, when they moved positively instead.
Looking back, could we have predicted this better given what we know now?
The two main points we got “wrong” was the extent of fiscal strength and the timing of sentiment changes. In retrospect, it’s hard to say whether we would consider either of these points differently.
We now know that Sri Lanka’s government was able to record what was probably one of the best, 3-year fiscal adjustments in modern history (outside of small island states). Would we have been bold enough to say that Sri Lanka, a country known for fiscal weakness and had almost never shown large primary surpluses before, would become one of the world’s best performers? Probably not. Even with the Central Bank now being constrained in monetary financing, we probably wouldn’t have expected SUCH overperformance, with tax administration and collection improving so much to support it.
What about on sentiment? Here, we could have read the market better. If we had recognized that part of the reason why the economy was “on track” on our expectations in the first half was due to some level of negative sentiment, given that we knew that the fundamentals were better than we expected, perhaps we could have shifted our expectations earlier. But if we recognized negative sentiment before the election, would we have expected one of the biggest “upsets” in Sri Lankan politics to result in a positive shift?
In such a context, one approach we have usually used, is to take an outside-in approach. Instead of looking at one country alone and trying to build a story from the bottom up, we have tended to look at other comparative countries to see how they have gone in the past. While no two cases are exactly alike, we have always felt that history (and economics) often rhymes enough to see broad trends. After doing substantial amounts of such cross-country comparatives in 2021, 2022, and 2023, we had consciously decided to reduce such work in 2024. Instead, we only looked at a few examples. This was a mistake in retrospect. Even if the Sri Lanka specific views we had didn’t change, having done such work would likely have meant we were a lot more open to ways that indicators could have gone the way they did. Perhaps we would have seen other mechanisms, other factors, or we might simply have been more balanced in the probabilities of our expectations.
What will we change for the future?
Across this period, as these developments were unfolding, one key measure we were spending a lot of time on (instead of doing cross country work) was to try and lay out the mechanisms through which any movement could take place in – what we thought of as the “plumbing” of the economy. For the fundamentals, this is a relatively obvious as a step to take – how do different parts of the economy fit in with other parts. Where it is a bit trickier is in figuring out the “mechanism” through which sentiment actually can affect the economy.
Here, for the Sri Lankan economy we saw three main “pipelines” through which either positive or negative sentiment could translate to economic reality. These were in terms of consumption decisions taken by individuals, maturity duration in the government securities market, and in terms of FX positioning within the balance sheet of the financial system. Having this meant that as the year went on, we were better able to explain why and crucially, HOW, any changes in sentiment could actually affect the economy differently. Ultimately, this did mean that when the changes DID happen, we were able to recognize their more longer-term impact as well.
Having laid out these mechanisms, we’re now in a much better place to apply any cross-country work that we will do as well. As opposed to merely looking at countries from a specific country-centric perspective, this now means we approach all economies from a more defined understanding. The expansion of our work outside of our Sri Lankan base is also well supported by this, as we look to regularize the work we have done on a bespoke basis over the last decade on South and South East Asia. This then means that we continue to take a much more holistic view on economies across the world as well, which hopefully avoids us falling into a “tunnel vision” perspective.
All this also allows us to recognize specific points and understand them better - some as specific as a seasonal pattern in revenue and domestic debt in Sri Lanka that probably affected the TIMING of our forecasts. This also means our own internal bias checks not only have to become stronger, but we have a better basis upon which to understand this.
We will continue to do our work on the basis of what we believe affects the economy at a certain time, but now from a stronger footing that was informed by the mistakes of 2024. If this means we are contrarian as we often end up being, we will continue to be so – but not purely for the sake of being contrarian. If on the other hand, our work tells us a story in line with consensus, that too is what we will bring.
2024 wasn’t a good year for our views. We can’t say that our forecasts will come 100% “right” in the future either. Instead, we will continue to focus on trying to help our clients understand the economy and prepare for all the realistic eventualities. Over the long-term, this is what we think can help our clients and where we feel we can do the most as well. In the meantime, we hope that our clients don’t consider any potential “right calls” we make as reflective of successful forecasting ability either. We might be “right” for the wrong reasons after all!
“You can't predict. You can prepare.”
- Howard Marks