country risk forecasting methodology
TRANSCRIPT
Country Risk Forecasting MethodologyFitch Solutions Country Risk & Industry Research
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Connected Thinking And Forecasting: More Than Just Econometrics
EconometricsIncoming data and
data modelling techniques to better
understand trend growth and shocks on key economic
indicators
Political RiskThis impacts
economic and financial market
outcomes through election cycles as
well as policy, spending and
taxation decisions
Financial MarketsIn particular,
commodity prices, exchange rates and capital markets have a significant impact
on leading economic indicators
Sector Analysis Ranging from
Infrastructure, to Oil & Gas, Banking,
Automotives, Pharma & Technology help us
understand the investment and capex
pipeline, as well as potential exports
Source: Fitch Solutions
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Various Data Sources Used To Ensure Multiple Views Of The Economy2
• The quality and frequency of data in smaller frontier markets are typically of poorer quality, and as such we use multiple sources to get a better view of the economy.
• We prioritise local sources such as the central bank, local ministries and regulatory bodies.
• However, we also rely on international organisations such as the IMF, the World Bank, the International Labour Organization, various development banks, the Bank of International Settlements, Bloomberg as well as local agencies for data.
• We also collect and use data from domestic and international industry bodies which often have very detailed sector-level data. These include construction, automotive, energy and consumer industry bodies.
We Use Multiple Sources Of Information
National Sources
International Organisations
Industry Bodies
Central Bank, Ministries,
Treasury, Banking Regulator
IMF, ILO, UN, World Bank, Development
Banks, BIS, Bloomberg
Construction, Automotive,
Energy, Consumer
Source: Fitch Solutions
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Forecasting GDP: A Comprehensive Approach3
Inputs Into Our GDP Forecasts
GDP Forecasting
ARIMA Model
GDP By Expenditure
Sector Inputs
Analyst Intervention
• We use multiple approaches to forecasting real GDP.
• We create and benchmark our forecasts using an ARIMA model to ensure consistency and robustness from an econometric perspective.
• Analysts forecast real GDP by individual components of expenditure to ensure consistency in the components of the economy.
• Our forecasts take into consideration key drivers of growth from our Sectors team by understanding key project pipelines and sector output forecasts. We cover over 15 sectors, which help inform our GDP forecasts.
• Analysts tweak the forecast to take into consideration other factors such as financial markets, policy and political risk.
Source: Fitch Solutions
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Econometric ARIMA Model4
Box Jenkins Methodology • We use an AutoRegressive Integrated Moving Average (ARIMA) model to create our time-series forecasts.
• We apply the Box-Jenkins Methodology in order to identify which model specification to use, estimate the model and check the adequacy of the model.
• This model is iterative and has self diagnostics embedded to ensure that the conditions of residuals’ non-autocorrelation and normality are satisfied.
• Using this model, we are able to forecast quarterly and annual GDP, and analysts can adjust individual quarters to simulate minor changes in our assumptions to test the coherence of our forecasts.
Source: Fitch Solutions
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GDP By Expenditure: A Layered Approach5
We Forecast Individual Components Of GDP • We forecast GDP by an ‘Expenditure’ approach as it isolates key drivers of growth and is among the richest and most comparable data series across countries.
• These components are: Consumption, Investment, Government Spending and Net Exports (exports minus imports).
• While there are various factors that can broadly impact several of these expenditure components, there are also particular drivers that are correlated to individual components.
• As such, we track several daily, weekly, monthly and quarterly data series as well as leading indicators to form our forecasts. Many of these are included in the graphic.
• We also take into account policy decisions, political risk and geopolitics when forecasting.
Consumption
• Leading Indices, Wages, Unemployment, PMIs, Asset Prices, Subsidies, Tax Policy, Consumer Confidence, Election Cycle, Currency, Interest Rates, Debt Loads, Credit Growth.
Investment
• PMI, Profitability, Business Sentiment, Tax Policy, Economic And Political Uncertainty, Asset Prices, Cost Of Finance, Balance Sheets, Leverage, Commodity Prices, Credit Growth, Industrial Production.
Government
• Annual Budget, Policy, Spending And Revenues, Commodity Prices, Extraordinary Events And Shocks, Bond Yields, Debt Maturity, Civil Unrest.
Net Exports
• Commodity Prices (terms of trade), Growth In Main Trade Partners, Trade Data, Geopolitics And Trade Relations, Fiscal Policy, Exchange Rates, Consumption.
Source: Fitch Solutions
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GDP By Expenditure: Considering Short- And Long-Term Trends6
The Long And Short Of It • Economic trends are also very important to monitor, both over the short and long term.
• Over the short term, growth can be impacted by credit cycles, external shocks, the election cycle as well as domestic regulatory or foreign policy changes.
• Other factors are important to consider when looking at the long-term trajectory of the economy: Overall debt burdens, demographics – such as the size and age of the working population – general productivity within the economy and capital stock, as well as trade openness of the economy, the business environment and per capita incomes.
• This framework allows us to understand how short-term economic activity can temporarily deviate from longer-term trends.
Short-Term Cyclical Trends
Long-Term Structural
Trends
Credit, External Shocks, Politics, Policy
Debt, Demographics, Productivity, Investment, Trade Agreements, Per
Capita Incomes, Business Environment
Source: Fitch Solutions
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Using Sector Inputs: Brazil As A Case Study7
Sectoral Inputs Into Our GDP Forecasts
GDPMining Forecasts
O&G Forecasts
Agribusiness Forecasts
Infrastructure Forecasts
Banking Sector
Forecasts
• Having in-depth knowledge of sectors and key forecasts helps us understand the drivers of economic activity from an output perspective.
• For example, Brazil is one of the largest exporters of iron ore, and our Mining team’s output and price forecasts help understand activity in the sector and its impact on GDP growth.
• This is a similar story for oil & gas and key agricultural commodities such as sugar, coffee and grains, all of which play an important role in the economy and exports.
• Our infrastructure database of key projects and forecasts give us insight into growth in the sector from a bottom-up perspective.
• Our banking sector analysis looks at the strength of banks and their ability to provide credit to businesses and consumers.
Source: Fitch Solutions
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Connected Thinking Across Various Different Sectors And Areas of Risk8
Source: Fitch Solutions
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