Do it yourself

Global economy slowing

The RBI paper highlights some areas of concern for the global economy. In RBI’s assessment global growth has lost some speed in the first half of 2024 relative to the preceding semester, and momentum has slackened further in the third quarter.

The paper notes, “All around, indicators point increasingly to slowing global economic activity, more so on the eastern shores of the Atlantic, which vindicated the ECB’s September rate cut to secure a soft landing. In the US, the now famous remark – “The time has come for policy to adjust” – has built up expectations that the economy is gaining prominence in monetary policy discourse. In China, even though consumer inflation has picked up modestly due to supply constraints related to extreme weather, weakening producer prices are fueling concerns that deflationary forces are taking root. A rising number of manufacturing industries face lacklustre demand alongside a deep property market downturn now into its third year.” In particular—

Job growth is getting softer than initially anticipated as labour markets continue to slow down, unemployment rates are ticking up and wage growth is easing, although historically high immigration is providing some offset. Consumer confidence surveys show a deterioration in sentiment about jobs.

Equity prices are still stretched but the crash in Nvidia’s stock in early September wiped out about US$ 300 billion in market value, hinting that the artificial intelligence (AI) overhype may be tapering off and expectations are catching up with reality.

Parched returns are drying up the venture capital ecosystem. Record volumes of corporate debt are being issued to head off the volatility triggered by worsening macroeconomic data, and to benefit from falling borrowing and refinancing costs.

OPEC plus has decided to delay a planned output increase as crude prices slumped below US$ 70 per barrel briefly on September 10, but it still plans to revive 2.2 million barrels per day of idle supplies over the course of 2025. Meanwhile, non-OPEC supplies are rising faster, and as the International Energy Agency warns in its September 2024 report, global oil demand is slowing sharply – electric vehicles are already displacing 1.8 million barrels of oil every day – and this is fuelling the sell-off in oil markets. In metal markets, the copper-gold price ratio is closing on to 4 – a rising ratio indicates higher industrial demand and hence a positive growth outlook.

Although upside pressures have likely been seen off, the pace of disinflation remains sluggish, provoking caution among monetary policy authorities about the pace of easing. In fact, the Governing Council of the ECB noted in its September meeting that inflation is expected to rise again in the latter part of this year, partly because previous sharp falls in energy prices will drop out of the annual rates.

Defying gravity, global merchandise trade volume continued to recover in the third quarter of 2024, according to the latest World Trade Organization (WTO) Goods Trade Barometer, amidst rising geopolitical tensions, ongoing regional conflicts, shifting monetary policy in advanced economies (AEs) and weakening export orders. Barring the sub-par performance of electronics, other components of global trade such as automotive products, container shipping and air freight are all firmly above trend, but new export orders are turning down, and raw materials have declined – causes for concern going forward.

EMEs are building up a growth rate lead over AEs to levels not seen in 15 years. Projections suggest that the proportion of EMEs other than China in which per capita GDP is likely to rise faster than the US is on course to surge from 48 per cent over the past five years to 88 per cent in the next five years.

In the recent period, the US dollar has weakened; historically, this has led to greater capital flows to emerging markets.

The global supply chain pressures index (GSCPI) increased in August 2024, rising above its historical average for the first time since November 2023. Geopolitical risks remained high due to continued tensions in the Middle East, albeit with a sequential moderation in August 2024. Supply disruptions have kept container shipping costs elevated, although they recorded some moderation during August-September 2024 from the peak levels recorded in July.

Domestic economy

The RBI sounds quite sanguine about the domestic economic growth, regardless of the soft 1QFY25 data. The paper cautions, “more needs to be read into the slowing of India’s GDP in Q1:2024-25 than just disappointment.” It points out that “The seasonally adjusted momentum of Q1 GDP was strong. Gross value added (GVA) growth actually rose sequentially in Q1, but the increase in subsidies – 3.6 per cent by the Union government and 26 per cent by the states – offset the gains from showing up in GDP growth.”

Household consumption is poised to grow faster in Q2 as headline inflation eases, with a revival of rural demand already taking hold.

The widening trade deficit and a spurt in overseas travel by Indians is likely to swing the current account balance from a small surplus in January-March 2024 to a deficit of 1-1.2 per cent of GDP in the first half of 2024-25. Capital flows in the form of portfolio debt flows, net FDI and non-resident deposits are providing comfortable financing.

Merger and acquisitions deals have been on the decline in the Asia-Pacific region in 2024, but India has emerged as a bright spot with an increase in volumes.

Agriculture suffered in Q1:2024-25 as India experienced the highest number of heatwave days in the summer of 2024, surpassing the previous high in 2010.

The underperformance of agriculture in Q1 was compensated for by a buoyant manufacturing sector and resilient services.

Global funds have been investing heavily in the Indian debt market for the fifth month in a row since May 2024. On the other hand, corporate debt issuances remained low during the financial year so far despite easing yields as issuers awaited the US rate cut.

In the credit market, with deposit mobilization becoming a challenge, banks continue to rely heavily on certificates of deposit to meet funding needs so that lagging deposit growth does not constrain credit. Banks are also offering higher interest rates on deposits, with more than two-thirds of term deposits earning 7 per cent and above. The gap between credit and deposit growth is, however, beginning to narrow. Non-banking financial companies are increasingly turning to offshore bonds. Microfinance institutions are facing some asset quality issues, warranting slowing down the pace of loan growth.

Headline CPI inflation came in below the Reserve Bank’s target for the second consecutive month in its August reading. This is a positive development, especially as the index has remained flat between July and August.

Surplus liquidity in the banking system moderated in the latter half of August, driven by build-up of government cash balances due to GST payments. In early September, however, a pickup in government spending led to the return of liquidity to the banking system. Overall, the average daily net absorption under the liquidity adjustment facility (LAF) decreased to ₹1.45 lakh crore during August 16 to September 17, 2024, from ₹1.52 lakh crore during July 16 and August 15, 2024.

No panic in the boardroom

Unlike the previous two rate cycles that started with a rather aggressive 50bps rate cut – first October 2008 post the Lehman collapse and second March 2020 post Covid-19 break out – this cut is apparently not a panic cut.

The Fed chairman sounded confident about growth and employment level. He emphasized that the central bank is not in a hurry to ease policy, as he sees no likelihood of an elevated downturn in the economy. He mentioned, “There’s nothing in the SEP (Summary of Economic Projections) that suggests the committee is in a rush to get this done.”

The Chairman categorically advised the markets to not take this 50bps cut as “new pace”. He said, “we’re going to go carefully meeting by meeting, and make our decisions as we go”.

The decision to cut was however not unanimous. In a rare dissent, one member (Michelle Bowman) voted for a 25bps. This could be seen as yet another sign of “no panic” in the Fed board room.

Committed to price stability without pain in labor market

Announcing a victory over inflation, Mr. Powell announced, “The U.S. economy is in good shape. It is growing at a solid pace. Inflation is coming down.”

As per the latest economic data release, the US GDP expanded at 3% annual rate in 2Q2024 with 4.2% unemployment rate (considered near full employment), and inflation at 2.2% in August 2024.

Outlining the latest policy objectives, he commented, “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation”. Guiding the markets, he emphasized that investors should take the Fed’s 50bps rate cut as a sign of its “strong commitment” toward achieving that goal.

Neutral rate seen close to 3%

The FOMC members see cuts of 25bps each in November and December FOMC meetings; 100bps cut in 2025 and 25bps cut in 2026 – implying that the latest easing cycle may end with the Fed rate range of 2.75-3.00%.

The Fed Chairman also mentioned in the post FOMC press meet that the neutral rate is likely significantly higher than it was on the previous occasions.

Markets ended lower

Markets – equity, bonds and commodities – ended the day with marginal cuts post the Fed announcement; while the USD was marginally stronger. This could be an outcome of either (i) sell on news; or (ii) traders’ disbelief in what Fed says about the strength of the economy.

What now

In my view, this aggressive 50bps cut is more of a correction than an aberration. Perhaps the Fed realized that they are running slightly behind the curve and hence tried to catch up. I do not see it as a panic move and would not like to indulge in “there is more to it than what meets the eye” debate.

Unlike 2008, there is no corporate balance sheet crisis, no risk of global markets freezing, and unlike 2020 there is no shutdown necessitating fiscal and monetary profligacy. It is a normal rate cycle change in response to a normalizing economic cycle. Therefore, expecting a market reaction like 2008 (sharply down) or 2020 (sharply higher) may not be appropriate.

I feel the US markets will adjust to the new policy trajectory in a couple of weeks and move accordingly. The lower rates shall help arrest the decline in the US housing markets and consumer spending. The bond yields may come down and the hedge trade in gold may begin to unwind. The corporate discretionary spend may also normalize as the cost of borrowing eases. This could be a relief for the Indian IT services companies.

For India, I am not sure if the RBI will rush to cut in October meeting, but would not rule it out completely. Financials and commodities are two sectors that need to be watched closely, in my view.

In the next couple of months, the markets in India will be driven by the 2QFY25 earnings. Any disappointment could lead to a decent correction in the markets. For now, I do not see a need to make any change in my investment strategy. (More on this next week)

The major risk to the markets comes from geopolitics now. The situation in the Middle East is worsening by the hour. NATO and CRIK (China, Russia, Iran and North Korea) alliances are hardening their positions, both on trade and war, making the situation explosive. (More on this next week)

Most medium sized farmers had a good standing crop of paddy and sugarcane. Most of them were, however, circumspect about the final yield, in view of the IMD’s forecast of excess rains in September.

Many small and marginal farmers had lost their pulses and vegetable crops due to heavy rains accompanied by strong winds. They were dismayed and worried about their ability to manage the resources to plant Rabi crops, mostly potato and wheat.

Some of them, who had taken advance from the traders, were also worried about the repayment. None of the small and marginal farmers mentioned the terms like crop insurance, bank loan, Kisan credit card, etc. Thankfully, there is an abundance of fodder for their cattle this time.

After a discussion of 10-12hrs with these farmers, NGO workers helping them with farming & other issues, and village leaders I gathered that the inflation debates in Delhi (in the Parliament & outside) and Mumbai (at the RBI and brokerage offices) may not be relevant for these farmers and common men like me, because—

·            Policymakers and analysts may be oversimplifying a very complex problem. Food inflation in India maybe influenced by a myriad of factors, e.g., (i) farm input prices, which are also affected by terms of trade, INR exchange rates, availability of subsidy, etc,; (ii) energy inflation as many farmers use electric or diesel pumps to water their farms, and motor vehicles to transport their produce to markets; (iii) farm labor wages, which in turn is also a function of multiple factors like food and energy inflation, availability of MNREGA wages, & other government cash payouts, demand from construction sector, etc.; (iv) weather condition affecting the volume of production; (v) productivity, which depends on the quality of soil and inputs, farming methods used and availability of equipment; (vi) cost of funds borrowed by the farmers, which also depends on access to institutional finance; and (vii) distance from the market, etc.

Bringing down food prices or slowing down food inflation may adversely impact about 60% of the Indian population that depends (directly or indirectly) on agriculture for their livelihood. The solution may therefore lie in enhancing productivity, market access, access to institutional finance, energy efficiency & renewable energy, land reforms and crop rationalization. Someone may argue that all this is already being done. True, there are government programs and policies for all these solutions but execution is seriously lacking.

·            Presently, the primary problem for a majority of the Indian household could be “price affordability” rather than “price inflation”. They may need either a substantial rise in their real wages or a material deflation in the prices of their consumption basket to maintain their regular lifestyle.

·            Statistical inflation being debated and analyzed by the policymakers and analysts may be entirely different from what a common household or investor faces (more on this later).

Reading minutes of the MPC’s previous few meetings, it appears that the policymakers might be waiting for a divine intervention to change their policy stance, as hardly any effective step has been taken by them to make life of people easier.