Jay Powell says, "Let the party continue"

Our goal with The Daily Brief is to simplify the biggest stories in the Indian markets and help you understand what they mean. We won’t just tell you what happened, but why and how too. We do this show in both formats: video and audio. This piece curates the stories that we talk about.

You can listen to the podcast on Spotify, Apple Podcasts or wherever you get your podcasts and video on YouTube.

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Today we look at 4 big stories:

- Powell bhai says get ready to party!

- Drama in the RBI monetary policy committee?

- The global shipping crisis has an Indian twist

- The fantastic world of SME IPOs?

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Powell bhai says get ready to party!

Throughout the year, everyone has been asking the same question: When will the US Federal Reserve cut interest rates? For the past eight Fed meetings, we've all been left waiting, but it looks like the time might finally be here.

Last week, the Jackson Hole Economic Symposium took place—a big annual conference where central bankers, finance ministers, academics, and financial market leaders from around the world gather to discuss important economic issues.

Jerome Powell, the Fed Chairman, was the star speaker, and he gave us some good news without directly saying it. But first, let's talk about the background Powell set in his speech.

He started by admitting that the Fed initially underestimated how persistent inflation would be. They thought the initial surge in inflation back in early 2021 would be temporary or "transitory." That turned out to be wrong, which delayed their decision to hike rates. After realizing this, the Fed kicked off one of the fastest rate hike cycles in history, pushing interest rates to a 23-year high.

Then came the good news the markets have been waiting for. See, central bankers rarely speak directly—they prefer to drop hints. So here's what Powell said:

"As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate. The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."

That's about as close as Powell can get to saying he's planning to cut rates in September.

Now, the context in which the Fed is cutting rates is pretty interesting. There's a lot of talk about a possible US recession. The jobs data is what’s causing the most concern. July saw the second-worst job numbers since the pandemic, with the unemployment rate spiking to 4.3%, the highest since October 2021.

Why does unemployment matter? Well, once it starts rising, it usually keeps going up, which signals that the economy is struggling.

So, what does Powell’s hint mean for the markets? When the Fed cuts rates, it’s like dropping a stone in a pond—the ripples spread across the entire globe. Let’s break down what typically happens when the Fed cuts rates. Keep in mind, we're making some broad generalizations here:

• When the Fed cuts rates, global risk appetite generally increases. US investors start looking outside the US markets for better returns. Lower US interest rates are usually good news for emerging markets like India.

• When US interest rates drop, the dollar typically weakens. Many emerging market countries and companies have debt denominated in US dollars, so a weaker dollar makes it easier for them to service this debt.

• Many emerging markets are also major commodity exporters. Since most commodities are priced in US dollars globally, a weaker dollar often means commodity prices rise in dollar terms.

• And perhaps most importantly, when the Fed cuts interest rates, it often signals to other central banks that it’s time to start cutting rates too.

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Drama in the RBI monetary policy committee?

The latest RBI Monetary Policy Committee (MPC) meeting took place from August 6 to 8, 2024, and the committee decided to keep interest rates unchanged. Out of the 6 members on the committee, 4 voted to maintain the current rates, while two members, Dr. Ashima Goyal and Prof. Jayanth R. Varma, voted for a rate cut. As we've discussed before, both of these members had also called for a rate cut in the previous meeting.

Now, the minutes from the latest meeting have been released, and the statements give us a good sense of what the members, including the governor, are thinking about growth and inflation. We went through all the statements and wanted to highlight some of the most interesting comments.

Let’s start with Dr. Ashima Goyal

Dr. Goyal kicked off her statement by pointing out that monetary policy works with a lag. In other words, when the RBI increases or decreases interest rates, it takes some time for these changes to filter through the financial system and impact consumers and their decisions about borrowing and spending. Because of this lag, she argued that the RBI can’t afford to wait until inflation hits the 4% target to start cutting rates.

She also drew a parallel with the US Federal Reserve, noting that the Fed ignored several small signals suggesting that inflation was on a downward path, which might have led to a significant mistake—pushing up the unemployment rate.

On food inflation, Dr. Goyal mentioned that while household inflation expectations have risen, the spike in food prices is temporary and should ease with good monsoon seasons.

Regarding core inflation, which excludes volatile items like food and energy, she suggested that it’s likely to stay around the current level of 3.1% due to falling global commodity prices.

Overall, she observed that inflation is trending downwards and that low core inflation indicates growth is below its potential. This, in her view, means the RBI can afford to cut rates to help push growth to its full potential.

Here’s what Professor Jayant Verma had to say

Prof. Verma was even more emphatic, voting for a rate cut and arguing that the monetary policy committee was making an unnecessary sacrifice when it comes to growth.

To add some context, the RBI expects our GDP to grow around 7.2%. However, Prof. Verma thinks this estimate is too pessimistic. He believes that thanks to reforms like digitization, tax changes, and increased infrastructure investment, India’s growth potential is actually at least 8%.

He also highlighted that with India’s massive youth population, we have a rare opportunity to accelerate growth over the next decade. He emphasized that our current growth projections are not only well below what the Indian economy can achieve but are also insufficient to create enough jobs for the millions of young Indians entering the workforce.

Speaking to CNBC TV18, Prof. Verma argued that the right benchmark for measuring growth isn’t the current rates seen in advanced economies. He pointed out that these economies are past their demographic peak, and China’s population is even declining. Instead, he suggested that we should compare India’s growth with how fast today’s advanced economies were growing when they were at a similar stage to where India is now—like China, which was growing at 11-12%.

In the MPC statement, he also flagged that there are warning signs that growth might already be slowing down. The expectation of high economic growth relies heavily on the hope that private capital investment will pick up soon, but this hasn’t happened yet, and as he pointed out, hope is not a strategy.

We’ve talked about the lack of private investment and consumption growth many times in previous episodes. In his CNBC interview, Prof. Verma expanded on this and questioned why private investment hasn’t picked up despite the optimism about economic growth. He hinted that the MPC needs to consider whether monetary policy is too restrictive.

He explained that to understand why investments haven’t increased, we need to look at two main factors: First, there needs to be sufficient demand and favourable capital conditions for capex to happen. High real interest rates make borrowing expensive, and insufficient demand discourages investment. Second, restrictive monetary policy impacts demand by making borrowing more costly, which in turn reduces consumption. Essentially, every additional rupee that households spend on paying EMIs because interest rates are high is one less rupee available for consumption.

Given that inflation is close to the target, Prof. Verma questioned whether the current restrictive monetary policy is too harsh and if it’s unnecessarily holding back economic growth. If private consumption isn’t growing, there might be a need for more fiscal support to stimulate demand.

These are some intriguing comments from two members who have now completed their terms on the MPC. With new members set to be appointed, it’ll be interesting to see how they approach the balance between growth and inflation in the coming months.

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The global shipping crisis has an Indian twist

If you've been following this show for a while, you probably remember when we discussed the chaos in global trade caused by problems in the Suez Canal. But in case you missed it, here’s a quick recap: The Suez Canal is a crucial artery for global trade because it connects Asia to Europe. To give you an idea of its importance:

• The Red Sea accounts for 12% of global trade.

• Between 7-10% of the world’s oil—about 1 million barrels—passes through the Red Sea.

• 8% of the global LNG supply flows through this region.

• The Red Sea facilitates the transit of 1 billion tons of cargo every year.

The Red Sea conflict started with Houthi rebels from Yemen targeting shipping in the area, often citing support for Hamas amid the Israel-Hamas conflict. This conflict has forced ships to avoid the usual route and take the much longer path around Africa instead.

Why are we bringing this up now? Just when we thought things couldn’t get worse for global trade, they did.

Now, according to news reports, major ports in India are planning to go on strike on August 28th. Dock workers are striking due to delays in concluding wage negotiations. We know that sounds complicated, but don’t worry—we’ll break it down for you.

The dispute centers around wages, and it began when the previous settlement expired on December 31, 2021. That settlement had been in place since August 30, 2018, and its expiration triggered the need for new wage negotiations. However, as of August 2024, these wage negotiations have yet to be finalized, even though the new settlement should have taken effect in January 2022.

The ongoing delay in finalizing the new settlement has led to growing frustration among port employees, culminating in a strike set to start on August 28, 2024. This strike is a big deal because it involves about 20,000 workers at 12 major ports. If it goes through, all the major ports, including the critical ones in Mumbai, Kochi, Mangalore, and Kolkata, among others, will see disruptions.

The fallout from this strike will likely be felt in the form of delays in unloading, congestion, costly re-routing, and increased turnaround time for ships docked at the ports. The longer the delay, the more money exporters and importers stand to lose. If things get worse, these shipping disruptions could hit consumers' wallets in the form of higher prices.

As of this recording, the true damage isn’t clear yet, but we’ll keep following the story and share updates as it develops. We can, however, make some reasonable estimates based on what happened when the shipping crisis worsened after the Red Sea attacks. Capital goods, pharma, oil imports, and exports are the most exposed to shipping disruptions.

But even without imagining the impact, we already know how a worsening shipping crisis can hurt Indian companies. For instance, rising freight costs recently forced around 250 ceramic units in Gujarat to temporarily shut down.

What’s worse this time is that this crisis comes at a time when shipping costs have already risen substantially. In August 2023, the cost of shipping a 40-foot container was about $1,700. As of this month, that cost has jumped to $5,300, which is actually a slight drop from the peak of $5,900 in July.

Source

But here’s the thing—these are just averages. They vary significantly depending on the region and country, and it also depends on the bargaining power of the shippers. Considering that most small exporters are…well…small, shipping companies are likely to charge them higher rates. Global average shipping costs have gone up by as much as 20% to 300% in the last year, but for Indian importers and exporters, this number will probably be much higher.

So, for purely selfish reasons—like keeping the prices we pay for goods from going up—let’s hope this strike ends soon.

Source

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The fantastic world of SME IPOs?

Since about 2017, SME IPOs have really taken off in popularity, coinciding with the bull market we've been seeing in the Indian markets. Just this year alone, 162 SMEs have raised over ₹5,700 crores from Indian investors in just eight months. That’s almost as much as what SME companies raised from April 2020 to December 2023. Back in 2020, there were only a couple of SME IPOs each month. Now, we’re seeing more than 20 a month.

But SME IPOs aren't without their problems. The idea behind creating a separate segment for SME companies was to help them raise funds more easily. SME companies are small and often struggle to get money. Banks aren’t eager to lend to them, or if they do, the interest rates are high. So in 2012, BSE, followed by NSE, launched separate platforms for SME companies to IPO and raise money.

Typical IPOs are expensive and come with heavy compliance requirements. SME companies are small, and if they had to follow the traditional IPO route, many wouldn’t be able to afford it. So SEBI made it easier for them to list. Unlike regular IPOs, SMEs don’t need to file documents with SEBI. Instead, exchanges like NSE and BSE handle the process. SEBI gives them the power to accept and verify these documents. While companies that list on the mainboard have to disclose their financials quarterly, SME companies only need to do it half-yearly.

While the intent was good, some SME companies started taking advantage of the easier regulatory environment. We’ve seen several frauds, and SEBI has even passed a few enforcement orders. For example, take the case of Varanium Cloud, a small tech company.

Varanium Cloud exploited the SME IPO platform to raise ₹33 crores in 2022. They promised to use the funds to expand their business, including setting up data and digital education centers. However, these facilities either didn’t exist or were purely for show. The company manipulated its financials and claimed expenses that didn’t align with real business operations.

The scandal deepened when it was discovered that Varanium Cloud used IPO funds for dubious transactions, including investing in companies where their Managing Director, Harshawardhan Sabale, had influential roles. They inflated costs and engaged in misleading practices to boost their stock price, which attracted many investors. Sabale then took advantage of this inflated stock price to sell his shares for a significant profit.

This is just one example, and there are countless others.

To improve the quality of companies listing in the SME segment, NSE and BSE have been making several changes. If you remember, in July, NSE imposed a cap on the listing gains of SME IPOs at 90%. BSE already had this in place.

Last week, NSE added a new rule: SMEs applying for an IPO must be cash flow positive for at least two of the last three financial years before they can go public.

Will this help? A little, but the issue of fraudulent SME IPOs still doesn’t go away.

There’s a fundamental trade-off for SEBI and the stock exchanges. On one hand, small companies face huge challenges in getting access to capital. On the other hand, if it’s too easy for these small companies to IPO and raise money, frauds are bound to happen. So it’s a delicate balancing act.

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