The Index of Industrial Production (IIP), after showing a slump in growth in the month of September 2012, depicted a smart bounce back in the month of October 2012. A favourable base effect helped IIP to touch 8.2%, it being the highest since the level clocked in June last year. It is noteworthy that a month prior to Diwali (which was celebrated in November this year), the IIP tends to show a smart uptick led by a greater industrial output, catering to festive demand of Diwali; thus seemingly that has aided such a smart bounce back. Earlier in the month the core sector data of 6.5% for October 2012 also hinted that IIP could be better, and indeed it did. But the trend thus far, been quite ‘see-saw’, wherein at most times the earlier estimates have been revised downwards.
 

IIP bounces back smartly

(Source: CSO, PersonalFN Research)  

The following factors had their bearing on the IIP data for the month of October 2012, which helped it to bounce back:
 

• Manufacturing index, which constitutes about 76% of the industrial production index, posted a strong uptick of +8.8%, after a contraction experienced in the previous month. So, one can construe that the low base effect did help. In terms of industries, seventeen (17) out of the twenty two (22) industry groups (as per 2-digit NIC-2004) in the manufacturing sector have shown positive growth during the month of October 2012 as compared to the corresponding month of the previous year. Industry groups such as "electrical machinery & apparatus", "motor vehicle trailer & semi-trailers" and "Coke, refined petroleum products & nuclear fuel", posted strong growth numbers.
   
• Consumer goods index too after a contraction in the previous month, bounced back with a growth of +13.2%. Amongst the consumer goods, robust growth was seen in the durable goods segment which grew by +16.5% ahead of the festive demand which was catered to. Likewise, consumer non-durable goods sector too posted a sharp uptick of 10.1% after a submissive growth of (+1.6%) seen in the previous month.
   
• The capital goods index posted a growth of +7.5%, after witnessing a contraction for the last seven months. The last strong uptick was seen in this sector in February this year. This indicates that with reform measures being put on the forefront, business confidence is building up and that’s turning around the capex cycle now. However what remains to be seen is, how the proceedings in the winter session of the Parliament transpire, as many reform measures are awaiting Parliamentary approvals. Likewise the interest rates cycle needs to be conducive for such growth of capital good index to sustain and ascend.
   

Our View:
We believe that the slew of reforms undertaken by the Government will reflect in the industrial growth albeit with a lag. As mentioned earlier, the bounce back in IIP for October 2012 has occurred due to a favourable base effect, and the advantage which the data has enjoyed by it being for the immediately preceding month before which Diwali was celebrated this year. But for the ensuing months of the calendar we may see a dip, as industrial output generally tapers down after meeting festive demand. Thus this data in our view shall not be construed as a recovery, as buoyancy may not be sustained. Moreover if we observe the trend in IIP, it appears rather ‘see-saw’ or volatile.

At present, while FDI in multi-brand retail has won votes in the both the houses of the Parliament, there are yet many crucial bills which are awaiting clearance (such as the Pension Bill, Banking Law Amendment Bill, Insurance Bill, Real Estate (regulation & development) Bill), in the winter session of the Parliament; and if all these go through, India can be placed on the growth path. But an uncertain political environment and the tainted political canvas with graft charges on the Government in power and the opposition, add on to risk events, because every political party is trying to flag their ideologies over critical reforms. So reforms can put India once again on a growth path, but what’s vital is sanctity and consensus in doing so.

As far as RBI’s stance over policy rates is concerned, we do not see RBI reducing policy rates on the excuse of a bounce back in IIP. The central bank would be watchful of the WPI inflation data, and if it indeed mellows down, we could see rate cut only in the first quarter of new calendar year. It is noteworthy that with diesel and LPG prices increased in the recent past, the detrimental impact could be seen in the intermediate. This is because diesel is an essential transport and industrial fuel, and the rise in the same may have a broader impact on WPI inflation. However with subsidies in LPG being controlled, it may provide some relief for achieving fiscal deficit target, which in turn may infuse positivity. But the RBI perceives inflationary pressures persists along with risk from twin deficits i.e. current account deficit and fiscal deficit. Thus assessing host of macro-economic factors, the RBI’s stance of policy will be conditioned by careful and continuous monitoring of:
 

• Evolving growth-inflation dynamics;
• Management of liquidity conditions (to ensure adequate flows of credit to productive sectors); and
• Appropriate responses to shocks emanating from external developments.
   

What should equity investors do?
Political sanctity and consensus remains the key for reforms to be implemented and put India in growth trajectory. it noteworthy that for inclusive growth, the financial sector reforms are needed which is still to be discussed in the winter session of the Parliament; where the opposition could have their reservation on certain critical issues, and even the Government alliance partners could try to extract their pound of flesh. For instance, the Government’s single largest opposition - the Bhartiya Janata Party (BJP), is not in favour of increasing the FDI cap in financial sectors beyond 26%. Likewise they (the BJP) are reluctant to back any provision that is not in line with the Parliamentary panel's recommendations, and could have certain reservation about some provisions of the banking laws amendment bill. Thus reckoning these risk facets on the Government’s reform agenda, Fitch (an international rating agency) has said that while recent reform proposals by the Government are potentially supportive of growth, the country may need time to work in uplifting economic growth rate and face political risks in their implementation. "Policy slippage and / or mounting evidence of a structural decline in the trend growth rate, such as protracted relatively weak economic data, could cause the ratings to be downgraded," its report said. It is also said by the rating agency that, India’s sovereign rating could be cut if the Government loosens fiscal policy in the run-up to elections due by 2014 or sees a prolonged slowdown in economic growth.

Speaking about the global economy, in the U.S. while the economy has shown an up-tick in the Q3 GDP number, supported by elevated consumer confidence, the fiscal cliff faced by the U.S. remains a source of concern; which if not handled well could pull the U.S. economy into a recession. In the month of December 2012, negotiations with the Republicans over the looming fiscal cliff will dominate the news flows from the U.S. The Federal Reserve may extend its monetary stimulus (commonly known as Quantitative Easing) to the New Year, but they are cognisant about the fact that this (the fiscal cliff) may pull the country into a recession, if the taxes aren’t increased. In the Euro zone although tense nerves of debt crisis have calmed down with European Union (EU) and the International Monetary Fund (IMF) have agreed to unblock Greek bailout with a package of measures worth €40 billion (aimed at bringing an immediate 20% reduction to the country's debt) and loan restructuring being approved (by European Commission) for Spanish bank loans (which is expected to inject around €37 billion into the Euro zone); it would not be too long before fresh crisis in Europe could flare up. Apparently, the stronger Euro zone nations are facing the risk of downgrades. Last month, Moody’s stripped France’s credit rating to "AA1" from "AAA" and declared that the outlook remains negative. Germany too has seen a descending trend in the GDP growth rate for the last three quarters; which again indicates that even the stronger nations in the Euro zone are now reeling under pressure, and if we assess, the entire Euro zone remains mired in a recession. While the European Commercial Bank (ECB) may think of cutting rates (from a record low of 0.75%), in order to revive economic growth rate in the Euro zone, this easy monetary policy would do more harm than good to the Euro zone economies in the long-term.

Thus in the backdrop of the global economic and political environment we flag concerns of risk inducement, and therefore recommend investors to stagger their investments to mitigate risk. While in investing in equity mutual funds, we recommend one to opt for the SIP (Systematic Investment Plan) mode of investing, as it will enable you to mitigate the volatility through rupee-cost averaging and power your portfolio with the benefit of compounding. However, while selecting mutual funds for your portfolio, prefer the diversified equity funds which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years.

What should debt investors do?
At present while taking exposure to debt mutual funds and fixed income instruments, one should clearly know their investment time horizon. Investors with an extreme short-term time horizon (of less than 3 months) would be better-off investing in liquid funds for the next 1 month, or liquid plus funds for next 3 to 6 months horizon. However, investors with a short to medium term investment horizon (of 1 to 2 years) may allocate a part of their investments to short-term income funds which should be held strictly with at least 1 year time horizon.

The present interest rate scenario also seems comfortable to look at longer horizon debt mutual funds. Thus, if you have a longer time horizon, then you can now hold some exposure to pure income funds. Since longer tenor papers could become attractive, longer duration funds (preferably through dynamic bond / flexi-debt funds) can be considered, if one has an investment horizon of say 2 to 3 years. However, one may witness some volatility in the near term as there is always an interest rate risk associated with longer maturity instruments.

Fixed Maturity Plans (FMPs) of upto 1 year may for some more time yield appealing returns and can also be considered as an option to bank FDs only if you are willing to hold it till maturity. You can consider investing your money in Fixed Deposits (FDs) as well, before the interest rates offered on them are reduced further. At present 1 year FDs are offering interest in the range of 7.50% - 9.00% p.a.

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