For many of you who are fond of driving and / or riding, it must be a pleasure hopping on to your speed machine of late, especially after fuel prices having mellowed. Both petrol and diesel have fallen by Rs 10 per litre and Rs 6 per litre respectively in the last few months.

But despite cheaper fuel, the price of many other commodities and services hasn't come down. Unfortunately, many good and services costs you almost the same even now. Nonetheless, inflation indicators suggest that over last few months, the Indian economy has managed to curtail rapidly rising prices in a substantial manner.

However the irony is you as a consumer may not have received much benefits. This is mainly because prices at wholesale level are falling rapidly, but they are not being wholly passed on to consumers. Now that inflation has started falling rapidly – and rather rapidly (as suggested by indicators) – a clamour for a rate cut is gaining strength.

Inflation indicators...
Inflation measured by the movement of Wholesale Price Index (WPI) for October 2014 fell to 1.77% marking a 5-Year low. Steady decline in manufacturing inflation and a sharp one in non-food inflation, has caused WPI inflation mellow down further more in October. Similarly, consumer inflation also registered its all-time low of 5.52% since the new data series started in 2012.
 

Inflation mellows down further...

(Source: MOSPI, Office of Economic Advisor, PersonalFN Research)  

The chart above suggests that inflation pressure appears to be waning since June 2014 and now the possibility of it settling at lower levels is being discussed. Before you conclude that inflation is now well within the comfort limits of RBI, you should have a look at how two different indicators of inflation, paint different a picture.
 

Hard facts...

Category	Weight in WPI	Weight in CPI	WPI	CPI
Food articles	14.34	47.58	2.70%	5.68%
Vegetables	1.74	5.44	-19.61%	-1.45%
Fruits	2.11	1.89	19.35%	17.49%
Fuel and Power	14.91	9.49	0.43%	3.29%
Egg, fish and meat	2.41	2.89	-2.58%	6.34%
Cereals	3.37	14.59	3.29%	6.00%

(Source: MOSPI, Office of Economic Advisor, PersonalFN Research)  

You see, the 'aam admi' bothers more about essential products. Food article inflation at consumer prices is higher than that on wholesale prices, suggesting pilferages and cost escalation while goods and services reach to the end user. It is noteworthy that, inflation in vegetable prices has dropped in negative for the first time in last many months; but considering sharp drop in vegetable prices at wholesale level, fall in prices at the retail level appears negligible. Likewise, prices of Egg, fish and meat have fallen at wholesale level, but at the retail level buyers are yet to benefit.

This in turn suggests that, phenomenon of falling inflation is more complex than it appears on its face. RBI being the responsible monetary regulator has to carefully analyse data points before it takes any decision pertaining to policy rates. If it lowers policy rates, interest rates on loans and deposits would come down.

Would inflation continue to go down?
Fall in commodity and crude oil prices at the international market are the prime reasons for fall in the inflation. But you must also note that, there are upside risks too. This year, kharif crop is expected to be about 7% lower than harvested last year. This is a threat to food prices. If crude oil prices were to go up again, fuel inflation may resurface causing prices to rise at broader level. Similarly, the fall in inflation has got exaggerated also due to higher base effect. Therefore it appears that moderation in inflation is transitory. The high base effect is expected to wane by early next calendar year, which could again lead to inflation put its ugly head up.

How markets reacted?
The market reaction was neutral, suggesting that although markets expect a rate cut, it is being realized that it may happen only in 2015. Going forward, any positive on the inflation front may raise expectations further.

What investors should do?
PersonalFN believes the RBI may not lower rates right away. In fact, it might wait for inflation to settle at lower trajectory. It may also closely monitor the performance of the Government on the fiscal deficit front. Recent hike in excise duty of Rs 1.5 per litre suggests that, Government is keen on raising its income too, consolidating fiscal position.

PersonalFN is of the view that, investors should not speculate on the monetary policy stance of RBI. Having said that, now that macroeconomic variables have turned favourable the scenario seems conducive to take exposure to longer end of the maturity curve. Thus debt fund managers are also in the process of building duration from 1 year to 5 years, since April 2014. You see, playing on duration at this juncture could fructify well and sweeten the returns if RBI indeed reduces policy rates in time to come. But while taking exposure to long term debt mutual funds, do not exceed the allocation beyond 20%-25% of the entire debt portfolio. While G-sec funds may start delivering returns as fundamentals improve and policy rates start to relax, going overboard now may not be very prudent.

With liquidity conditions being stable in the system, it was worked constructively for yields of shorter maturity papers. Moreover, with the RBI likely to actively manage liquidity situation; if you have a short-term investment horizon of 3 to 6 months you could consider investing in ultra-short term funds (also known as liquid plus funds). And if you have an extreme short-term time horizon (of less than 3 months) you would be better-off investing in liquid funds.

Equity investors shouldn't invest in rate sensitive sectors, expecting a rate cut. Those who don't have time or expertise to invest directly in equity shares of companies should invest in opportunities funds in a staggered manner to take advantage of investment opportunities. You would be better of avoiding sector and thematic funds.

Add Comments