Fuel prices signaling towards double digit Inflation
May 16, 2011

Author: PersonalFN Content & Research Team

(Source: Office of Economic Advisor, PersonalFN Research)

The WPI inflation of 8.66% for the month of April 2011 didn’t come up much as a surprise, as fuel cost remained elevated. Moreover, now with the Government having increased the prices of petrol by ` 5 to compensate for the under-recoveries suffered by the oil marketing companies the chances that the headline WPI inflation treading upwards in the months to come increases.

Also, if the EGoM (Empowered Group of Ministers) hike the prices of diesel, cooking gas and kerosene, we may witness a domino effect which could possibly pull the food inflation up in double digits once again (food inflation for the week ended April 30, 2011 was 7.7%) and hurt the aam-admi.

Diesel is widely used by transporters of fruits, vegetables and other food items from one state to another. Any rise in diesel prices may agitate the transporters, to go on a nation- wide stir thus crippling the food supply across the country.

RBI’s stance in taming inflation:

The Reserve Bank of India (RBI) has been battling quite hard without much respite since last March, and has raised policy rates 9 times successively since then, as inflation remained above the comfort range (of 8.00%, earlier the comfort zone was 7.00%).

	Increase / (Decrease) since March 2010	At present
Repo Rate	250 bps	7.25%
Reverse Repo Rate	300 bps	6.25%
Cash Reserve Ratio	100 bps	6.00%
Statutory Liquidity Ratio	(100 bps)	24.00%
Bank Rate	Unchanged	6.00%

(Source: RBI website, PersonalFN Research)

With these elevated levels of inflation, and it remaining sticky due to rise in fuel prices the RBI is likely be vigilant and may increase policy rates further. At its upcoming first mid-quarter review of monetary policy 2011-12 scheduled on June 16, 2011, we expect the RBI to raise policy rates by 25 basis points in a move to tame inflation.

Our view and outlook on policy rate:

We believe that the WPI inflation will continue to display a northward bias as long as fuel prices and non-food items continue to exhibit upward trend. Furthermore, rise in prices of diesel and cooking gas will add fuel to the fire and once again we may witness double digit growth in the inflation. This in turn would keep RBI vigilant about increasing policy rates in order to tame inflation. Citing this we may also see some consolidation and slow down in the growth of the country amidst high inflation.

At its first mid-quarter monetary policy review 2011-12 scheduled on June 16, 2011 we expect RBI to increase policy rates (both repo rate as well as the reverse repo rate) by 25 basis points, as any hawkish stance may derail growth.

Where you should invest as inflation risk remains?

But in order to safeguard yourself against inflationary pressures building in, you investors need to wisely focus on the following two major asset classes which can enable your portfolio deliver positive returns after accounting for inflation.

Equity:

Yes, we aren’t ruling out that the Indian markets are currently showing some downtrend, but as Indian market shows knee-jerk reactions to this downbeat economic data, you investors need to enter the equity markets. It would be wise to stagger your investments and adopt the SIP (Systematic Investment Plan) / STP (Systematic Transfer Plan) route while investing in equity mutual funds, as this will enable you to manage the volatility of the equity markets well (through rupee-cost averaging) and also provide your investments with the power of compounding. But remember, while investing select only those equity funds which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years.

Gold:

This asset class has displayed a secular uptrend since a long time now. In 1971, the price of gold was about $32 an ounce and today (i.e. on April 30, 2011) it is $1,556 an ounce – which indicates that price of gold has gone up by 48 times over the last 40 years.

Moreover, whenever economic uncertainties increase gold tends to become bold, thus acting as a safe haven. Hence, at PersonalFN, we recommend that you should have a minimum of 5% - 10% allocation to gold. Invest in gold with a long term perspective with a time horizon of 10 to 20 years.