Gradual recovery in IIP, will RBI continue its rate hikes?
Oct 12, 2011

Author: PersonalFN Content & Research Team

After plummeting to 3.8% (revised upwards from 3.3%) in the month of July 2011, the Index of Industrial Production (IIP) recovered somewhat marginally to 4.1% in the month of August 2011. And surprisingly the IIP for the month of May 2011 has been revised upwards to 6.2% (5.9% estimated earlier).

(Source: CSO, PersonalFN Research)

The graph above depicts the see-saw ride of the IIP number amidst global economic turmoil accentuated by the world’s largest economy the United States and the debt contagion created by the Euro zone. The Reserve Bank of India’s (RBI’s) too, will be watchful this time when it goes in for the monetary policy review (second quarter review) on the October 25, 2011. However, the RBI will also take into account the inflation numbers which are to be released on October 14, 2011.

Policy rate tracker

	Increase / (Decrease) since March 2010	At present
Repo Rate	350 bps	8.25%
Reverse Repo Rate	400 bps	7.25%
Cash Reserve Ratio	100 bps	6.00%
Statutory Liquidity Ratio	(100 bps)	24.00%
Bank Rate	Unchanged	6.00%

(Source: RBI website, PersonalFN Research)

In its last monetary policy review (held on September 16, 2011) the RBI increased policy rates rather by 25 basis points (bps) to tame inflation, thereby signaling its commitment to drag the inflation bug down even at the cost of growth.

Our View:

Though the August IIP numbers improved marginally due to the manufacturing sector gaining some momentum but by and large the August IIP numbers indicate that the economic growth has been affected adversely.

What should equity investors do?

Equity investors should adopt calm and compose approach by staying invested and also investing further as soon as valuations look attractive and there is potential for robust future growth.

Hence taking a holistic view of the prevailing global and domestic economic scenario we believe that uncertainty will prevail, and thus one needs to be cautious while investing in equities and rather have a staggered approach. Indian equity markets look fairly robust but are susceptible to negative news from the U.S. and Euro zone.

Therefore while investing in equities we think diversification benefit provided by mutual funds can help to reduce risk (however one needs to stay away from U.S. or Euro oriented offshore funds in such a scenario). While investing in equity mutual funds we recommend that you opt for value styled funds and adopt the SIP (Systematic Investment Plan) mode of investing as this will help you to manage the volatility of the equity markets well (through rupee-cost averaging) and also provide your investments with the power of compounding.

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.

What should debt investors do?

Well, we are almost nearing the peaks as far as the interest rates are concerned. We recommend investors to take gradual exposure to pure income and short-term Government securities funds, since longer tenor papers will become attractive. Longer duration funds (preferably through dynamic bond / flexi-debt funds) can be considered, provided one has a longer investment horizon (of say 2 to 3 years). Short term income funds should be held strictly with a 1 year time horizon. Fixed Maturity Plans (FMPs) of 3 months to 1 year can also be considered as an option to bank FDs only if you are willing to hold it till maturity, but you may not have a very attractive post tax benefit as indexation benefit will not be available on FMPs maturing within 5 months. One may also consider investing their money in Fixed Deposits (FDs). At present 1 yr FDs are offering interest in the range of 7.25% - 9.40% p.a.

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