After being in the positive in the last four months, the Index of Industrial Production (IIP) slumped in the month of May 2013 and thus the ‘see-saw’ movement continued. The data was a disappointment as it was much below expectations (of 1.5%). Likewise sharp downward revision to April 2013’s data (to 1.9% from the quick estimate of 2.3% released earlier); also made the situation appear grim.

  IIP continues its ‘see-saw’ movement

Data as on May 2013
(Source: CSO, PersonalFN Research)  

Evaluation of some of the important components of IIP for April 2013 reveals the following:

 

• Manufacturing index after being on an expansive mode in the earlier four months registered a contraction of -2.0% in May 2013. In terms of industries, eleven (11) out of the twenty two (22) industrygroups (as per 2-digit NIC-2004) in the manufacturing sector have shownnegative growth during the month of May 2013 as compared to thecorresponding month of the previous year.The average growth in manufacturing for the fiscal year 2012-13 has been mere 1.2% and thus far for the current fiscal year (for the two months reported) has been 0.15%; which reflects lull in industrial growth.



 
• Consumer goods index too fell rather sharply by -4.0% in May 2013 after being on an expansive mode in the earlier four months. But if we segment it as consumer durable goods and consumer non-durables, there was a stark contraction of -10.4% was seen in the former in May 2013, while the latter continued to expand at 1.7% in May 2013. But a noteworthy point is, despite an expansion in non-durable goods segment the pace of expansion has slowed down (as it expanded by 11.5% in April 2013).



 
• Similarly Basic and Capital Goods, limped yet again by reporting a contraction of -0.4% and -2.7% respectively. However, Intermediate goods index reported an uptick with May 2013 data at 1.5% and also an upward revision for April 2013, which in quick estimates had depicted a contraction.
   

So would RBI cut policy rates now?

PersonalFN is of the view that,the slump in IIP reveals that the scenario in grim. The Consumer Price Index (CPI) inflation data too has accelerate to 9.87% in June 2013 from 9.31% in May 2013 due to increasing prices of food articles and fuel; thereby reversing three months of deceleration. The fall in exports for May 2013 by 4.6% also exhibits a worrisome picture and reveals that demand has slowed down not only in domestic economy but also export markets. Also the depreciation of the Indian rupee against the U.S. dollar remains a potent risk, which puts pressure on country’s Current Account Deficit (CAD) and pervadeschances of imported inflation. Hence in such a scenario, although the Reserve Bank of India (RBI) may want to address to growth risk, the aforementioned backdrop poses to be a challenge for RBI to cut rates in its 1st quarter review of monetary policy 2013-14 (scheduled on July 30, 2013) and therefore may refrain from being accommodative, although monsoons have been favourable thus far and trade deficit has narrowed to a 3-month low of U.S. $12.2 billion in June 2013 (from U.S. $20.1 billion in May 2013) as result of sharp fall in gold imports.

 

So what strategy equity investors should adopt?

At present comments from U.S. Federal Reserve Chairman, Mr Ben Bernanke – that the U.S. central bank might not roll back its stimulus programme earlier than expected – has infused positive sentiments in the market as easy monetary policy adopted by the U.S. Federal Reserve is expected to continue and thus FIIs too are once again buying into Indian equities. So, there seem to be “Bernanke bounce” in the markets. Also the trade deficit for June 2013 has narrowed to a 3-month low of U.S. $12.2 billion (from U.S. $20.1 billion in May 2013) as result of sharp fall in gold imports.

At the same time the follow there are following downbeat factors as well:
 

• Lull in industrial activity
• CPI inflation has moved up
• Intermediate pressures are evident on WPI inflation
• Weak Indian rupee
• Pressure on CAD
• Tainted political canvas
• Scam stories unveiling
• Deteriorating state of governance
• Reform measures not translating too welland
• Risk of rating downgrade

 

So there is mix of factors in play – both positive and negative – although the markets are moving upwards aided by global liquidity flow.

In the Euro zone, the lenders are unhappy with progress Greece has made towards reforming its public sector. Athens, which has about €2.2 billion of bonds to redeem in August 2013,is scrambling to bridge differences with troika (i.e. European Union (EU), International Monetary Fund (IMF) and European Central Bank (ECB)) inspectors and wrap up the review by the end of this week. Likewise tensions over bailout terms have also mounted in Portugal, with Finance Minister, Mr Vitor Gaspar, the architect of its bailout measures, resigning. The Markit's final Composite Eurozone PMI although it has climbed to 48.7 in June 2013 from 47.7 in May 2013, the reading is yet below the mark of 50.0 which distinguishes contraction and expansion. Such a data in our view would not encourage ECB to change their monetary policy stance although the Euro zone is encountering a recessionary phase. This is because their benchmark rates are near to zero at 0.50%. Speaking about China, their PMI data for manufacturing too has slipped to 50.1 in June 2013 from 50.8 in May 2013. Likewise, while the PMI for services has inched up to 51.3 last month from May's 51.2, but new orders grew at their weakest pace in more than four years; which indicates that the world’s second largest economy is also losing momentum.

Hence in the background of the above and specifically the risk emanating, we recommend investor to stagger their investments to mitigate risk, since volatility could persist, although markets may tread upwards in the intermediate. While 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.

To read our full view on how equities are likely to perform in year 2013, please click here

What strategy debt investors should adopt?

Liquidity position and path for interest rates

Going forward it remains to be seen whether policy rates are indeed reduced, albeit moderation in WPI inflation and reversal in trend now in CPI inflation. In the guidance from monetary policy 2013-14, the RBI has clearly enunciated that monetary policy stance will be determined by how growth and inflation trajectories and the balance of payments situation evolve in the months ahead. At present, although CAD data for March-quarter has come in at 3.6% of GDP, for the complete fiscal year 2012-13 it has touched a record high of 4.5% (at U.S. $87.8 billion), which is much above the central bank’s comfort level of 2.5% of GDP. So, until pressure on CAD is reduced and also the rupee, the RBI may refrain from reducing policy rates in its 1st quarter review of monetary policy 2013-14 (scheduled on July 30, 2013).

It is noteworthy that debt fund managers are significantly lowering their exposure of G-Secs from bond and income funds after the central bank introduced the new 10-year bond maturing in 2023 at a coupon rate of 7.16%. Moreover, now that yield therein has risen amid worry over widening CAD and weak rupee, cautiousness seems to be prevailing. Thus ascertaining the risk-reward relationship in the present interest rate scenario, debt fund managers are preferring shorter maturity papers.

PersonalFN is of the view that, it would be best to refrain investing in longer maturity debt papers in the aforesaid backdrop, and instead prefer shorter maturity debt papers. In case if one wishes to take exposure to longer duration instruments or debt mutual fund schemes holding longer maturity papers (as permitted by their high risk appetite), PersonalFN recommends that you do so by investing in dynamic bond funds, since there would always be intermediate interest rate risk involved.

In the current scenario while investing in debt instrument, it would be ideal to invest in shorter duration instruments vide debt mutual fund schemes having shorter maturity profile. 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. If you as an investor have a short to medium term investment horizon (of 1 to 2 years), you may allocate a part of your investment to short-term income funds, provided that you are willing to take some interest rate risk. Avoid investing in G-sec funds , as they may see high volatility and may not be an ideal instrument to yield fruitful returns. Fixed Maturity Plans (FMPs) of 3 months to 1 year period can also be considered as an option to bank FDs only if you are willing to hold it till maturity. Alternatively you can also invest in 1 year Fixed Deposits (FDs), as banks are offering interest on 1 year FDs in the range of 7.00% - 8.75% p.a.

To read if bond markets are poised for another rally in 2013, please click here

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