After hovering around the little above the 5.5% plus mark in April and May, the Index of Industrial Production (IIP) once again surged to 8.8% in June 2011. The acceleration in industrial growth occurred due 10% growth registered in manufacturing activity (as against 6.0% in May 2011), along with robust growth (of 37%) in capital goods.

 

(Source: CSO, PersonalFN Research)

 

This upsurge in industrial growth occurred despite the Reserve Bank of India’s (RBI’s) persistent anti-inflationary stance of increasing policy rate 11 times successively since March 2011.

 

Policy rate tracker

	Increase / (Decrease) since March 2010	At present
Repo Rate	325 bps	8.00%
Reverse Repo Rate	375 bps	7.00%
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 July 26, 2011) the RBI increased policy rates rather in a hawkish way – by 50 basis points (bps) to tame inflation, but the impact of the same was not witnessed as the rate hike came towards the end of the month of June 2011.

 

Our View:

Going forward we think even though the IIP numbers are very encouraging, the RBI may have a limited room for increasing policy rates further, since at present the global economic factors led by the U.S. sovereign rating being downgraded (to AA+ with a negative outlook), along with debt overhang situation in the Euro zone may desist the central bank from increasing policy rates further. Moreover, the domestic factors such as the ones mentioned below, may also hold back the RBI from a further policy rate hike, at least in its 2nd quarter mid review of monetary policy 2011-12 (schedule on September 16, 2011):

 

• Elevated borrowing cost
• Elevated input cost
• Chances of slowdown in consumer spending
• Downward revision in GDP targets (from 9.0% to 8.2% by PMEAC)
• Nervous sentiment in the capital markets
• Manufacturing Purchasing Manager’s Index (PMI) at a 20-month low of 53.6 points in July 2011

What should equity investors do?

We believe that this surge in the IIP would not enthuse the Indian equity market to display much upward movement. At present the global economic headwinds will pave the path for the Indian equity markets. At present the House of Representatives have voted on August 2, 2011 for an increase in the U.S. debt ceiling limit by U.S. $2.1 trillion (making it U.S $16.4 trillion), and also agreed to cut federal spending by U.S. $2.4 trillion dollars or more. This in our opinion would purely bloat the U.S. economy (which already has been made a 92% increase in debt ceiling in the last 3 decades) and make its debt to GDP ratio daunting to manage.

 

Big fat U.S. debt ceiling

(Source: whitehouse.gov)

 

Moreover we believe while the debt ceiling limit is increased, the long-term risk of sovereign default crisis by the U.S. still remains because this decision of increasing debt ceiling limit is purely a case of postponing a sovereign default to happen. Also with persisting Euro zone debt crisis, may encourage the bear cartel to further tighten their grip.

 

But after the immediate knee-jerk selling in most equity markets around the world, we may witness Foreign Institutional Investors (FIIs) turning their head towards the Asian economies. But they would be watchful on export oriented economies such as China and Japan (as they collectively hold more than U.S. $2,000 billion of total US Debt) and this may be destructive for the respective countries reserves as well as foreign exchange earnings. Hence given that, FIIs would turn their focus on India, and continue to exude confidence due its inward looking Indian economy (which doesn’t focus much on exports), and the strong economic fundamentals which it has to offer such as luring growth, prudent policy measures, strong consumption story and lower debt to GDP ratio.

 

Hence taking a holistic view of the prevailing global 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.

Hence 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 8 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% - 9.25% p.a.

 

Disclaimer: All the information and opinion compiled in the note, article, report, as well as all the data and figures mentioned and used for compiling such views and opinion are obtained from sources believed to be reliable and available in public. PersonalFN does not warrant completeness or accuracy of any information published in this note. PersonalFN disclaims warranty of any kind, whether express or implied, as to any matter/content contained in this note and will not be liable and responsible for any direct/indirect loss or liability incurred by the user as a consequence of his or any other person on his behalf taking any investment decisions based on the contents of this note. This note is for your personal use and you shall not sell, resell, copy, or redistribute this note, or use it for any commercial purpose. Please read the terms of use of the website.

Add Comments

Comments
info@kaisya-s.com Aug 19, 2011 And I was just wonedring about that too!
mike-adams@leavitt.com Aug 19, 2011 Good job making it appear easy.
qmptishp@qgblumkc.com Aug 19, 2011 Now I'm like, well duh! Truly thankful for your help.

 1