IIP slows down. Would RBI take a pause in rate hikes?
Jul 13, 2011

Author: PersonalFN Content & Research Team

The sluggish Index of Industrial Production (IIP) for May 2011 (5.6%) sent shivers down the spine as the Indian equity market (the BSE Sensex) slid 309.77 points on July 12, 2011. The revision in April 2011 IIP to 5.8% (from earlier estimates of 6.3%), also accentuated the downward move of the Indian equity markets, as the buzz now is whether the Indian economy slowing down.

(Source: CSO, PersonalFN Research)

Moreover, with the debt contagion spreading to Italy and Spain (and worsening the public finances in the Euro zone), shivers are also felt by global markets, thus getting the markets in a nervous grip.

While India has shown its prudence by having robust monetary policy and financial regulations, the question now arises would the Reserve Bank of India (RBI) take a pause from its calibrated exit stance, in reflection to the gloomy picture presently displayed by the global economy, and in a situation where we have some domestic factors such as the under-mentioned ones, detrimental to our overall economic growth.

Rise in borrowing cost (due to increasing interest rates)
Rise in labour cost (due to increase in cost of living)
Rise in input cost (due to increasing interest rates)
Sticky WPI inflation (9.06% in May 2011)
Reduction in credit growth
So far deficient monsoon (which may impact farm output)
Scam stories unfolding and tarnish the image of India

Our View:

We believe that the RBI would continue maintain its calibrated exit stance and raise policy rates - both repo rate as well as reverse repo rates by 25 basis points in its forthcoming 1st quarter review of monetary policy 2011-12 (scheduled on July 26, 2011; this is because the prime concern now would be tame spiraling inflation, which in our opinion likely to show an upward bias due to the recent hike in fuel prices. Moreover, they may also take a cue from the positive data points such as the ones mentioned below:

Manufacturing Purchasing Manager’s Index (PMI) at a nine-month low of 55.3 points in June 2011
Services sector PMI up at 56.1 points in June from 55.0 points in May 2011
Government’s net indirect tax receipts up 32% to 79,499 crore in Q1 of FY 2011-12
Gross direct tax collections up about 23% to 1,03,000 crore in Q1 of FY 2011-12
Merchandise exports up 46.4% to $29.2 billion in June 2011 and up 45.7% to $79 billion in Q1 of FY 2011-12

What should equity investors do?

Taking a holistic view from the above we continue to remain cautious, and expect some consolidation to take place in the ensuing month(s) in the equity markets. We therefore would remain cautious on the Indian equity markets. However having said that, we recommend that investors gradually start investing now, because the Indian equity markets have already corrected by good 12% from their last peak of 21,004.96 (made on November 5, 2010). Moreover our year-on-year GDP growth rates is good (at 8.5%) and we expect monsoons to pick up and be normal this year, which in turn would lead to a better harvest thus also fuel farm sector growth and bring relief to food inflation.

In our opinion it would be wise to stagger your investments. All those who have enrolled for the SIP (Systematic Investment Plan) / STP (Systematic Transfer Plan) mode of investing need not worry, 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.

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 9 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.