IIP takes a free fall, Will RBI pause rate hikes?
Sep 12, 2011

Author: PersonalFN Content & Research Team

The smart recovery shown by the Index of Industrial Production (IIP) in June 2011 - registering a growth of 8.8% was completely washed out in July 2011 as the IIP posted a dismal growth of 3.3% as against 10.0% posted for the same period last year.

(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 as it announces the monetary policy review (second quarter mid-review) on the September 16, 2011. However, the RBI will also take into account the inflation numbers which are to be released on September 14, 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 effect of the same is witnessed in the somber industrial growth, as it implied an increase in input cost.

Our View:

The July IIP numbers are a clear indication of the impact of high interest rates prevailing in the country. 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 2^nd quarter mid review of monetary policy 2011-12 (scheduled 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 52.6 points in August 2011

What should equity investors do?

Equity investors at this stage need not panic. Equity markets by nature exude volatility on downbeat economic data like this IIP number for July 2011. Instead of pressing the panic button and offloading your investments in haste, it would be wise to stay invested because our economic growth rate is quite robust (7.7% in Q1FY2011-12). Yes volatility is likely to be experienced by this IIP number, but to manage the same you should adopt the SIP (Systematic Investment Plan) mode of investing as this well enable you to manage the volatility well (through rupee-cost averaging) as well power your portfolio through the benefit of compounding. The present levels of the Indian equity markets are quite attractive to invest as valuations look attractive and there is potential for robust future growth.

However, you need to be wary of the news dissemination from the developed economies – especially Euro zone and the U.S. as this may show an rippling and crippling effect on the Indian equity markets. Hence one needs to be cautious while investing in equities and rather have a staggered approach.

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 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.

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