The high interest rate environment in the country for the last 4 to 5 months (ever since the 50 basis points hike in its Annual Monetary Policy on May 3, 2011) has led to increase in input costs for the manufacturing sector, thus leading to rise in cost of manufactured goods (inflation in the manufacturing goods sector stood at 7.79% in August 2011). And hence, the general rise in prices of goods has led the headline inflation (Wholesale Price Index) close to the double digit mark in the month of August 2011. Thus as an outcome of the above mentioned environment, the WPI inflation for the month of August 2011 stood at 9.78% standing taller from 9.22% in July 2011.

 

(Source: of the Economic Adivsor, PersonalFN Research)

 

This is the ninth consecutive month when headline inflation has been above the 9% mark. Moreover, on an annual basis the food inflation became 9.62% more expensive during August 2011. Inflation in the fuel and power segment too, stood at 12.84% year-on-year in August 2011.

RBI’s stance in taming inflation:

Battling hard with the inflation monster, the Reserve Bank of India (RBI) has been relentlessly increasing the key interest rates consecutively for 11 times now. And with this August 2011 reading (9.78%), the RBI may be tempted to increase the interest rates for the 12th time. However, the Index of Industrial Production (IIP) for the month of July 2011 stood at its 2 year low at 3.3% making the job of the RBI even more difficult.

  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)

 

Thus, it will be interesting to see how the country’s central bank reacts to these numbers at its second quarter mid-review of monetary policy scheduled on September 16, 2011.

Our View:

In our opinion though the headline inflation is ticking towards the double digit mark, the RBI may take a cue from the dismal growth put up by the IIP at 3.3% in July 2011 and refrain from taking any hawkish stance. Further the following factors would also weigh on the RBI’s mind before making any attempt to increase the policy rates again:

 

• 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 and WPI number for August 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 WPI number, but to manage the same you 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 a 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 investors in gold do?

In our opinion the downbeat global economic headwinds make the case for gold becoming bolder. Moreover inflationary pressures are likely to haunt most emerging nations including India; and central banks across the world are likely to be vigilant on raising policy rates, which in turn would lead to smart investors taking refuge under the precious metal.

It is noteworthy that gold has displayed a secular uptrend since a long time now. In 1971, the price of gold was about $32 an ounce and today (i.e. on September 13, 2011) it is $1,835.2 an ounce – which indicates that price of gold has gone up by 57 times over the last 40 years. Hence, nothing has changed for gold and we believe it will continue to maintain its upward trend in the long-term. Moreover if the Euro zone crisis accentuates and the US goes into recession again, the precious yellow metal is bound to accelerate its northward journey. At PersonalFN, we recommend that you should have a minimum of 5%-10% allocation to gold. Invest in gold with a long term perspective with a time horizon of 10 to 20 years.

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Comments
swfinch@wisealloys.com Sep 28, 2011 Time to face the music armed with this great information.
nward@hallmarkhealth.org Sep 29, 2011 Until I found this I thought I'd have to spend the day inside.
fcamargo@campus.cem.itesm.mx Sep 29, 2011 Stay with this guys, you're helping a lot of people.

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