The inflationary pressure once again seems to creeping in. The WPI inflation bug after being on a downward trend for four months period i.e. from February 2013 to May 2013 has once started inching up. The data for August 2013 inched-up to 6.10% from the earlier month, and now for the month of September 2013 too, the data came in at 6.46% breaching poll estimates of 6.00%. Moreover, the data for July 2013 was revised upwards to 5.85% (from the earlier provisional data of 5.79%), thereby reflecting that inflationary pressures building in and disturbing the moderation which was evident a few months ago.
 

WPI Inflation inches-up again!

Data as on September 2013
(Source: Office of the Economic Advisor, PersonalFN Research)  

The ascending move inWPI inflation for September 2013was mainly account of:

Food inflation:
The data here revealed that food articles (which have a weightage of 14.34% in WPI) continued to be on a rise with its data in double-digits at 18.40% for the month of September 2013, and ascending further from the sharp increase to 18.18%, reported for the month of August 2013. The inflationary pressures here were mainly attributed by increase in prices of vegetables, onions, and fruits. It is noteworthy that inflation in onions shot to alarming 323.00% in September 2013. Likewise the prices of vegetables in general rose by 89.37% making life difficult for the common man. Fruits too were costlier by 13.54% year-on-year during the month. However high protein based items such as eggs, meat and fish saw softening in prices.

Non-Food article inflation: Non-food articles (which have a weightage of 4.26% in WPI) which consist of fibre, oil seeds and minerals, after easing noticeably in the last couple of months inched-up once again – and rather sharply – to 5.17%, a level close to that in July 2013.

Manufacturing products inflation:
The data here too revealed that prices of manufactured products(which have a weightage of 64.97% in WPI), also inflicted some inflationary pressures. The data for September 2013 came in at 2.03% after a drop seen in August 2013 (to 1.90%). Thus being on a descending trend since last twelve months, manufacturing inflation seemed to have caused some inflationary pressures; but this seemed more cyclical.

The following constituent of WPI on the other hand which was inflicting inflationary pressures until August 2013 saw a decrease.

Fuel & Power inflation:
Fuel and power inflation (which has weightage of 14.91% in WPI) after being on upswing in the last three months i.e. from June 2013 to August 2013 relaxed in the month of September 2013, but the data remained in the double-digit terrain at 10.08%. The earlier increase in fuel prices, followed by the roll-back depicted its impact on fuel and power inflation. Also some appreciation in the Indian rupee and some softening in international crude oil price, led to easing pressures.

So, would RBI cut rates in its 2nd quarter review of monetary policy 2013-14?

PersonalFN is of the view that, WPI inflation, especially a sharp surge in food articles, would pose to be challenge for Dr Raghuram Rajan. The stronger than expected monsoon has not yet softened food inflation as much as it should have. In particular, vegetable prices have been impacted by weather-driven supply disruptions.

The Consumer Price Index (CPI) inflation too for the month of September 2013 is expected to remain at elevated levels, which in turn may guide RBI monetary policy action. In fact, Dr Rajan has mentioned that the CPI remains a big concern. Thus we feel the focus is gradually shifting towards CPI data and elevated CPI may preclude the central bank from cutting policy rates.

The industrial activity in the country is showing a 'see-saw' trend, but that may not encourage the RBI to cut rates in times when inflationary pressures are evident. Dr Rajan has cited that maintaining a stable and relatively low inflation is needed to help growth in the long-term. So, RBI may stick to that view. The monetary policy stance of RBI may also be influenced by the decision of the U.S. Federal Reserve regarding continuation of monetary stimulus in the U.S.

PersonalFN is of the view that being concerned about currency stability and persistently high CPI inflation, the RBI may not take a softer stance or reduce rates or maintain status quo in spite of poor industrial growth. Rather RBI may hike rates by another 25 basis points (bps) if it sees upside risk to CPI inflation.

 

PersonalFN's View on inflation:

While monsoon has been above normal, it has done damage to vital kharif crops due to which we are witnessing rise in price of food articles. Manufacturing inflation may be benign with yet docile industrial activity.

What strategy should debt investors should adopt?

Liquidity position and path for interest rates
In the guidance from monetary policy the RBI has mentioned that it would continuously monitor the evolving growth-inflation dynamics with a readiness to act pre-emptively, as necessary. It has also been mentioned by the central bank that further actions need not be announced only on policy dates; so vigilance appears. Moreover, focus has turned to internal determinants of the value of the rupee, primarily the fiscal deficit and domestic inflation. But to manage the liquidity conditions in the intermediate, the central bank has announced an Open Market Operation (OMO)which would ease the liquidity constraints. Moreover the RBI has reduced Marginal Standing Facility (MSF) twice in the in the recent past (by 75 basis points on September 20, 2013 and 50 basis points on October 7, 2013) which again has implication of lowering short-term rates and therefore even reduction in short-term yields. Moreover the move to introduce 7-day and 14-day tenor repos for a notified amount equivalent to 0.25% of net demand and time liabilities (NDTL) of the banking system through variable rate auctions on every Friday (beginning October 11, 2013) would help manage liquidity conditions in the short-term. Also, cash management bills which were issued to suck out liquidity from the system a few weeks ago are maturing in the near term. This would release another Rs 52,000 crore in the system and would have a positive impact on yields of short term instrument. But the longer end of the yield curve would be affected with several factors such as inflation and fiscal deficit to name a few.

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.

So in the aforesaid backdrop, 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. If permitted by your time horizon and risk appetite if you still want to invest in long-term debt funds, it would be wise to take exposure via dynamic bond funds (as enabled by their mandate they hold debt instruments across maturities). But PersonalFN thinks that given the aforementioned interest rate scenario and macroeconomic variables thereto, one should not hold more than 20% of their debt portfolio in longer tenure funds. 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 8.25% - 9.00% p.a. In the present scenario, 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 1month, or liquid plus funds for next 3 to 6 months horizon.

What strategy should equity investors adopt?

Economic and industrial growth may remain subdued going forward, even after taking into consideration possibility of spur in demand ahead of festive season. If RBI goes for another rate hike, borrowing cost, which is already high due to higher short term borrowing rates and liquidity crunch, may go even higher. Higher borrowing costs may affect profitability of companies negatively. This may keep markets range-bound. Moreover, performance of Indian equities would also be impacted with global developments.

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

Hence In the background of the above and the risk emanating therefrom, PersonalFN is of the view that investor should stagger their investments to mitigate risk, since volatility could persist. While investing in equity mutual funds, PersonalFN recommends 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. Also PersonalFN believes that your investment discipline and asset allocation would decide your success in investing.

What strategy should investors in gold adopt?

With on-going festive and wedding season, gold is likely to ascend. It is noteworthy that according to the World Gold Council (WCG), gold demand in India could reach a record 1,000 tonnes this year as consumers buy for the festival and wedding season. The hike in custom duty on gold may not be a dampener. Moreover now that the monsoon have been good – in fact above normal; it could stoke up rural demand as it means more cash in the hands of farmers who often invest mainly in two asset classes gold and land.

Also right now, a relatively stable exchange rate would also take the spotlight off gold imports, which in turn would keep demand buoyant. Nevertheless smuggling activity due to hike in custom duty may be resurrected recognising the fact that India has an insatiable appetite and flair to own the precious yellow metal, due to various emotional and financial reasons. PersonalFN thinks that smart investors could view gold as a monetary asset rather than mere commodity and that would keep the long-term trend for gold intact until economic uncertainties, both in domestic and global economy recede.

One can take refuge under the precious yellow metal and add it to your portfolio from diversification point of view. At PersonalFN, we believe that, you should consider your investment time horizon and accordingly allocate 10% to 15% of your total portfolio towards gold (via gold ETFs). Gold is not an instrument to make quick money but a solid long term asset and hence you should ideally invest in gold with a longer investment horizon.

Add Comments