(Source: Office of Economic Advisor, PersonalFN Research)

 

After showing some respite in January 2011, the Wholesale Price Index (WPI) increased marginally to 8.31% in February 2011 from 8.23% in January 2011. Despite moderation in prices of food articles, costlier fuel raised input costs and along with a strong consumer demand pushed the headline inflation upwards to 8.31%.

 

This acceleration in February’s WPI has once again put pressure on the Reserve Bank of India (RBI) to tame the spiraling inflation without hurting growth.

 

The December 2010 inflation also underwent an upward revision to 9.41% from 8.43% (provisional figure) indicating that the problem of price rise is more severe than expected.

 

However, despite above 8.0% inflation number, Mr. Pranab Mukherjee remained positive by saying that, “By March-end, it would be possible to have 7% to 7.5% (of inflation).”

Our View:

In our opinion as the base effect fades away the WPI inflation is likely to come down in the following months. For the fiscal year 2010-11 (ending in March 2011), we expect WPI inflation to be around 6.5% - 7.00% levels, assuming that nothing major adverse event takes place further (like the one in Japan) in the global arena.

 

But besides the fact that inflation will mellow in the coming months (as base effect fades), at present the RBI has been once again caught up in a catch-22 situation where at one end it needs to tame the spiralling inflation and at the other end sustain India’s growth story. However, we feel that RBI at this point would be more concerned with bringing the inflation levels down as it (inflation) has already hurt the sentiments of the “aam aadmi”.

 

We believe that we may witness a hike of 25 basis points in the repo as well as the reverse repo rates in the RBI’s fourth quarter mid-review of monetary policy 2010-11 scheduled on March 17, 2011.

 

But in order to safeguard yourself against inflationary pressures building in, you as investors need to wisely focus on the following two major asset classes thus enabling your portfolio deliver positive returns after accounting for inflation.

Equity:

At present the Indian equity markets from a valuation perspective are looking quite appealing as BSE Sensex is down by 16.4% when assessed on the basis of the PE multiple.

 

	As on March 14, 2011	As on Nov 05, 2010	Change	% Change
BSE Sensex	18,439.5	21,004.9	(2,565.4)	-12.2%
Price to Earnings Multiple	20.2	24.2	(4.0)	-16.4%

(Source: BSE Website, PersonalFN Research)

 

Yes , we do recognise that the markets are confronting multiple risks at present such as:

 

1. Higher commodity prices (especially crude oil prices)
2. Increase in borrowing cost (due to increasing interest rates)
3. Increase in labour cost
4. Slowing demand
5. Reduction in credit growth
6. Political instability due to shadows of various scams
    

But the Budget 2011 has done sufficient justice to the main areas of allocation such as infrastructure, agriculture, education and banking.

 

Sector	Allocation (Rs in crore)	Objective
Infrastructure	214,000	Suitable infrastructure to attract FDI flows and overall improve the state of infrastructure
Agriculture
Rashtriya Krishi Vikas Yojana	7,860	Remove production and distribution bottlenecks
Agriculture credit to farmers	475,000	Making credit affordable
Education	52,057 (Rs 21,000 crore to Sarva Shiksha Abhiyan)	To increase literacy level and improve infrastructure for education
Banking
Regional Rural Banks (RRBs)	500	To maintain a Capital Reserve Adequacy Ratio (CRAR) of at least 9% as on March 31, 2012
Public Sector Banks	6,000	To maintain their Tier I Capital to Risk Weighted Asset Ratio (CRAR) at 8 %

(Source: Union Budget 2010-11, PersonalFN Research)

 

Moreover excise duty hasn’t been revised upwards, thereby attempting to unhurt corporate earnings. Also with the Indian economy expected to grow by 9.0% (with an outside band of +/- 0.25%) for FY 2012 and the fiscal deficit target of 4.6% (for FY 2012) likely to be achieved, we see this asset class offering a good long-term prospects for shielding against inflationary risks.

 

While taking exposure to equity as an asset class you may invest through equity oriented mutual funds. However weighing the present risks mentioned above, it would be wise to stagger your investments and adopt the SIP (Systematic Investment Plan) / STP (Systematic Transfer Plan) route while investing, 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. Moreover, it may be prudent to adopt a defensive stance and invest in value style funds and refrain from investing in growth style funds which may turn out to be more risky.

 

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.

Gold:

As an asset class this precious yellow metal has a characteristic of becoming bolder, once all down-beat economic data is released. In 1971, the price of gold was about U.S. dollar 32 an ounce and today (i.e. on February 28, 2011) it is U.S. dollar 1,383.50 an ounce –which indicates that price of gold has gone up by 43 times over the last 40 years. So, in that sense the gold prices have revealed a secular uptrend.

 

Hence fundamentally nothing has changed for gold so far. In fact as long as dismaying economic data is released across the globe (including India), we see gold prices showing a secular upward trend, which in turn would hedge your portfolio against all economic risks.

 

While investing in gold prefer Gold ETFs and stay invested in this asset class for a period of 10 to 20 years by having a minimum allocation of 5% - 10%.

 

So remember while the RBI may continue to remain under the dilemma of managing inflationary risks, we opine that you be smarter on your investment strategies and invest in equity and gold (which are promising asset classes) to safeguard yourself against the bug called inflation biting your portfolio.

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