The Inflation threat continues...
Jul 14, 2011

Author: PersonalFN Content & Research Team

In order to reduce the under-recoveries of the oil marketing companies, the United Progressive Alliance (UPA) Government raised the prices of diesel by 3 a litre. Along with this prices of kerosene was raised by 2 a litre and domestic LPG by 50 a cylinder. As a result of this hike in diesel prices the food inflation too inched up to 7.61% for the week ended June 25, 2011 (food inflation for the week ended July 2, 2011 stood at 8.31%).

(Source: : Office of Economic Advisor, PersonalFN Research)

The above events led to the inflation becoming more and more generalised across sectors and thus, the WPI inflation for the month of June 2011 has fuelled up to 9.44% up from 9.06% in May 2011 (inflation for June 2010 was at 10.55%). Moreover, the inflation figure for the month of April 2011 has also been revised upwards to 9.74% from the provisional figure of 8.66% mentioned earlier.

RBI’s stance in taming inflation:

The Reserve Bank of India (RBI) still battling quite hard to tame WPI inflation since last March, but has not received much success in doing so. Since March 2010 it has raised policy rates 10 times successively as inflation continued to remain above their comfort range (of 8.00%, earlier the comfort zone was 7.00%).

	Increase / (Decrease) since March 2010	At present
Repo Rate	275 bps	7.50%
Reverse Repo Rate	325 bps	6.50%
Cash Reserve Ratio	100 bps	6.00%
Statutory Liquidity Ratio	(100 bps)	24.00%
Bank Rate	Unchanged	6.00%

(Source: : RBI website, PersonalFN Research)

With these elevated levels of inflation, and it remaining sticky due to rise in food and fuel prices the RBI is likely be vigilant and may increase policy rates further. At its upcoming first quarter review of monetary policy 2011-12 (scheduled on July 26, 2011), we expect the RBI to further raise policy rates by 25 basis points – both on the repo rate as well as the reverse repo rate in a move to tame the inflation bug.

Our View:

We believe that with the inflation remaining sticky and the economy showing signs of a slowdown, the Indian equity markets would continue to witness absurd volatility which may also result in consolidation going forward. The headline inflation may cool down in the next couple of months if monsoons gain momentum in the coming months which in turn may cool down food prices.

But at present, taking into account the stickiness in the inflation as mentioned earlier we expect the RBI to raise policy rates by 25 basis points – both on the repo rate as well as the reverse repo rate in a move to tame the inflation bug at its first quarter review of monetary policy scheduled on July 26, 2011.

Where you should invest as inflation risk remains?

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

Equity:

Yes, we aren’t ruling out that the Indian markets are currently showing some downtrend as they corrected smartly by 12% from their peaks (November 5, 2010 BSE Sensex was at 21,004.95), but as Indian market shows knee-jerk reactions to this downbeat economic data, you investors need to enter the equity markets.

It would be wise to stagger your investments and adopt the SIP (Systematic Investment Plan) / STP (Systematic Transfer Plan) route while investing in equity mutual funds, 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. But 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:

This asset class 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 June 30, 2011) it is $1,508.0 an ounce – which indicates that price of gold has gone up by 47 times over the last 40 years. Moreover, whenever economic uncertainties increase gold tends to become bold, thus acting as a safe haven. Hence, 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.