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 came in at 6.10%, and even breachedsome poll estimates of 5.80% - 5.90%.Moreover, the data for June 2013 was revised upwards to 5.16% (from the earlier provisional data of 4.86%), thereby reflecting that inflationary pressures have now crept in, disturbing the moderation which was evident a few months ago.
 

WPI Inflation inches-up again!

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

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

Food inflation:
The data here revealed that food articles (which have a weightage of 14.34% in WPI) increased sharply to 18.18% in August 2013 from 11.91% in July 2013, mainly attributed by increase in prices of vegetables, onions, rice, fruits, milk, eggs, meat and fish.It is noteworthy that inflation in onions shot to alarming 244.62% in August 2013 from 144.94% in July 2013. Likewise inflation in other vegetables shot up to 77.81% in August 2013 from 46.59% in July 2013. Milk prices too jumped posting an inflation rate of 5.63% in August 2013 as against 2.35% in July 2013. Similarly, inflation in high protein based items such as eggs, meat and fish rose to 18.86% in August 2013 from 10.94% in July 2013.

Fuel & Power inflation:
Similarly fuel and power inflation (which has weightage of 14.91% in WPI) after relaxing noticeable during the period from March 2013 to June 2013, once again entered the double-digit terrain, as it did in the month of July 2013 with a data of 11.31%. The data for August 2013 fuelled further to 11.34%, with weakness in the Indian rupee and its impact on this constituent of WPI as oil imports became costlier.

On the other hand, the following constituents of WPI saw a decrease and remained rather benign.

Non-Food article inflation:
Non-food articles (which have a weightage of 4.26% in WPI) which consist of fibre, oil seeds and minerals, eased noticeably further to 1.06% in August 2013 from 5.51% in July 2013.

Manufacturing products inflation:
The data here revealed that prices of manufactured products(which have a weightage of 64.97% in WPI), continued to mellow down. The data for August 2013 mellowed further down to 1.90% from 2.81% in July 2013, and such a descending trend in manufacturing inflation was seen since last eleven months. So this constituent of WPI inflation also remained rather benign.

So, would RBI cut rates in its 2nd mid-quarter review of monetary policy2013-14?

PersonalFN is of the view that, WPI inflation, especially a sharp surge in food articles, would pose to be challenge for the new Governor of Reserve Bank of India (RBI), Dr Raghuram Rajan. While the Consumer Price Index (CPI) inflation has softened to 9.52% in August 2013 from the double-digit terrain, inflationary pressures yet remain.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. Moreover, increase in fuel prices and its pass-through effect would show its impact on inflation. Also yet a pressure on the Indian rupee and volatility thereinis infusing risk of imported inflation.

The Index of Industrial Production (IIP) has jumped in July 2013, but it would be premature to term it as a "turnaround" in the industrial activity. Such a data in our view would provide some elbow room toDr Raghuram Rajan to keep policy rates high, until volatility persists in the Indian rupee; it stabilises and until inflationary pressures reduce.

Fortunately, India's trade deficit has narrowed to a 5-month low of U.S. $10.9 billion in August 2013 aided by surge in exports (grew by 13% in August 2013 from a year ago) and fall in imports, that again would be supportive for RBI to keep interest rates at elevated levels in the backdrop of volatility in rupee and persistent worry on the Current Account Deficit (CAD) front due to rise in Brent crude oil price.

In the last guidance to last monetary policy (i.e. 1st quarter review of monetary policy 2013-14), the central bank mentioned that India is currently caught in a classic "impossible trinity" trilemma, where the risk emanates from:
 

• External sector concerns;
• Volatility in foreign exchange; and
• Current Account Deficit
   

Hence the aforesaid backdrop, it appears unlikely that the RBI would reduce policy rates in its ensuing monetary policy meet, and in fact the central bank may keep at elevated levels in the aforesaid backdrop.


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 price of food articles. Hike in fuel price and its pass-through effect is infusing inflationary pressures. Moreover with pressure yet on the Indian rupee and volatility therein, risk of imported inflation persists. Manufacturing inflation in our view would continue to look benign with yet docile industrial activity.


What strategy should debt investors should adopt?

Liquidity position and path for interest rates
PersonalFN is of the view that, unless rupee stabilises and recovers, RBI may not be able to soften its stance on short-term rates. This may also keep liquidity situation tight even in future. The RBI in the last guidance to monetary policy (i.e. 1st quarter review of monetary policy 2013-14), has mentioned that India is currently caught in a classic "impossible trinity" trilemma.

Recently, the Government also increased import duty on gold in its endeavour to reduce India's Current Account Deficit (CAD), but weakness in the Indian rupee poses to be a challenge. The Government is vowing to restrict the CAD to 3.7% of GDP, or U.S. $70 billion, in the current fiscal and ensure its "full and safe" financing to stem the rupee's slide. But this is a huge challenge. While at present, the Indian rupee has appreciated quite smartly (from the low of Rs 68.85 against the U.S. dollar) after slew of announcements made by the 23rd Governor of RBI, Dr.Raghuram Rajan; external concerns such as escalation of tensions in Syria could again put pressure on the rupee, which could put pressure on India's import bill. Also ahead of the general election next year (in 2014), with the Government is loosening its purse strings (by instructing ministries and department to front load spending and increasing subsidies) challenges to the path of fiscal consolidation remain which also infuse a risk of rating downgrade. It is noteworthy that pressure could be felt at the longer end of the yield curve. Recently yield on 10-year benchmark G-Sec bond had moved close to 9.50% although it came off sharply (to 8.48% as on September 12, 2013), highlights volatility. Betting on longer end of the yield curve may be risky even if you have a longer time horizon.

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 8.00% - 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 1 month, or liquid plus funds for next 3 to 6 months horizon.


What strategy should equity investors adopt?

At present the markets have tread upward in the last few trading session, after Dr Raghuram Rajan brought in the following announcements:
 

Announcement	Impact
(Pertaining to Banking)
Well-run scheduled domestic commercial banks won’t need any approval from RBI to open new branches	Banks would gain freedom in decision making, competition may grow among banks.
Appointment of a committee under chairmanship of Dr. Bimal Jalan to screen applications for new bank licenses	May speed-up the process of scrutiny and help issue bank licenses faster.
A committee is appointed under Dr Urjit Patel, Deputy Governor of RBI to review the structure of monetary policy	May be beneficial in introducing some key changes.
A committee under Mr Nachiket Mor to study the scope for financial inclusion	We might see more announcements aiming greater financial inclusion.
Overseas borrowing limit of banks is raised to 100% of their tier-1 capital from 50% allowed earlier.	Banks would be able garner more foreign money. However this may expose them to a risk of currency volatility.
(Pertaining to financial inclusion)
Issuance of inflation indexed bonds linked to Consumer price Index.	Investors would have an attractive investment option to counter inflation.
Introduction of new electronic bill payment system	Would help households settle their dues by making all payments in an electronic form. Further it will make it possible to transfer funds to anyone anywhere electronically.
(Pertaining to financial markets)
Partial rollback of capital controls announced earlier; limit for individuals to remit money abroad raised from $75,000 dollars to $1,00,000 in case of payments made for the purpose of education. No limit on remittances for medical treatments subject to provision of estimates by the doctor. Overseas investment limit of companies called back to 400% of their network from 100% earlier.	Lesser capital control may boost confidence of Foreign Institutional Investors (FIIs) as now fears of possible tightening of capital movement would recede.
Exporters are allowed to rebook upto 50% (from 25%) of their cancelled forward contracts	Would help corporate deal with currency volatility in a better way and mitigate currency risk they are exposed to by way of hedging.
Importers are allowed to rebook upto 50% of their cancelled forward contracts.	Same as above.

(Source: PersonalFN Research)  

But it is noteworthy that the intermediate volatility persists due to macroeconomic risk yet involved. The Geopolitical tensions in Syria have eased at present and have eased Brent crude oil prices as well. But if tensions abruptly escalate, it could take fuel prices higher from the present levels as supply from Iran, Iraq and Strait of Hormuz may be impacted. This in turn may pose a worry for India (which imports about 80% of its oil requirements) and that can put pressure on India’s Current Account Deficit (CAD) and take the rupee to even lower levels. It is noteworthy that at present the RBI has appreciated quite smartly (from the low of Rs 68.85 against the U.S. dollar) after slew of announcements made by the 23rd Governor of RBI, Dr.Raghuram Rajan, but pressure yet remains and volatility yet persist with fundamental macroeconomic variables involved.

Ahead of the general election next year (in 2014), with the Government is loosening its purse strings (by instructing ministries and department to front load spending and increasing subsidies) that is raising concerns on India’s fiscal deficit. Rating agencies too are signalling this as a concern. Standard & Poor's has already said chances of a credit ratings downgrade for India was higher than for Indonesia.

Likewise the economic slowdown is getting evident and griping with Q1FY14 GDP growth rate reported at 4.4% from 4.8% in Q4FY13. Moreover, the mood too has been soured with GDP growth estimates been lowered. It is noteworthy that, the HSBC Purchasing Managers’ Index (PMI) data for the month of August have been disappointing and has dashed hopes of an economic recovery in Q2FY14. The Services PMI fell to 47.6 points in August 2013 from 47.9 points in July 2013 due to weakness in new orders. The manufacturing PMI too has contracted for the first time since March 2009 as the reading dipped to 48.5 points in August 2013 from a more or less flat growth of 50.1 points in July 2013. Thus the composite PMI too, which takes into account services and manufacturing data, has come in at 47.6 points in August 2013 from 48.4 points in the previous month.

Speaking about inflation, with petrol and diesel prices increased to correct the under-recoveries, intermediate inflationary risk persist. 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. Moreover, the risk of imported inflation is also imminent if the Indian rupee plunges after slight recovery in the recent past. In fact, the sharp depreciation of the rupee since mid-May is expected to pass through in the months ahead to domestic fuel inflation as well as to non-food manufactured products inflation through its import content.

As far as the global economic scenario is concerned, in the U.S. with the fall in jobless claims to a six-year low (of 3,20,000), unemployment rate descending to 7.30% and consumer confidence haven elevated to 81.50 in August 2013, there are signs of economic vigour in the U.S. economy and is supportive of tapering of bond-buying programme. But it remains to be seen whether the Federal Reserve, indeed does that in September 2013 policy review meeting; and if they actually wind-down the current bond-buying programme (worth U.S. $85 billion per month), then the impact of the same on the U.S. economy and rest of the economies – both Advanced Economies (AEs) and Emerging and Developing Economies (EDEs) remains to be seen. As far as the Euro zone is concerned, while there have been reports of recession being over for the Euro zone (due to expansion in economic growth reported in the last quarter); the fact remains that situation of debt-overhang yet persists for the Euro zone, which again is a risk. Speaking about China, the HSBC Purchasing Manager Index (PMI) for August 2013 has been posted at 50.1, which signals that operational conditions are relatively unchanged. In fact the manufacturing PMI is just at cusp of the mark 50.0 which separates contraction and expansion. The Services PMI for China however has posted a good expansion of 52.8 in August 2013 led by growth of new businesses. But Employment decreased as service providers saw their profit margins squeezed despite a moderate increase of output prices in August 2013.

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?

Going forward too, demand is going to build-up as the festive season has begun. 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 in the second half.

At present the acquisition cost of gold has shot up with hike in import duty and weak Indian rupee. In such a scenario, PersonalFN is of the view that this would further buoy-up smuggling activity for 'tola' bars (or unnumbered gold bars) in the country. Smuggling activity in gold has been 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 uncertainty recedes.

Moreover, as long as the U.S. Federal Reserve continues with it bond-buying programme at its current pace, it would be supportive for gold. Also due to downbeat domestic economic variables such slowdown in economic growth rate, widening CAD, intermediate inflationary pressures, weakness in rupee, amongst host of other intricate ones; many would be encouraged to take refuge under the precious yellow metal. In the Euro zone with the PIIGS (Portugal, Italy, Ireland, Greece and Spain) in a situation of a debt-overhang,would encourage smart investors to take refuge under gold, as risks persists.

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.

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