Once again the Index of Industrial Production (IIP) displayed signs of a see-saw movement as it posted a negative growth of -1.8% for the month of June 2012 as against the 2.5% (revised from 2.4%) for the previous month. Moreover, when analysed from a year-on-year point of view, the IIP growth decelerated to -1.8% in June 2012 from 9.4% in June 2011.

Various factors like high interest rates for a long period of time, high inflation, poor business environment, unclear tax laws on the domestic front as well as slowdown in the developed nations like the U.S. and Europe weighed heavily on the production index of the country.
 

IIP growth on a slippery slope

(Source: CSO, PersonalFN Research)
The following factors had their share of impact on the IIP growth:
 

• Manufacturing index, which constitutes about 76% of the industrial production index, displayed a negative growth of -3.3% as against almost 2.6% growth in the previous month. Moreover, on a Y-o-Y basis the manufacturing index underperformed by 14.5% (Manufacturing index for the month of June 2011 came in at 11.2%). A part of the negative growth can be attributed to the high base effect of June 2011.
   
• Consumer goods index once again, managed to put up a good show by registering a growth of 3.5% for the month of June 2012 as against 4.5% in the previous month. While the consumer durables registered a positive growth of 9.1%, the consumer non-durables posted a negative growth of -1.0%.
   
• Continuing with its negative performance since the month of March 2012, the capital goods index registered a negative growth of -27.9% in the month of June 2012 as against -8.8% (revised downwards from -7.7%) in the previous month. Low business confidence due to lack of policy reforms and below normal monsoon this season have been weighing heavily on the investor sentiment.
   

Our View:

We believe that, the IIP numbers have once again shown their see-saw movement as seen in the past periods. Going forward, with the change at the FM position (Mr P. Chidambaram back as the Finance Minister); we might see some action on the part of the Government as far as policy reforms are concerned. If the positive statements as voiced by the FM are truly implemented, the business confidence in the country may get a boost. Clear tax laws, FDI friendly reforms and better supply management could well translate into lower inflation and better growth.

Moreover, in order to stimulate growth there will pressure on the central bank of the country - the RBI, to cut interest rates. However, we are of the opinion that unless the headline inflation as measured by the WPI mellows down to levels comfortable to the RBI, the RBI may not touch the policy rates. The RBI in its recently concluded, first quarter review of monetary policy had highlighted the fact that unless inflation cools down, reducing the interest rates may not stimulate growth.

What should equity investors do?

Equity investors should adopt a calm and composed approach towards their investments. Redeeming their investments in case of panic selling in the equity markets will do more harm than good and instead investors should invest when the markets correct or valuations look attractive.

No doubt that the developed nations (Europe and United States) are still not out of the woods and in case of any negative news disseminating from them will have an impact on our markets as well. The slow pace of growth in the U.S. (GDP growth of 1.5% for Q2 2012) and the third largest economy of Europe, the United Kingdom shrinking by -0.7% in the second quarter of 2012 are clear signs of poor pace of growth in the developed nations.

On the domestic front too, inflation is still above the comfort zone of the RBI and with below average monsoons this season, there could be a possible spike in the food inflation. However, as promised by the Finance Minister - Mr P. Chidambaram to take action on the supply constraints front, the food inflation may well be controlled. Other important impediments on the domestic front are poor business confidence, high interest rates, unclear tax laws which need to be addressed to. Citing these impediments and with an aim to bring back growth on track, the FM said that the Government was ready with an action plan. He said, "Price stability is an important objective. There has been pressure on prices, and inflation, especially food inflation, is high. The causes are well known...some are beyond our control, such as prices of crude oil and imported commodities, but some others can be addressed by determined action. We will take steps to remove the constraints on the supply side." Assuaging the fears about the proposed strong tax laws by his predecessor Mr Chidambaram said, "Clarity in tax laws, a stable tax regime, a non-adversarial tax administration, a fair mechanism for dispute resolution, and an independent judiciary will provide great assurance to investors. We will take corrective measures wherever necessary."

Moreover, when investing in mutual funds it is vital to select only those equity mutual funds which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years.

What should debt investors do?

Well, we think that the current situation is attractive to take exposure to debt mutual fund instruments as interest rates are likely to go down gradually over the months.

Hence at present while taking exposure to debt mutual funds and fixed income instruments, one should clearly know their investment time horizon. 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. However, investors with a short to medium term investment horizon (of 1 to 2 years) may allocate a part of their investments to short-term income funds which should be held strictly with at least 1 year time horizon.

The present scenario also seems comfortable to look at longer horizon debt mutual funds. Thus, if you have a longer time horizon, then you can now hold some exposure to pure income funds. Since longer tenor papers will become attractive, longer duration funds (preferably through dynamic bond / flexi-debt funds) can be considered, if one has an investment horizon of say 2 to 3 years. However, one may witness some volatility in the near term as there is always an interest rate risk associated with longer maturity instruments.

Fixed Maturity Plans (FMPs) of upto 1 year may for some more time yield appealing returns and can also be considered as an option to bank FDs only if you are willing to hold it till maturity. You can consider investing your money in Fixed Deposits (FDs) as well, before the interest rates offered on them are reduced. At present 1 year FDs are offering interest in the range of 7.25% - 9.25% p.a.

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