The WPI inflation bug for May 2013 mellowed down further much beyond expectations (of 4.8% - 5.0%) to 4.70%. This thus resulted in a further descending move placing WPI inflation to a 42-month low, after plateauing above the 7.0% plus mark for over a year. Likewise, contrary to upward revision seen earlier, WPI inflation data for March 2013 was also revised downward to 5.65% from 5.96% provisional data released earlier.
 

WPI Inflation mellowed down further

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

The drop in WPI inflation for May 2013 can mainly be attributed to:

Manufacturing products inflation:
The data here revealed that prices of manufactured products (which have a weightage of 64.97% in WPI) continued to mellow to 3.11% in May 2013 from 3.41% in the previous month and 5.24% in May 2012. It is noteworthy that since the last eight months, manufacturing inflation has been on a descending trend.

Non-Food article inflation:
Likewise non-food articles (which have a weightage of 4.26% in WPI) eased rather noticeable to 4.88% in May 2013 from 7.59% in the previous month, while there was an upward revision to 9.32% for the provisional data of March 2013.

Fuel & Power inflation:
Similarly fuel and power inflation (which has weightage of 14.91% in WPI) also relaxed noticeable to 7.32% in May 2013 from the revised figure of 8.84% in the previous month and 11.53% in May 2012.

But it is noteworthy that inflation in food articles (which have a weightage of 14.34% in WPI) inched up to 8.25% in May 2013 from 6.08% in the previous month, although it was down from the data of 10.63% seen in May 2012. The rise in food inflation was on account of increase in prices of onions, vegetables, cereals and protein-based items.

So, would RBI cut rates in its 1stmid-quarter review of monetary policy2013-14?

The WPI inflation has dropped further in May 2013 aided by the aforementioned attributes and so has the retail inflation by 8 basis points (bps) to 9.39% (versus 9.39% in April 2013). But it is noteworthy that, widening Current Account Deficit and weak Indian rupee pose to be challenge for the domestic economic, due to which the Reserve Bank of India (RBI) would refrain from cutting policy rates in its 1st mid-quarter review of monetary policy 2013-14 (scheduled on June 17, 2013), although the economic growth rate has slowed down, industrial activity is experiencing a lull and there is favourable news of progress of monsoon in play. But in order to manage liquidity situation in the interim and to ensure adequate credit to productive sectors, the central bank would keep all options available including Cash Reserve Ratio (CRR), Open Market Operations (OMOs) or any other for that matter; which would be consistent with the growth-inflation balance.

As far as addressing growth risk is concerned, RBI has put onus on the Government by saying that growth needs to be supplemented by efforts towards easing the supply bottlenecks, improving governance and stepping up public investment, alongside continuing commitment to fiscal consolidation.

PersonalFN believes, if WPI inflation data remains docile going forward and if signs of improvement are depicted in CAD and rupee (in the form of appreciation), the central bank in its 1st quarter review of monetary policy 2013-14 (schedule on July 30, 2013) may consider a 25 bps reduction in policy rates. A hawkish move may not be probable because in the calendar year 2013, asthus far the central bank has already cut policy rates by 50 bps and CRR by 25 bps. Likewise in the fiscal year gone by too, the RBI has been quite accommodative in its policy stance to fuel growth (see table below).
 

Policy rate tracker

	Increase / (Decrease) in FY12-13	At present (as on May 14, 2013)
Repo Rate	(100 bps)	7.50%
Reverse Repo Rate	(100 bps)	6.50%
Cash Reserve Ratio	(75 bps)	4.00%
Statutory Liquidity Ratio	(100 bps)	23.00%
Bank Rate	(100 bps)	8.50%

(Source: RBI website, PersonalFN Research)

 

PersonalFN's View on inflation:

WPI inflation has come in lower on account of weak aggregate demand amid a slowdown in economic growth rate. Although a descending trend is evident, in our view WPI inflation could under pressure on account of:
 

• Vulnerability in fuel & power inflation [due to partial decontrol of diesel price which (would have a pass-through effect), coal prices and electricity prices amongst others]
   
• Supply chain issues for food inflation; and
   
• Weakness in the Indian rupee (leading to imported inflation)
   

What strategy should debt investors should adopt?
 

The liquidity situation seems to have been getting tight since yields of shorter maturity papers are inching up. It is noteworthy that since the end of May 2013, 1-month and 3-month CD yields have moved up by 44 bps and 12 bps respectively, placing them at 8.08% and 8.21% respectively as on June 13, 2013. While the RBI has refrained from reducing CRR in the last monetary policy review, the RBI Governor, Dr. D. Subbarao is expected to handle the liquidity situation by considering all options available including Cash Reserve Ratio (CRR), Open Market Operations (OMOs) or any other, to manage liquidity in the system and ensure adequate credit to productive sectors. In fact expecting liquidity to get tight ahead of advance tax obligations of corporates in June, the RBI announced an OMO worth Rs 70 billion on June 7, 2013. In the 1st mid-quarter of monetary policy 2013-14 (scheduled on June 17, 2013), while there are expectations of 25 bps rate cut looming; yawning CAD and weak Indian rupee pose to be challenge for the RBI despite WPI inflation having dropped further and moderated and fiscal deficit for fiscal year 2012-13 having positively surprised by coming in at 4.9% vs. 5.2% of GDP - the revised estimates. So going forward, it remains to be seen whether policy rates are indeed reduced, although WPI inflation is at a 42-month low. Moreover, to address to growth concerns the RBI has put onus on the Government by saying that growth needs to be supplemented by efforts towards easing the supply bottlenecks, improving governance and stepping up public investment, alongside continuing commitment to fiscal consolidation. The RBI in its report on currency and finance 2009-12, has pressed on need to design credible fiscal consolidation plans and coordination strategies to ensure an appropriate fiscal-monetary mix. This according to the central bank will facilitate attainment of the growth target and more headroom for monetary policy to address macroeconomic goals. Thus the report has noted that careful calibration towards reverting to fiscal consolidation and proper assessment of any likely institutional changes in public debt management constituted key imperatives for the outlook of fiscal-monetary debt management coordination.

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 to 7.32% 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. On the other hand, the rally in G-Secs - the old 8.15% 10-Yr G-Sec has been rather strong with a 75 bps reduction in policy rates thus far in calendar year 2013.

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.In case if one wishes to take exposure to longer duration instruments or debt mutual fund schemes holding longer maturity papers (as permitted by their high risk appetite), PersonalFN recommends that you do so by investing in dynamic bond funds, since there would always be intermediate interest rate risk involved.

In the current scenario while investing in debt instrument, 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 1½ months, or liquid plus funds for next 3 to 6 months horizon. If you as an investor have a short to medium term investment horizon (of 1 to 2 years), you may allocate a part of your investment to short-term income funds, provided that you are willing to take some interest rate risk. 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 7.50% - 8.75% p.a.

What strategy should equity investors adopt?

Plagued by slowdown in economic growth, lull in industrial activity and uncertain political environment in the domestic economy, markets thus far in the month of June 2013 have treaded downwards. Concerns that global liquidity - especially the quantitative easing in the U.S. - may not last for too long (as signs of economic vigour are seen) is also worrying the Indian equity markets. It is noteworthy that earlier in May 2013, the U.S. Federal Reserve had said that they may wind down the monthly $85-billion bond-buying programme and are mapping out a strategy thereto; had spooked investors and rattled Indian equities. And if this indeed happens, central banks in other economies too would follow suit. But in order to ensure adequate credit to productive sectors and to ensure intermediate liquidity, the central bank would consider all options available including Cash Reserve Ratio (CRR), Open Market Operations (OMOs) or any other for that matter.

At present, decent Q4FY13 earnings of certain companies and expectations of normal monsoon are illustrating an upward bias in selective stocks, but it is noteworthy that apart from the aforementioned downbeat economic factors, the markets are also concerned about the following factors amongst others:
 

• Political uncertainty;
• Scam stories unveiling;
• Policy logjam;
• Structural bottlenecks;
• Reform measures not translating too well; and
• Risk of rating downgrade
   

Hence in the background of the above and specifically the risk emanating, we recommend investor to stagger their investments to mitigate risk, since volatility could persist, although markets may tread upwards on expectation and progress of normal monsoon. While investing in equity mutual funds, we recommend 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.

What strategy should investors in gold adopt?

Not ruling out that uncertainty yet persists in the global as well as domestic economy smart investors would continue to take refuge under precious yellow metal and global liquidity would be supportive of this asset class well. It is noteworthy that according to the World Gold Council (WGC) shipment of gold to India is expected to reach at around 900 tonnes level in calendar year 2013 due to rise in demand following lower prices. Last year (i.e. in calendar year 2012), India imported 860 tonnes of the precious metal, while demand stood at 864 tonnes in the same year. Thus far although gold prices down from their high, relative cheaper prices are likely to boost the physical demand for gold as many may prefer to invest for both - emotional and financial reasons. While the RBI has put restriction on banks and nominated agencies to import gold on consignment basis (to meet only genuine needs of exporters of gold jewellery) and the Government too is mulling ways to curb gold imports (as its putting pressure on country's CAD); it may not yield the desired results but in fact encourage smuggling of gold. In fact the WGC has also said that curbing gold import may have short-term benefit in containing demand, but cautioned that consumers' appetite for yellow metal will ultimately be fulfilled by the unauthorised grey market. The WGC has suggested that the Government should treat gold as strategic assets, while advocating monetisation of country's huge gold stock to support economic growth. While WGC recognises that the aforesaid measures from the Government are intended to reduce pressure on India's CAD; they are of the view that there are number of factors which influence CAD, and gold is only one of the factors.

Studying from a macroeconomic perspective, while signs of economic vigour are appearing in the U.S. economy, what remains to be seen going forward is whether the recovery is really sustainable. If the Federal Reserve, encouraged by these signs of economic vigour, withdraws the Quantitative Easing (QE) program, then chances of stumbling seem high. But on the side-lines of a gloomy picture from the Euro zone - where there is contraction in economic growth rate and double-digit unemployment rate; smart investors would continue to take refuge under gold. Investors would view gold as a monetary asset rather than mere commodity.

At PersonalFN, we recommend that you should have a minimum of 10%-15% allocation to gold. Invest in gold with a long term perspective with a time horizon of 10 to 20 years.

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bookings@captscott.com Jun 22, 2013 Rajat, you are very welcome. India is an instituter country, but given the closed nature of the economy there is little global interest in the country at least among private sector economists. That is too bad. I hope I have helped a little with these posts to spur some interest in the country.

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