The WPI inflation for the month of October 2013 mounted yet again, placing the data at 7.00%. Moreover, there seem to be an uptrend formed signalling inflationary pressures creeping in. The inflation data for October 2013 touched a level where earlier WPI inflation has plateaued for quite some time. While the data was almost in line with most poll estimates, it is worrisome because it is at an 8-month high. Moreover, the data for August 2013 was revised upwards to 6.99% (from the earlier provisional data of 6.10%) and such upward revisions have been repeatedly seen in the past.
 

WPI Inflation inches-up again!

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

The ascending move in WPI inflation for October 2013 was mainly account of:

Food inflation:
While the data here revealed that food articles (which have a weightage of 14.34% in WPI) mellowed a bit from 18.40% in the previous month to 18.19% in October 2013, it continued to be strikingly high. The inflationary pressures here were mainly attributed by increase in prices of vegetables, where onions and tomatoes in the month of October 2013 shot up to 278.21% and 122% respectively on a year-on-year basis. While the overall prices of vegetables in general, reduced to 78.38% in October 2013 from 89.37% registered in the previous month; it yet made life difficult for the common man. Prices of fruits too rose to 15.94% in October 2013 from 13.54% registered for the previous month.

High protein based items such as eggs, meat and fish which saw softening in prices in September 2013 (13.37%) also witnessed an increase, placing the data for October 2013 at 17.47%.

Non-Food article inflation:
Non-food articles (which have a weightage of 4.26% in WPI) which consist of fibre, oil seeds and minerals, also inched-up to 6.79% in October 2013 from 51.17% in the previous month. Thus the ease in this segment which was seen in the months of July 2013 and August 2013 too was disturbed.

Fuel & Power inflation:
Fuel and power inflation (which has weightage of 14.91% in WPI) too after depicting some relaxation in the month of September 2013 (10.08%), once again rose to 10.33% in October 2013. The earlier increase in price of fuel along with yet elevated levels of international crude oil price (placed over U.S. $100 per barrel) and depreciated rupee, reflected in this constituent of WPI inflation.

Manufacturing products inflation:
The data here also revealed that prices of manufactured products (which have a weightage of 64.97% in WPI), also inflicted some inflationary pressures. The data for October 2013 came in at 2.50%, ascending from 2.30% registered for the month of September 2013. Thus manufacturing inflation too seemed to have brought in some inflationary pressures; but it seemed that base effect too striding the data.

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 rise in price of food articles. Therefore food inflation may inflict inflationary pressures going forward due to escalation in prices of vegetables. Moreover, increase in price of diesel – which is an essential transportation fuel – is likely to put pressure on food inflation and fuel & power inflation.

The manufacturing inflation may remain benign with yet docile industrial activity.

So, would RBI cut rates in its 3rd mid-quarter review of monetary policy 2013-14?

PersonalFN is of the view that, inflationary pressures are yet evident and such a scenario would remain for at least a couple of months now. The recently released Consumer Price Index (CPI) inflation for the month of October 2013 too has mounted to the double-digit terrain to 10.09% from 9.84% in the previous month.

As seen above, while food inflation has mellowed a bit from the previous month’s data, strikingly high double-digit therein perseveres to be a major cause of concern. In fact, Dr Rajan has described food inflation as "worryingly high". Going forward too, food inflation is likely to remain high due to escalation in prices of vegetables. Moreover, increase in price of diesel – which is an essential transportation fuel – is likely to put pressure on food inflation. Fuel and power inflation is already seeing pressures as reflected by rise in data for October 2013 over the previous month.

While the Indian rupee has slipped against the greenback in the last few days, Dr Rajan seems to have allayed fears on the rupee recently. But fiscal deficit, which has already run up to 76% of the budgeted full year target in just six month of the current fiscal year, seems to be an area of concern. Rating agencies are already signalling concern over fiscal deficit problem and if any further slippage on this takes place, it may not be viewed favourably by rating agencies.

Under the backdrop of inflationary pressures and concerns of the fiscal deficit front, PersonalFN is of the view that the central bank would maintain its anti-inflationary stance and may increase policy rates by another 25 basis points (bps) in its 3rd mid-quarter review of monetary policy 2013-14.

What strategy should debt investors should adopt?

While the RBI has reduced Marginal Standing Facility (MSF) twice in the month of October 2013 by 75 bps and attempted to infuse short-term liquidity in the system, the policy rates have been hiked by 50 bps in the last two monetary policy actions in a move to tame inflation. In the monetary policy review (held on October 29, 2013) to, the central bank has made it clear that inflation would remain under focus while being mindful of the growth dynamics. Thus the longer end of the yield curve (due to inflationary pressures evident and RBI focus thereon) would remain under pressure with macroeconomic concerns on inflation, fiscal deficit and sovereign rating.

So in the aforesaid backdrop, PersonalFN is of the view that, it would be best to refrain investing in longer maturity debt papers, 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 1month, or liquid plus funds for next 3 to 6 months horizon.

What strategy should equity investors adopt?

The Indian equity markets, breached the all-time of the markets recorded on January 10, 2008 on the Muhurat trading day by ending at 21,239.36 points; but since then the markets have corrected and investors seem to be wary of going long and in fact are booking profits or at least breaking even in some of their earlier positions. The U.S. Federal Reserve at present has decided to continue with its stimulus (vide bond-buying worth U.S $85 billion per month) as a measure to address to slowing growth concerns. The U.S. Federal Reserve indicated that the recovery in housing had lost steam, while noting some reversal in a recent spike in borrowing costs. But this may not encourage many to go long on the markets, because it may not be too long before the U.S. Federal Reserve starts winding down its bond buying programme in 2014.

Moreover, the domestic macroeconomic variables aren’t appearing conducive. The HSBC India Manufacturing PMI for October 2013 (data released in November 2013) has remained unchanged at 49.6, the level reported in the month prior. The fall in level of production and new orders in the Indian manufacturing economy (as the business climate in India remains tough), reflects some sedation in India’s manufacturing activity. While the HSBC India Services PMI rose to 47.5 in October 2013 (data release in November 2013) from 46.1 in the previous month, the data is yet under the contraction mode for the fourth consecutive month led by slower pace of activity, reduction at service providers and drop in new business placed at private firms.

Also as mentioned earlier, inflationary pressures are likely to remain in the months ahead headed by food inflation. Likewise, the risk of a rating downgrade also tends to hound as the rating agencies are signalling concern over fiscal deficit problem. India has the lowest investment grade rating and any further hit to the country's rating would increase the borrowing cost and trigger capital outflows. Standard & Poor's has already said chances of a credit ratings downgrade for India was higher than for Indonesia. Moreover, the S&P has indicated that the negative outlook maintained on India may be lowered if the Government that takes office after the general election does not appear capable of reversing India’s low economic growth and put the house in order.

So give the above scenario in the domestic economy and the global economic headwinds, markets may consolidate on lack of fresh positive triggers.

Thus 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?

The supply side constraints are likely to instil premium of gold prices in India. In such a scenario, smuggling activity may resurrect (due to hike in custom duty) recognising the fact that India has an insatiable appetite and flair to own the precious yellow metal, due to various emotional and financial reasons. But investment demand may sombre (due to elevated prices), while physical demand in the form of jewellery may remain robust ahead of the marriage season. Also having witnessed above normal monsoon this year, rural demand for gold could stoke up as it means more cash in the hands of farmers who often invest mainly in two asset classes gold and land. 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.

PersonalFN thinks that in the backdrop of the downbeat economic variables and global economic headwinds, smart investors would view gold as a monetary asset rather than mere commodity; and that would keep the long-term trend for gold intact until economic uncertainties recede.

So, 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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