Will WPI inflation for Feb'13 at 6.84%, hold back RBI from cutting rates?
Mar 14, 2013

Author: PersonalFN Content & Research Team

The inflation bug after showing some signs of respite at the beginning of the year 2013, once again inched-up to 6.84% for the month February 2013; although the rise was not very alarming when compared to the data reported for the month of January 2013. Hence so far in the last couple of months, WPI inflation has remained below the 7.0% plus mark which was witnessed over a year.

WPI Inflation inches-up

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

The rise in WPI inflation for February 2013 can mainly be attributed to:

Fuel & Power inflation:
Fuel and power inflation (which has weightage of 14.91% in WPI) once again rose to 10.5% for the month of February 2013 from 7.1% in the month of January 2013. Such an increase (of 3.0%) over the last month mainly occurred on account of higher prices of LPG (21%), furnace oil (7%), lubricants (5%), high speed diesel (4%), light diesel oil and bitumen (3% each), petrol and aviation turbine fuel (2% each) and kerosene (1%). Moreover, the data for the month of December 2012 in this group too was revised upwards to 10.25%.

Food inflation:
The data here reveals that food articles (which have a weightage of 14.34% in WPI) continued to depict inflationary pressure as the data for February 2013 remained rather stiff at 11.38% with a 0.2% increase seen over the previous month. The petite increase was on account of higher prices of masur (8%), ragi (7%), poultry chicken (6%), fish-inland (4%), jowar (3%), urad, condiments & spices, barley, fish-marine, arhar and rice (2% each) and egg, mutton, maize and wheat (1% each). However, the prices of gram (7%), coffee (6%) and fruits & vegetables and tea (2% each) declined.

It is noteworthy that inflation in manufactured products (which has a weightage of 64.97% in WPI) for the month of February 2013 mellowed down to 4.51% from 4.81% in January 2013. Likewise non-food manufacturing inflation, which the central bank uses to gauge demand-driven price pressures, slowed to 3.8% in February 2013 from 4.1% a month ago. Thus it can be said that decrease manufactured products and non-food manufactured products had some cascading effect to increase in prices seen in fuel and power and food articles.

So, would RBI go in for a rate cut in the upcoming monetary policy review?

Keeping in view the expected moderation in non-food manufactured products inflation, domestic supply-demand balances and global trends in commodity prices, the baseline WPI inflation projection for March 2013 is revised downwards by the Reserve Bank of India (RBI) from 7.5% (as set out in the 2nd quarter review of monetary policy) to 6.8%. The RBI would continue to condition and contain perception of inflation in the range of 4.0% - 4.5%; which is in line with the medium-term objective of 3.0% inflation consistent with India’s broader integration into the global economy. The rise in WPI inflation for February 2013, although diminutive; in our view would refrain the central bank from reducing policy rates in its upcoming mid-quarter review of monetary policy 2012-13 (scheduled on March 19, 2013) despite focus has been turned to address growth risk. This is because intermediate inflationary pressures remain on account of increase in freight and diesel prices, which will have a pass-through effect on WPI inflation. We think that the RBI could only reduce CRR in order to address to tightened liquidity conditions due to advance tax obligation in mid-March 2013, and now cut rates only in its annual monetary policy 2013-14 (scheduled on May 3, 2013-14), depending upon growth-inflation dynamic and twin deficit situation. It is noteworthy that, the central bank thus far in this fiscal year has already reduced rates by 75 bps (one in April 2012 by 50 bps and the other in January 2013 by 25 bps).

Policy Rate Tracker

	Increase / (Decrease) in FY12-13	At present
Repo Rate	(75 bps)	7.75%
Reverse Repo Rate	(75 bps)	6.75%
Cash Reserve Ratio	(75 bps)	4.00%
Statutory Liquidity Ratio	(100 bps)	23.00%
Bank Rate	(75 bps)	8.75%

(Source: RBI website, PersonalFN Research)

Our View on inflation:

WPI inflation as enunciated above in our view would continue to remain under pressure on account of:

Elevated level of Brent crude oil prices;
Increase in freight charges
Pass-through of diesel prices
Food inflation; and
Weakness in the Indian rupee (leading to imported inflation)

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. For the fiscal year 2013-14 the government has raised the budget expenditure and will need to borrow Rs 4.84 lakh crore or around 89% of the fiscal deficit from the bond markets. Such high borrowing target may keep the debt markets under pressure for some time.

What strategy debt investors adopt?

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 a little more 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 could 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. One should also be cautious while investing in long term gilt funds, and refrain from speculating in a falling interest rate scenario.

Fixed Maturity Plans (FMPs) of a little over 1 year may be considered for some more time, as double indexation benefit that you may avail can provide you appealing post tax returns. It 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 further. At present 1 year FDs are offering interest in the range of 7.25% - 9.00% p.a.

To read if bond markets are poised for another rally in 2013, please click here

What should equity investors do?

Since the time Budget 2013 has been announced, the Indian equity markets have thus far recovered (by +4.2%) after undergoing a corrective move in the month gone by. Clarification from the Finance Minister on TRC announcement saying that that there was no intention to question tax residency certificate holders and TRCs will be accepted as evidence of residence; has helped to restore confidence of FIIs towards Indian equity market. But going forward we believe, for FIIs flows to gush into Indian equity market, acceleration on reform measures would be needed if India wants to moniker as the Asia’s fastest growing economy. At present the Q3GDP growth rate has been reported at 4.5% lower than the 5.3% a quarter ago and 6.0% a year ago. Moreover, economic growth estimates for the current fiscal year have been revised downwards assessing the economic scenario. The Government has lined up a number key bill for consideration and passing during the ongoing Budget session, including The Forward Contracts Amendment Bill, The Pension Fund Regulator Bill, The Land Acquisition Bill and The Insurance Laws Bill; so determination to walk on the path of reforms seems visible. In our view the Budget 2013 has done a balancing act to bring back fiscal prudence, but now we need to see how the proposals go through in the Parliament and their implementation thereafter. Also, with India heading for general election next year (i.e. in 2014), political environment would also be carefully watched.

The RBI has turned it focus on addressing to growth risk; but intermediate inflationary pressures (occurring on account of increase in freight and diesel prices) remain a challenge for the central bank. Moreover with IIP for January 2013 expanding at +2.4% (versus -0.6% in December 2012), chance of a rate cut from the central bank appears dim, but in order to address to tight liquidity situation occurring on account of advance tax obligation in mid-March, the Cash Reserve Ratio (CRR) could be reduced in next mid-quarter review of monetary policy 2012-13 (scheduled on March 19, 2013). As far as reduction in policy rates are concerned, we think RBI may reduce policy rates only in in its monetary policy 2013-14 (scheduled on May 3, 2013-14), depending upon growth-inflation dynamic and twin deficit situation.

Global cues too would be a driving force for the market. At present, the U.S. stocks markets trading at a record high would determine the sentiments of the global markets. They seem to shrugging the debt crisis in the Euro zone, so sentiments in the U.S. markets seem to be supportive for the recovery in Indian equity markets at present.

Thus in the background of the above, we recommend investor to stagger their investments to mitigate risk, since volatility could persist. 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.

To read our full view on how equities are likely to perform in year 2013, please click here

What should investors in gold do?

Thus far in March 2013, gold prices in U.S. dollar terms and Indian rupee are lingering near the levels seen during the tail of the month gone by. But with the easy monetary policy adopted by the central banks of developed economies and catalyst for gold once again getting evident (due to debt-overhang situation yet evident in the Euro zone) despite billions doled out and certain strict austerity measures taken, gold would be looked upon as safe haven by many smart investors, until headwinds recede. It is noteworthy that, the entire Euro zone (comprising of 17 nations) is undergoing a contraction and the expansionary hasn’t yet able to stimulate growth in the Euro zone. Moreover we expect the protracted expansionary monetary policies, to have an effect of devaluation of currency, which could lead long-term problems.

In India, with slump in quarter-on-quarter economic growth, ‘see-saw’ movement in in industrial activity, twin deficit problems, risk of sovereign rating downgrade, FDI not kick-starting despite reform measures taken) and intermediate inflationary pressures perceived; many would take refuge under the precious yellow metal until this economic concerns do not recede. Every corrective, we think would encourage smart investors to buy gold and thus despite import duty on gold hike to 6.0%, demand would not deter. In fact as mentioned above, the rise in import duty on gold could lead to illegal activity such as smuggling of gold, thereby keep demand buoyant until global economy shows signs of stability.

So given the above backdrop where long-term economic problems still persist – especially in the developed economies, and now concerns over India’s fiscal deficit, economic growth rate and sovereign rating downgrade concerns yet lingering around; we think the ascending move for gold is intact over the long-term, because smart 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.

To read if gold would continue to shine in 2013, please click here