The WPI inflation bug for April 2013 mellowed down further much beyond expectations (of 5.4% - 5.5%) to 4.89%, it being the lowest in 41 months. Thus there appeared a descending trend in the last three months after plateauing above the 7.0% plus mark for over a year. But what is worrisome, is the frequent upward revision in the data.
 

WPI Inflation mellowed down further

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

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

Food inflation:
The data here revealed that prices of food articles (which have a weightage of 14.34% in WPI) eased noticeable to 6.08% in April 2013 from 8.73% reported in the previous month and from 10.92% in April 2012. The reduction was broad based on account of decrease in prices of pulses, vegetables, cereals, fruits, milk and protein based items (such as egg, meat and fish).

Manufacturing inflation:
Likewise inflation in manufactured products (which has a weightage of 64.97% in WPI) continued to mellow to 3.41% for April 2013 from 4.07% in the previous month and 5.27% in April 2012. It is noteworthy that since the last seven months, manufacturing inflation has been on a descending trend.

Fuel & Power inflation:
Fuel and power inflation (which has weightage of 14.91% in WPI) also relaxed noticeable to 8.84% in April 2013 from 10.18% reported in the previous month and 12.10% in April 2012. The decrease in this segment was on account lower prices of Aviation Turbine Fuel (ATF), petrol and furnace oil, and Liquefied Petroleum Gas (LPG). High speed diesel, however exhibited an ascending trend in the month gone due to partial decontrol of diesel prices by the Government.

So, would RBI cut rates in its 1st mid-quarter review of monetary policy 2013-14?

The WPI inflation has dropped further in April 2013 aided by the aforementioned attributes and so has the retail inflation by 100 basis points (bps) to 9.39%. This provides a sufficient cushion for the Reserve Bank of India (RBI) to reduce policy rates by another 25 basis points in the 1st mid-quarter review of monetary policy 2013-14 (scheduled on June 17, 2013); but they would also keep a watch on May 2013 WPI data and trend.

Likewise, they would take into account the trade deficit and Current Account Deficit (CAD) too which is depicting a worrisome picture. At present, as many of you may be aware, India’s trade deficit for April 2013 has widened upto U.S. $ 17.8 billion led by high gold imports. The Current Account Deficit (CAD) data too is expected to touch a record high of 5.0% of GDP in 2012-13 (as measures to curb gold imports have only had a marginal effect thus far); so all these facets would be evaluated carefully and then the central bank would take stance whether to cut rates in its 1st mid-quarter review of monetary policy 2013-14 (scheduled on June 17, 2013).

In the guidance from the annual monetary policy 2013-14 (held on May 03, 2013), the RBI has mentioned that the balance of risks stemming from assessment of the growth-inflation dynamic yields little space for further monetary easing. But to manage the liquidity situation in the interim, it would be their endeavour to actively manage liquidity to reinforce monetary transmission, consistent with the growth-inflation balance.

PersonalFN believes, if WPI inflation data too mellows down further and risks to inflation are low, the may take a calibrated stance of reducing policy rates as mentioned above. A hawkish move may not be probable because in the calendar year 2013, because thus far the central banks has already cut policy rates by 50 bps and CRR by 25 bps. Likewise in the fiscal year gone 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	(75 bps)	8.50%

(Source: RBI website, PersonalFN Research)

 

Hence given the aforementioned backdrop, if RBI indeed reduces rates a bit in the ensuing monetary policy 2013-14 review, there are likely chances that interest rates on Fixed Deposits from banks would also reduce and therefore even interest rates on home loans and car loans. It is noteworthy that some banks have already reduces rates, but going forward it would also depend upon cost of funds to banks.

PersonalFN’s View on inflation:

WPI inflation has come in lower on account of weak aggregate demand amid a slowdown in economic growth rate. In fact the descending trend in manufacturing inflation reflects growth risk. 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?

At present while taking exposure to debt mutual fund schemes and fixed income instruments, it would not be very prudent to take exposure to longer duration instruments as most of the rally has already occurred ahead of expectation of a 25 bps policy rate cut from RBI. 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 1 month, 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% - 9.00% p.a.

What strategy should equity investors adopt?

Despite a slowdown in economic growth, lull in industrial activity and uncertain political environment in the domestic economy, the month of May 2013 began with an optimistic note for the Indian equity markets (S&P BSE Sensex) - ascending +3.2% aided by global liquidity and signs of economic vigour in the U.S. But yesterday’s (i.e. May 13, 2013) fall of -430.65 points (or -2.1%) on account of wider trade deficit data, probe on large private banks by RBI and fears that the U.S. Federal Reserve may map out a strategy to wind down the monthly U.S. $85-billion bond-buying programme; has left the Indian equity markets with gains of +1.0% and infused nervousness once again.

Going forward, the risk emanates from:
 

• Yet a low capex cycle;
• Industrial activity;
• Widening CAD;
• Policy logjam;
• Uncertain political environment;
• Global headwinds
   

But if monsoon turns out to be normal as expected, the Indian equity markets may tread upwards.

Thus 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. 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?

Studying from a macroeconomic perspective, while signs of economic vigour are appearing in U.S. economic growth rate, 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. Thus far the number of people in the U.S. living on food stalls yet appears to be high and retail sales and empire manufacturing numbers aren’t looking very encouraging. In the Euro zone too, there’s been a contraction in economic growth amid a situation of debt-overhang encountered by some of the Euro nations. The unemployment rate too has been on ascending trend with it being in double-digits (at 12.0% in March 2013). As result of such a gloomy clouds evident in Euro zone, business confidence too has dwindled (to -0.93 in April of 2013 from -0.75 in March of 2013) and so has the consumer confidence. In order to revive economic growth the ECB has adopted an accommodative stance in monetary policy, have cut rates (by 25 bps) further (on May 02, 2013) to a record low of 0.50%, thereby providing some relief to the Euro zone. In India too, the Reserve Bank of India (RBI) in its annual monetary policy 2013-14 held recently, has cut rates by 25 bps (matching expectations of the market) facilitated by the drop and moderation in WPI inflation, which is perceived to do good to stimulate economic growth. The flush in global liquidity amid a slowdown in economic growth rate, would encourage smart investors to take refuge under precious metal and therefore gold may not drop, but in fact may show a gradual ascending move until economic worries recede. 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.

Add Comments