The WPI inflation bug after being on a downward trend in the last four months, once again inched-up in June 2013 with the data coming in at 4.86%. But the data didn't seem very worrisome.In fact signs of moderation appeared as it was only a marginal increase from the previous month. It is noteworthy that the data for April 2013 too was revised downwards to 4.86% from 4.89% provisional data released earlier.
 

WPI Inflation increased marginally

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

The marginal increase in WPI inflation for June 2013 was mainly account of:

Food inflation:
The data here revealed that food articles (which have a weightage of 14.34% in WPI) increased to 9.74% in June 2013 from 8.25% in May 2013, mainly attributed by increase in prices of onions, cereals and rice. It is noteworthy that inflation in onions shotup by 114.00% in June, from 97.40% in the previous month.Inflation in cereals and rice stood at 17.18% and 19.11%, as against 16.01% and 18.48%, respectively, in the earlier month.Overall vegetable prices went up by 16.47% during the month, from 4.85% in May 2013.Similarly inflation in protein based items such as egg, meat and fish stood at 12.23% as against 11.21% in the previous month.

Non-Food article inflation: Non-food articles (which have a weightage of 4.26% in WPI) which consist of fibre, oil seeds and minerals, which eased rather noticeable to 4.88% in May 2013 from 7.59% April, also went up to 7.57% in June 2013.

On the other hand, the following attribute to WPI saw a decrease.

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 2.75% in June 2013 from 3.11% in the previous month and 3.69% in April 2013. It is noteworthy that since the last nine months, manufacturing inflation has been on a descending trend.

Fuel & Power inflation:
Similarly fuel and power inflation (which has weightage of 14.91% in WPI) also relaxed noticeable to 7.12% in June 2013 from 7.32% in the previous month and 8.33% in April 2013. This segment too has been depicting a descending trend in prices since the last four months.

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

While WPI inflation despite a marginal increase is yet appears below the comfort level (of 5.00%) of the Reserve Bank of India (RBI), the deprecation in the Indian rupee which has an effect on exerting pressure on India's Current Account Deficit (CAD) and infuses the risk of imported inflation, may restrain the RBI from being accommodative in its stance via a policy rate cut in its 1st quarter review of monetary policy 2013-14 (scheduled on July 30, 2013) although the central bank may want to address growth risk in times when there's a lull in industrial activity and slowdown in economic growth . Moreover, the Consumer Price Index (CPI) inflation data too has accelerate to 9.87% in June 2013 from 9.31% in May 2013; thereby reversing three months of deceleration, which again the central bank would take into account in its monetary policy action. So while core inflation has mellowed down to 2.0% in June 2013 (from 2.4% in the previous month) the aforementioned challenging macro-economic scenario may refrain RBI from cutting policy rates.
 

Policy Rate Tracker

	Increase / (Decrease) since FY12-13	At present
Repo Rate	(125 bps)	7.25%
Reverse Repo Rate	(125 bps)	6.25%
Cash Reserve Ratio	((75 bps)	4.00%
Statutory Liquidity Ratio	(100 bps)	23.00%
Bank Rate	(100 bps)	8.25%

Data as on July 15, 2013
(Source: RBI website, PersonalFN Research)

 

PersonalFN's View on inflation:

While good monsoon are expected to bring down food inflation in coming months, the risk to it emanates from supply change issues. Similarly, while fuel inflation has descended since the last four months, rising oil prices (mainly crude oil and petroleum products) coupled with depreciation of the Indian rupee would put pressure on fuel & power inflation and therefore even the headline WPI inflation. Thus due to these aspects, manufacturing inflation may also be vulnerable if industrial fuels rise further and therefore so would be WPI inflation.

What strategy should debt investors should adopt?

Liquidity position and path for interest rates
Going forward it remains to be seen whether policy rates are indeed reduced, albeit moderation in WPI inflation and reversal in trend now in CPI inflation. In the guidance from monetary policy 2013-14, the RBI has clearly enunciated that monetary policy stance will be determined by how growth and inflation trajectories and the balance of payments situation evolve in the months ahead. At present, although CAD data for March-quarter has come in at 3.6% of GDP, for the complete fiscal year 2012-13 it has touched a record high of 4.5% (at U.S. $87.8 billion), which is much above the central bank's comfort level of 2.5% of GDP. So, until pressure on CAD is reduced and also the rupee, the RBI may refrain from reducing policy rates in its 1st quarter review of monetary policy 2013-14 (scheduled on July 30, 2013).

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 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.

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 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 7.00% - 8.75% p.a.

What strategy should equity investors adopt?

At present comments from U.S. Federal Reserve Chairman, Mr Ben Bernanke - that the U.S. central bank might not roll back its stimulus programme earlier than expected - has infused positive sentiments in the market as easy monetary policy adopted by the U.S. Federal Reserve is expected to continue and thus FIIs too are once again evincing interest in Indian equities. So, there seem to be "Bernanke bounce" in the markets. Also the trade deficit for June 2013 has narrowed to a 3-month low of U.S. $12.2 billion (from U.S. $20.1 billion in May 2013) as result of sharp fall in gold imports.

At the same time the follow there are following downbeat factors as well:
 

• Lull in industrial activity
• CPI inflation has moved up
• Intermediate pressures are evident on WPI inflation
• Weak Indian rupee
• Pressure on CAD
• Tainted political canvas
• Scam stories unveiling
• Deteriorating state of governance
• Reform measures not translating too well and
• Risk of rating downgrade
   

So there is mix of factors in play - both positive and negative - although the markets are moving upwards aided by global liquidity flow.

In the Euro zone, the lenders are unhappy with progress Greece has made towards reforming its public sector. Athens, which has about € 2.2 billion of bonds to redeem in August 2013,is scrambling to bridge differences with troika (i.e. European Union (EU), International Monetary Fund (IMF) and European Central Bank (ECB)) inspectors and wrap up the review by the end of this week. Likewise tensions over bailout terms have also mounted in Portugal, with Finance Minister, Mr Vitor Gaspar, the architect of its bailout measures, resigning. The Markit's final Composite Eurozone PMI although it has climbed to 48.7 in June 2013 from 47.7 in May 2013, the reading is yet below the mark of 50.0 which distinguishes contraction and expansion. Such a data in our view would not encourage ECB to change their monetary policy stance although the Euro zone is encountering a recessionary phase. This is because their benchmark rates are near to zero at 0.50%. Speaking about China, their PMI data for manufacturing too has slipped to 50.1 in June 2013 from 50.8 in May 2013. Likewise, while the PMI for services has inched up to 51.3 last month from May's 51.2, but new orders grew at their weakest pace in more than four years; which indicates that the world's second largest economy is also losing momentum.

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 in the intermediate. 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?

Going forward, demand is expected to build up as smart investors would make use of correction in prices to buy before the ensuing festive season. It is noteworthy that according to the World Gold Council (WCG) 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. At present the acquisition cost of gold has shot up with hike in import duty of gold. Moreover, the weak Indian rupee has increased the landing cost of gold. But this in our view would not preclude smart investors from buying into the precious yellow since prices are relatively cheaper as compared to their earlier high. People would still buy for both emotional and financial reasons as worries from Euro zone - especially Greece and Portugal again seem to be imminent. As mentioned earlier, in the Euro zone, the lenders are unhappy with progress Greece has made towards reforming its public sector. Athens, which has about € 2.2 billion of bonds to redeem in August 2013,is scrambling to bridge differences with troika (i.e. European Union (EU), International Monetary Fund (IMF) and European Central Bank (ECB)) inspectors and wrap up the review by the end of this week. Likewise tensions over bailout terms have also mounted in Portugal, with Finance Minister, Mr Vitor Gaspar, the architect of its bailout measures, resigning. While the Markit's final Composite Eurozone PMI has climbed to 48.7 in June 2013 from 47.7 in May 2013, the reading is yet below the mark of 50.0 which distinguishes contraction and expansion. In India, slowdown in economic growth rate, lull in industrial activity, pressure on CAD and weak Indian rupee; would again encourage smart investors to take refuge under gold.

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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