Maintaining its stubbornness for over 11 months now, the Wholesale Price Index inflation for the month of October 2011 stood at 9.73% just a tad above the previous month’s figure of 9.72%. However, the base effect will start playing its role from the month of December 2011 which will help cool the stubbornly high inflation. But the recent fuel price hike of 1.80 on November 04, 2011 may further fuel in the inflation in the coming months (this may not actually take place if there is a reversal in the fuel price hike as is rumoured).

 

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

 

This is the eleventh consecutive month when headline inflation has been above the 9% mark. Moreover, the food inflation stood at 11.06% for the month of October 2011 as against 9.23% in the previous and similarly inflation in the fuel and power segment stood at 14.79% in October 2011 as against 14.09% in the previous month.

RBI’s stance in taming inflation:

Fighting hard with the inflation monster, the Reserve Bank of India (RBI) has been inflexibly increasing the key interest rates consecutively for 13 times now. And with this October 2011 reading (9.73%), the RBI may be tempted once again to increase the interest rates for the 14th time. However the weak Index of Industrial Production (IIP) for the month of September 2011 (which stood at 1.9% showcasing the pitiful state of the economy) may restrict the RBI from increasing policy rates further.

  Policy rate tracker

	Increase / (Decrease) since March 2010	At present
Repo Rate	375 bps	8.50%
Reverse Repo Rate	425 bps	7.50%
Cash Reserve Ratio	100 bps	6.00%
Statutory Liquidity Ratio	(100 bps)	24.00%
Bank Rate	Unchanged	6.00%

(Source: RBI website, PersonalFN Research)

Thus, it will be interesting to see how the country’s central bank reacts to these numbers at its third quarter mid-review of monetary policy scheduled in the month of December, 2011.

Our View:

We believe that the headline WPI inflation may cool down and taper off in the coming few months primarily due to the high base effect and secondly due to the consecutive policy rate hikes undertaken by the RBI. Also, it will be interesting to see whether there is any downward revision in the fuel prices in the coming few days as this may have a positive impact on bringing down the headline inflation. Further the following factors would also weigh on the RBI’s mind before making any attempt to increase the policy rates again:

 

• Elevated borrowing cost
• Elevated input cost
• Chances of slowdown in consumer spending
• Downward revision in GDP targets (from 8.2% to 8.0% by PMEAC)
• Nervous sentiment in the capital markets



 

What should equity investors do?

Equity investors should adopt calm and compose approach by staying invested and also investing further as soon as valuations look attractive and there is potential for robust future growth.

However, you need to be wary of the news dissemination from the developed economies – especially Euro zone and the U.S. as this may show a rippling and crippling effect on the Indian equity markets. Hence one needs to be cautious while investing in equities and rather have a staggered approach.

Therefore while investing in equities we think diversification benefit provided by mutual funds can help to reduce risk (however one needs to stay away from U.S. or Euro oriented offshore funds in such a scenario). While investing in equity mutual funds we recommend that you opt for value styled funds and adopt the SIP (Systematic Investment Plan) mode of investing as this will help you to manage the volatility of the equity markets well (through rupee-cost averaging) and also provide your investments with the power of compounding.

Remember, while investing select only those equity funds which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years.

What should debt investors do?

Well, we think that the current situation is attractive to take exposure to debt mutual fund instruments as interest rates are likely to consolidate at these higher levels before they start going down. We recommend investors to take gradual exposure to pure income and short-term Government securities funds, since longer tenor papers will become attractive. Longer duration funds (preferably through dynamic bond / flexi-debt funds) can be considered, provided one has a longer investment horizon (of say 2 to 3 years). Short term income funds should be held strictly with a 1 year time horizon. Fixed Maturity Plans (FMPs) of 3 months to 1 year can also be considered as an option to bank FDs only if you are willing to hold it till maturity, but you may not have a very attractive post tax benefit as indexation benefit will not be available on FMPs maturing within 5 months. One may also consider investing their money in Fixed Deposits (FDs). At present 1-yr FDs are offering interest in the range of 7.25% - 9.40% p.a.

What should investors in gold do?

In our opinion the downbeat global economic headwinds make the case for gold becoming bolder. Moreover inflationary pressures are likely to haunt most emerging nations including India; and central banks across the world are likely to be vigilant on raising policy rates, which in turn would lead to smart investors taking refuge under the precious metal.

It is noteworthy that gold has displayed a secular uptrend since a long time now. In 1971, the price of gold was about $32 an ounce and today (i.e. on November 14, 2011) it is $1,780.3 an ounce – which indicates that price of gold has gone up by 56 times over the last 40 years. Also, due to the festive demand and the current marriage season Gold has hit a new high of 29,000. Hence, nothing has changed for gold and we believe it will continue to maintain its upward trend in the long-term. Moreover if the Euro zone crisis accentuates and the US goes into recession again, the precious yellow metal is bound to accelerate its northward journey. At PersonalFN , we recommend that you should have a minimum of 5%-10% allocation to gold. Invest in gold with a long term perspective with a time horizon of 10 to 20 years.

Add Comments

Comments
johnc474@gmail.com Oct 17, 2014 Hello! Do you use Twitter? I'd like to follow you if that would be okay. I'm undoubtedly enjoying your blog and look forward to new posts.
johna693@gmail.com Oct 17, 2014 Somebody necessarily lend a hand to make significantly posts I might state. This is the very first time I frequented your website page and thus far? I surprised with the analysis you made to make this actual publish incredible. Magnificent job!

 1