The headline inflation as measured by the Wholesale Price Index (WPI) for the month of May 2012 stood at 7.55% as against 7.23% in the previous month. Moreover, the WPI inflation for the month of March 2012 was revised upwards to 7.69% from 6.89% estimated earlier. Clearly the inflation bug has raised its ugly head once again pushing economic growth into doldrums.
The graph below highlights the trend in the WPI inflation since May 2011.The inflation bug has been maintaining its stickiness despite efforts from the RBI's anti-inflationary stance. Though it has stepped down from its 9% mark since November 2011, it still remains high above the RBI's comfort zone of 6% to 7%.
(Source: Office of the Economic Advisor, PersonalFN Research)
The rise in the headline inflation can be attributed to the following components which constitute the WPI.
Food inflation: With a weightage of 14.34%, the food inflation for the month of May 2012 stood at 10.74% as against 10.49% in the previous month. Going forward if the monsoon season results in subnormal rains, it may further spur the food inflation.
Fuel & Power inflation: The fuel & power inflation for the month of May 2012 stood at 11.53% as against 11.03% in the previous month. Petrol prices in Mumbai saw its steepest ever rise by Rs 7.54 per litre on May 23, 2012 pulling up the price of petrol to Rs 78.57 per litre. But after nine days, owing to the nationwide protest, the Government quickly slashed the petrol prices by Rs 2 per litre. Also, going forward if the diesel prices are decontrolled in order to reduce the under-recoveries of the Oil Marketing Companies (OMCs) we may further see a steep rise in the fuel inflation.
However, the country's import bill may get some respite as the Brent crude oil prices have mellowed down below $100 per barrel. But if the rupee continues to depreciate vis-a-vis the dollar, the gains would be off-set to some extent.
So, would RBI go in for a rate cut in the upcoming monetary policy review?
The RBI will again find itself in a dilemma where at one end it needs to propel growth (IIP for April 2012 0.1%) and at the other tame the inflation bug which has again raised its ugly head above the 7% mark. If the policy rates are reduced by the RBI then this may give an impetus to the slowdown in the economy (as reflected in the subdued GDP growth of 6.5% for FY12) as the borrowing costs will reduce which will further help in bringing down the input costs as well. However, the supply side constraints need to be looked into as even though interest rates are reduced, the input costs may not be affected immediately due to lack of supply. Thus, the possibility of a rate cut seems negligible but the RBI may slash the cash reserve ratio (CRR) to ease the tight liquidity situation seen ahead of advance tax payments.
Our View on inflation:
In our opinion the chances of the WPI inflation heading northwards are higher owing to the present facts reflecting the monsoon this year to be below normal. If this happens it could further push up the food inflation. Fuel prices too need to be watched for as any spike in the fuel price can have a direct bearing on the fuel & power inflation.
What should equity investors do?
The global economy is still not out of the woods, though a bailout of $125 billion has been received by Spain, it is a temporary relief and not a permanent solution. Moreover, with the U.K. showing signs of a double-dip recession and a chance of "Grexit" happening, a Lehman-like situation cannot be ruled out. If we assess the economic growth for the complete Euro zone, at present it is dismal and the latest Purchasing Manager Index (PMI) data for May 2012 does not have sunny picture to portray. It is noteworthy that the final data of Markit Euro zone Composite PMI has hit near-three year low in May 2012 at 46.0, down from 46.7 in April 2012 - signalling steepest rate decline in manufacturing and services output since June 2009.
The Indian Government at present is pinning hopes on southwest monsoons and fall in prices of Brent crude oil to revive economic growth; but they are also of the view that there's little headroom to stimulate the economy. Monsoons are progressing in a very sluggish manner, and with scientist and Indian Meteorological Department expecting "El Nino" phenomenon developing in August 2012 along with weak anti-cyclonic upper circulation, it could suppress rainfall.
Hence taking a holistic view, the Indian equity markets are expected to undergo turbulence amid gloomy global economic outlook and slump in domestic economic growth. In fact a correction of about 5% - 10% cannot be ruled out. But having said that, we think these are appealing levels to start investing in the Indian equity markets in a staggered manner. Recognising that we may experience volatile times until more clarity is disseminated on "Grexit" and Bankia bailout, 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 (preferably which adopt value style of investing or the opportunities style of investing) which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years.
But when investing in mutual funds it is vital to select only those equity mutual 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 go down gradually over the months.
Hence at present while taking exposure to debt mutual funds and fixed income instruments, one should clearly know their investment time horizon. Since short-term rates may be still high in the near term (in mid-June) and then ease due to liquidity infusion, you can benefit from being invested in mutual funds having exposure to shorter maturity instruments. Hence 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 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 will 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.
Fixed Maturity Plans (FMPs) of upto 1 year would continue to yield appealing returns and 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. At present 1 year FDs are offering interest in the range of 7.25% - 9.25% p.a.
What should investors in gold do?
Even at the present price range, gold still can be considered as your hedge against the spiralling inflation. Though there will be some sideways movements due to any temporary relief in the paining Euro nations, we believe that there could be volatility in the equity markets if the paining Euro nations like Greece, Italy and Spain do not come with some concrete solutions to get their finances in place. Any negative news may send a wave of shock and apprehension across the globe dampening the investment environment. Under such situation, investors are bound to take refuge to this precious yellow metal - gold.
Hence, nothing has changed for gold and we believe it will continue to maintain its upward trend in the long-term along with some sideways movement too.