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What's El Nino?
'An El Nino occurs when sea surface temperatures in the central and eastern tropical Pacific Ocean become substantially warmer than average and this causes a shift in atmospheric circulation. Typically, the equatorial trade winds blow from east to west across the Pacific Ocean. El Nino events are associated with a weakening, or even reversal, of the prevailing trade winds'. (Bureau of Meteorology, Australia.)
Well, that's nice to know - for a geography student, perhaps. What's it got to do with markets and why is it a jargon that Indian financial advisors must understand? Let's go on with the geography lesson for a bit more, and then things will get a lot clearer.
The tropical areas of the Pacific are in the early stages of El Nino this year, according to the Bureau of Meteorology, Australia. Even the IMD (Indian counterpart) now acknowledges that there is a 70% chance that this phenomenon will continue through the Indian monsoon period. This means that the chances of a poor monsoon this year are quite high. In recent times, most droughts in India have occurred during an El Nino year.
Is our economy still rain dependent - in the 21st century?
So now we know the connection : El Nino disrupts the winds that bring in rain bearing clouds that provide rains across India during the monsoon season. That's bad news for farmers, for sure. But how badly is the economy really affected due to weak monsoons? Is 21st century India still a rain dependent economy?
Historically, Indian agriculture has been dependant on the vagaries of the monsoon for its water needs. The fortunes of agriculture directly impacts economic growth since a big slice of the GDP is contributed by agriculture. Further, a large percentage of the population depends on agriculture for its livelihood. Will a weak monsoon this year affect the economy and markets in quite the same way it used to even a decade ago?
What is a poor monsoon?
The Indian Meteorological Bureau, IMD, published on 22nd April, its annual Long Range Forecast rainfall report for the 2015 Southwest monsoon season. The IMD predicted that the monsoon this year would likely be at 93% of the Long Period Average, or LPA. The LPA is calculated as the average of rainfall covering fifty years. According to the bureau, rainfall between 96% and 104% of the LPA is classed as 'normal'. Anything less is below normal and less than 90% is termed 'deficient'. Since this is an early forecast the IMD has allowed for an error margin of plus or minus 5%.
Many analysts feel that this first forecast by the IMD can be taken only as a broad guide, since the IMD has often revised the numbers in later forecasts. Moreover the error percentage itself shows that the rainfall this year could well be within normal limits.
How will it affect agriculture?
Some agricultural experts worry that, if rainfall is indeed below normal this year, production would be adversely affected. Last year the monsoon played truant in June and July before recovering in August and September. This abnormal pattern, possibly influenced by El Nino, did affect agricultural activities. On top of this, there has been extensive crop damage in several states due to unseasonal rains in the winter months this year. Thus if the monsoon were to be poor this year, it might cause widespread crop short fall.
Another view states that while rains remain important for Indian agriculture, shortage of rains does not affect all regions in the same way. The west and the east traditionally have little to fear as even in below normal years rainfall in these areas is adequate. The northern plains are drained by snow fed rivers which act as a buffer against any rain shortfall in those areas. In fact the northern dams are now full of water. "Water storage in 91 key reservoirs in India remains comfortable at 113% of the last ten year's average, according to Citi Research Economics. (24rth April Wall Street Journal)
Thus it is only the central areas of the country, which are dependent on rain fed irrigation that will be affected the most. The extent of this vulnerable area is about 60% of the total agricultural area. Further, monsoon failure, particularly in the first weeks of the season would essentially affect the sowing and production of long term crops. It will not impact short term crops so much, and most vegetables fall under this category.
As far as the overall effect on the economy is concerned, divergent views have been expressed.
View # 1: Yes, the economy will be adversely affected
Today agriculture contributes only 15% to 20% of the economy. On the other hand, well over 50% of the population is still engaged in agriculture. Any shortfall in agricultural production would dampen rural demand. In any case, even if overall economic growth is not affected badly, it would still lead to human misery on a large scale in rural areas. In good years, farmers would be able to pay off their loans and then go in for needed purchases for their consumption, both short term and long term. Thus, if there is a drought this year and agricultural production slumps, rural demand is likely to fall off.
View # 2: No, the economy won't be affected
Any shortfall in agricultural production will not have as sizable effect on the economy as before, according to this view. "Agricultural productivity has improved with yield for food grains rising to 2,101 kilograms a hectare compared to 1,727 kilograms ten years ago," Citi Research Economics said in a note .(24rth April, Wall Street Journal)
The market for agricultural products also differs from commodity to commodity. For example, the tea industry expects a bumper year for exports, as there has been extensive damage to Kenya's tea gardens due to inclement weather. With prices of African tea shooting up, many exporters are hopeful of increasing exports by up to 30% this year. Further, the Indian tea industry's harvesting period would be over long before the monsoon rains can affect them.
Apart from rainfall many other factors affect the rural economy. Studies at the international level have shown that rural roads are as important in securing remunerative farm prices as irrigation. In this scenario an uptick in rural infrastructure building could well offset the deleterious effects of a poor monsoon. Thus rural demand need not necessarily decrease.
Inflation fears
There is indeed a correlation between adequate rainfall and food production and an equally positive correlation between food production and food prices. Yet after a long inflationary run, food prices have cooled in the last few months. Food stocks are adequate and even if the rainfall is poor this year, there is no great danger of food price inflation based on supply factors.
India's consumer prices have moderated meaningfully over the past year - to 5.17 percent in March from 8.25 percent in the period a year ago. It should be noted that mainly vegetable price inflation has been behind the food price increases .However even these prices have been cooling for some time now.
How will it impact markets?
For markets a bad monsoon is a real worry. Corporate earnings in the fourth quarter have been none too good, leading to market corrections. Analysts point out that at current valuations the market is overpriced. Thus if monsoon were to be weak, and rural demand indeed falls off, a significant sector of industry and associated services like transport would be adversely affected. Yet, in earlier years, markets have grown while agriculture has faltered. In fact in the bad monsoon year of 2009 the markets surged 81%. However this came after a major sell off in 2007-08.
"There have not been two years of bad rainfall in a row. If the monsoons are bad this year as well, there could be a major problem even in the irrigated areas, as groundwater levels would have been depleted. The markets are likely to be impacted," said G Chokkalingam, founder & managing director, Equinomics Research & Advisory. (23rd April, Business Standard)
Conclusion
The full picture would emerge only in June, if and when the monsoon fails to show up. If rains are indeed below par, what the government can do is to boost expenditure on rural infrastructure; particularly in the areas which suffer low rainfall during the season. This will provide jobs to marginal farmers and more importantly to farm labour. Targeting such areas under MNREGA as well can mitigate undue suffering. This will ensure that rural demand does not fall and the economy is able to withstand the blow.
The economy may withstand a poor monsoon, if we have agile responses from the Government. How will markets react though, if the next set of monsoon forecasts from IMD in early June paint a not-so-rosy picture? Will markets assume swift Government intervention and stay unperturbed, or will they swoon with the burden of weak monsoon expectations on top of weak corporate performance? That's what we need to watch out for.
Share your thoughts and perspectives
Do you have any observations or insights or perspectives to share on this issue? Did this help you understand the topic better? Do you disagree with some of the observations? Please post your comments in the box below ..... it's YOUR forum !
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