By Deepak Jasani
Although the Indian monsoon season is still a few months away, analysts and economists have expressed concerns regarding the El Nino effect in the forthcoming monsoon season on the Indian economy and financial markets. There are fears about the possibility of drought-like conditions for India in 2023, which could impact agricultural output and lead to high inflation. As per ENSO Forecast data as of March 14, 2023, by the Australian Bureau of Meteorology, El Niño WATCH indicates that there is a ~50% chance that El Niño conditions will develop. This is about twice the normal likelihood. El Niño WATCH is not a guarantee that El Niño will occur, but it is an indication that some of the typical precursors are currently observed.
El Nino is a climate pattern (increased temperature) witnessed in the Pacific Ocean, which impacts weather conditions globally and affects the pressure conditions over the Indian Ocean. El Nino typically leads to hotter and dryer summers, warmer winters and a deficit in rainfall during the monsoon. El Nino has been blamed for 60% of the Indian droughts in the past 130 years when rainfall was more than 10% below normal levels. In the last 10 years, there were two instances of drought in India and El Nino in those two years. Going to 20 years the numbers are 4 and 5. However, the El Nino year of 2007 did not result in a drought, with rainfall at normal levels. During its last occurrence, in 2009, rainfall was recorded at 23% below normal, leading to drought-like conditions. Consequently, food prices rose and commodities like rice and sugar cane were hit, leading to sugar prices reaching record highs globally in 2009-10.
Expectations for 2023
The US National Oceanic Atmospheric Administration (NOAA) predicts that there is a 55%-60% probability of El Nino phenomenon during June-December 2023 which is the “highest in many years.” India’s finance ministry’s monthly economic review in February 2023 said, “If these predictions are accurate, then monsoon rains could be deficient, leading to lower agricultural output and higher prices.”
Impact of El Nino on the Indian Economy
With regard to the agricultural sector, El Nino could pose a threat not just to the existing Rabi crop but could lead to poor Kharif yield as well, if the monsoon is weaker than normal. Low Rabi and Kharif output could then drive food inflation, leading to a delay in the recovery in rural demand. Any decline in the production of food grain could have an inflationary impact, although buffer stock and India’s fiscal policy could alleviate some of these concerns. Higher temperatures, associated with climatic conditions, are likely to result in higher energy demand during the summer, which would drive up demand for coal imports. More demand for power is likely from rural areas for irrigation purposes. Commodities like sugar, rice and other agricultural products, such as pulses and cereals, could also see a rise in prices since the government could be forced to increase the minimum support prices for crops.
Agricultural production accounts for 20% of the Indian GDP in FY21, while about 38% of the country’s workforce is involved in agriculture. So, poor rainfall could lead to a decline in rural incomes, leading to a fall in consumer demand. On the other hand, inflation concerns could lead the RBI to keep interest rates up. The Govt may be forced to spend money on schemes in rural areas to generate employment pressurising the fiscal situation. Fertiliser usage may rise in deficient monsoon times to maintain output, further pressurising the subsidy bill. There are concerns regarding sectors such as FMCG and auto, apart from agriculture, if El Nino leads to inflation and poses a risk to rural demand. Now, rural India accounts for about 36% of the total sales of the average consumer business. Any impact on rural demand could affect the fortunes of the FMCG sector in 2023.
In the event of an El Nino and a poor monsoon in India, comfortable reservoir levels (mostly above their 10-year average) provide some mitigation. However, states like Bihar and West Bengal may face stress on the back of a poor monsoon in 2022. Also, Crop insurance via the PM Fasal Bima Yojana and the Restructured Weather-Based Crop Insurance Scheme (RWBCIS) since 2016 provides protection to banks and to some extent farmers against any adverse weather and crop losses, mitigating damage. A study by ASSOCHAM stated that if there is a rainfall deficit of 5%, as a result of El Nino, it could lead to a GDP loss of about 1.75%, which could hurt lakhs of jobs in the unskilled segments. Given these predictions, how does one invest smartly to make the most of the Indian economy during fiscal 2023?
Commodities and Commodity Stocks
Commodity investors could capitalise on the rise in commodity prices due to the El Nino-related shortages. Looking back at 2002-03, when El Nino led to monsoon deficits, castor seed production declined 34%, leading to a 30% increase in price during the summer while Sugar prices in another El Nino year (2009-10) reached all-time highs in global markets. So, this year, the crop of oilseeds, including castor seeds, groundnuts and soybean, could be hit. Among pulses, analysts say the worse affected might be moong, urad and toor production, while sugar, rice and cotton prices are also likely to increase. Data from the Food Corporation of India suggests wheat reserves currently have contracted to the lowest level at this point in the year since 2017, highlighting the tight supply status.
Other Stocks
Equity investors could benefit from focusing on non-cyclical stocks, such as those from the technology, healthcare, pharma and energy sectors. These apart, BFSI, defence, infrastructure, housing, capital goods, cement and railway sectors may also be less impacted by lower rains. This could also be a good time to hold on to dividend-paying stocks to ensure some passive income during times of stock market volatility.
The Bottom Line
Amid all the fears generated by El Nino predictions, it is important to remember that consumer price inflation is dependent on multiple factors beyond agricultural output and the monsoons. One of the primary contributors to inflation is crude oil price, and any decline therein could well offset food price increases. The key now for investors is to keep a close eye on the progress of El Nino, equity and commodity price changes to make informed investing decisions. Appropriate asset allocation and portfolio reviews may be carried out and evolved investors may build hedges over time if El Nino progresses as feared. In 2009, Indian markets were recovering from the Lehman episode and hence did not see much downside as a result of the El Nino phenomenon. In 2023, Indian markets are grappling with various other concern areas and hence El Nino, even if it occurs, may just result in magnifying the impact of other negatives, if these are not resolved by then.
(Deepak Jasani, Head of Retail Research, HDFC Securities. Views expressed are author’s own.)