Poor monsoon can spike food inflation; can it push RBI to hike rates? Experts weigh in

Monsoon this year to expected to remain weak because of the El Nino phenomenon. According to India Meteorological Department (IMD) director-general Mrutyunjay Mohapatra, El Nino will turn moderate in September and remain strong till December this year.

A couple of days ago, Reuters reported India is poised for its lowest monsoon rains in eight years.

"India is poised for its lowest monsoon rains in eight years, with the El Niño weather pattern seen crimping September precipitation after an August that is on track to be the driest in more than a century," Reuters quoted two weather department officials saying so.

The monsoon is critical for India as the country's agri sector significantly depends on monsoon rains. As Reuters pointed out the monsoon delivers nearly 70 per cent of the rain the country needs to water crops and refill reservoirs.

Concerns are growing that as inflation is rising again, a poor monsoon can spoil RBI's efforts to control inflation.

India's consumer price index (CPI) inflation, or retail inflation, surged sharply to a 15-month high peak of 7.44 per cent in July 2023, driven by high food and vegetable prices.

"The elephant in India is the monsoon, with August shortfalls rendering the outlook uncertain in the shadow of El Niño effects even as Indian Ocean dipole conditions are turning positive,'' said RBI's Deputy Governor Dr Michael Debabrata Patra in the latest MPC minutes released on August 24.

The significance of monsoon

More than half of India's population is dependent on agriculture and allied sectors for their livelihood. The agri sector, which contributes roughly around 18 per cent to the national output, is heavily dependent on the monsoon.

As rating agency CARE Ratings points out, "The monsoon has a far-reaching effect on domestic macroeconomic conditions and directly or indirectly impacts domestic inflation, rural income, consumption demand, trade, and agricultural productivity."

"Only about 57 per cent of the farm area is covered by irrigation, with large states like Maharashtra, Karnataka, Odisha, West Bengal, and Tamil Nadu having coverage below the national average. Since over 75 per cent of India’s annual rainfall occurs between June and September, these four months are crucial for Kharif output and can impact domestic reservoir levels, affecting irrigation-dependent rabi output."

Poor monsoon to spike inflation

Experts and economists do not appear worried about monsoon's impact on growth but they highlight that it can raise food inflation significantly.

"With agriculture accounting for 15 to 17 per cent of GDP, the impact of monsoon on GDP is rather muted. Our estimate of GDP growth for the year 2023-24 at 6.2 per cent is about 0.3 percentage points lower than the consensus expectation. Consequently, we are not revising our number downwards because of the monsoon effect," said Sujan Hajra, Chief Economist and Executive Director, Anand Rathi Shares & Stock Brokers.

Hajra, however, added that the impact of a suboptimal monsoon on inflation can be substantial as food products account for nearly 50 per cent of the retail inflation basket.

"Suboptimal monsoon can result in inflation being 1-1.5 per cent higher than earlier expected for the full year. Supply-sided measures by the government including restrictions on food product exports and import of food products can mitigate part of the upward pressure on inflation," said Hajra.

Aditi Nayar, Chief Economist and Head of Research and Outreach at ICRA said if the rains remain below average in the next four weeks, they could lower kharif yields and also affect the area sown under rabi crops. This would infuse caution into rural sentiment ahead of the festive season, dampening the economic growth prospects in the next two to three quarters.

Dipti Deshpande, Principal Economist at CRISIL agrees that a weak monsoon is adding risk to the already-elevated food inflation.

Deshpande underscored that wheat, rice, pulses and coarse cereals have sustained double-digit inflation in recent months. Some hit to production in the previous year, weather anomalies in the current monsoon season and global shortages are all adding upside risks to food prices, said Deshpande, adding that most of these crops that are facing high food inflation are majorly produced in the kharif season between June and October.

"With rains turning deficit at the all-India level and deficit increasing in some of the major kharif-producing states of Jharkhand, Bihar, and Karnataka, sowing for pulses and oilseeds for instance, has taken a hit. All this adds to the inflationary pressures for this fiscal. Rural demand, which is still catching up after the pandemic hit, already faces headwinds from stagnating wages and high food inflation. If weak rains yield a lower output, some dent to agriculture incomes and hence rural demand is inevitable," said Deshpande.

In case of a spike in inflation due to poor monsoon, can the RBI go back to hiking rates? Experts do not think so.

"For the near term, we see headline inflation below 6 per cent by October and expect it to average 5.4 per cent in the year, with the second half (H2) of FY24, undershooting RBI's estimates. We do not see any policy urgency in RBI to hike even though they are likely to stay cautious and vigilant," said Madhavi Arora, Lead Economist at Emkay Global Financial Services.

Arora believes while perishable inflation will ease materially ahead, led by vegetables mean reversion, and structural uptrends in cereals, pulses and even spices inflation in the food category needs monitoring.

"An adequate and sustainable supply-side response to these will be key to inflation management ahead in an era of weather vagaries and disruption will become more rampant," Arora said.

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