Soaring temperatures overtake rainfall as key driver of India's food inflation, HSBC report finds

Amid India's sweltering summer, with temperatures nearing 50°C, a new report by HSBC Global Research has uncovered a pivotal shift in the drivers of India's food inflation. Rising temperatures have surpassed rainfall as the primary predictor of food inflation, marking a crucial turning point in the country's economic landscape.

The report, titled India: Feeling the Heat, authored by HSBC economists Pranjul Bhandari and Maitreyi Das, highlights a significant increase in both average temperatures and their volatility over time. The March 2022 and March 2024 heatwaves are still fresh in memory, and the correlation between rising temperatures and India's food inflation has grown sharply over the last decade. This trend is evident across various food categories, including perishable crops, durable crops, and animal protein sources.

Temperature vs rainfall

As temperatures gain prominence, the role of traditional factors like rainfall and reservoir levels in predicting food inflation has diminished. Bhandari and Das pose a critical question in their report: "If the importance of temperature has risen over time, what role do rains and reservoirs play?" 

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They explain that while changes in reservoir levels, minimum support prices, and government food management initiatives have historically influenced food inflation, the study's findings suggest that adding temperature to the food inflation model reduces the significance of reservoir levels. When temperature is included without reservoirs, the model's predictive power improves even further.

Temperatures have overtaken rainfall as the more accurate predictor of food inflation for several reasons, the report adds. 

First, advancements in irrigation have mitigated the impact of low rainfall, but no equivalent solution exists for rising temperatures. Second, there is a 50% correlation between reservoir levels and temperatures, meaning that much of the data previously captured by reservoirs is now reflected in temperature. Third, the relationship between temperature and food inflation is non-linear, with non-perishable food items showing an even greater sensitivity to rising temperatures than perishable ones.

Implications for monetary policy

The report suggests that the normalization of temperatures following the March heatwave may pave the way for the Reserve Bank of India (RBI) to ease interest rates over time. 

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"Applying our model coefficient, food inflation could fall by 2 percentage points over the next few months, lowering headline inflation by 1 percentage point," Bhandari said in the report. 

Headline inflation has averaged about 5% so far in 2024. By the end of 2024, headline, core, and food inflation are all likely to converge towards the 4% target, opening up space for rate easing, she said. "We expect two 25-basis-point repo rate cuts, bringing the policy repo rate to 6% by March 2025."

Food inflation fell to a 13-month low of 5.42% in July, following eight consecutive months of staying above 7%, largely due to the arrival of the southwest monsoon and the heavy rains it brought. While prices of meat, fish, eggs, spices, sugar, and confectionery products increased in July, those of cereals, fruits, vegetables, and pulses declined sequentially.

In June, the RBI's Monetary Policy Committee (MPC) decided to keep the repo rate unchanged at 6.5% for the eighth consecutive time to combat high inflation. The MPC also revised its GDP growth forecast for FY25 upward from 7% to 7.2%, emphasizing the resilience of domestic economic activity. 

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Although the southwest monsoon, which arrived in Kerala on 30 May, is expected to be above normal—benefiting agriculture and rural demand—geopolitical tensions, volatility in international commodity prices, and geo-economic fragmentation continue to pose risks to the economic outlook.