Monsoon blues

The El Nino impact on southwest rains could complicate efforts to put the economy back on fast track

By Mohan Sule

After reaching a new closing high on 23 April, the market lost over a quarter of the 8% gain notched in the current calendar year in the next five trading sessions following an alert about the El Nino effect on southwest monsoon. Historical evidence suggests that below-average rainfall is losing its potency to dent growth, though it does affect agriculture output. A year after the global financial meltdown in September 2008, the economy grew 8.6% despite receiving just 78% of normal rainfall. FY 2010 was officially declared as a drought year. Two years later, the GDP rose just 6.7% even after 101% of normal rainfall. FY 2014 saw 106% of normal rains. Yet, output is expected to slump below 5%. Besides, the Indian Met has been off the mark about its forecast. Only in FY 2011 has the actual rainfall matched the predictions made since FY 2001. In a normal year, the warning would have caused a blip for a day or two, before the market returning to its preoccupation with inflows from foreign investors. 2014, however, is no ordinary year. Besides uncertainty about the formation of a stable Union government, withdrawal of stimulus in instalments by the US Federal Reserve since December 2013 and the slowdown in China are overhangs. Concerns that a coalition government will have less flexibility to carry out reforms have already led to foreign capital outflow. Foreign institutional investors were net sellers of debt in April, perhaps worried about the inability of the Reserve Bank of India to lower interest rates, and slowed down purchases of equity after their buying reached the highest level in March of this calendar year.
The immediate concern about scanty rainfall is the pressure on food prices. Food items have been the biggest contributor to the Consumer Price Index despite good rainfall in seven of the past 10 years. Slump in demand has stalled manufacturing growth. But consumption of food continues to be buoyant as the population coming out of poverty due to reforms and welfare schemes is increasing. Shortages, therefore, could lead to a spike in food inflation and nix the chances of the RBI beginning its interest rate reduction cycle soon. Cut in household expenses could affect discretionary usage. In fact, India is caught in a paradoxical situation. Both above average and less-than-normal rainfall bolster food prices. The government hikes prices of farm output to lend support during bumper production and to compensate for the fall in harvest during drought. Hence, consumers end up paying more year after year. Indication of scarcity of any agricultural produce leads to spurt in international prices. This is what happened when India wanted to import sugar for the October 2009-Sepetmebr 2010 season after the failure of sugarcane crop. Global sugar prices shot up more than 60% from end 2008 till August 2009. A glut in Indian production, on the other hand, saw a worldwide slump in global sugar prices and duty on sugar imports had to be raised to 15% in October 2013 from 10%.

What can be done? The economy could expand in FY 2010 despite drought due to fiscal stimulus of the earlier year. Standard excise on non-petroleum products was reduced to 8% from 14% to insulate India from the worldwide credit crunch. As a result, fiscal deficit ballooned to 6% of GDP in FY 2009 from 2.5% in the previous year. In contrast, GDP could grow just 3.8% in FY 2003, another drought year, with rainfall 81% below normal, in the absence of booster doses. These sops have not been rolled back fully. Excise duty remains at 12% now. The interim budget presented in February 2014 introduced more relief for automobiles. Any more reduction in domestic levies will have to be at the expense of personal and corporate taxes. Nonetheless, any stimulus would be a short-term measure. In the medium term, infrastructure proposals need to be given clearances quickly and irrigation and low-cost housing projects have to be initiated to increase offtake of commodities such as cement, aluminum and steel and to revive the manufacturing sector. The budget for 2012-13 had proposed setting up a financial holding company for PSU banks to meet their capital needs. The idea should be extended to other PSUs, too. The holding company could offer a mix of PSU shares to get better pricing instead of seeing the stock of a standalone entity poised to enter the market getting hammered. The CPSE exchange traded fund, comprising shares of 10 PSUs constituting the CPSE index, launched in March 2014 has met with good response and should embolden the government to undertake aggressive offloading of its shares to boost the market as well as to mop up funds for growth activities.