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Weather conditions are under watch over the next 3-6 months, which will matter for India’s crop cycles and in turn, impact the economy. IMD’s forecasts in April and June will provide more clarity on the risks.

IMD adopts a cautious stance

In its recent update, the Indian Meteorological Department (IMD) forecasted ‘above normal’ temperatures from March to May 2023 in most states. A second consecutive year of heatwave might be accompanied by an uneven bout of rainfall around mid-2023. February temperatures have already hit a record high, with unseasonal rains in the past week across various northern and western states reportedly affected standing crops of wheat and selected vegetables in the north and north-west of the country.

El Nino weather pattern risk is also under watch, associated with drier conditions and a monsoon deficit, as a more benign La Nina, which entered its third year in 2023, is unlikely to endure.

The Australian Bureau of Meteorology issued an ‘El Nino watch’ last week as La Niña ended and the El Niño–Southern Oscillation (ENSO) returned to neutral levels. For India, the extent of the impact will depend on the severity, intensity, and length of the El Nino occurrence.

Pre-emptive steps to backstop power supply

Power demand grew by 9% in CY2022 and quickened to an average of 11% in Jan-Feb23. On an aggregate basis, the industrial sector (low to heavy voltage) accounts for a third of the total electricity sales, followed by domestic households at ~30% and next, agriculture at ~20%, with inter-state differences in these proportions.

Authorities have undertaken pre-emptive steps to prevent power outages this summer when demand seasonally peaks. While fixing structural gaps like overcoming delays in adding new coal and hydropower capacities will be a challenge, more short-term fixes such as these will be tapped:

• power utilities have been asked to undertake maintenance for coal-based power plants in advance to avoid disruptions during the peak summer months of April and May
• adequate coal stocks will be made available
• railways to ensure there are sufficient rakes to transport coal from the mines to the plants
• imported coal-based plants asked to run at full capacity from March 16
• power companies have been asked to avoid load shedding in summer
• hydro-based plants will be required to optimise water utilisation
• gas plans to also be tapped to meet peak power demand periods

 
Macro implications

Farm output and growth

Monsoon performance is eventually determined by production levels, although there are spillovers between crop seasons due to reservoir conditions and soil moisture.

The upcoming few months are important for agricultural output. The threat of heat waves around the harvest period (Apr-May) poses a risk to the winter crop. Temperature and rainfall intensity will matter as we head into the next crop cycle. The southwest monsoon (Jun-Sep) covers three-fourths of the annual rainfall for the country, with the summer crop during this period influenced by spatial distribution, intensity, and geographical spread of the rain.

While monsoon usually tends to weaken during the El Nino year, not all have resulted in droughts. The IMD defines drought in any area when the rainfall deficiency is >26% of the long-term normal. El Nino had last occurred in 2018-19, which coincided with a below-normal southwest monsoon (-9%). In the past 15y, the largest rainfall shortfall (-22.5%) was in 2009, followed by 2014-2015 (-12.5% and 14.5%). Foodgrain output contracted in FY10, modest fall in FY13, FY15, and FY16.

Encouragingly, half of India’s cropped area is irrigated, but the rest is vulnerable to evolving conditions. Current live water storage levels at the reservoir are higher than the 10-year average but with wide intra-state differences, which suggests timely rainfall will still be crucial to maintain such buffers.

Delays in onset or belated withdrawal coupled with bouts of excessive rainfall are all risks for the final produce. A case in point was last year’s cycle which witnessed above-normal southwest monsoon on aggregate. Yet, the distribution of rains was uneven through the different states with delayed withdrawal (Oct22 rains were 47% higher than normal), affecting the final output.

The government’s second advance estimate for 2022-23 farm production is upbeat, with total foodgrain output seen at a record high of 323mn tonnes, of which the second largest grain sown, i.e., wheat is pegged at a record 112mn tonnes, up 4% from the year before.

Market participants see a risk that the final output might be closer to 105-108mn tonnes if harvests are impacted by unfavourable weather (planted in Oct-Nov and harvested in late 1Q) in a repeat of 2021-22. Last year’s below-forecast output had nudged officials to suspend wheat exports.

The agriculture sector is a crucial contributor to overall growth, accounting for 15% of GDP but ~45% of overall employment. GVA (gross value added) crops, which make up half of the overall GVA agriculture forestry and fishing (AFF), and foodgrain output are highly correlated. A material shortfall in foodgrain output could hurt FY23 (rabi crop) output as well as FY24 (kharif) if weather conditions turn temperamental.

For instance, one percent slower growth (2%yoy instead of assumed 3%) in FY24 agriculture fisheries and forestry growth can lower headline GVA growth by 20bp. If AFF contracts by -1%, headline GVA growth might be slower by 60bp. Second derivative risks will extend to rural-farm incomes, notwithstanding the more dominant (two-thirds) share of non-farm rural activities in overall output as well as better income prospects in those sectors.

With wide variations in the progress of the monsoon, extreme weather events have become more frequent, which will be a medium-term risk for foodgrain, oilseeds, and horticulture production, necessitating longer-term support plans for the farm sector to lower vulnerabilities.

Inflation

Food inflation (~40% of the basket) faces upside risks from these vulnerabilities, with cereals already facing the heat in the current fiscal, especially wheat. Retail wheat inflation rose by a record 16% yoy in Jan-Feb23, partly influenced by changes to the subsidy program and hurt to output from inclement weather.

As the chart shows, cereals and products have punched above their weight in the past year, overshadowing the decline in the contribution of the more volatile vegetable segment.

Addressing this nature of inflation will require administrative measures in the short-term, whilst corrective measures are put in place in the medium term to lower rain (and supply) dependency.

A few steps have already been initiated. For one, foodgrain stocks are likely to be beefed up, which will require stepped up procurement efforts during the winter crop harvests. Plans are to procure 34mn tonnes of wheat in the coming season, much higher than the 2022-23 procurement, i.e., 18.7mn. Half of the wheat procurement was from Punjab, and about a quarter each from Haryana and Madhya Pradesh (link), suggesting rainfall in these states in the upcoming crop seasons will be important to replenish stocks.

According to the FCI, total storage capacity available within its facilities, state agencies, and private bodies stood at 78mn as of Apr22. Besides these, equipping producing farms with better warehousing facilities, improved food-processing units, productivity enhancements, and a push to expand irrigated lands will also help. A dire monsoon season and low output might also lay the ground for higher minimum support prices to supplement farmers’ incomes.

The inflation path will also be dictated by the interplay of a rising share of horticulture vs foodgrain production, as volatile movements of vegetables and fruits (9% weightage in the CPI basket) etc., have also been a major driver of food inflation, apart from the rain-fed foodgrains.

We maintain our FY23 forecast at 6.8% yoy (food 6.8%). Any extended delay in rainfall combined with heatwaves could push FY24 inflation up by 30-50bp vs our forecast at 5.2% average, negating favourable base effects. Price movements are also influenced by other variables such as rural wage growth, recovering global food prices, minimum support price hikes, and improving irrigation capacity and reservoir levels. Besides the monsoon, oil prices, the rupee, the narrowing output gap, fiscal dynamics, etc., will also influence this year’s trajectory.

Policy

Beyond anchoring inflationary expectations, the impact of tighter monetary policy on supply-side inflationary shocks is limited. Hence, the spectre of high inflation due to poor weather conditions is unlikely to convince the central bank to continue hiking rates. Instead, beyond the April rate hike, we expect the RBI MPC to remain on an extended pause at high levels to anchor expectations.

Macro stability

The FY24 Budget saw the government prioritise fiscal consolidation and forecast a lower deficit -5.9% of GDP for the year ahead. If the need for additional support to the farm community to compensate arises due to material impact on agriculture, we expect higher outlays towards minimum support prices, cheaper agri inputs, support on fertilisers and other crop-specific measures.

Reprioritization in the existing spending heads is likely to make room for these additional needs rather than delaying consolidation plans. As it stands, lower energy prices are expected to benefit the economy’s external balances in FY24 (read India: Counting on terms of trade relief).

Response mechanism needs to factor in emerging climate change risks

The Intergovernmental Panel on Climate Change (IPCC), an UN-backed body, cautioned in its March 2023 Synthesis Report (link) that the world’s ecosystem might face irrevocable damage as the 1.5degree Celsius warming limit would be breached by the 2030s. Besides other countries, India was also vulnerable to climate change given its location in the tropics, facing risks ranging from extreme heat, cyclones, and water management issues, even as India’s per capita emissions are lower than the Western countries and China.

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