Monsoon and growth: For now, we maintain our GDP growth estimate at 5.3% and March CPI inflation at 7.1% for FY2015. In case of a full-blown drought, growth can be lower by 40 bps and March CPI inflation is likely to be higher by 100 bps. Consequently, we maintain our view that the RBI would remain cautious and on an extended monetary policy pause.
Temporal distribution: July and September are the most significant months
July is the most significant month in terms of sowing and hence kharif crop production. The kharif production has more than 50% correlation with the July rainfall. This is intuitive given that sowing for cereals and pulses needs to begin in June and pushed to July depending on the monsoon pick-up. Most crops have growth and harvesting phase between August and November. Consequently, September is the next important month (with a correlation of ~30%) and risks are from unseasonal rains affecting the standing crop. Exhibit 1 highlights the rainfall status across India. (Read Full Report)
Spatial distribution: Food grains at significant risk; vegetables depend on governments measures
Exhibit 2 highlights the risks to food grains production across the country. Most of the recent food price increase has been due to vegetables. Although some of the vegetables are available throughout the year, onion, potato and tomato prices remain susceptible to a weak monsoon.
Reservoir levels can only sustain as much; risks to winter (rabi) crops too
Comfortable reservoir levels were expected to have mitigated some of the risks of a weak monsoon. However, reservoir and basin levels turned deficient by early July (see Exhibits 3 and 4) due to the extremely weak monsoon conditions. While this poses a risk to the kharif production, a bigger challenge will be for the rabi crops, dependent mainly on the irrigation/reservoir levels. Around 45% of the total agricultural land (~65 mn hectares on net basis) is irrigated though improvements are wanting in most of the larger states (see Exhibit 5). We note that Indias agriculture output is now equally weighted between kharif and rabi outputs.
Food prices are on the rise in July
Since 2010, most of the volatility has stemmed from vegetable prices and eggs, meats and fishes. The GameChanger Perspective report dated July 3, 2014 (Action and achievement) indicated that the government has a poor record of conviction and confiscations under the Essential Commodities Act. While the government has acted upon restricting hoarding, eventual demand-supply mismatches will also be a challenge in case of poor production. Vegetable prices in July have been on the upside compared to June (see Exhibit 6). The sowing pattern indicates that acreage till July 18 is 44% lower than the same period last year.
March 2015 retail inflation could be higher by 100 bps; growth could be at 5.0% in FY2015
Factoring in a full-blown drought, we expect GDP growth to be 40 bps lower than our estimated 5.3% in FY2015 (see Exhibit 7). Some loss in agricultural production can be neutralized by the higher-than-expected growth in industrial sector. However, we would wait till the end of July to factor in any change in growth-inflation dynamics as a clearer picture of the sowing pattern and temporal/spatial distribution of precipitation will emerge by then. We calculate retail inflation to be higher by 100 bps against our March 2015 estimate of 7.1% (see Exhibit 8) as the worst-case scenario of a monsoon failure.