With the India Meteorological Department (IMD) last week reducing its rainfall estimates, 2009 is almost certain to be a drought year. An instance of 30% rainfall above the average level for the remaining 45 days of the southwest monsoon alone can save India from the severest drought since 2002. And it seems to be a near impossibility. The impact of the monsoon-deficiency on the economic growth will be, according to most economists, at least 1% even though the share of agriculture in GDP has declined to 17.5% from almost 34% in 1980.
There is a divergence of opinion about its impact on the financial markets, though. HSBC Global Research believes poor monsoon has rattled the market, but the correlation is limited. It says the bigger issue for investors is lack of catalysts and stretched valuations. Dinesh Thakkar, chairman and managing director, Angel Broking, agrees, ?As the contribution of agriculture in overall GDP has come down, the impact of weak monsoon on the markets will be limited. However, I feel there will be a correction in the short term for various reasons.? Goldman Sachs has dubbed the Prime Minister?s Economic Advisory Council?s GDP forecast of 7% as ?rich? and settled down for a much lower 5.8% for the current financial year. It also believes the weak monsoon will have a significant near-term negative impact on rural demand. Edelweiss, similarly, has revised its GDP estimates downward by a full 100 bps to 5.5% and estimates that agricultural GDP is likely to decline 3% in 2009-10.
At the lower end, Jayesh Sheth, managing director of KC Securities, foresees only a 0.5% impact on GDP. Deena Mehta, managing director, Acit C Mehta Investment Intermediates, also rebuts the direct correlation between monsoons and stock market. She is bullish on sectors such as banking, adding, ?The interest rates are most likely to go up.?
For the last 25 years, a drought year has been usually followed by a year of robust economic growth. In 1987, GDP fell to 3.5% but shot to a record 10.2% the next year. The last major nation-wide drought was in financial year 2002-03, the worst in almost two decades, which dragged the economic growth to a 3.8%. Real agriculture output too plunged 7.2%. But recovery followed soon.
This year around, improved industrial production and larger thrust on infrastructure can compensate the adverse impact of monsoon. The government?s Budget announcement of rural dole-outs, especially spending on NREGA, also will partly help maintain rural incomes and demand. Also, there is a significant buffer of food grains from the good crop last year, reducing the need for import. Food import would have eroded the rupee. In the last drought year 2002, the Indian currency appreciated from 48.59 in end July that year to 48.26 a dollar by end-November. Crude oil price, however, remains a threat to the rupee.
As for the impact of weak monsoon on the stock market, opinion varies among market participants. Macquarie Research says in a recent report, ?The share price movements in selected sectors exposed to the vagaries of monsoon season rainfall suggest that drought-related concerns seem to be overdone, at least so far.?
Research carried out by HDFC Securities says, in 2002, markets formed a long-term bottom in April-May 2003 from where a long term bull market began. After the 2002-03 drought, the Indian markets formed a bottom in early May 2003 and thereafter entered a five-year rally. If 2009-10 ends up as a drought year, the markets would correct the recent (election) rally. This will lead to a sustainable long-term bottom formation giving an opportunity to investors to enter the market at attractive levels, adds the HDFC Securities research report. “Overall some weakness could be seen followed by consolidation. Of course, the Indian markets will continue to be driven by global cues, fund flows into emerging markets and risk appetite towards emerging market equities. This trigger could be a local trigger that can accelerate a downtrend in case global equities correct,” said the report.
One sector to benefit the most from monsoon deficit will be sugar. Sugar manufacturers will witness increased realisation, provided the government does not intervene to prevent price rise in a bid to stem inflation. ?The unprecedented monsoon deficiency is worrisome. But for agri industries, especially sugar manufacturers, this may bode well. The rise in price of sugar will certainly be good for the industry, and the stocks. For many sugar companies, the cash flow is equal to the market capitalisation,? said Jayesh Sheth of KC Securities. Renuka Sugar, Bajaj Hindustan, and Balrampur Chini are companies to watch out for. The cost of trading of Renuka Sugar, for example, is low at present. The stocks of these companies along with other sugar manufacturers are likely to rise in the weeks to come, feel many analysts.
Sheth also estimates that cement companies are set for a rally on the back of increased demand from stimulus to rural development and construction of check-dams. According to broking firms, Shree Cement will attract a lot of attention in near term. Power and mining are the other two sectors to watch out for, if data since April 2009 is an indication. Weak monsoon will lead to lower reservoir levels and reduced hydel power generation?which will certainly affect the overall GDP?but in a country where power deficit is a major issue, the companies in this sector will see increased demand.
?Banking and financial sector growth is likely to improve with the ongoing recovery in the economy, pick-up in credit off-take and capital market activity, and a favourable base,? says an Edelweiss report. Analysts are bullish on the stocks of Bank of Baroda and ICICI Bank. Interest rates may not rise as credit demand will remain subdued, but government demand for more money to bridge fiscal deficit will rise. In comparison, in drought year 2002 interest rates did not change either.
Analysts feel telecom and media will remain neutral. Bharti Airtel has received a buy rating from many firms such as HSBC Global Research.
Research analysts are largely downgrading FMCG and automobile sectors,mainly due to a perceived slump in rural demand. FMCG earnings grew 25% year-on-year in the first quarter of fiscal year 2009-10, the strongest in three years. This was led by a strong recovery in volumes, pricing base effect and drop in raw material cost. Hemant Patel and Akhil Kejriwal, FMCG analysts at Enam Securities, believe monsoon holds the key to both input costs and rural demand, and shortage in rainfall may play spoilsport for FMCG companies.
Automobile sales, especially tractors, will be affected as rural incomes do down. Stocks of Hero Honda, Bajaj Auto, TVS Motor, and Tube Investments may lose out in valuation. Information technology companies and pharmaceutical companies are, on the other hand, immune from the whole monsoon effect.
Analysts believe higher government spending will make good for monsoon impact, but it may lead to higher fiscal deficit. If this happens, there is a serious concern about rating agencies downgrading India?s sovereign ratings. What is worse is downgrading corporate earnings estimates, a fall in the premium accorded to Indian markets and then a plunge in equity indices. If the foreign institutional investors (FIIs) react negatively to this prospect and exit Indian markets, then decline will be heightened. FIIs with a long-term investment horizon will, however, corroborates the HDFC Securities report, try to buy up equities at lower levels, leading to higher fund inflow.