Weak Monsoon Rains Threaten India's Economic Rebound

An unusually dry start to India's monsoon season is threatening to hurt agricultural output in an economy still hugely dependent on rural areas for growth.

This file picture taken on May 14, 2009 shows an Indian farmer and his son walking over their parched paddy field on the outskirts of Agartala. (Parthajit Datta/AFP/Getty Images)

A below normal crop yield may weigh on a nascent economic recovery and push up food prices, straining the government's budget further and complicating the central bank's efforts to revive the economy without letting inflation get out of hand.

After the driest June in 83 years, four of India's 28 provinces have declared drought. Rainfall between June 1 and July 22 was 19% below normal, with the northern and northwestern regions worst hit.

The Meteorological Department forecasts rainfall in the June-September wet season at 93% of the long-term average, which is not an unusually large deviation. But the distribution so far has been extremely uneven, with some areas flooded while others have been parched.

The June-September monsoon is critical for summer-sown crops, including oilseeds, rice, and sugarcane, as 60% of fields are rain fed. If rainfall remains sporadic through September, winter crop yields, such as wheat, could also be hurt, analysts said.

This is a challenge to a country where two thirds of the 1.1 billion population live in villages and agriculture accounts for around 18% of gross domestic product. Rural demand accounts for more than half of domestic consumption so any hit to farmers' incomes would hurt demand for everything from fuel and motorcycles to soap and gold, with knock-on effects on the broader economy.

The government is alert to the risks but hasn't sounded the alarm yet. That may reflect confidence that various measures it's taken to spur economic growth in rural areas will help offset some of the shock from a weak crop.

"It's premature to draw any doomsday conclusion and it's better to wait to check if rains revive," said Arvind Virmani, chief economic adviser to the federal Finance Ministry.

But economists are starting to pencil in downside risks to their forecasts for the economy, which has remained one of the most resilient in Asia to the global credit crisis thanks to its relatively small dependence on exports.

Robust rural demand has helped cushion the blow from the global downturn, with India's economic expansion outpacing those of all its regional peers except China. Growth slowed to 6.7% in the year ended March 31 from 9% a year earlier. The government forecasts an expansion between 6.25% and 7.75% for the current year but a poor harvest could cast that projection into doubt.

"If overall rainfall deficiency falls to 20%-25%, India's gross domestic product growth could be pared to sub-5% this fiscal year," said Mridul Saggar, chief economist at Kotak Securities.

It's not clear if the dry weather so far portends more of the same. Heavy rains last Tuesday lashed the northern province of Punjab, among India's top five rice producing provinces, ending its dry spell. Last year's monsoon revived later in the season, helping farm sector output grow 1.6%.

The government forecast a 4% expansion in farm production when it unveiled its budget last month, but Morgan Stanley said low rainfall could limit growth to between 1.5% and 2%.

A slump in the agricultural sector would put pressure on the government to respond with support measures, even as it already struggles with a fiscal deficit that is estimated to swell to a record 6.8% of GDP this fiscal year.

"The government can't look away from the problem and despite the tight fiscal situation, it will try to incentivize farmers, which may swell its subsidy bill," said Shubhada Rao, Chief Economist at Yes Bank.

The Specter Of Higher Prices

A bigger hazard could be higher inflation.

The wholesale price index - the main gauge of inflation - fell 1.17% in the week to July 11 from a year earlier, a sixth straight week of declines. But economists say inflation will likely reappear in September, as elevated food prices remain sticky and a recent fuel price hike ripples through the economy.

The Reserve Bank of India expects inflation at 4% by the end of this fiscal year on March 31. Jahangir Aziz, chief India economist at JP Morgan Chase, said inflation could rise by two-to-three percentage points over that baseline forecast if the monsoon rains don't pick up.

India doesn't have a large stock of oilseeds and may have to resort to imports which may cost up to 0.4% of GDP, he said.

Scarce rains have forced some farmers to switch from rice to other crops, such as coarse cereals that can survive with less water. India's summer-sown rice acreage fell about 21% between June 1-July 17 to 11.5 million hectares from a year earlier.

Farm Minister Sharad Pawar Friday told Parliament he has banned exports of wheat and non-premium rice for over a year because of the poor monsoon.

The government may also raise procurement prices for some summer sown crops such as rice by 500 rupees per metric ton to encourage more sowing, a senior farm ministry official said.

Prices of sugar and tea have risen 30%, pulses 17%, and cereals 12% from year ago levels, said Citigroup's Rohini Malkani adding that the government may be able to head off a serious spike in food prices, given high stocks of rice and wheat from previous bumper crops and adequate foreign exchange reserves for imports.