Bad monsoon need not aggravate inflation

This year’s South-West monsoon, by playing truant, has given policymakers and companies something new to worry about. Will the erratic monsoon fire up inflation?

But a study of trends in the quantum of monsoon rain and inflation in the past shows that a poor monsoon doesn’t always lead to sky-rocketing prices. But then, neither do bountiful rains put a damper on inflation.

Droughts, low inflation

Monsoon data over two decades show that the worst droughts in this period occurred in 2002, 2004 and 2009. These didn’t turn out to be particularly inflationary years for the country’s economy. For instance, in 2002-03, despite monsoon being 19 per cent deficient, inflation as measured by the Wholesale Price Index (WPI) averaged a comfortable 3.4 per cent for the year. Inflation had, in fact, receded from a peak of 7 per cent hit two years before. In 2004-05, when a milder drought was in progress, WPI inflation was at 6.4 per cent.

The clincher, however, is that in 2009-10 that witnessed the worst drought in recent history (monsoon was 22 per cent deficient) inflation was at its lowest ebb in recent years. WPI inflation in 2009-10 averaged just 3.8 per cent. This was a low–inflation year sandwiched between two years of fairly high price rise (and better monsoon!).

How come bad monsoon doesn’t aggravate inflation? The explanations appear to be two-fold.

It isn’t only food prices

A bad monsoon often leads to a fall in the output of key agricultural crops and results in higher food prices. But food prices are only one part of the inflation equation. If its other components such as fuel or manufactured product prices remain soft, the overall inflation may turn out to be sedate too.

This is what happened in 2009-10. Poor monsoon rains triggered a 7 per cent drop in foodgrain and cereals output for the year. This sparked off a 15 per cent rise in food prices. But a year-on-year fall in fuel and power prices and negligible price rise in manufactured products kept overall inflation under check. Average WPI inflation for the year was below 4 per cent.

Remember that the combined weight that food articles occupy today in the WPI is just 14.3 per cent. It was 22 per cent in the old index. With just a 2 per cent weight in the index, prices of rice for example can’t swing the official WPI numbers much, even if they double from current levels.

More resilient now?

What is more important from a fundamental perspective, the South-West monsoon, despite all the attention it gets, represents rainfall over just four months of the year. Post-monsoon rain and winter rain can substantially alter the overall picture on agriculture and prices as well.

A good example is 2004-05. When the South-west monsoon proved erratic with a 13 per cent deficit, winter rains proved exceptionally bountiful, reducing the overall rainfall deficit to just 9 per cent. That actually transforms a ‘bad’ monsoon year into an acceptable one.

Rains outside of the South west monsoon season are quite important because today, the Rabi season is as important as the Kharif season when it comes to agricultural output. If in the sixties, over two-thirds of India’s foodgrain output came from the Kharif crop, in recent years, both the Kharif and Rabi have contributed in equal parts. Rice, coarse cereals, tur and groundnut are mainly kharif crops, while wheat, gram and sunflower are Rabi crops.

A bad monsoon doesn’t equally impact all food or even non-food crops. Even in a drought year, good output in one crop could well offset shortfalls in another, making the country’s overall agricultural output fairly resilient to the monsoon performance.

This may be why droughts in recent years have not been a major ‘swing’ factor in deciding the annual agricultural output. In the drought year of 2009-10, overall crop output dipped by just 1.4 per cent. This contrasts with 2002-03, when a less serious drought trimmed output by a whopping 13 per cent. All this does not necessarily lead to the conclusion that inflation will remain benign this year. For one, if the unfolding El Nino conditions do lead to very poor rainfall for the rest of the year, agricultural output can take a hit.

If the output of several key food crops takes a hit, this can trigger an upward spiral in food component of WPI.

We would then need to pin hopes on a steep correction in the prices of the other items that make up the inflation basket – fuel, metals, chemicals and other manufactured products- to restrain the pace of price rise. Amen to that!

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