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A severe drought when inflation is high and growth low could prevent the new government from launching sweeping reforms, according to HSBC’s report “Dry Heat: India at risk of poor rains.”
By HSBC’s estimates, a full-blown drought in 2014-15 could lower GDP growth by up to 0.5 percentage point (ppt).
For the Reserve Bank of India, high food inflation due to poor weather conditions might increase its resolve to remain hawkish.
As nearly 53 per cent of the country’s total workforce depends on agriculture, and food inflation is a key election issue, droughts are major events for policy makers.
“The droughts in 2009 and 2004 coincided with general elections. If the drought proves too severe, tough decisions such as subsidy reforms could be put off,” the report said.
HSBC said, to be sure, the RBI cannot address food inflation via interest rates. Also, once weather conditions improve and supply is restored, food inflation would subside naturally.
But, the RBI still needs to contain inflation expectations in the interim, and prevent second round effects from driving up core prices.
The report assessed that while the impact on growth will only be felt towards the latter half of the year in 2014, the impact on prices will be more immediate and would persist depending on the progress of monsoons.
“If precipitation is 10 per cent below the long period average in 2014, it could lead to a 2.8 ppt increase in food inflation.
“This would raise headline WPI (wholesale price index based inflation) and CPI (consumer price index based inflation) by 0.7 ppt and by 1.3ppt, respectively,” the report said.
Government granaries are well stocked, which could help augment market supply, but the new “right to food” law will likely constrain the government from drawing down its reserves, HSBC said.
Moreover, food stocks only apply to cereals. Other food items such as pulses or oilseeds would have to be imported.
The report said a monsoon failure will also impact other sectors such as insurance, banking and retail trade. The agricultural and allied sectors account for around 12 per cent of total bank credit.
Historically, poor monsoons have added to stress in the banking sector. Fertiliser and fuel bills tend to rise during droughts, adding strain to the fiscal position.
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