Delhiites and Mumbaikars, the often genially warring siblings over supposed supremacy for most lively city tag, were joyously united by an unlikely seasonal guest; the Great Indian Monsoon that hit both on June 25th, a somewhat inexplicable phenomenon occurring after a gap of 62 years!
Behind the serendipity, accentuated by cyclone Biporjoy and later developments in Bay of Bengal, SBI Research finds evidence of myriad changes unfolding in the monsoon pattern that could become new fault lines as climate change on a global scale becomes a sword of Damocles for policy makers and populace alike though there is some good news on rainfall pattern and distribution.
Beyond such changes, given the critical impact of southwest monsoon, the current status of shortfall (-23% below normal as compared to –7% last year, though improving sharply) and delayed arrival imparts a coefficient of fear on inflation and growth estimates as spatial patterns and distribution of rainfall assume utmost significance. For the record, uneven spatial distribution in select states within an ‘overall normal’ monsoon in 2022 (6% above LPA) saw CPI food inflation increasing to 6.7% from 4.2% of preceding year.
The “SBI Monsoon Impact Index / MI” incorporates four parameters from 15 major food grains producing states, viz. their share in total food grains production, rainfall deviation from normal, irrigation status, and overall skewness in rainfall among states. On a scale of 0-100, values closer to 100 indicate lesser impact while values with increased distance from 100 indicate rising impact of spatial distribution of rainfall on economy. The current MI Index, with present value of 64.0 fares better than 2022 full season MI Index at 60.2. It strengthens the belief that better prospects of monsoon from this point should transgress MI Index towards 90, where the negative impact on economy would be virtually nil.
Within the agriculture sector, food grains production is highly reliant on monsoon performance and hence it is more appropriate to appreciate the performance of monsoon with CPI cereals & products inflation. While the correlation of CPI cereals inflation with IMD monsoon LPA is low and positive (which is obviously incorrect), the correlation with our monsoon impact index is high and negative. This validates the effectiveness of our index in predicting actual impact.
Interestingly, even though on an overall basis rainfall is deficient, the cereal producing states have received plenty of rainfall in FY23 unlike in FY22 when it was in deficient. The predictions of somewhat normal monsoon is propagated by IMD factoring Indian Ocean Dipole (IOD) indicator, an interplay of warm and cold waters in distinct parts of Indian Ocean, despite strong possibility of El Nino developing in the Pacific. India has received lower than long period average rainfall at times when El Nino was accompanied by neutral or negative IOD index. The IOD is currently neutral (>0.4 is positive, <-0.4 is negative and values in between read neutral) though a positive IOD is likely to develop in the coming months, thereby ruling out any negative impact on monsoon in India due to El Nino. SBI Research further estimates that in case of prevailing El Nino conditions but supportive conditions in Indian ocean (IOD>0), there is no impact on real agriculture GVA, barring a worst case scenario of an unlikely severe El-Nino occurrence that could push up food prices.
On policy rate front, of the 44 central banks whose meetings took place in June 2023, only 10 central banks raised rates, while 29 went for a pause and 5 cut their policy rate. Clearly, divergence can be seen with Fed pivoting to ‘wait & watch’ by skipping rate hike in May FOMC meet while both ECB and BoE decided to stick to rate hikes with BoE going ahead with a 0.50% rate push to highest level post 2008. BoJ, however, has refrained from any pivot, keeping its ultra-loose monetary policy intact to spur growth in a fledgling economy despite CPI staying above mandated 2% for the last 14 months (3.2% in May against 3.4% of April).
SBI Research believes that BoE will have to raise rates much more as independent estimates show close to a quarter of fiscal stimulus (%of GDP) post covid had happened. Also, most consumers in UK have fixed rate of mortgages, limiting the impact of rate increases for now. Labour markets in UK have also been disrupted with a lot of people missing from the labour force.
The US Fed paused in Jun’23 meeting unanimously as some of the members were dissatisfied by the higher rates hence it made sense to pause the rate in order to assess evolving macro conditions. As per the latest Summary of Economic Projections, most of the indicators (real GDP, unemployment, PCE inflation) have been changed favourably, except for Core PCE inflation whose median projection for 2023 has now been updated to 3.9% from 3.3% given in March meeting. June CPI is also expected to remain low and will be the only CPI data available before the Jul’23 meeting, therefore making a case for another pause in Jul’23.
Though Fed has indicated 2 more rate hikes by Dec’23, SBI Research desk remains sceptical of such move. The question is will Fed return to more hikes after a second pause in July? Fed History shows otherwise. By September, there could be enough data points (banking system, credit markets) to suggest that Fed may have just been done with rate hikes! If this is so, then Dollar Index would decline indicating rupee to continue its appreciating trend. India has already received $11 bn portfolio inflows till June 27 (FY23).
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