MONSOON AND MACROS. The big story: The swing factor in GDP growth

Are India’s monsoon rains critical to its stock markets? One would certainly think so, from the 1,000-point rally in the BSE Sensex after the IMD forecast an above-normal monsoon for 2016 on April 12. But is this just a knee-jerk reaction or do rains really make a difference to economic growth, rural consumption and inflation — the parameters that matter to India Inc? We took a hard look at the empirical data from 2000 to 2016, to find out.

If there’s one segment of the economy that the monsoons have a direct impact on, it is agricultural output. So, mapping monsoon performance to growth in the agriculture component of GDP, it is clear that the quantum of annual rainfall does have a direct impact on agri GDP growth.

In the last 15 years, India has had three drought years — 2002, 2009 and 2015, when annual rainfall was 15-20 per cent below par and all of them saw sluggish agri output. In FY03, agri GDP contracted by 6.6 per cent, in FY10, it expanded by 0.8 per cent and for FY16 we are staring at a tiny 1.1 per cent growth. Years of bountiful monsoons such as 2003, 2005 and 2010 have also seen agri GDP expanding by leaps and bounds.

However, what has changed over the years is the difference that agriculture can make to the overall GDP number. If the farm economy chipped in with 30 per cent of overall output in the nineties, its current contribution is just 17 per cent.

But having said this, in the slow-growth environment that we live in, even small contributions are welcome. Agriculture has, in fact, been a ‘swing factor’ in the overall GDP numbers in the last couple of years. In 2015-16, Indian industry grew by 7.3 per cent and services by a healthy 9.2 per cent. But it was the tepid show by agriculture (1.1 per cent) that kept GDP growth at sub-8 per cent.

So, if the 2016 monsoons do turn out to be bountiful and agri growth rebounds to 4-5 per cent levels (the base effect will help too), that could mean a direct kicker of 0.60 to 0.75 percentage points to the GDP.

But it would be short-sighted to think that the monsoon’s impact on the economy is restricted to such direct effects alone. Let’s not forget that the Indian economy leans quite heavily on its consumers to power it (private consumption drives over 55 per cent of GDP).

Agriculture provides employment to about 49 per cent of the Indian population and this is probably why rural consumers account for about 45 per cent of domestic FMCG sales and 25 per cent of consumer durable sales in the country.

Tracing trends in consumption growth relative to monsoons, the trends are unexpected. Drought years have not always led to poor consumption, but good monsoon years have always led to a bump-up in consumer spending! The drought year of 2002 saw a distinct cutback in the country’s consumption (measured by Private Final Consumption Expenditure or PFCE). The drought years of 2009 and 2015, however, saw healthy consumption growth.

While this may appear counter-intuitive, it is easily explained. Farmers’ incomes in any given year are made up of a combination of their actual produce, multiplied by the prices they realise. Even when poor rains shrink their output, farm incomes may still turn out healthy if crop prices are holding high.

This was indeed the case in the years from 2008 to 2013. Thanks to sharp increases in the minimum support prices of major crops from the UPA-led government and a global commodity rally, farm incomes were growing at a healthy clip.

Production data on consumer products favoured by rural consumers (two-wheelers, tractors, fertilisers) shows that sales of these products fell sharply in the drought year of 2002, but in 2009, they all managed healthy double-digit growth. The only credible explanation for this is that, sky-high food inflation (15 per cent) ensured reasonably good income levels. Stimulus measures rolled out by the government (post-global crisis) and high MGNREGA spends are also likely to have buoyed up rural incomes.

This also explains why 2015 has been such a lacklustre year for rural FMCG products, two-wheelers, tractors and agri inputs. With global agri prices melting and the Centre making concerted efforts to crack down on inflation since 2014, rural incomes have faced the double whammy of lower output and low prices. Welfare giveaways under Central schemes have also been cut back.

This suggests that for rural consumption to rebound in 2016, what India needs is not just a good monsoon (which will raise farm output) but also a rebound in agri and food product prices (which will help realisations). It is still early days to call a rebound in global commodity prices.

But going by the agri-centric Budget, the Centre seems to be coming alive to rural distress by stepping up rural infrastructure spending. Therefore, one can probably expect some easing of the pressure on rural incomes in 2016. But going back to the heydays of 2008-2013 will be difficult.

Unlike the other two factors, the link between monsoons and domestic inflation rates is quite tenuous. In the drought years of 2002 and 2015, all three key inflation indicators — the CPI, WPI and food inflation — were down in the dumps. On the contrary, 2003 and 2010-11 actually saw good rains marching hand in hand with elevated inflation rates. Despite 2014 and 2015 seeing consecutive years of deficient rains, inflationary pressure was at a multi-year low.

The month-wise and spatial distribution of rains may decide whether individual commodities like pulses, see a spike in prices in 2016 (See accompanying story). But the performance of the global commodity cycle and domestic policy actions (on MSP and money supply) may hold far greater influence on overall inflation rates, than the monsoons, per se .

So, yes, the market is right. A bountiful monsoon will mean better growth and a consumption kicker to India Inc.