Vijay Kumar Gaba

I made a rudimentary assessment of the potential impact on the financial market, assuming the monsoon rains are inadequate and/or prolonged heat wave conditions persist over a large part of north and central India, as anticipated by the weather experts. In my view, investment strategy needs a tweak to make it ready for a hotter and drier summer.

Asset allocation

An inadequate monsoon would essentially mean (i) persisting higher food inflation; (ii) higher fiscal support to the rural sector; (iii) high food credit demand; and (iv) higher short term yields.

Raise some tactical cash

I shall therefore like to raise some tactical cash from my equity allocation and deploy it in short term or liquid funds. I however do not see any case for changing the strategic allocation at this point in time. A sharper than presently anticipated correction in equity prices will motivate me to increase my equity allocation to “overweight” from the present “standard”.

Sectoral impact

I am no expert in equity research or economics. I mostly manage my investment strategy by applying learnings from my travels; observation of behavioral patterns and public information about economic trends. From my experience of working with rural communities and traveling to hinterlands, I have observed some broad sectoral impact of a deficient monsoon. Few examples are listed below.

It is pertinent to note that inadequate monsoon usually does not mean a pan India drought. Hence, it is more likely that different regions (and regional players) experience a divergent impact of a deficient monsoon.

Farmers’ economic behaviour

In case of a deficient monsoon, farmers quickly adapt to “drought mode” – deferring discretionary spend, e.g., on marriages, jewelry, vehicle, pilgrimage etc. and changing to shorter cycle crops. In the past two decades a tendency is growing amongst farmers (especially the young ones) to defer paying their dues to government and lenders etc.

It is pertinent to note that as per the latest NSSO statistics over 50% agriculture households are indebted with an average outstanding debt of Rs74121. More critically, only 57.5% of loans taken by agriculture households are for agricultural purposes, the rest are for personal purposes.

Given that most of the rural population is now assured of free/highly subsidized food under various government schemes, the sustenance farming (growing for self-consumption) is gradually reducing. A substantial number of small and marginal farmers is moving to cash crops that have usually higher input cost. A crop failure thus causes more stress to small and marginal farmers as compared to a decade ago. The insurance coverage to these farmers is highly ineffective due to a variety of reasons; unclear land title being one of the major reasons.

Energy intensity of water

In case of deficient monsoon, the energy intensity of water rises materially, as farmers rely on exploitation of ground water. Though the use of solar power for ground water extraction has increased materially in the past few years; the reliance on the grid is still very high. If we add to this the increased household (mostly urban) demand for cooling, the demand for power usually rises significantly. The demand for diesel (and diesel genset) could also be higher to meet the additional load of water extraction.

Livestock

Livestock is worst affected due to rain deficiency. Poor winter rains have already created severe fodder shortages and rise in milk prices. The dairy and meat production could be further impacted by deficient rains – impacting the income of farmers and food inflation adversely.

Important to note that about 25% of agriculture GDP is contributed by livestock.

Labor migration

The demand supply equilibrium for farm labor usually shifts down during deficient monsoon seasons. The real wages could see a sharp decline. The labor migration towards non-agriculture jobs is also higher. The availability of unskilled labor for construction in particular rises materially.

Food transportation

Traditionally, deficient monsoon years used to witness significant rise in the quantity of food transported across the country as part of the drought relief work. However, given the fact that the public food distribution system is now adjusted to free food for almost 800 million people, the incremental food transportation may not be as significant as it used to be a decade ago. Nonetheless, there could be some additional food movement in case of a material divergence in spatial distribution of monsoon.

I would therefore consider the following in my overall investment plan:

Negative List

Farm input – agri chemical, fertilizers, seeds.

Rural consumption – jewelry, gold, footwear, alcohol, home upgrade, personal vehicles, etc.

Dairy, poultry and edible oil production

Cotton yarn

Close watch

Rural lending, especially microfinance

Farm equipment, especially tractors

Crop insurance

Construction

Water intensive industries like paper, alcohol

Sugar

Positive List

Short term bonds

Diesel genset

Air cooling appliances like Fans, Coolers, Air conditioners

It is pertinent to note that La Nina conditions are known to cause normal to above normal rains in India, while El Nino conditions are known to cause rain deficiency in India. Neutral ENSO conditions help a normal (+ 10% of long term average) monsoon.

In India La Nina conditions have prevailed during the past three monsoon seasons (2020-2022), resulting in good overall rains; though spatial (regional) and temporal (time wise) distribution of the rains was erratic causing floods in some regions and drought in some other regions. The most populated Gangetic plains are suffering from severe drought conditions since last summer.

Kharif (monsoon) crop sowing suffered due to delayed or deficient rains in many parts of the country. Besides, the 2022-23 Rabi season has witnessed deficient rainfall in most parts of the country (see here).

Even though so far El Nino conditions have not developed for India, some professional forecasters have predicted development of these conditions as early as June 2023, resulting in deficient monsoon rains in India. For example, the US government weather agency, National Oceanic and Atmospheric Administration (NOAA), has said that El Niño is expected to begin within the next couple of months and persist through the Northern Hemisphere spring and early summer.

Skymet Weather has said that “El Nino threat during the Indian monsoon 2023 is growing big.” It further said, “El Nino projection based on initial conditions of Feb 2023 is finding semblance with Feb 2018. Both are evolving El Nino, albeit 2023 appears to be stronger than 2018.  El Nino share starts with 30% in June, reaches 50% by July and climbs to >/= 60% during 2^nd half of the season.”

Admittedly, it may still be early to conclude about a deficient monsoon this year. Nonetheless, the erratic weather pattern and early onset of summers across north, central and western India is indicating prevalence of unusual weather conditions over the next few months. Obviously, this will have implications for the economy and therefore financial markets.

Economy and monsoon

Over the past seven decades the share of agriculture and allied activities in the overall GDP of India has consistently declined. Agriculture and allied services accounted for almost two third of India’s GDP at the time of independence; and now it accounts for less than one sixth. The proportion of population relying on agriculture and allied activities for their livelihood has also declined from about three fourth to two fifth. The declining importance of the agriculture sector in the overall economy has resulted in under investment in the sector over the past 3 decades in particular.

The importance of monsoon for the Indian agriculture sector has seen a steady decline. Self-sufficiency in the area of food grains broadly means that impact of a deficient monsoon is mostly limited to (i) temporary food inflation; (ii) financial stress for small and marginal farmers’; (iii) additional burden on fiscal condition (loan waiver and food subsidy); and (iv) consumption demand of the affected population. Adequate food grain stock and an effective public distribution system minimises the cases of starvation in case of drought.

Besides, in the past seven decades the crop area fully dependent on rains for irrigation has fallen from ~80% to 50%. Out of a total of 141 million hectare net sown area, only about 70million hectare is rain fed; the rest of the area uses water supplied by irrigation channels. (see Under the Shadow of Development: Rainfed Agriculture and Droughts in Agricultural Development of India, R. S. Deshpande, NABARD)

Regardless, drought can hurt some areas and some crops disproportionately. For example, in the state of Maharashtra still over 81% agriculture area is rain fed. Besides, rain-fed areas produce nearly 90% of millets, 80% of oilseeds and pulses, 60% of cotton and support 60% of our livestock.

Adequate water in reservoirs

As per the latest bulletin of the Central Water Commission (CWC) as on 02 March 2023, , the live storage available in 143 reservoirs is 93% of the live storage of corresponding period of last year and 116% of storage of average of last ten years. States of Odisha (-20%), Bihar (-38%), UP (-21%) and West Bengal (-44%) have water availability in reservoirs which is below normal range; while most other states have large surplus.

Regardless, the current storage is significantly lower than the total reservoir capacity in all the regions. Thus in case of a severe drought the hydro power generation as well as area irrigated through channels could also suffer.

I would like to review my investment strategy in light of the probability of a poor monsoon. I shall share my thoughts on this coming Tuesday.