The northwestern Indian state of Rajasthan, and the southern state of Karnataka have declared a drought, according to the Wall Street Journal. And the monsoon’s are 15 percent lower than the long-term average now, down from 22 percent.
While the drought in the U.S. has been severe and impacted the nation’s farm industry, the drought in India is likely to have a much bigger impact on the local economy.
Agriculture still accounts for about 15 percent of the country’s GDP, compared with 1.2 percent in the U.S. Indians also spend a larger portion of their income on food, which accounts for 36 percent of the consumption basket.
In fact, emerging economies tend to have a higher share of food in their consumption baskets with food having a 17 percent median CPI weight in developed economies, compared with 31 percent in emerging economies.
For India which is still struggling to rein in inflation after poor monsoon’s in 2009, there is clear cause for concern.
“India is yet to recover from the brunt of the 2009 monsoon failure” write HDFC Securities analysts Sameer Narang and Vishal Modi. “Moreover the impact of a poor monsoon on inflation lingers for two years owing to minimum support price (MSP)* hikes and crop cycles.”
For India which is already struggling with an economic slowdown, this would only stoke inflation limiting discretionary spending and curbing monetary tools at the disposal of its central bank.
With expected diesel price increases the Reserve Bank of India (RBI), the country’s central bank is expected to have limited room to cut interest rates and support growth. The RBI for its part has already made it clear that inflation is a priority and is pushing for changes in fiscal policy to support growth.
Given this Narang and Modi have lowered their agriculture growth forecast to 1 percent year-over-year (YoY) for the fiscal year 2012 – 2013 (FY12-13). They have also lowered their GDP forecast to 6 percent YoY in FY12-13, down from 6.4 percent.
This chart from HDFC shows that inflation always moves higher with a poor monsoon:
And this chart, also from HDFC shows that inflation has already started trending higher:
Finally, this chart shows how lower agricultural output impacts overall GDP: