Drought threat: 4 challenges that deficient monsoon throws up for Modi

That was too fast for Prime Minister Narendra Modi. Within a year, the honey moon he enjoyed has not only ended, but now he is staring at a phase that promises to be extremely bitter. The Indian Meteorological Department has predicted that this year monsoon is going to be deficient, that is about 88 percent of the long-period average. The reason for this is the looming El Nino, a weather phenomenon in which ocean waters warm up causing droughts and floods across different countries. Though an analysis of earlier data sets suggests a drought or deficient rain scenario in itself does not necessarily result in a economic downturn, this time it is different for two reasons: for one, this is the second consecutive year of rain deficiency and secondly, there is a burden of expectations on the government because of the promises made by Modi during in the run-up to the elections. [caption id=“attachment_2279354” align=“alignleft” width=“380”]  AFP[/caption] To be sure, this is not the first time a drought is happening in two consecutive years. That happened in 1986 too. But that was a different time, if not altogether an another planet. Water table in India was not as low, demand situation was not as high, prices of essential items were not as high and above all expectations were much much sober. So, if indeed the drought strikes, it is unlikely to be a repetition of the history. Moreover, according to the US Climate Prediction Centre, there is “90 percent chance that El Niño will continue through Northern Hemisphere summer 2015, and a greater than 80 percent chance it will last through 2015”. As the Modi government seems to be preparing to face an unusually long summer here is a look at the major challenges it faces: 1) Food inflation: This is one aspect the Modi government has been extremely lucky in the first year. With crude oil prices declining about 50 percent, inflation has been on the down trend on a whole. From 8.33 percent in May 2014, the retail inflation fell to 4.87 percent in April 2015. What has aided the decline is the government’s decision to release food grain stocks. Also, there is the base effect, which means the prices were much higher in the previous year. When it comes to wheat and rice, the government has leg room to release the stock this year too. There is enough buffer stock with the Central pool (rice 17 million tonne and wheat 34 million tonne as of 1 May). Pulses should also be not much of a problem because the government can import without the fear of current account deficit spinning out of control (CAD now stands at just 1.6 percent of GDP). The issue will be with perishable commodities like vegetables. The government, according to Agriculture Minister Radha Mohan Singh, is gearing up to use the Rs 500 crore price stabilisation fund to intervene in the market. This may help rein in the prices to an extent but is unlikely to pull down the prices significantly. In other words, in the second year Modi may not be as lucky as he was in the first year when it comes to inflation. 2) Farm distress: The farm economy is already in distress. A deficient monsoon will only heighten their troubles. Their indebtedness is likely to increase and output fall. Last year, the sector grew just 0.2 percent due to the deficient monsoon. This year, if the prediction come true, the sector GDP is likely to contract. One way the government can address this is by raising the minimum support prices. But the RBI has already raised a red flag against any such plans. A steeper increase in the MSP will have an adverse impact on the inflation, while it really doesn’t help the farmers. Many of them are even unaware of the MSPs. According to a survey by NSSO, only only 322 households per 1,000 were aware of the support prices for paddy. The number of households which were aware about the procurement agency was just 251 per 1,000. The number which actually sold their produce to the agency at the MSP was even lesser - just 135 (data for July 2012-December 2012). This is just about paddy. When it comes to other crops, the corresponding numbers are minuscule (sugarcane is the only exception). So clearly, MSP is not a way out as it is not the farmers who are getting richer with it. But the government may have to resort to this step in a dire situation. Another way is to increase the NREGA allocation, so that the rural income at least perks up a little bit. However, both the steps are likely to attract criticism from the liberal economists, a key constituency of Modi. 3) Bank NPAs: Banks have lent Rs 7.83 lakh crore (as of April) to the farm sector, 12.8 percent of the total advances. Finance Minister Arun Jaitley has given a target of Rs 8.5 lakh crore for this year in his budget speech. In the event of a monsoon failure, these loans are likely to turn non-performers. It is to be remembered that public sector banks are already reeling under high gross NPAs (Rs 3 lakh crore as of March), with a significant chunk being from the farm sector. For instance, in the case of SBI, the country’s largest bank, gross NPAs from the sector constitute about 19 percent of the total as of March 2015. A rise in this, with no industrial recovery that could otherwise offset by bringing down the corporate NPAs, would only add to the burden. If the government resorts to a farm loan waiver, which has been an easy tool in such situations earlier, that will further dent the banking sector. Public banks capital requirement will only rise. Remember, the government has provided just about Rs 8,000 crore, nearly half of what they need. Given the market situation and their own financials, they are not in a position to raise capital from the market. 4) Fiscal deficit: All the above discussed issues boil down to this key figure, which is difference between the government’s expenditure over income. The target for the deficit has been set at 3.9 percent for current financial year, that too despite many economists arguing for a generous relaxation so as to allow a ramp-up of public investment. Given the unfolding situation, the target will probably have to be moved up further. Already there are doubts about the government’s ability to meet the Rs 69,500 crore disinvestment target due to the turmoil in the market. A better tax buoyancy is also out of bounds without a meaningful recovery in corporate earnings. On top of all these comes the expenditure to fight the drought and mitigating rural distress. Overall, the monsoon this year is going to be the first major challenge for Modi. As explained earlier, it can throw the nascent recovery into disarray. For instance, a rise in inflation may even force the RBI to reverse its rate stance, which can squeeze the growth further. A deeper distress in rural economy will detrimental to corporates, especially in the auto and FMCG sectors. It is time for the government to make well thought out moves. Data from Kishor Kadam