This could be the first challenge that the new govt has to face. And it's no walk in the park

While the stock market appears to have taken for granted a Modi-led NDA government at the Centre after the polls, it could be underestimating the challenges posed by deficient rains. Benchmark indices Sensex and Nifty are trading close to their record highs, having risen 7 percent so far in 2014 on hopes that a stable government will help kickstart the economy.

But it may not be a one-way ride.

Last week, the Indian Meteorological Department had said there was 33 percent possibility of a below normal monsoon.

“Dealing with the fallout from the sub-normal monsoon will be the first major challenge for the new government, irrespective of who heads it,” wrote Rajeev Mallik of CLSA in a note to clients this morning.

CLSA expects agriculture production to be hit, but said overall non-agriculture GDP growth would be less affected unless there was a severe drought.

The bad news is that food inflation could climb further, and make the RBI’s fight against inflation more challenging.

“Expectations of monetary easing by the RBI this year are wishful thinking, in our view. We maintain our non-consensus view of another increase in the policy rate, most likely in late 3Q14,” the CLSA note said.

The odds of interest rates staying high, or even climbing, seem to be narrowing.

A few days back, Kotak Securities warned that the RBI could hike rates more than what the market was expecting, should monsoon be weak.

“While higher food prices may not necessarily prompt immediate action from the RBI, it would keenly watch the secondary inflationary impact on the manufactured products (in WPI) and services sectors (in CPI). We expect that the RBI will deal with signs of sustained increase in core inflation swiftly,” said the Kotak report.

“Given the current probabilities of an El Nino-induced weak monsoon and associated inflationary impact, we see significantly higher chances of the RBI hiking policy rates than the markets may be expecting,” the report said.

Nomura economists Sonal Varma and Aman Mohunta are estimating zero agriculture GDP growth this fiscal if rainfall is inadequate.

“In case of below-normal rains, we would expect agriculture GDP growth of zero in FY15 (versus our current forecast of 2.8% y-o-y), which would reduce our overall GDP growth forecast of 5.0% y-o-y by around 40 bps,” the Nomura note said.

“Overall, monsoons look very likely to be below normal in 2014, which will hurt food output, agriculture GDP growth and possibly inflation output and prices of pulses and oil seeds will likely be impacted, while the impact on cereals may be contained given the higher stocks,” the note said.