After two consecutive years of deficient monsoons, the Indian Meteorological Department has projected above-normal rains in 2016. But, monsoon forecasts by the IMD have been wrong in the past. Will a poor or below-average monsoon lead to higher food prices or will a good monsoon lower food inflation? In fact, there has been little correlation between poor monsoons and food prices, despite what market commentators, economists and policymakers would have us believe. A recent research titled ‘Busting the monsoon and food price inflation myth’ by Nomura finds that while rains do impact food production, the production and food price inflation link is weak across food categories. Nomura expects food inflation to be approximately 5-5.50% in FY16-17 versus 5.10% in FY15-16
According to Nomura’s research, correlation between rains and food price inflation is has been low. In the past, during bad monsoons, food inflation has been less than 5% for FY01-02, FY02-03 and FY04-05. During good monsoons, in FY06-07, FY08-09 and FY10-11, food inflation has been above 8%. Despite two below-average monsoons over the past two years food inflation has remained below double digits.
Using data for the last 15 years (FY01-02 to FY15-16), Nomura calculated the correlation between monsoon rainfall (percentage deviation from normal) and food price inflation is 0.14. Ideally, if a poor monsoon leads to higher inflation, the correlation should be negative.
The research finds that the average food price inflation in years with below-normal monsoons is 6.5%, surprisingly lower than for a normal monsoon year which is at 7.6%, indicating a weak correlation between monsoon rains and food price inflation.
Could the low correlation be because of the monsoon only affect certain food items? Analysts at Nomura find no clear link. The write that, “There is no single category driving food price inflation up (down) in bad (good) monsoon years. Food shocks have hit different food products across different years, irrespective of monsoon performance.” They find that “From pulses, edible oils, fruits & vegetables to cereals, the drivers of high food price inflation keep changing. Nor is the impact symmetrical. For instance, FY04-05 and FY09-10 were both below-normal monsoon years. Yet, protein food price inflation (pulses, egg, meat, milk, fish) was very low in FY04-05, but rose significantly in FY09-10.”
Rather than the monsoon, Nomura states the key drivers of food inflation are minimum support prices, nominal rural wages, non-labour agriculture input costs, and global food price trends. And since the above drivers have already stabilised, they do not expect food price inflation to fall from current levels, even if monsoon rains are normal. The analysts write that the, “Ongoing public infrastructure construction could raise demand for rural labour and gradually push up nominal rural wages. Rising diesel prices can incrementally add to agriculture input costs.” Similarly, they expect the government to remain prudent in its MSP announcements in 2016 and do not expect hikes to be any lower than the last two years. Hence they expect food inflation to be approximately 5-5.50% in FY16-17 versus 5.10% in FY15-16.
On 5 April 2016, the RBI Governor in the first bi-monthly monetary policy statement mentioned that “Going forward we will be looking for further monetary room in signs of good monsoon, further readings of low headline inflation, indications of softening in core inflation and further evidence of transmission of rate cuts.” In an interview he also stated that “We’re looking for signs of a good monsoon. Unfortunately, India is still somewhat sensitive to monsoons, though people find it hard to see a link between monsoons and food prices. But there is potentially (a link), with this being the third bad monsoon in a row (if) that happens.”