El Nino threatens to delay rate cut, hold back growth

Tags: News

Revival in capex cycle to suffer if RBI stays hawkish for long

El Nino conditions over the Pacific Ocean will likely delay interest rate cuts in India and clip the nation’s economic growth by 50 basis points, warn economists.

With weather forecasters hinting at increased possibility of El Nino impacting monsoon rains, the fear is that the much-awaited rate-easing cycle won’t begin anytime soon. The next credit policy is due on June 3.

The Reserve Bank of India’s stated policy stance is to remain firmly focused on keeping the economy on disinflationary mode, and to do that the central bank might have to hold interest rates longer, lest drought-like conditions push up food prices.

El Nino is a phenomenon that leads to an unusual warming of waters in the eastern and central Pacific Ocean, which is known to cause droughts in Asia, including India. This happens because variations in surface temperatures of the tropical eastern Pacific Ocean and air surface pressure in the tropical western Pacific lead to lower rainfall.

Poor rains can delay rate cuts and hit growth by 50 basis points, warns Indranil Sen Gupta, India economist at the Bank of America Merrill Lynch. “We continue to warn investors about the rising El Nino risks, although the picture will get clear only in July. India Met has also forecast below-normal monsoon at 95 per cent of the long-run average for the June-September season with 60 per cent chance of El Nino,” he said.

RBI did allude to the El Nino risk in the first bimonthly credit policy on April 1.

“There are risks to the central forecast of 8 per cent CPI inflation by January 2015 stemming from a less-than-normal monsoon due to possible El Nino effects, uncertainty over fixing of minimum support prices for agricultural commodities and other administered prices, especially of fuel, fertiliser and electricity; the outlook for fiscal policy; geo-political developments and their impact on international commodity prices,” the central bank said in its policy document.

But governor Raghuram Rajan doesn’t believe El Nino can send inflation soaring. “First it is not a given that El Nino will happen. Conditional to El Nino happening, it is not a given that food production will plummet. If food production plummets also, it is not a given that inflation will be high across the board, depending on which commodities are particularly impacted,” Rajan said, while unveiling his first bimonthly credit policy.

“Even if food prices do increase, we need to assess if it is a short-term transient increase, such as the vegetable price rise we saw in December,” he said.

Credit growth of Indian banks decelerated to 13.8 per cent in April from 14.8 per cent in the March quarter, while deposits grew at 15 per cent, slower than the 16 per cent growth reported in December.

Aditi Nayar, senior economist at Icra, said, “A mild deficit in monsoon rainfall and structural constraints is likely keep CPI inflation sticky in 2014, delaying monetary easing.”

The industry and market analysts expect a revival in the capex cycle after the elections, but that can get delayed further should RBI hold policy rates for long. Nitin Kumar, a banking analyst with Quant Capital, said, “El Nino is certainly a factor for interest rate. March quarter earnings of most banks show slower growth in deposits than credit. Lenders cut down on investments to grow balance sheets.” Kumar expects the capex cycle to kick off after the elections, but says it remains to be seen if higher interest rates impacts growth.

DBS Bank economist Radhika Rao calls El Nino a tail risk. “If confirmed, El Nino carries upside risks to inflation and can potentially hurt agricultural output. RBI had alluded to this risk at the recent rate review. A monsoon deficient will likely delay any reversal in the central bank’s tight monetary policy.”


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