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India Monsoons: A Reality Check
Poor monsoons this year are being dreaded to have a significant impact on India’s GDP. The sectors that could potentially be hit are Automobiles, FMCG and Cement. However, our analysis of the past trends and correlation between monsoons and the performance of these sectors (in terms of business and not stock market performance) indicate that the correlation has not been very strong as is being feared. More so, the gradual and consistent transition of the Indian economy over the years from an agrarian economy to one being led by the services and the manufacturing sectors and the emergence of various other sectors, factors influencing consumer decision making, has ensured that the impact of the monsoons on the Indian economy reduces.
In fact, if we consider corporate India’s annual Net Sales and Net Profit growth over the last decade, it is evident that the impact of poor monsoons on corporate profitability is not prominent. Thus, we have arrived at the conclusion that any impact on the stockmarket is primarily a factor of nervous investor sentiments who prefer to exit/stay on the sidelines pending concrete evidence of the little impact on India Inc.’s profits.
Further, in order to get a greater understanding of the impact of Monsoons on Agricultural GDP and the latter’s impact on the Manufacturing and Services sectors and the Indian economy at large, we carried out a Regression Analysis of the same. This analysis indicates that the impact of a change in Agricultural GDP is minimal on the other two segments of the economy. Also, the impact on the GDP is largely restricted to that arising on account of the slowdown in agricultural GDP, which does get impacted by the monsoons.
“Monsoon deficit rises to 29%”
“FMCG, durables makers on rain watch”
“Clouds of apprehension”
These are some of the headlines being flashed across the media, all depicting the poor state of monsoons in the country this year around Contrary to the three bumper years of rains and agricultural produce in the country and the consequent good times witnessed by rural India, 2009 has been the worst in decades with the monsoon deficiency this season to date being a high 29% of Long Period Average (LPA). Latest figures reveal that 72% of Met districts in the country — comprising more than 40% of the geographical area — are rainfall deficient.
Importance & Impact
This season has always been the most important season for the Indian sub-continent owing to the fact that almost 70% of the Indian population is dependant on the agrarian economy for a livelihood in some way or the other way, the fortunes of which in turn are decided by the monsoons in a particular year. Apart from being a source of livelihood, agriculture is also an important source of raw material for many industries.
Considering the weight of agriculture in the Indian economy in the 1990s, a slowdown in the segment had a telling impact (2-3%) on India's GDP. Further, monsoons do impact the short-term spending pattern of rural consumers, which is important for corporate India, especially for sectors like Automobiles, FMCG and Cement. Thus, if we consider the monsoon pattern and its impact over the last decade (a period which reflects the current times more aptly than the 1990s or 1980s when not only was the Indian economy structurally different but the factors affecting it and the Indian consumer demand was also different from today), some conclusions can be distinctly arrived at. And the crux of this is the fact that while the monsoons do alter the spending pattern of consumers temporarily, the impact is reflected largely in the form of a slowdown in volume sales for these sectors rather than de-growth across some or all sub-categories of products within these sectors.
Impact on Auto Industry
Thus, in the case of the Auto sector, data indicates that the behavior of auto sales is not consistent with the monsoon pattern on all occasions over the past decade, which suggests that there are other factors at play that influence the decision making of consumers at a particular time.
Impact on FMCG Industry
Similarly in the case of FMCG, the trends were quite clear (though contradicting) in FY2001 and FY2003. Those companies which enjoyed strong volume growth witnessed pricing pressures and vice-versa. Nonetheless, the impact of weak monsoons was the most prominent on FMCG companies relative to other sectors.
Impact on Cement Industry
Cement, however, on the other hand, displays a much weaker co-relation with the success/failure of monsoons in a particular year. In fact, even during the lean monsoon period of FY2001-03 and assuming that there would be some lag effect on demand in FY2002 and in FY2004, cement consumption grew at a CAGR of 7.4% during FY2000-04.
While the impact of weak monsoons is inevitable on consumer spending, it is also important to assess the impact of poor monsoons on India Inc.’s profitability. The data below suggests that corporate profitability performance remained more-orless intact over the last decade irrespective of the performance of the monsoon, which is a big positive for India Inc. This clearly indicates that the apprehensions raised on account of monsoons are largely unfounded and in fact are (now) restricted to a smaller universe of segments of the economy economy.
Even looking at the broader Manufacturing and Services components of our GDP, the impact of a fall in Agricultural GDP has been minimal in the past. In fact our Regression Analysis (20-years) of the same indicates that the impact of a 1% change in the latter is minimal on the other two segments of the economy i.e. less than 0.05% respectively. Consequently, the impact on the GDP (0.2%) is largely restricted to that arising on account of the change in agricultural GDP itself.
Further, while the inter-linkage between Agriculture and the other segments of the economy have not been strong, it is also important to note the impact of the change in monsoon patterns on Agricultural GDP. In this case, our Regression Analysis (20-years) indicates that the impact of a 1% deviation in monsoons affects India’s Agricultural GDP by ~0.3%.
The Mitigating Factors
- Lower dependence on Agriculture
Over the years, the dependence of the Indian economy on agriculture, and consequently the monsoons, has been on the decline. Notably, agriculture had a share of over 29% in FY1991 in Indian GDP, which has come down to 17.2% in 4QFY2009.
Thus, in the current scenario, a poor agriculture season would affect the Indian GDP by 1-1.5%. This cushioned impact could also be attributed to some other factors.
- Lower seasonal dependence & higher Irrigation
Firstly, India's dependence on monsoons for foodgrains has been relatively reducing. Notably, the contribution of the Kharif crop (Monsoon Crop) has steadily declined from 60% of India's foodgrains production in FY1990 to the current ~50%, while that of the Rabi Crop (Winter Crop) has gone up in proportion.
Secondly, the area under irrigation has also increased over the years, thus effectively reducing the dependence on monsoons for a good crop.
- Higher agri-product realizations
Apart from this, it would not be incorrect to assume that, broadly, an Indian farmer would be far better off than 3-4 years ago considering that the agricultural GDP has performed quite well since FY2006 (CAGR of 4.1% over FY2005-09) on account of the normal monsoons received by the country. The benefits were further enlarged for rural India as the Minimum Support Prices (MSPs) for rice and wheat increased substantially. Sugar prices have also been on an upward trajectory since 2008.
- Government measures
Other factors that would help mitigate the impact of poor monsoons are the various measures taken by the government.
Measures like the National Rural Employment Guarantee Scheme (NREGS) have and will continue to provide considerable support to rural India, which will ensure that the demand from this segment of the economy does not collapse. The table below indicates the concerted government efforts towards this programme and the huge allocation that has been made towards it indicate of the government’s seriousness of making this plan a huge success. This plan already covers the entire nation and provides a good support to the rural income.
Government’s spending on Infrastructure – both rural and urban – will also provide the necessary cushion in the event of a slowdown in the economy by supplementing rural incomes.
- Low Interest Rates
One of the other factors that will come to the rescue of the Indian economy is the falling Interest rates. Domestic interest rates have come crashing down by almost 3 to 4% over the last one year.
Banks are flush with liquidity, having recently deployed an excess of almost Rs4lakh crore in risk-free investments like government bonds and reverse repo auctions, even as our strong domestic savings continue to drive 22% growth in deposits a result although rural incomes could be under some pressure in the current fiscal however given the deposits. As result, fiscal, however, availability of credit (directed and otherwise) at attractive interest rates, there is scope for consumption demand to be less affected in the current year on the back of borrowings.
- Capital Inflows to improve
Further, the coordinated efforts taken by governments across the world, both on the monetary front – through a lowering of interest rates and an unprecedented increase in the money supply – and on the fiscal front through stimulus packages – have been successful in bringing back confidence over the past few months. This has enhanced the risk appetite of investors and restored stability in global financial markets.
At the same time, the amount of liquidity waiting on the sidelines to finance corporate India’s funding needs is huge. It was the emerging economies which were driven primarily by domestic demand that remained resilient in the face of the crisis. This growth momentum for emerging markets is likely to accelerate further in the future, with lower interest rates acting as a lever. Moreover, now, developed economies, such as the US, have largely saturated their potential for growth from any increase in financial leverage. Therefore, it is unlikely that the US for instance will continue to attract the kind of inflows that it relished during the boom. India, which even in the current scenario is the second-fastest growing economy, has seen FII inflows accelerate in recent months. Between Jan-Jul 2009, we have seen a massive US $6.5b of net inflows as compared to an outflow of 7bn during the corresponding period last year. India’s forex reserves have swelled by almost US $12bn during this period, after declining by a total of almost US $57bn through most of FY2009. Out of the massive global pie, even small re-allocations of capital to India, as little as US $40-50bn, would mean additional investments of 4 to 5% GDP; this in turn take GDP growth back to 8% US, instance, of our this, turn, could our up 8%.
Considering all of the above, we believe that while the impact of a high monsoon deficiency will be felt largely across rural India, we expect the impact on consumption trends not to be severe and short-term in nature. Undoubtedly agricultural GDP will be hurt; however, we expect the recovery in manufacturing and services segments in 2HFY2010 to mitigate these pressures.
Nonetheless, it is possible that in the near-term, the Indian stockmarkets would not be able to escape the negative sentimental impact that arises from the likely repercussions that a highly deficient monsoon may have on India’s GDP (which we concur) and India Inc.’s profitability (which we do not concur with in totality). Thus, we would advise investors to take advantage of any correction that may come by to Accumulate/Buy stocks on the decline, as these would provide a good entry point for investors looking to invest with a 12-18 month horizon. The biggest risk to our investment calls would arise if the monsoon deficiency worsens significantly from hereon, which could have a much larger impact on consumption trends than what we are anticipating.
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