Below Normal Monsoon But don't panic yet

Indian Express April 26, 2006

The first monsoon forecast has arrived. It says that this year the

monsoon is expected to be 93 percent of the normal monsoon. Since

there is a margin of error of 5 percent, this means that the monsoon

could be normal at 98 percent, or lower at 88 percent. Very soon, GDP

growth forecasts based on the monsoon scenario will be produced by

various think tanks and analysts. As the monsoon forecast moves up and

down, models will be run, forecasting GDP growth rates for the

year. They will contribute to changing expectations and moving stock

market indices.

But is India still as sensitive to the monsoons as it is going to

appear in the next few weeks?

While it is true that a bad monsoon will immediately affect the

incomes of farmers in unirrigated areas (which constitute more than

half the cultivated area) and the poorer farmers in these areas will

suffer a drop in consumption, the impact of the monsoon on the Indian

economy as a whole is no longer as strong as it used to be. When GDP

forecasts based on the "normal" or otherwise monsoon scenario come

out, and before we start panicking, we should not forget that the

Indian economy has undergone rapid structural change in the last 15

years. The share of agriculture in the Indian economy is rapidly

shrinking as it did in all advanced economies. Agriculture's share in

GDP in 1991 was 33 percent. By 2000 it had fallen to 25 percent. Now

it is down to 21 percent of GDP. Looking forward, we can expect it to

fall further.

However, in general, the models that are used to estimate the impact

of the monsoon on GDP are backward looking, as are all

macroeconometric models. Usually the elasticities that have been

estimated reflect the reponse of the economy to the monsoon over an

average of the last 30 years. This tends to overstate the impact of

the monsoon on non-agricultural growth and on overall GDP growth.

The direct impact of the lower share of the monsoon is that as

agriculture constitutes about 20 percent of GDP, a one percentage

point decline in agricultural production directly translates into only

a 0.2 percentage point decline in GDP growth. This by itself makes a

big difference. What makes an even bigger difference is the change in

the linkages between the agricultural and non-agricultural sectors.

An important change that has accompanied the decline in the share of

agricuture is the growth of foreign trade. This has reduced the impact

of agricultural performance on non-agricultural sectors. The linkages

between agriculture and GDP arise from both the demand and the supply

side. On the demand side, when agricuture does well, rural incomes

rise. A rise in rural incomes leads to greater demand for industrial

products. It has been seen that consumer goods do well when rural

incomes rise. In some cases the impact is immediate, in others it

comes with a lag. So, for example, the sales of shampoos, soap and

bicycles might respond immediately, whereas the sales of motorcycles,

fertiliser, tractors and TVs may have a lagged impact. The sharp

increase in the share of manufactured goods that are exported in the

last fifteen years have made manufacturing far more resilient to

the ups and downs in demand associated with changes in farm incomes.

On the supply side, increase in agricultural production increases the

supply of food and raw materials. Cereals, fruit, vegetables, milk,

meat, eggs etc. enter the consumption bundle of households. Their

plentiful supply and lower prices, following a good monsoon, reduces

the cost of living. Real incomes of both the urban and rural

populations increase. They both have more to spend on non-agricultural

products. Also, there are a large number of industries that use farm

products as raw materials. Products such as sugarcane, cotton and

oilseeds are directly used by industry. Cleaper raw materials augur

well for these industries. Again, the liberalisation of the external

sector, greater options to import and the availability of resources to

do so, has reduced the dependence of manufacturing on agriculture.

Futher, many non-agricultural businesses may not do well when there is

a bad monsoon and a fall in farm income. But today even the impact on

their consumption is not as sharp as it used to be. Higher financial

savings and physical assets as well as acccess to credit allows

households, especially in urban areas, to smooth consumption and not

add to the shrinkage in demand when there is a bad monsoon and their

profits decline.

In the period before the 1990s, a drop in agricultural growth rates

were accompanied by a sharp drop in non-agricultural

growth. Manufacturing and services grow slowly not only in that year,

but even beyond that year into the first few months of the next

year. This has changed. The last time when GDP saw an actual decline

was in 1979-80 a result of a very bad monsoon when agricultural output

fell by a shocking 13 percent, and an oil price shock shook the

world. Nor surprisingly, industrial growth declined by over 3 percent,

and GDP fell by 5.2 percent.

But in the 1990s when agricultural output declined, though industrial

growth slowed down, industrial production did not fall. Even when

agricultural output fell by 7 percent in 2002-03 (a very bad monsoon),

industrial growth remained positive at 6.6 percent and services at 8

percent. Overall GDP grew at 4 percent. Last year (2004-05) when

agriculture grew at 1.15 percent, GDP grew at 7 percent.

In summary, while the monsoons are important, especially for farm

incomes and for certain industries, the impact of the monsoons on the

overall Indian economy is often overstated. Today the Indian economy

is far more resilient to the monsoons than it ever was.



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