Below Normal Monsoon But don't panic yet
Ila Patnaik
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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