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Rains lose momentum
The agri-critical SouthWest monsoon lost momentum into August, entering a dry spell. The month accounts for a third of the rains during the southwest period (Jun-Sep) and ~20% of the annual rainfall. The monthly run-rate fell by a record 36% deficit in August (see chart) from a 13.5% surplus in July, raising the risk that the overall southwest season would end with a below normal or deficient rainfall. As of 3-Sep, the cumulative rainfall stands a deficit of -11% of long-term average, accompanied by an uneven geographical spread – 18% shortfall in the east & northeast India, -14% in southern peninsula, a 12% fall in central India, while the northwest region was 0%. With two-thirds of the key farm producing regions, heavy-weights like South and Central India, experiencing a shortfall in rains, crop yields and harvests are likely to be impacted this year.
The sowing of the summer crop (kharif) is nearly flat from the comparable period last year, marked by a 3.7% rise in the planting of the crucial rice crop on one end, whilst pulses are down the most -8.5% by early-Sep (see chart).
Higher rice sowing is encouraging considering the elevated cereals inflation; however, pulses, oilseeds and other cash groups are set to miss last year’s levels, suggesting commodity prices will stay high in the near-term.
Setting the stage for a weaker handover to the winter crop – reservoir levels have also been affected by the dry patch in August. Water level at major reservoirs now stand at 23% below last year’s levels (see chart) and 7% below the 10Y average, as of late-Aug.
Arid conditions in August were likely magnified by the risk of El Nino, which continues to play out in the background. The Southern Oscillation Index (see chart) has returned to the area which is considered a potential El Nino weather. The commonly viewed NINO readings have also been gradually on the rise, notwithstanding the positive the Indian Dipole Index.
Fiscal defence to contain prices
Monetary policy is a blunt tool in arresting supply-side price pressures. Fiscal defence is a more potent means, instead. The government has undertaken and continues to explore a mix of measures, including market intervention efforts, export restrictions, and relaxation in imports, few of which we touched upon in India: RBI maintains a prudent hawkish pause. In addition:
Domestic media had reported that the government might consider allocating up to INR 1trn towards fighting food and fuel inflation, by rejigging existing ministerial allocations. This might be accompanied by plans to reduce taxes on local fuel prices and import tax on essentials. After cooking gas, expectations have risen that lower petrol/ diesel prices might follow, via excise duty cuts. Last such move was undertaken in May22 to curb inflation. While a jump in global international old prices lowers the window for a price cut, excise duty reductions might allow for a move lower in the retail pump prices, ahead of a busy election calendar. Timing might also coincide with approaching festive period. Prorated for 2HFY24, total fiscal cost might be to the tune of 0.1-0.2% of GDP.
Overall, the government has been focused on frontloading capex expenditure to deliver on the promise of higher multiplier to growth. Nonetheless, a heightened need to support the economy and address inflationary risks in 2HFY might necessitate additional spending, ahead of a busy state polls and general election calendar. Any strain on the fiscal balance will, however, be address by reallocation amongst the spending heads rather than a material slippage in the budget metrics.
Inflation and policy implications
Food was responsible for all the increase in the headline July inflation at 7.4% vs 4.8% in June, with sequential MoM rise three times that of the monthly average in the past nine years. Vegetables led the pack (37% yoy) due to inclement weather and contributed to ~90% of the rise in food, accompanied by pulses up 13.3% and cereals (including rice) at 13%.
Into August, 45% of the food segments for which high frequency retail data is available, eased on month-on-month basis, including one of the key pain points i.e., tomatoes. On year-on-year basis, however more than 60% of the items continued to increase. Onions joined the camp, up 17% yoy in Aug vs 4.5% in Jul.
Our consolidated weighted average proxy for August continues to point towards an overall stickiness in food inflation (see chart). Building this into the headline, we expect August CPI inflation to stay above 7% yoy before turning back into the 6% handle in Sep23. LPG prices have been lowered, alongside which more impact of the easing measures is likely to reflect in the Sep prices. We will also monitor the rigidity in international oil prices, even as domestic fuel remains unchanged.
We lift our FY24 CPI inflation forecast to 5.5% yoy (upside risks) from 5.2% earlier, with core at 4.5% average. Minutes from the RBI MPC’s July meeting reinforced the central bank’s preference to tolerate the near-term surge in vegetables, counting on a seasonal correction late 3Q onwards, which could help bring headline inflation back into the target range. View on growth was sanguine, which came to pass in the 2Q23 (1QFY24) GDP numbers (see next section). These combined with high frequency food prints showing signs of softening, back the case for a pause in October.
Growth kickstarts FY24 on a strong note
Real GDP growth in 2Q23 (1QFY24) rose 7.8% yoy, above our forecast of 7.5% and up from 6.1% in the quarter before. This marks the fastest pace of growth in nearly a year, also growing on seasonally adjusted basis. The supply-side gauge GVA also rose 7.8% from 6.5% quarter before. Nominal GDP eased to 8% yoy from 10.4% quarter before on lower deflators – latter decelerated to 0.2% yoy from 4.3% in 1Q23. Spurt at the start of the new fiscal year was propelled by strong domestic demand i.e., consumption and investments, and strong services from the supply end, which offset headwinds from a weaker external environment. Discrepancies surged while base effects helped.
On the demand end
On the supply end
Incoming high frequency numbers still suggest that domestic catalysts will continue to fare better than the external trade sector. Nonetheless, real demand could moderate on back of a surge in inflation and lagged impact of a tighter policy. Farm output is expected to reflect the impact on uneven rainfall, which could hurt kharif production. With the government expected to frontload capex in rest of first half of the fiscal year 23-24, we count on public investments to help fixed capital investments. Recurrent spending might also rise ahead of the heavy state election calendar and general elections in May 2024. 3Q23 (2QFY) growth is likely to be in the 6-6.5% range as per our latest assessment, prodding us to maintain our full-year projection at 6%, lower than the RBI’s 6.5%. Armed with a strong growth print, policymakers are expected to monitor price developments. More fiscal defence is likely to address price risks, whilst monetary policy maintains a hawkish bias to anchor inflationary expectations.
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