Have markets over-reacted to monsoon forecast?

While IMD has sounded caution and tempered expectations, private forecaster Skymet, for now, has stuck to its earlier estimates

Despite the expected cut of 25 basis points (bps) in repo rate by the Reserve Bank of India (RBI) on Tuesday, the S&P BSE Sensex slumped 660 points after the Indian Metrological Department (IMD) lowered forecast to 88 per cent of the long-term average, stoking fears of a drought and a possible spike in inflation.

"North-west India, comprising major grain producing states such as Punjab, Haryana, Rajasthan and Uttar Pradesh, the south-west monsoon this year was expected to be at only 85 per cent of long period average (LPA)," the IMD said. CLICK HERE FOR THE FULL REPORT

While the domestic forecaster has sounded caution, Skymet, a private weather forecasting agency hasn't yet downgraded its estimates. In an interview on Tuesday, Jatin Singh chief executive officer at Skymet stuck to their earlier forecast of a normal monsoon.

Given the wide divergence between the two forecasters, which one should you believe?

In 2009, the IMD forecasted that monsoons for the year would be normal. Two months later, in June, it scaled-down its earlier forecast and said that the monsoons would be slightly lower than normal levels. By the end of 2009, both the predictions went horribly wrong as India witnessed its worst drought in 30 years. CLICK HERE FOR THE FULL REPORT

Explains G. Chokkalingam, founder & managing director, Equinomics Research & Advisory: "In the last three years, the errors in IMD forecast varied from 600 bps to 700 bps. The maximum rainfall happens normally in the months of July and August, so the performance of these months is highly crucial. What actually matters to the economy is not only this cumulative rainfall, but also the spatial distribution. Last year, the deficit in the cumulative rainfall was only 12 per cent, but 20 per cent area failed to receive normal rainfall."

Since 1950, there have been 19 El Ninos and during these years, India has seen below normal / deficient (or drought-like) rainfall in 11 cases, normal rainfall in 7 and excess in 1, reports suggest. In fact, in 1997, which was one of the strongest El Ninos, rainfall during the monsoon season was normal (105 per cent of LPA).

Have the markets over-reacted?

Chokkalingam does think so. "It is too early to panic on the monsoon forecast and on its impact. Unless the actual rainfall fails miserably both in terms of quantum of rainfall and also spatial distribution, India would be forced to continue with easing of benchmark interest rates. We suggest investors don't panic at this juncture and continue to invest with more tilt towards pharma and IT stocks," he says.

Sonal Varma an economist with Nomura also suggests that though overall, risks to agricultural production, rural demand and food price inflation have increased, the actual impact will be known only sometime in July.

Rakesh Arora, managing director and head of research at Macquarie Capital Securities (India) also feels that the markets seems to have jumped the gun.

"Having said that, one must also note that there are a lot of agencies that have forecasted that the rainfall would be deficient. The RBI has taken cognizance of that and said they'll take a pause on the interest rate easing cycle. The earnings season, too, wasn't great. All these things have contributed to the negative sentiment. Going ahead, we need some catalysts to change all this," he said.

"For the Nifty, we feel that 8,200 is our worst-case target from a 12-month perspective. By December 2015, we don't see the Nifty much below 8,200 levels and it is already around that level. In terms of sectors, consumer stocks don't look that cheap even now. We prefer industrial stocks to consumer or consumption-related stocks," he adds.