Stocks may drop on drought: Merrill Lynch

Indian stocks may decline as much as 15 per cent on concern that lower monsoon rainfall will slash farm output and cut consumer spending, Bank of America Merrill Lynch said.

The brokerage forecasts earnings downgrades for automobile and consumer companies in India, a report to clients said on Monday. India’s Sensitive index or Sensex fell 4.1 per cent in Mumbai trading Monday, paring this year’s rally to 53 per cent.

“We expect a 10 per cent to 15 per cent pullback in equities, led by drought-led growth cuts,” a report by analysts including Jyotivardhan Jaipuria at Bank of America Merrill Lynch said in the note. Also “the market is now trading at a relatively rich 17 times one-year forward earnings.”

The monsoon season, which brings about three-quarters of the nation’s annual rainfall, may be the driest in seven years, Ajit Tyagi, director general at the India Meteorological Department, said on August 13, curbing farm output in the world’s second-biggest producer of rice, wheat and sugar. As many as 209 of 626 districts have declared drought, the farm ministry said August 14.

Merrill Lynch cut its growth forecast to 5.8 per cent from 6.3 per cent for the year ending March 2010 because of a drop in the autumn crop. Merrill Lynch is assuming no growth in the winter crop for its estimates.

Merrill Lynch raised its inflation forecast for the year ending March 2010 to 6.9 per cent from 6.5 per cent on higher food prices. Oilseed price inflation may shoot up to 15 per cent, while drought relief measures by the government will increase the fiscal deficit to as much as 12 per cent of gross domestic product from 11.7 per cent, Merrill Lynch estimates.

The government will give rice farmers a subsidy of Rs 1,000 crore ($204 million) for diesel so that pumps can be run to draw water from tube-wells for irrigating the crops, Agriculture Minister Sharad Pawar said July 31.

The economy will start to recover by the end of 2009 though “the ride will be bumpier than we thought,” as India faces severe drought, Jaipuria said in the note.

Rainfall deficiency at 29 per cent is running at the previous 2002 drought level, Merrill said. The deficiency refers to the shortfall below the 50-year average.