Concerns had emerged in recent months regarding higher-than-normal temperatures of water in equatorial Pacific Ocean, termed as El Nino, which sometimes negatively impact monsoon rainfall in India. The IMD has indicated in its April 2014 release that the El Nino Southern Oscillation conditions are neutral at present. However, there is a 60% probability of sea surface temperatures over the equatorial Pacific Ocean reaching El Nino levels during the monsoon season. Updated forecasts regarding the magnitude and regional dispersion of the monsoon are to be issued in June 2014. Given the mixed trends regarding actual rainfall as compared to the forecasts prepared in April over the last decade, concerns regarding the magnitude of monsoon in 2014 are not fully allayed by the IMD's forecast. For instance, following the occurrence of the El Nino phenomenon in 2009, the magnitude of monsoon rainfall fell to a multi-year low of 22% below the LPA. This was substantially weaker than the IMD's April 2009 forecast of 96% +/-5%, which is similar to the forecast for the 2014 monsoon released today.
The impact of low monsoon rainfall on economic growth has been limited in recent years, partly on account of the declining share of agriculture in India's GDP. Moreover, consumption has been supported by sizable increases in minimum support prices (MSP) in some years as well as automatic stabilisers such as the rural employment guarantee scheme. However, a weak monsoon has been associated with rising food inflation in recent years, which has squeezed disposable income and consumption demand of urban households. The generalisation of food inflation into headline inflation has also contributed to a tight monetary policy regime in recent years.
Under the revised monetary policy framework, CPI inflation has been designated the nominal anchor for monetary policy. In April 2014, the RBI signalled an end to monetary tightening if consumer inflation moderates along the intended glide path described by the Dr. Urjit Patel Committee, i.e. to 8.0% by January 2015 and 6.0% by January 2016. While the present level of inflation at 8.3% in March 2014 is close to the January 2015 target, apprehensions related to the monsoon dynamics in 2014 have led to concerns regarding the outlook for food production and prices. In addition to the overall magnitude, the temporal dispersion of rainfall in 2014 would be crucial. Adequate rainfall in June-July, the key period for sowing, may lessen impact of overall monsoon deficiency. Other factors that may mitigate the impact of a weak monsoon on inflation include enhanced moisture in the sub-soil as a result of substantial rainfall since June 2013, relatively healthy reservoir levels and considerable buffer stocks of cereals.
Nevertheless, the expectation of below-average rainfall in conjunction with the structural factors that exert stickiness on food and non-food CPI inflation, suggest that achieving the RBI's target of containing CPI inflation below 8% by January 2015 would be challenging. Accordingly, the most likely scenario at present appears to be an extended pause for policy rates, with monetary easing delayed until at least early-2015, which would in turn dampen a revival in the other sectors of the economy.
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