India's sovereign credit profile is more exposed to the negative effects of a drought than most other Baa rated sovereigns because of five major reasons, a new Moody's report says. The reasons are:
1) Relatively high share of agriculture in overall employment2) Weak rural infrastructure and irrigation3) Inefficient food distribution 4) Large proportion of Indian household spending that goes towards food, and 5) Share of food subsidy costs in the government's fiscal deficits
The Indian government's efforts to improve rural employment, food distribution and infrastructure are credit positive for the nation as they address three out of the five structural issues mentioned in the Moody's report. Although India may avoid drought this year, until the government's efforts yield material results, the Indian economy remains vulnerable to future droughts via its impact on growth, inflation and government finances, the report further states. Moreover, even in years when drought doesn’t actually occur, the annual uncertainty around agricultural output constrains monetary policy making as highlighted this year, the report says. A weak monsoon forecast coincided with an uncertain cyclical recovery.
Atsi Sheth of Moody's Investors Service says the report compares India to several other countries that also have a fairly high proportion of agriculture in their gross domestic product (GDP).
Below is the verbatim transcript of Atsi Sheth's interview with Ekta Batra & Nigel D'Souza on CNBC-TV18.
Ekta: Take us through the crux of your report on how India’s vulnerable to drought is actually a sovereign credit challenge. The crux of what you have written in your latest report?
A: When you look at what happens in India every summer you see that every time the IMD makes its weather forecast or updates them there is a market reaction to it. The stock market actually sometimes rises or falls based on a weather forecast. The question that our report answer is why is it that financial market is so sensitive to weather forecast regarding the monsoon? The answer of course is that India’s economy itself is a little bit more vulnerable to impact of drought or the monsoon than say comparable BAA three rated economies.
What our report did was it compared India to several other countries that we rate that also have a fairly high proportion of agriculture in their gross domestic product (GDP). Given that other countries also have negatively affected by drought, why does India see more vulnerable? The answer seems to be that India is a little bit more vulnerable for variety of reasons. One is that in India a lot more of the population relies on agriculture for income. So drought poses more hardship for them.
Second, given average low per capita incomes in India the proportion that any household whether rural or urban spends on food is higher than another comparable economies. This means that the impact of drought affects not just the inflation, but also the purchasing power of household and that affects growth.
Thirdly, India’s agriculture productivity is constraint because of poor irrigation, poor rural infrastructure and this means that even in a regular year India’ productivity is lower and this is exacerbated in a drought year so that is another factor. Lastly, India’s food distribution system because it is not as efficient as it might be, in a drought year food shortages get exacerbated again. So, you don’t have the distribution system that can take food output from a part of the country where rainfall as been okay to another part of the country where rainfall has been not so okay.
That summaries why India is more vulnerable and you see the impact not just in growth but in inflation. You see also in the fiscal matrix because of course the Indian government offers one of the largest food subsidy programs in the world in terms of coverage of people.
Nigel: What is your expectation for food inflation for the month of July and also the trajectory till January 2016 and in fact factoring in unseasonal rains and monsoons as well?
A: We don't forecast month-to-month inflation at Moody's, at the rating agency but what I will say is that what we had assumed two months ago which is that the rainfall might reveal drought conditions doesn't appear to have come true. I think the rainfall has performed a little bit better than the initial estimates and the crops particularly the sowing patterns have been a little bit better than initially sown. So that in some ways mitigates some fears of food inflation but as you know, it depends on how the harvest occurs, how the distribution occurs post that harvest and sort of the measures that various state governments and the central government take to ensure the food inflation is kept limited. I think that we are seeing some of those actions come into place so our current assumption is that you are not going to see a spike in food inflation, knowing what we know today. But I think over the next three months we will know a lot more to make that forecast a little more strongly.
Ekta: When and what will possibly result in room to ease possibly by the Reserve Bank of India (RBI)?
A: I think there is a couple of things that the RBI itself has pointed too. One is a little bit more from data on where inflation expectations are going, where current inflation is of course and second is more knowledge of where fiscal policy is going. What we have seen in the last few months is that the Budget numbers are coming out as expected. We expect that the government will be able to meet its fiscal target and so that is another thing that favours perhaps later easing by the RBI. The big question over the next three months will be the effect that a potential US Federal Reserve rate hike could have on financial markets and the effect of that will have particularly on India's balance of payments and the exchange rate and I think that is going to determine actions in the next couple of months as well.
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