Tuesday, June 23, 2009

Sensex, Rains and a Little Boy

The Sensex has begun showing signs of recovery but a news item warns of a relapse due to “weakening of the monsoon”. A discussion in one of the sections revealed a fairly decent insight into how the summer monsoon affects both the farming community as well as the business community in India. Yet few issues needing further clarification did rise.


Q1. Is the Agriculture Sector Still That Important?

The question was based on the fact that the last time a failed monsoon brought the economy to its knees was in the early 50s. At that time the contribution of agriculture to the GDP was about 60% which fell to 30% in mid 90s and is hovering around the 20% mark. Yet the success of agriculture in India remains important as 70% of the population is still directly and indirectly dependent on it.

Consider this; In 2002 the rains failed and the agricultural output fell by around 8% and the GDP growth rate dropped from 5.8% to 4%. It is very simple; failed rains = failed crops = lower than expected income for 70% population = reduction in disposable income and therefore reduction in demand for almost all kinds of products and services. Of course some products are hit more than the others. For example, two wheelers and to an extent the four wheeler market will be hit hard.

It is only common sense that if demand drops at the grassroots level, the domino effect will cause slowdown across the board.


Q2. But How Does Rain or a Lack of it Affect the Sensex?

The previous answer would have made it amply clear that how monsoons behave has a definite effect on the demand patterns in India. It is only a fair assumption that a lower demand all over the country would eventually lead to an overall economic slowdown and since the sensex is barometer of the national economic activity it should reflect the downturn.

More than anything, the market is predominantly “sentiment” based. An overall slowdown means an overall slump in sentiment and this slump will be reflected on the bourses. So less rain = less demand = lower performance = lower expectations from the market = overall slowdown.

Remember the indices are bound to react to announcements especially the quarterly figures. So consider what can be the effect on few companies whose stocks are a part of the sensex:

·         ACC: lower rain, failed crops, lesser income, and postponement of new projects there fore a dip in demand for cement. Similarly Reliance Infra, TATA Steel, Larsen & Toubro, Jaiprakash Associates and Hindalco will be negatively affected.

·         TATA Motors: Similar to the ACC example, lesser disposable income means lesser demand for the consumer products like Indica and Indigo. Lowered economic activity and tighter purses mean lesser demand for commercial vehicles too. Similarly Mahindra and Mahindra and Maruti Udyog Ltd will be affected negatively.


In these two cases we have covered about one third of the sensex. So is it not obvious that if the majority of the companies in the sensex experience a downfall, the sensex may go down?


Q3. Ok Agriculture is Important. But Why are Rains Still Important?

Israel has been able to grow fruits in the Negev desert and farmers in India still depend on rains for watering their fields. Welcome to the concept of “Rainfed Agriculture”.

Lets go back in history. At the time of independence, the newly formed government was faced with running a country where a very large part of the humanity lived on the edge of sustainability. It was only natural that the government was concerned about what we might call growth at the grassroots level. One of the ways in which this growth was driven was through massive public investments in irrigation, agricultural research and extension, rural infrastructure, farm credit and rural development programs.

And even though we have miles to go, we have transformed from the “food insecurity” of the 60s to surpluses of today.

It is however very important to understand that almost all of the growth, research and development in agriculture has been in “irrigated agriculture”. Irrigated agriculture is agriculture carried out using man made irrigation facilities like canals and tube wells whereas rainfed agriculture depends solely on the seasonal rain for irrigation needs.

According to government statistics, rainfed agriculture accounts for about two-thirds of total cropped area nearly half of the total value of agricultural output. Nearly half of all food grains are grown under rainfed conditions, and hundreds of millions of poor rural people depend on rainfed agriculture as the primary source of their livelihoods.

Again it is a simple deduction that if 2/3rd of the agriculture sector in India millions of the rural folk depends on timely well distributed rains during monsoon, any abnormality or weakening of the monsoon will adversely impact the whole nation.


Q4. Ok. So Rains are Important, But is it Only the Amount of rain that Matters?

No. Amount of rain is one of the variables, the other critical variable is the distribution of rainfall.  In simple words it is not only how much it rains that matters, even when and for how long matters. For example let us say that the normal rainfall for the month of July for a particular place is 200 mm. If it rains on and off but the final figure indicates only 100 mm in July, it is obviously a problem. But in another situation, let us say there is very heavy rainfall and 200 mm comes down in just a couple of days, it actually means that even though the monthly targets have been met, it is still a problem. Ideally 200 mm rain in July at this place should be well distributed throughout July.

It is also important to point out that abnormal monsoon can be because of deficient as well as excessive rainfall. Even more rain than normal can cause problems. In countries like India and our south Asian neighbors, the primary crop during the monsoon season is Paddy (Rice and Paddy are different, find out how..) which needs a lot of standing water at all times. So excessive rainfall does not have that detrimental an effect, especially if the excessive rains were not accompanied by strong winds (winds can damage crop by logging).


Q5. They Say That the Monsoons are Failing This Year Because of the El Nino Affect. What is it?

El Nino stands for “The Little Boy” in Spanish. El Nino is what we call a weather phenomenon. Technically, it is called ENSO (El Nino Southern Oscillation). It is a very complicated cycle of temperature changes in the Pacific Ocean off the coast of South America that causes changes in the normal weather patterns. Warm ocean currents heat up the ocean and all sorts of changes to the wind patterns take place. Places that normally remain dry, gets plenty of rain like Peru and places where it is supposed to rain may see a reduction as is the case in India.  

Oh!! By the way there is another weather phenomenon which causes the exact opposite to what El Nino does. It is called “La Nina” or the little girl in Spanish!!


So we can see that the performance of the indices and monsoons are inextricably linked. But does it mean that every time El Nino strikes, we will have a drought and the sensex will crash? No!!! Weather systems and phenomenon like the El Nino are very unpredictable and so is their impact on India. But general indications are that El Nino means less rain and it is already happening is it not?

As far as the sensex goes, the logical link between El Nino and the sensex is undeniable but so many other forces are at play this year that the sensex is probably more unpredictable than the weather!!

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