Central Banks

El Niño cloud hangs over Asian stimulus

NOAH SEELAM | AFP | Getty Images

Adverse weather could hit central banks' scope for stimulating emerging markets, economists have warned.

In a report, Hak Bin Chua, economist at Bank of America Merrill Lynch (BoFA), cautioned that Asian central banks faced "risks and uncertainty" from the El Niño phenomenon, with "potential severe weather shocks on growth."

Caused by cyclical warming of the Pacific Ocean, this year's El Niño is the first in five years. Australia's Bureau of Meteorology recently warned that current levels of warmth across the Pacific are higher than normal and reminiscent of 1997's event – the most severe one on record.

Higher temperatures and drought - characteristics of El Niño- are expected to drive up food prices and inflation in countries like India and Indonesia, where the share of food in consumer price inflation is large.

In the three quarters following an El Niño occurrence, inflation tends to spike 1 percent in Indonesia, 0.6 percent in India and 0.5 percent in Thailand, Chua noted.

"That may narrow the room for easing monetary policy and cutting interest rates," he said.

A country-by-country look

Indonesia tends to suffer the most, with gross domestic product (GDP) dropping nearly 1 percent in the two quarters after the event, Chua noted. The unfavorable weather hits the agriculture, forestry and fishing sectors, which account for 18 percent of Indonesia's GDP.

With inflation accelerating to 7.1 percent on year in May, Barclays expects interest rates to stay unchanged for the rest of this year. Credit Suisse echoed that view, expecting Bank Indonesia to ease only when annual inflation falls to 4 percent.

For India, a strong El Niño weakens the country's annual monsoons during the June-September period.

El Nino's impact on soft commodities
El Nino's impact on soft commodities

This year's rainfall is already expected to be below average and the additional impact from El Niño could see a return of high consumer price inflation, said Radhika Rao, economist at DBS.

"Assuming food inflation quickens to 7.5 percent on year in 2015, headline inflation could rise above the RBI's 2-6 percent inflation target." That will derail India's disinflationary trend, and delay rate cuts until the end of the year, she added.

Read MoreRBI cuts rates forthird time this year

In the Philippines, drier-than-normal weather conditions have seen vegetable prices rise and with a strong El Niño looming, the central bank won't be taking any chances despite a drop in near-term inflationary pressures, Barclays said in note.

"We continue to think it is unlikely the BSP will join other central banks in easing monetary policy. We forecast the next policy move to be a hike, most likely in the fourth-quarter."

Bucking the trend, the Bank of Thailand will likely be less concerned about price pressures, said BoFA's Chua.

"Thailand may be better placed this time given the large rice inventory (which will benefit from higher food prices), a more diversified economy, and negative headline inflation."

The central bank left its benchmark interest rate unchanged at its policy review on Wednesday following two straight cuts.