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Why a weak monsoon won't rain on India's parade

Chandan Khanna | AFP | Getty Images

India's monsoon isn't your average rainy season. Not only do the annual showers take on mythical importance for the 50 percent of the population dependent on farming, they are a headache for policymakers who worry that deficient rains could bring back ghosts of inflation past.

But that shouldn't be the case, economists argue.

"While the general belief is that monsoon failure would lead to skyrocketing inflation, led by high food prices, there's no conclusive evidence of this," said Société Générale economist Kunal Kumar Kundu in a note on Monday. "Structural impediments, not the monsoon, are the key driver of inflation."

Not everyone agrees.

For one, the Reserve Bank of India (RBI) has repeatedly noted that monsoon-related risks dominate its concerns around consumer price inflation (CPI). At the end of June, a few weeks following the start of the official monsoon season, S. S. Mundra, the deputy central bank governor, said rains would be monitored to determine whether another interest cut would be needed, Reuters reported.

Read MoreIndian parliament faces washout monsoon session

The RBI has slashed rates by 75 basis-points so far this year, including a 25 basis-point cut in June.

Spiking food prices have long been New Delhi's bête noire. After averaging around 10 percent in 2013, CPI halved to 5.4 percent as of June this year thanks to stringent efforts by current Governor Raghuram Rajan. The previous double-digit level was a major impediment to foreign investment and a chief factor behind India's 2013 market sell-off when the Federal Reserve first broached the idea of higher U.S. interest rates, known as the taper tantrum.

With data pointing to a shortfall of rain in July, the central bank is indeed on its toes. Cumulative rainfall between June 1 and July 19 was 8 percent below normal, Barclays noted on Monday, and the Indian Meteorological Department has forecast rains to be 88 percent of the long-period average.

If the rains weaken further this month and stay below-normal into August, inflation could breach 6 percent, DBS warned on Tuesday.

But Société Générale's Kundu says food inflation is more a result of sub-optimal policy choices rather than rainfall fluctuations.

"While we do believe that failing monsoon will raise food inflation, the overall impact is unlikely to be high enough (unless we see a real drought-like situation) to propel headline inflation to levels capable of materially threatening the RBI's inflation target."

Read MoreIndia monsoons: Another dry season ahead?

He believes that better policy responses, such as releasing the existing buffer stock of food grains to the market as a response to falling production, will help keep inflation in check.

Kundu is not alone in questioning the monsoon ideology. Thomas Aubrey, founder of consultancy firm Credit Capital Advisory, also warns of the monsoon's misleading importance to inflation.

"India's inflation challenges, particularly related to food, are more supply-side related and would be better resolved through further reform by Prime Minister Narendra Modi's administration in conjunction with a nominal income target," he said in a recent note posted on the firm's website.

"Jacking up interest rates every time the monsoon disappoints, particularly when by most measures Indian monetary policy remains far too tight, is a bad idea. Such an approach will only lead to more capital destruction, with higher levels of non-performing loans and businesses defaulting," Aubrey said.

But for now, additional easing from the RBI remains on the table given the monsoon's weak performance thus far, according to Barclays.

The central bank's next scheduled rate review is in August.