Weak Monsoon Another Headache for India’s Central Bank?

A weak monsoon this year, which is threatening India’s already slowing economic growth while fueling inflation, could put the central bank in a quandary ahead of its policy review meeting on Tuesday, experts tell CNBC.

Indian children fish underneath monsoon clouds on the outskirts of Siliguri
Diptendu Dutta | AFP | Getty Images
Indian children fish underneath monsoon clouds on the outskirts of Siliguri

The Reserve Bank of India (RBI), which has been under pressure to reignite growth in the absence of structural and economic reforms by the government, kept rates steady at its last meeting in June on inflation concerns.

This time around a weak monsoon may pose a challenge for the central bank, say economists, as below par rainfall could send food prices even higher while also further stalling economic growth.

“Monsoons have significant implications for the Reserve Bank of India. Food inflation - a driver of inflation expectations - is in double digits. The RBI will be careful around the monsoons," Rahul Bajoria, Regional Economist at Barclays told CNBC.

Weak rainfall translates into lower output from the country’s agricultural sector, which accounts for around 20 percent of gross domestic product (GDP), as well as leads to higher food prices that have been on the climb, rising 11 percent in June year on year.

“I’m worried about inflation and the negative impact of a bad monsoon - food inflation could go towards 15 percent during the course of the year,” Sonal Varma, Mumbai-based economist at Nomura, said.

The critical June-September monsoon rains – when Indian farmers plant most of their summer crops - were 29 percent below average in the first month of the season, and have been 15 percent below average in July. The government, which raised the possibility of a drought last week, said it will assemble a specialist panel of ministers this week to review the monsoon situation.

Despite continued pessimism over India’s sluggish growth, the RBI is expected to give more weightage to inflation, and hold rates at 8 percent on Tuesday, according to economists polled by CNBC.

The recent rise in global oil prices – which have jumped 13 percent from the June lows - as well as the weaker rupee are adding to already high inflation, says Taimur Baig, Chief India Economist for Deustche Bank.

According to Leif Eskesen, Chief Economist for India at HSBC, “A significant portion of India’s economic problems are unrelated to interest rates. It’s related to lack of supply-side reforms which have allowed supply-side bottlenecks to build up. That’s why there has been a slowdown in growth and inflation hasn’t decelerated.”

The rise in India’s main inflation gauge – the Wholesale Price Index (WPI) – eased to7.25 percent in June, from 7.5 percent in May, but the RBI’s governor said it was still above the central bank’s comfort level, Reuters reported.

However, economists say the RBI is likely to resume its rate cutting cycle later this year. It had last cut rates by 50 basis points in April.

“We think RBI would signal a possible small window for rate cut in the fourth quarter, contingent on inflation stabilizing below 7 percent and some fiscal steps taken by the government in the interim,” Baig said.

By CNBC's Ansuya Harjani