Monsoons: Lifeline of Indian Economy

Posted in Finance Articles, Total Reads: 2660 , Published on 21 August 2012
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Long long ago, So long ago, Not so long ago, But a little long ago – There were good monsoons. Everyone knows Monsoons are the lifelines for India. The direction of these trade winds that blow for a period of three months over the Indian subcontinent can lead to situations as extreme as drought on the one hand to floods on the other.

In the present year, we have been reeling under the effects of a weak and deficient monsoon. A poor and deficient monsoon results in

  • Lower farm yields
  • Water Deficiency
  • Cashless farmers, to quote the major ones among a host of other after effects.

Here we try to find out the impact of each one of these factors on the stocks in sectors of equity markets.


Cashless farmers:

This has a direct bearing on the sales of farm equipment like tractors and tillers. The slowdown is already evident among the tractor manufacturers with the industry recording a muted sales growth of 3% this year. Consequently, stocks like Mahindra & Mahindra and Escorts tractors which have respectively 40% and 10% market share by volume get affected. It is a no brainer that they have reported 0.5% and 20% fall in sales recently.

One step ahead lies the market for agriculture supporting activities. It becomes difficult for farmers to use agricultural applications like power sprayers, pump sets, power reapers and power tillers in the wake of weak monsoon. Needless to mention stocks like Greaves Cotton gets affected from it.

Before mentioning about FMCG Industry, an important point to note is that the rural FMCG market had posted growth in excess of 40% while compared to a moderate growth in the urban segment. This has been possible due to the rise in rural income coupled with the welfare schemes of the government like NREGA which fuelled the growth aspirations of the FMCG giants. As a direct outcome of this, rural segment now accounts for revenues as high as 30-35% for major FMCG giants like Hindustan Unilever Limited, Dabur India Limited, Marico and Godrej Consumer Products Limited, especially for their consumer durables product line.

Lower farm yields bring a decrease in rural per capita income which forces the rural people to fall back to commodities than packaged goods to reduce their rural consumption which hits FMCG sector badly. There are two notable exceptions to this direct correlation - Giffen goods, which do not come under FMCG umbrella and urban markets, which are nearing saturation. As a result of this, most of FMCG firms bank on rural market. However, there is a time lag before this effect gets captured and the impact is more pronounced near festival season which is about to arrive in a few months.

The monsoon has been 22% less than the LPA (long period average) this time, as reported by MET and as it has been mentioned till now, this has a bearing on almost all the sectors related to agriculture. To add to the list above, we find that in anticipation of a weak monsoon, the average spending done by a farmer on seeds, fertilizers and in general on crops declines due to the decrease in affordability.

The companies which are mainly in this business segment- the seed companies and the fertilizer and pesticide companies such as Rallis India, Coromandel Fertilizers, Chambal Fertilizers etc. are the ones which have to bear the brunt. There are a few that escape this fate which happen to be in perennial demand fertilizers segment such as urea.

Water Deficiency:

If there is lack of water, for meeting requirements, we need to get water by alternative ways because the conventional ways such as wells, bore wells, tube wells and natural sources such as ponds dry up due to no ground water recharge. The alternatives can be through the use of mechanized drilling to reach deep down into the earth or by purifying sea water by the use of advanced techniques such as reverse osmosis. Due to this, the demand for engineering equipment and heavy machinery increases and there by BHEL, Larsen etc can pick up.

But since the volumes for agriculture unit manufactured by engineering sector proportion is less and hence impact is little.This is coupled with an increase in demand for oil and gas – fuel required to run these equipment. To add to the woes, it is hard to expect fuel subsidy or any help from government in this case, as government tries to focus on reducing loan burden on farmers and equalizing supply and demand prices of basic food.

A poor monsoon also affects the power sector. There has been a drive towards the renewable sources of power generation. However, with the poor monsoon, the generation of hydroelectric power, economical power source, declines which puts pressure on other forms of power generation such as thermal, wind, solar, nuclear and geothermal to meet the ever increasing demand requirements and it becomes difficult to pass on this cost to the end consumers. Utilities sector comes into action andmajor stocks affected areSuzlon, NHPC, Adani Power, Tata Power, Reliance Power.

Lower farm yields :

In the article we have talked about the effect of monsoons on the demand side. But it does not stop there; we have supply side shocks also coming due to weak monsoon. Supply side economics gets adversely affected due to the paucity of raw materials in food & beverages segment which accounts for 40% of the total revenues of the FMCG companies. This, in turn, leads to inflationary pressures on the supply side. Even for companies like Nestle which has a product mix which is less likely to get affected by rural demand, the supply side would be adversely affected.

Government has made agriculture a priority sector in lending for banks and precisely this is the reason that agricultural credit which was previously dealt with mainly by cooperative banks has now been dominated by commercial banks. However, as mentioned above, the decline in farm produce reduces the debt repayment capacity of the farmers who are completely dependent on the agricultural output for their operational expenses.

Consequently, the NPAs in this sector increase for the banks, more so for the banks which derive majority of the business from agricultural lending, such as small cooperative banks and some commercial banks like Dena Bank, Bank of Baroda which have higher percentage of lending done to this sector. This hit directly affects the top as well as the bottom-line for the banks which is more intensified than consumer durables, where the effect is limited to an increase in cash conversion cycle. Banks have to write losses and revenues may very well become negative.

Carry forwarding above point, this even has a bearing on the Non Banking Financial Institutions (NBFCs) some of which are purely engaged in agriculture financing. Most of the times these NBFCs are a part of some of the big companies which manufacture farm equipment and accessories (e.g. Financial services arm of Mahindra and Mahindra which lends to farmers for purchase of tractors). The interest rate charged by these is slightly on the higher side and in this situation and the chances of the loans going bust increases.

The tremors of rising pressure on the income statements of the banks can be felt across the economic and financial indicators of the country as it is the banks which deal with creation of money supply in the economy and the economic strength of a country depends on the strength of its banking and financial services sector. If such a banking industry is affected with shortage of money, harder it becomes to provide the loans and capital intensive sectors such as Infrastructure and Real estate which completely depend on loans get affected.

There is a radically different view to take into consideration as the infrastructure and construction activity gets delayed when there is a good monsoon and one can argue that a weak monsoon might improve the activity in this sector. However with the use of advanced technology and few proactive measures which most of construction companies are following, the effect of rains can be minimized.

Monsoons can change the fate of many companies from specific sectors independent of political influence, fiscal policies or regulations which are hitherto considered to be more impactful than monsoon. Care should be taken to analyze few more factors before picking the stock from any sector some of which include:

- Geographical location of company and respective rainfall status at theplace – a company which has a locational advantage of having a plant at a “wet” place is less likely to be affected

- Portfolio of company – a well diversified company is less likely to get hit across all of its businesses compared to a niche business firm.

This article has been authored by Sivakumar Nandipati & Mrinal Roushan from IIM Indore.

Image: FreeDigitalPhotos.net


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