Parched Economy: DNA 17th August 2009

The prospect of a monsoon failure and a drought is scary not just because it means the obvious pain caused to people who derive a living from it. A monsoon failure actually affects every segment of the economy. The stress it causes calls for policy actions that would once again upset the apple cart. It goes beyond those numbers shown on the calculators or the back of envelopes.Agriculture per se accounts for around 18 per cent of GDP which means that all those who derive their income from this sector would face declining incomes. Around 60 per cent of our workforce is employed here which means that these families will have to face hardships for the entire year until the next season if they were solely dependent on farming for a livelihood which would be so in over half the families. The meltdown caused by a drought can be traced from the time the harvest is impacted.First, the incomes of the farmers get affected as the kharif crop provides at least 60 per cent of the income to farmers, even those who follow dual cropping covering the two seasons. A loss of income affects their consumption power which gets reflected in lower demand for goods. The limited income earned is used for sustenance. White goods and rural housing (and by implication cement, steel and machinery) will see a fall in demand. A related fallout is unemployment, which can only partly be compensated for by the National Rural Employment Guarantee Schemewhich again provides income for sustenance but cannot start a spending spiral. A more serious fallout is urban migration which has already been prompted by the relative unattractiveness of farming to manufacturing and service jobs (such as unskilled labour, coolies, running small retail outlets, road labour) in cities. This has medium-term implications for agriculture as there will gradually be less labour available to cultivate land.Industry will also be affected in a dual manner. The first is low demand from farmers starting from October onwards when the harvest begins. On the supply side, the food industries will be affected in terms of supply of inputs such as oilseeds, cereals, sugarcane which will increase costs while putting pressure on availability. While industrial growth is still possible at an elevated path notwithstanding this slowdown if the non-rural middle and upper classes continue to spend, that growth would have been smoother with support from the farm sector.Intuitively one can smell higher inflation this year as food prices will continue to be under pressure. The fuel price hike has already increased cost of transportation of farm products and limited supplies will accentuate it. It may just be a goodbye to the 5 per cent inflation number. Typically government's reaction to a drought is to increase the Minimum Support Price (MSP) of all farm products at harvest time which has high latent inflation potential.In the past the government has acted proactively, albeit with a characteristic delay, to supplement domestic production with imports when production falters. It happened with wheat in 2007 and sugar this year. Interestingly, whenever the Indian government plans to import food products, there is a ratcheting of global prices. The trade balance will be affected as imports will increase thus putting pressure on the rupee even if other conditions remain constant.Droughts always invariably lead to higher government subsidies and outlays which mean further pressure on the fiscal deficit. Programmes have to be introduced to provide more employment to the unemployed, increased quotas for those covered by the Public Distribution System, outlays on fertilisers and other inputs. The fiscal deficit level of Rs4.5 lakh crore will be surpassed depending on the extent of government intervention. Therefore, fiscal policy will come for further review in these circumstances which will once again raise questions on government borrowing and movement in interest rates.Lastly, the Reserve Bank of India will have to get active. Anecdotal evidence shows that farm failures invariably lead to interest rate subvention, loan waivers (we are just trying to put to an end the earlier scheme which cost more than Rs70,000 cr) and public sector banks being forced to lend more to farmers through various resuscitation packages.Therefore, the impact of a drought is all-pervasive and all sectors intertwined in some way or the other would have to brace up to face the challenge. Even with its small share in GDP, the farming sector could influence the way in which the entire economy conducts its operations. Unfortunately, there is no solution for avoiding drought -- the only common-sense hint being that we need to spruce up our attempts at providing irrigation to more farm land -- against the low 20 per cent that is covered today. There is really no alternative if we do not want to hear the replay of this story again in the future.