El Nino and the Fate of Agri Commodity Prices

The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.

- William Arthur Ward

A weather pattern called El Niño has cast a dark cloud over the prospects for Indian agricultural production in 2019.

This phenomenon, coupled with other factors such as low-interest rates, seasonality and higher minimum support prices (MSPs), could impact agri-commodity prices in the months ahead.

Does this mean inflation will bottom out and start heading north? And more importantly, does it present an opportunity for agri-commodity market bulls?

India has witnessed combinations of these factors in the past and revisiting those situations could guide us about how things are likely to pan out…

But first, what’s the El Niño effect?

Every 4-12 years, the central and eastern surfaces of the Pacific Ocean get noticeably warmer-than-average. This deviation from normal is called El Niño.

As this mighty ocean covers over 30% of the earth’s surface, it’s not difficult to imagine that when it has a mood swing, the rest of the planet feels the impact but with varying outcomes and degrees of impact.

So while Australia, Chile, Indonesia, India, Japan, New Zealand and South Africa face drought-like conditions and consequently, a lull in economic activity after an El Niño weather shock, the US, Europe and China could typically face wetter winters but could still actually benefit economically, from such a climate change.

And is 2019 the year of the El Niño?

After much debate, it was finally confirmed that 2019 is experiencing a weak El Niño. Skymet Weather explained that El Niño is declared when the Oceanic Niño Index (ONI) is higher than or equal to 0.5°C for an overlapping period of 3 months for five consecutive episodes. And as things stand, The Nino index exceeded the threshold value of 0.5°C for the required period of time.

The India Impact - Revisiting El Nino and Drought Years in India

Here’s something to mull over. Since 1980, the five most severe drought years - 1982, 1987, 2002, 2009 and 2015 – were El Nino years. In 1991, we had a near-drought experience in the country; guess what? It was an El Nino year.

But then again, three El Nino events - 1994, 1997 and 2006 - didn't impact the Indian monsoons at all. Interestingly, three other droughts we faced since 1980, i.e. in 1986, 2004 and 2014, were not during 'officially declared' El Nino years.

So the connect between drought and El Nino is not really that straightforward. All we can say is that El Nino has been known to be accompanied by drought. Even our weather forecasters are unsure about what will ensue; while the IMD has forecast 96% of Long Period Average (LPA), suggesting a near normal monsoon, the private forecaster Skymet has predicted 93% LPA rainfall, which would clearly make this monsoon below normal.

Recent correlation between El Nino and Food Grain production

Now, having said that a drought is likely but not certain, let’s look how it could impact us in the worst case scenario, i.e. in case the El Nino does trigger a drought. The south west monsoon delivers 70% of India’s rainfall and most agricultural activities depend upon it. If there is any delay or deficit in rainfall it could adversely affect food grain production. The table below illustrates how food production declined during El Nino years (2009, 2015) and during years of below normal rainfall (2018).

Source: Times of India, Ventura securities

Lower growth in food grain production has usually resulted in higher commodity prices…

Commodity price performance

Source: NCDEX, Tickerplant, Skymet, Ventura Securities

Our learnings from the past don’t end here…there are other factors that could compound the El Nino impact on Agricultural output.

Lower inflation and interest rates

India's retail price inflation rate rose to a five-month high of 2.86% year-on-year in March 2019 from 2.57% in the previous month, slightly above market expectations of 2.8%. Food prices rose for the first time in six months. However, the current inflation rate in India is low compared to its longer-term average of 6.18% for 2012 to 2019 and its all-time high of 12.17% in November of 2013.

India’s Retail Inflation Rate

Source: Trading economics, Ventura Securities

 This falling inflation rate trend has given the RBI leeway to reduce interest rates.

India’s Repo rate (Interest rate)

Source: Trading Economics, Ventura Securities

In order to give the economy a fillip, the RBI has been reducing interest rates and taking measures to infuse greater liquidity into the system, in order to boost the economy. Lower rates and better liquidity, in good measure, is a recipe for higher prices.

 Higher MSP price will increase agri-prices

On 3^rd Oct 2018, the Cabinet Committee on Economic Affairs (CCEA), headed by Prime Minister Narendra Modi, approved higher minimum support prices (MSP) for winter-sown or Rabi crops. The Government also increased the prices of Kharif crops during first week of July 2018.

Source: Ministry of Agriculture & Farmers Welfare, GOI, Ventura Securities

The below table illustrates, most commodity prices rose, mainly due to MSP price increases in July and lower production

Source: NCDEX, Ticker plant, Ventura Securities

Moving forward, higher MSP prices will result in higher agri-commodity prices.

The seasonality trend is expected to drive prices upwards too

Our seasonality trend analysis form 2011 to 2018 for Kariff crops, such as Soyabean, Cotton and Turmeric, etc., reveals that prices bottom-out during the peak Arrivals season and peak before the Sowing season starts.

For example, the price of MCX Cotton bottoms out during December to January and peaks before the next sowing season. In the case of Turmeric, the price peaks during December months (before the harvest season starts) and reaches the bottom of the trough during May-June each year. The trends for Rabi crops such as Rm seed, Wheat, Maize, Jeera and Dhaniya are similar.

While the seasonality effect is quite strong, it is further fuelled by any delay in the Monsoon (or lower rain fall and the festival seasons which lasts all through August to December. In the event of an El Nino that causes chaos in our monsoon, we can expect the seasonality factor to be aggravated.

 Crops to Watch: Longer cycles and crops in Arrival season usually deliver higher price rises

Prices of crops like Sugar and Turmeric outperformed considerably during El Nino years, mainly due to longer crop cycle periods. Sugar usually takes 10 months to a year from sowing to harvesting and Turmeric has a crop cycle of 8 to 9 months.

Further, in the Mandi, some commodity prices, such as that of Chana (Rs 200 to Rs 300 below MSP Price), are still below the MSP. This is mainly due to the Arrivals seasonal effect; once the Arrivals season is over, we expect these Rabi crop prices to rise in the coming months.

 Agri-commodity price are also impacted by other factors, such as movements in oil prices and the Rupee exchange rate, import/export duties, etc. Depending on how these factors move, they could exert an upward or downward pressure on agri-commodity prices.

 So, what’s the ‘Endgame’?

The confluence of monetary stimulus, higher MSPs and the El Nino effect, conditional on its impact, may drive agri-commodity prices upwards.

 The important question is: even if the monsoon fails, will it necessarily fuel (raise) the inflation rate?

In 2014-2015, which was a drought year for India, commodity prices did not move much as compared to the 2009-10 period, mainly due to a tighter monetary policy. In 2009-10, when the world economy was recovering from the sub-prime economic crisis in the US and El Nino conditions prevailed, headline inflation was low at 3.8%, agricultural growth was 0.8% and overall GDP grew at 8.6%. On the other hand, inflation rose very sharply in 2010 because of monetary stimulus (lower Interest rates) and higher MSPs, which increased the prices of food grains.

Similar trend can be expected in 2019-2020, if the monsoon fails...

Currently inflation rates are low and the RBI has lowered interest rates, which may trigger rises in agri-commodities prices in the coming months.

Disclaimer: Ventura Securities Ltd has taken due care and caution in compilation of data for its web blog. The information has been obtained from different sources which it considers reliable. However, Ventura Securities Ltd does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Ventura Securities Ltd especially states that it has no financial liability whatsoever to any user on account of the use of information provided on its web blog. The information provided herein is just for the knowledge purpose and shouldn’t be construed as investment advice under any circumstances.