Some differences have crept up in the Monetary Policy Committee of the Reserve Bank of India over what the rate-setting body was guiding the markets over the next course of action. While some of the external members, like Jayant Varma and Ashima Goyal, are worried about the impact of high real interest rates on growth, the RBI members on the committee, led by Governor Shaktikanta Das, are warning that interest rates may not have peaked as inflation is not entirely in control.

Das’s worry seems to be the impact of the monsoon.

The next bone of contention could likely be how the committee members read the impact of monsoon, or the lack of it, on the monetary policy. Some signs of discord are already evident even as the monsoon current is expected to be hurt by the prospects of El Nino in India. In an interview this week, Jayant Varma said that monsoon is as much a growth shock as it is an inflation shock.

Whereas, MPC member and RBI Executive Director Rajiv Ranjan wrote in the minutes of the June meeting that a poor monsoon would hurt inflation a lot more. The weight of the farm sector in GDP is pretty low, whereas food in inflation is very high, he wrote.

So, what are the implications of poor monsoons on interest rates and markets?

Deficit Rains

The monsoon has started late. But that is not the main problem. In June, the overall deficit in rainfall was 10 percent. What is worrying about the rainfall this year is that it has not been evenly spread. The rainfall in the first half of the month was 51 percent below the long-period average, while it was 14 percent above average in the second half. The rainfall in June has been less than 80 percent of the long-period average in about 46 percent of the country. This has had a negative impact on the sowing of Kharif crops, which are planted during the monsoon season. As of June 30th, the sowing of Kharif crops is marginally higher on a low base. But rice, which is the main Kharif crop, is down 26.4 percent year-on-year.

But there is no reason for alarm. Not yet. Monsoons in July are more critical than in June. From a sowing perspective, monsoon performance in July is more important than in June, as nearly 80 percent of the sowing is usually completed by this period. The real worry remains the impact of El Nino. Although the IMD seems confident that the monsoon will likely be normal this year, statistics suggest otherwise. El Nino has a close relationship with rain in India. Since 1950, there have been 15 El Nino years and the monsoon was deficient (below 90% of the long period average) in 9 of those.

Out of the 11 years when monsoon was below 90 percent since 1950, nine have occurred during El Nino years. Even with El Nino, the distribution of the rainfall more than the quantity will be important. If the rice-growing areas have adequate rainfall, the impact on inflation may be low. El Nino is expected to affect rains in the second half of the season. The rainfall in the second half is crucial for rabi crops. Good rains in the second half keep the moisture level in the soil high, which is crucial for the rabi crops. Also, that is the time when reservoirs are recharged.

Inflation or Growth?

From a monetary policy standpoint, what would be important are international food prices, the government’s supply-side policies, and rural wages. Data shows that even when rainfall fell, food inflation was lower in 2014 and 2015 due to low international prices and low rural wages. This year’s trend will be significant. According to some estimates, rural wage growth has been low (however, urban wage growth has been high). There is still time for MPC to take into account all these aspects.

The impact of the monsoon on India's economic growth has weakened over the years. In the last 20 years, there have been three instances--2009, 2014, and 2015--when monsoon has been deficient. Though food grain production contracted in all these three years, the GDP grew between 7.4 to 8.0 percent in these three years (inflation too fell, as mentioned earlier).

The key worry with regard to growth, especially in the context of advanced economies staring at recession, is how deficit monsoons continue to impact rural wages and, consequently, rural demand and overall demand conditions. So, will weak monsoons sway MPC towards inflation (to keep policy hawkish) or growth (dovish)? It is early days. But MPC’s Varma may have compelling arguments when the committee meets next on Aug 8.