It could be one of those years when exposure in commodity futures, along with equities could be a good investment strategy.
One key factor in the turnaround of 1991-96 was five decent monsoons in a row. Since then, the rainfall pattern has been more hit-and-miss. It appears that 2009 is not going to be a good year. Since only about 35-40 per cent of arable land is irrigated, a weak monsoon always has a significant impact on the economy.
However, the influence of the monsoon on GDP is less in 2009 than it was at the time of liberalisation. In 1992,.agriculture generated around 33 per cent of GDP while services and manufacturing contributed 40 per cent and 27 per cent respectively.
As of 2008, agriculture contributed only 17 per cent to GDP while manufacturing and services contributed 29 and 54 per cent respectively. Agriculture now has only 15-16 per cent weight in the wholesale price index.
Obviously in value terms, agriculture is the least important sector. But over 60 per cent of the workforce is officially estimated as agricultural labour. According to Dipankar Gupta, this may be a gross over-estimate because a worker is considered an agriculturist if he or she has worked in the sector for a single day in the past year.
Nevertheless, over 50 per cent of India's population does live in its villages and small towns. So, a poor harvest does have an adverse impact on consumption patterns. The importance of the monsoon was underlined in 2003-04 when the economy started to climb out of a long recession (2000-2003) on the back of a good monsoon and 9 per cent growth in agriculture.
Agriculture is the most volatile sector in terms of expansion-contraction patterns. Since 1992-93, manufacturing and services have never registered negative growth whereas agriculture has on several occasions. In 2002-03, agricultural GDP shrank by over 5 percent. Even with the bumper performance of 2003-04, food production was no better than in 1999-2000.
Agriculture is also difficult to estimate in value terms due to its inflation-sensitivity. If supply tightens slightly, food prices can spike a lot. A trader may make far more profits during a drought than after a bumper harvest. For example, sugar, soya, pepper, etc, have risen on the back of poor monsoon forecasts.
Additional issues such as politically-controlled procurement prices and an absence of free markets adds to challenges in estimation. But one can safely assume changes in agricultural GDP have big effects on sentiment. This will be the case until a much larger chunk of the labour-force moves away from agriculture. Food scarcity also makes poverty-reduction programmes more expensive.
Will a poor monsoon be enough to end the runaway bull market we have witnessed since March? Apart from the impact on sugar, cotton and other agricultural products, a poor monsoon usually hits two-wheelers, tractors, lower-end FMCG goods, etc. This year, it may retard growth in the telecom sector, which is relying on strong rural penetration.
A poor monsoon and lower rural spending is also likely to have a negative impact on transport-related revenues such as toll collections and railways freight. It may panic the government into further Budgetary subsidies for an already-subsidised sector, stressing weak government finances. If fears of a poor monsoon does trigger a big market correction, does it create a buying opportunity?
Some institutions believe it will. JP Morgan (JPM) for instance, has released an advisory that projects a weak monsoon as a “near-term pressure point” and a buying opportunity. JPM projects fair-valuations of between 15,100 and 16,000 for the Sensex (using different models) in a 12-18 month timeframe. JPM also projects a high low trading range of between Sensex 12,500-16,500 inside the next 9 months.
That trading range implies a correction that knocks 13-14 per cent off current values, followed by a rally of some 30 per cent. The further advice is that portfolios should be rebalanced to downgrade consumer goods and increase tech-service exposures. This is despite the apparently gloomy outlook for the IT sector, due to the US recession.
It may make sense to seek some diversification into agri-commodity futures as well. The danger is the government often indulges in knee-jerk bans on food-trading in times of scarcity. Nevertheless, this is the classic hedge. Commodity exposures are often recommended by portfolio theorists because movements in equity markets and commodity futures are often uncorrelated. This could be one of those years.
