Will the monsoon affect your portfolio?

In this issue:
» Can the new government combat food inflation?
» FMCG firms may not shine this monsoon season
» Oil prices give the government a fresh headache
» China goes the US way with subprime loans
» And more!

00:00

The Indian equity markets are climbing new highs almost every week. The optimism among market participants over the last one month has filtered down to almost every sector. Even stocks of companies with questionable fundamentals have run up a lot. In times like these it is more important than ever to be aware of the risks faced by companies that you are investing in. Sometimes the risk may not be very clear. At other times a very big risk, staring investors in the face, might go unnoticed in the market euphoria. When the reality of these risks comes to the fore, it leads to big losses. The equity markets might just be ignoring a key risk faced by the Indian economy right now.

The Indian met department has predicted a below normal monsoon for the year due to the El Nino. Now most people have never given too much importance to such predictions. However, we believe that it would be prudent to consider the consequences to the economy and to the market if the rain Gods were to be unkind to India. It is true that agriculture accounts for 17% of the economy. But it employs (fully or partially) nearly two thirds of the work force. Thus a bad monsoon will no doubt have a negative ripple effect on the economy. First and foremost, about half of India's arable land is not covered by irrigation. Thus, we can expect food production to be badly affected. The impact will be even worse if the rainfall is not well distributed across arable areas of the country. In such a situation, food prices will inevitably rise, leading to stress on household budgets. In addition to this, incomes derived from agri related activities are bound to fall. With less money being spent on discretionary items, rural consumption will take a hit. The consumption story is a key driver of the equity markets and many stocks in this space have become multi baggers over the last few years. So how can the government protect the economy from the annual risk of a bad monsoon?

The short term measures being considered right now are quite predictable we believe. The government plans to clamp down hard on hoarders to prevent sharp spikes in food prices. The finance ministry is also considering reducing import duties on pulses and oil seeds to counter the supply side shock. These measures may or may not succeed in controlling food inflation in the next few months but they are certainly not long term solutions. The new government has already highlighted food inflation as one of its key challenges. If it is really serious then it should permanently insulate the economy from the vagaries of the monsoon. Ensuring that 100% of arable land is put under irrigation will lead to stable food prices and end India's dependence on the rain Gods. Then the markets too will also be insulated from this risk faced by the economy every year. Other long term reforms like amending the archaic APMC Act and developing a system to provide farmers with real time price data will go a long way to boost agricultural incomes. Finally, developing the manufacturing sector will lead to more people moving away from their dependence on the rains for their livelihood. Nobody wants India to suffer a drought like situation. However, in the face of an imminent danger posed by the El Nino, we hope the new government will be proactive and bring about much needed reforms in the agri sector. For investors with a significant exposure to the consumption space, there is a distinct possibility of an adverse impact due to a poor monsoon. But it must be kept in mind that companies with strong balance sheets and good growth prospects will continue to do well.

Do you think that that a poor monsoon will adversely affect your portfolio? Let us know in the Equitymaster Club or share your comments below.

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01:45		Chart of the day

News of a high possibility of a poor monsoon season and El Nino effects has been making rounds for a while now. And going by this rationale, one would expect the demand-supply situation of agri products to become in favour of the former, leading to higher prices. However, as you can see from today's chart of the day, that does not seem to be the case. Prices of key products such as wheat, cotton, palm oil, rice, and pepper have all declined in the range of 4 to 8% in the month gone by. As per the Business Standard, this occurrence is largely due to the arrival of Rabi crops. How will things pan out for the future? Difficult to say as a host of factors determine agri commodity prices. Firstly there is of course the monsoon factor; secondly, there are fears amongst traders that the government's plan to keep a check on food inflation will keep pressure in prices.

Fall in prices of key Agri Commodities

02:10

As we pointed out above, if the predictions of the Indian Meteorological Department (IMD) are anything to go by, the new Government is likely to face its first big test over the next few months. We are indeed talking about the possibility of a deficient monsoon, any Government's worst nightmare. Thus, with the IMD predicting a lower than average monsoon this season, looks like the Government has already sprung into action. It's not going to be easy minimizing its damage though. Especially at a time when the food inflation in India is already running at elevated levels. One solace could be the comfortable wheat and rice stocks in the country. However, it is the oilseed, pulses and horticulture where the biggest impact could be felt. Another area where the impact could be felt is the Government's finances we believe. Relief in the form of things like diesel subsidy for irrigation and restructuring of loans in deficient areas could involve fund outgo, thus leaving that much less money for other developmental activities. Therefore, in other words, Mother Nature could indeed throw a spanner in India's economic revival plans.

02:38

The scorching summer and predictions of low rainfall can be a blessing in disguise for FMCG companies. As per a feature in Business Standard, beverage, ice-cream and dairy products manufacturers expect their sales to shoot up as people seek comfort in their products from the heat wave. The blazing heat coupled with improvement in consumer sentiments is likely to pace up the growth, which had slowed down last year because of an early monsoon. Weather plays a big role in the growth of FMCG sector as for products such as ice cream, juices and other beverages, the companies make more than 50% of their sales during summer. As a result, companies have already started building up inventories of fruit pulp and milk powder in order to meet the rising demand.

On the contrary, delayed monsoon affects the entire economy; which can have a prolonged negative impact on the sector. Increasing demand in rural areas is largely a result of good monsoon as it leads to increase in spending on essential items. However, if the rains are delayed it will result in low farm or agriculture income in the hands of rural people. This essentially means lower purchasing power. Also, bad monsoon will affect the crop; which will eventually lead to increase in food and input prices. This shall give rise to inflation and slow down demand across the country. Thus, in the long run, lower demand and high input cost because of low rainfall can actually prove to be a bane for the FMCG sector.

03:07

On one hand deficiency in rainfall is proving to be a major headache for the government, while on the other rising crude price seems to be exaggerating the pain. Crude prices have risen to a 9 month high over concerns that turmoil in Iraq will disrupt supplies from Middle East. It may be noted that crude supplies are already down due to a major outage in production from Libya. Thus, in such a scenario, if supplies from Iraq also weaken, crude prices will shot up.

Rising crude prices will be negative for India as it imports majority of its oil requirements. Higher prices will increase the import bill and widen the trade deficit. This will put a pressure on the Rupee. We believe it is high time that India takes steps to be self sufficient in its energy needs. It is not that we are deprived of crude oil reserves and hence are import reliant. It is just that the policy on exploration and production (E&P) is not growth oriented with conflicts arising over sharing of profits, cost recovery benchmarks etc. Thus, the government should come out with a more transparent and business friendly policy which will encourage investment in the sector. This shall reduce our dependence on oil imports at least to some extent.

03:45

Eight years have passed since the subprime crisis surfaced in the US. And by now it is fading from our memories. However, China seems to be preparing to remind us of it. As per an article in Bloomberg, the current trend of 'zero down payment 'in China is a scary reminder of the subprime bubble. The ghost cities in China are a reflection of the frothy property market. However, in a bid to remove the signs of glut in property markets, the housing financers are easing up down payment norms. The authorities defend the decision citing the need to offer easy payment terms to students and fresh graduates. However, loosening down-payment requirements could erode China's financial stability. Banks in the country already have a shoddy track record in sustaining asset quality. In addition by allowing realty companies to flourish, the economy could be skirting with a banking crisis in the years to come. At a time when China is headed towards the weakest growth in 24 years, a subprime crisis-of-sorts could lead the economy to a very hard landing.

04:35

The Indian stock markets are in a free fall. At the time of writing, the benchmark BSE-Sensex was down by 320 points (down 1.3%). All the sectoral indices were trading in the red with realty and consumer durables stocks being the biggest losers. Barring Japan and China, majority of the Asian stock markets were trading weak today. European markets have also opened the day on a negative note.

04:50

Today's investing mantra

"I think you should read everything you can. In my case, by the age of 10, I'd read every book in the Omaha public library about investing, some twice. You need to fill your mind with various competing thoughts and decide which make sense" - Warren Buffet