Uneven monsoon could lift inflation, hurt rural economy: S&P

New Delhi: A weak southwest monsoon could push India’s inflation to 5.1% in FY27, hurt rural demand and put pressure on sectors from agriculture and microfinance to tractors and two-wheelers, even as the broader economy and banking system remain resilient, S&P Global Ratings said in a report on Monday.

The India Meteorological Department (IMD) expects the southwest monsoon to reach around 90% of the long-term average (LPA) in 2026, while the new El Niño conditions are likely to intensify during the season, increasing the risk of deficient and patchy rainfall.

The twin impact of poor rains and rising farm input costs due to geopolitical tensions could hurt farm incomes, raise food prices and slow rural consumption. S&P expects higher food and energy prices to lift headline inflation to 5.1% in FY27, likely prompting the Reserve Bank of India (RBI) to keep monetary policy on a slightly tighter footing. Food accounts for about 40% of India’s CPI index, making inflation particularly sensitive to disruptions in agricultural production.

Read also | “A bad monsoon is a risk but unlikely to trigger food inflation”

India’s retail inflation accelerated to 3.93% in May, up from 3.48% in April, driven by higher food and fuel prices.

“The inflation outlook is favorable here as a weak monsoon has the potential to push inflation above 5% this year. This will become clearer once we reach September. This upward trend, in my view, supports the rate hike outlook. Core (inflation) is also rising and not falling,” said Madan Sadnavis, Chief Economist, Bank of Baroda.

Last month, the RBI’s monetary policy committee kept the repo rate unchanged at 5.25%, citing geopolitical risks, supply chain disruptions and weather-related uncertainties.

The most vulnerable

The S&P report has identified agrochemicals, tractors and two-wheelers as the most vulnerable sectors, noting that these segments have seen around 10% decline in volume during previous weak monsoon years, including 2009, 2014, 2015, 2018 and 2022. Rural FMCG companies may continue to face less impact.

While agriculture contributes about 18% to India’s gross value added and employs nearly 40% of the workforce, S&P noted that the economy has become less dependent on the agricultural sector over the past three decades as manufacturing, infrastructure, finance and technology have come to the fore.

India’s economy grew by 7.7% in FY26, while agriculture grew by 3%, helping to cushion the impact of a weak monsoon on overall economic activity.

Read also | Will El Niño derail India’s monsoon this year?

In the power sector, annual hydroelectric production could fall by 10-15%, with some states seeing a 20-30% drop. But S&P said the impact on the nation’s power system would be limited, as higher coal-based generation and a modest increase in solar output could offset most of the hydropower shortfall.

The report said banks are likely to see slower rural credit growth and a slight deterioration in asset quality, particularly in agriculture-linked portfolios, but diversified loan books, prudent underwriting standards and government support should limit the impact on earnings. Agricultural loans account for only 12.9% of total bank loans, while rural and suburban loans make up about a quarter of banks’ loan portfolios.

However, microfinance institutions remain more exposed as almost 80% of their loan portfolios are rural, with significant exposure to agriculture and allied activities. S&P said that while regulatory safeguards and stronger underwriting have improved the sector’s resilience, persistent inflation and weak farm incomes may impact borrowers’ ability to repay.

Limited financial impact

On the fiscal front, S&P said a slight lack of rainfall will have only a limited impact on government finances, but a prolonged dry spell could force the Center and states to expand food and fertilizer subsidies as well as rural employment programs, which could complicate fiscal consolidation efforts.

Despite near-term risks, the rating agency said structural improvements — including wider irrigation coverage, higher crop insurance penetration, increased minimum support prices, fertilizer subsidies and stronger rural household finances after two good monsoons — should help curb broader credit stress in the financial system.

Read also | A weak monsoon may reduce paddy area, raising concerns about rice production and inflation

cOn May 29, the IMD revised its 2026 southwest monsoon forecast to 90% of long-term average (LPA) rainfall of 87 cm, down from an earlier estimate of 92%, citing El Niño conditions.

India experienced its driest June in over a decade and the fifth driest since records began in 1901, with southwest monsoon rainfall 39.8% below the LPA. The country received 99.5 mm of rainfall during the month compared to the normal 165.3 mm.

On June 30, the IMD said India is likely to see below normal rainfall in July, at less than 94% of the long-term average. The Southwest Monsoon, which accounts for 70% of the country’s rainfall, has already covered most of the country and is expected to cover the remaining parts in the coming days. The monsoon hit the Kerala coast on June 4, three days after its usual start date of June 1.