A lot of investors pin their hopes of a bullish market on monsoons, and rightly so, because monsoons substantially affect the stock market. But, why is monsoon such an important factor affecting the stock market?
Why does monsoon affect stock markets?
In India, southwest monsoon hits the coast somewhere in the second week of June and stays until the end of September. It is estimated that India receives 75-80% of its total rainfall in this period of four months.
Several aspects of the economy are dependent on normal rainfall. The most important of these would be agriculture. India is still an agrarian economy, with several industries such as pesticides, fertilizers, grains, edible oil, tea and coffee dependent on agriculture. A deficit in rainfall implies that agricultural production will suffer; this sets of a chain of reactions in related industry sets.
Monsoon Deficit – A Chain of Reactions:
Deficient rainfall has the potential of uprooting various subsectors of the economy through a chain of reactions.
The Agriculture impact
A single deficit monsoon can have devastating impacts on various sectors of the economy. If rainfall is deficient, it leads to delays agricultural activities, such as production of important grains, cash-crops, and harvesting.
Agriculture contributes ~17% to India’s GDP, while employing about 48% of the total workforce. A fall in the production of crops can lead to a decline in the Gross Domestic Product (GDP) of the economy - even a small decline in the GDP vis-à-vis forecasts could dent investor confidence sending markets in a tizzy.
Apart from a direct impact of agriculture on the economy, there are also a few other effects.
Lower agricultural output results in lower rural income. Rural income largely affects regional rural banks, microfinance companies, and rural non-banking financial institutions (NBFCs) because declining incomes of farmers may lead to an increase in non-performing assets (NPAs) and bad loans. A large proportion of companies listed on the NSE are involved in rural finance and related sectors.
In addition, rural income directly affects consumer goods firms’ performance. Further, the sale of tractors and other farm equipment is also impacted, causing a decline in corresponding sectors/stocks if rural income falls.
Exports & Foreign Currency Reserves
When the monsoon is normal or above normal, there is surplus production of grains and other crops. This surplus is usually exported to other countries, which repletes India’s foreign reserves.
The stock market’s performance significantly depends on exports and foreign currency reserves with the Government of India. A greater amount of exports results in higher foreign currency reserves, narrowing our current account and capital account deficits, which augurs well for the economy and enhances investor sentiment.
In conclusion, a normal monsoon is very important for the well-being of the economy. A rainfall deficit can have unprecedented effects on stock markets. There have been instances of the Nifty falling up to 2% in intraday trade when unfavorable monsoon forecasts were announced. This portrays the importance monsoons hold in keeping the markets buoyant.