Unleashing the Tempest: El Niño's Looming Threat to Asian Economies
El Niño's menacing return casts a dark shadow over the economies of Asia, particularly India, Indonesia and Malaysia. The risks to these nations' agricultural sectors, inflation rates and overall economic stability are significant. While the severity of El Niño's impact remains uncertain, the governments are gearing up for a potential hit to the agriculture sector and food security overall. The risks to Asia remain high and could impact growth and inflation over 2023 and 2024.
Asia has emerged as a resilient region having faced a triad of shocks in the past year (Ukraine conflict, monetary tightening and commodity price rally), now faces a looming threat in the form of El Niño, with far-reaching consequences. Climate experts globally have highlighted a moderate to high risk of a severe El Niño event, which in our view could cause significant economic disruptions across Asia. While the effects will vary across the region, South and Southeast Asia, including countries such as India, Indonesia, and Malaysia, are expected to be more vulnerable, particularly in their agricultural sectors.
India: Walking a Fragile Tightrope
India, the world's fifth-largest economy, finds itself precariously positioned in the face of El Niño's wrath. The current forecast for India's real GDP growth in FY2023 (Apr-Mar) stands at 5.9% y/y, factoring in a "mild" El Niño. However, in our view, a more severe El Niño event could lead to a downward revision of up to 0.7 percentage points. Historically, El Niño has foreshadowed significant droughts in India, posing risks to agricultural output and GDP growth. While the Indian Meteorological Department forecasts a normal monsoon season for 2023, a severe El Niño could disrupt rainfall patterns, severely impacting agriculture.
Early signs of climate change events affecting India’s macroeconomic fundamentals have already become visible. India’s latest uptick in its consumer prices in June, to 4.8% y/y from 4.3% y/y in May, highlights how sensitive the economy is to such shocks. The uptick in June is entirely a result of an upsurge in vegetable prices stemming from supply disruptions caused due to the heavy onslaught of the ongoing south west monsoon. Given that the rural economy had only in the previous quarter shown signs of strengthening, a hit to India’s agriculture sector could derail any progress made on this front.For now, a delayed onset of the southwest monsoon, coupled with excessive rainfall has delayed sowing and could effectively dent India’s rice, maize, cotton, and sugarcane output. Meanwhile, the IMD has forecast drier conditions in India, owing to the El Niño in the winter months, suggesting that rabi crop will also be disrupted (particularly wheat). Such events will exacerbate India's inflation trajectory, particularly for perishable goods. The current forecasts already includes a moderate risk of elevated inflation resulting from climate-induced agricultural disruptions. However, a more severe El Niño event could escalate cost-of-living pressures beyond expectations. Consequently, this could force the government to respond with consumer subsidies, handouts to the large farming community straining an already wide fiscal deficit. India already has a ban on export of wheat and certain varieties of rice, and lower harvests could result further export restrictions that may strain global relations. A drought or flooding related destruction in a pre-electoral year would force the government to introduce a series of populist measures, in addition to the existing free food grain scheme and fertilizer subsidies.
Indonesia: Vulnerabilities in the Palm Oil Sector
Meanwhile, across the Indian ocean, Indonesia, the world's largest producer of palm oil, faces a cascade of risks from the El Niño. Severe El Niño events can trigger forest fires, haze and water shortages, with dire consequences for the palm oil industry. In 2015, Indonesia experienced one of the most severe El Niño events, as consequence of which, the reduced palm oil production caused global prices to rise, given Indonesia and Malaysia's dominant position in the market. In Indonesia too, the trajectory of the economy is likely to follow a similar path as that of India. While a dent to GDP growth figure is likely in 2024 (owing to the lagged effect on production of palm oil), the consumer price trend would remain similar. Lower palm oil output has implications for both consumer spending in 2024 and Indonesia’s current account.
Malaysia: Navigating the Challenges
Malaysia, another major player in the palm oil industry, confronts risks similar to those faced by Indonesia. While the country has made strides in addressing potential disruptions caused by El Niño, including importing additional rice to counter shocks to local crop yields, vulnerabilities remain. The recurrence of severe El Niño events and low level of institutional capacity to offset the impact of such events poses a threat to palm oil output and overall economic stability.
Institutional capacity and coordination play crucial roles in determining South East Asian nations’ resilience to extreme weather events. For instance, Vietnam’s coffee output too remains vulnerable, while Thailand’s rice production is also at risk. Asia is only now emerging from the rice-related supply chain disruptions caused by floods in Pakistan last year and a drought in China. As a consequence, several Asian economies face the threat of food insecurity over 2023 and 2024. Indonesia has already sanction imports of 2mn tonnes of rice for this year, and is looking to negotiate another bilateral agreement with India, in the event of climate change events disrupting domestic output.
The intensification of El Niño events in recent decades serves as a stark reminder of the broader challenges posed by climate change. Emerging economies in South and Southeast Asia, heavily reliant on agriculture and face long-term losses in real GDP. Given that a huge part of these economies is still agrarian and rain-fed (example India) the countries remain vulnerable to climate change. Weak administrative coordination, poor governance, and limited fiscal resources compound the vulnerability of these nations.