Climate of uncertainty

Climate of uncertainty

Subject :Environment

Context-

• CLIMATE CHANGE IS altering weather patterns, directly impacting 55 per cent of the country’s inflation basket.
• There are implications for incomes and the twin deficits too.

Take the current year, for example- 

• A debilitating heatwave in March led to rise in wheat prices by 19 per cent, despite the ban on export of wheat.
• Even though the season ended with rains that were 6 per cent above normal for the country as a whole, there were large regional and inter-temporal variations, especially in eastern India.
• A delayed withdrawal of monsoon and uncharacteristically heavy rains in October are threatening to damage crops ahead of the harvest season.
• Vegetable prices have begun to rise and early estimates suggest that rice production could be 6 per cent below last year.
• All of this could stoke inflation expectations at a time when India’s inflation is well above the central bank’s target range.

And it’s not just about2022.

• Decade-old rainfall trends are changing.
• Reservoir levels matter much more than rains for India’s food production and inflation, as reservoirs not only capture contemporaneous rains, but also store water from previous rain episodes. We find that reservoir patterns are changing too.
• With insufficient moisture, sowing patterns have become far more volatile, creating inflationary pressures for food crops, even if temporarily.

Food inflation trends-

• Long-held seasonality patterns in food prices are changing. Looking at the last, decade, food prices used to rise gently each month between April and October every year.
• Repeating the study for only the last three years suggests that the rise in food prices in the April to October period is not as uniform as before.
• Rather it is bunched up as sharp increases across fewer months, making food price changes more volatile.
• This new trend is most pronounced for cereal prices.
• Similarly, in the past vegetable prices used to fall in the December to February period.
• This was popularly known as the winter disinflation, with an implicit message to the central bank not to get carried away by the rise in vegetable prices over the summer months; rather to look through it and wait for the winter disinflation in order to get a clearer sense of where food inflation really is.
• Now vegetable prices, too, are displaying changing seasonality patterns.
• The disinflation that was spread out over the December to February months now starts later and is concentrated in January and February.
• It’s no surprise that vegetable prices remain the most volatile component of the food basket.

And it’s not just food-

• Fuel inflation is impacted too.
• To assess the changing demand for energy due to climate change, we model oil demand with the usual drivers like GDP growth, the ratio of manufacturing to services, and domestic oil prices.
• Our regression is economically and statistically significant. But what is most interesting for us is the on- economic drivers of energy demand.

Climate change and energy demand-

• It is worth clarifying here that climate change can impact energy demand in several ways.
• In the first instance, episodes like a heatwave in March,or a colder-than-normal winter, raise demand for energy.
• Second, as the world transition to renewables, there is likely to be a transition period during which fossil fuel-derived power is disincentivised before renewables reach their full potential.
• This period could be marked by volatile energy prices.

Inflation forcasting-

• Together ,food and fuel make up 55 per cent of India’s CPI basket.
• With such a large weight of food and fuel, inflation in India has always been susceptible to supply shocks.
• And now weather-related surprises are on the rise, making India’s Inflation Patterns Even Harder to predict than before.
• It is therefore no surprise that inflation forecasting errors are on the rise.
• This, then, raises the challenge for the central bank. With inflation volatility rising, it will become more challenging over time to anchor inflation expectations at desired levels.
• In some situations, this may require larger rate hikes inorder to remain close to the inflation target, which, inturn, would slow GDP growth.
• The RBI may have to experiment with new techniques. For instance, raising rates earlier rather than later in the cycle, as a way of keeping inflation contained without too much cumulative tightening (a kind of early mover advantage).

Way forward-

• And we’re only just getting started. Climate change is likely to impact other aspects of the economy too.
• Volatile rains can hurt farm incomes, and climate change-led increases in energy demand can widen the trade deficit, by raising coal imports, for instance.

India may eventually need a coordinated institutional framework tying together the different parts of policy making in order to navigate the increasing volatility triggered by climate change and energy transition.