The developing world is more vulnerable to El Niño risks

After three consecutive years of La Niña conditions, the world now faces the risk of an opposite phenomenon called El Niño that occurs as a result of warming of the ocean surface in the central and eastern tropical Pacific Ocean.

While La Niña typically brings above-normal rainfall to South and Southeast Asia, the southern hemisphere, especially South America, typically sees below-normal rainfall. Now, with El Niño, West Africa, Southeast Asia and South Asia face the risk of below-normal rainfall.

The World Meteorological Organization has calculated that there is a high probability (up to a 90 percent probability) that El Niño will occur in the coming months. However, it is less clear how severe or mild the El Niño event would turn out to be.

South America is critical to the global agricultural market. Interestingly, the impact of El Niño in South America shows regional variation. While the northern regions of South America face a drier climate, the southern parts of South America face a wetter climate.

More importantly, during El Niño periods, North America often witnesses excellent spring weather that boosts agricultural production.

Given the likely geographic impact, the crops most vulnerable to El Niño include sugar, cocoa, coffee, rice, and palm oil. In other words, the market for these products faces an upside price risk. We are already witnessing price spikes.

For example, cocoa prices continue to soar to multi-year highs. The most active forward contract in New York, due to expire in September, hit $3,400 a tonne, the highest level since December 2015. Crude palm oil is trading around 3,700 ringgit a tonne, and expected to reach 4,000 ringgit a tonne as El Niño forecast prompted lower output two quarters from now. Other crops also show rising price levels.

Inflation concerns

While overall inflation has shown signs of moderating with tighter monetary conditions, any likely damage that El Niño may cause to these crops may delay the decline in inflation. In any case, developing countries are more vulnerable to the adverse effects of El Niño.

The dry weather that this phenomenon brings reduces the size of the harvest, reduces availability and raises food prices.

Also in tropical countries, El Niño-induced reductions in rainfall can result in reduced hydropower generation. If that is combined with higher global energy prices (crude oil, natural gas), emerging economies may face a double whammy of food inflation and energy inflation.

What are the crops most likely to be affected by El Niño? In West Africa, cocoa production in the Ivory Coast and Ghana is in jeopardy. In Asia, sugar production in India and Thailand, coffee in Vietnam and Indonesia, and rice in the Philippines and Thailand may be vulnerable.

These are countries where agriculture contributes a significant part of GDP. So central bankers should be very concerned. Rampant inflation is likely to discourage them from cutting interest rates. For India, four months from June to September are critical for growing Kharif. Rice, pulses, oilseeds, cotton and coarse grains are key seasonal crops. Sugarcane, a long-lived crop, is also affected by the monsoon.

This year, we saw a late start to the southwest monsoon and late progress until mid-July. After being delayed until early July, crop planting progress has just caught up, except for pulses. If anything, the window for planting is closing fast. Even for the last week of July, various weather subdivisions covering Uttar Pradesh, Bihar, Jharkhand, Madhya Pradesh and Rajasthan showed poor rainfall.

If dry conditions begin during August-September, crops may wilt at harvest time. These risks cannot be ignored.

The inflation situation may worsen as we move into the second half of the calendar year. The global crude oil market will tighten with supplies forecast to follow demand by 2 million barrels per day.

The political implication of the emerging scenario cannot go unnoticed. It is time for policymakers to be prepared with responses that limit the damage.

The author is a policy commentator and commodity market specialist. views are personal