A couple of years ago, we pointed out that reservoir levels matter more than rains when it comes to forecasting India’s food production and inflation. Now, we take it a step further by focusing on temperatures. We find that they do a much better job in explaining and predicting food output and price rises.
Using records that stretch back to the 1950s, we can see that average temperatures have been rising along with temperature volatility. Sure, that’s not a surprise. But what we find next is that with an appropriate lag, the correlation between average temperatures and India’s food inflation has been rising consistently over time. As Earth heats up, crop yields fall. Indeed, scientists and researchers project that a 2.5-4.9 degrees Celsius increase in temperatures across the country could lead to a decrease in wheat yields of 41-52 per cent, and a fall in rice yields of 32-40 per cent.
Look no further than the heatwave of March 2022 which lowered the sugarcane crop yield by 30 per cent, while hurting the production of vegetables, as well as oilseeds. Or, the heatwave of March 2024, where temperatures rose to 50.5 degrees Celsius in some areas, leading to a sharp rise in vegetable prices due to crop damage caused by heat stress. In both cases, crop damage led to high inflation and weak rural incomes.
All of this is clearly visible across various food items. Analysing a decade of data, we find the correlation between average temperatures and food inflation has been rising across all the main crops — perishables (vegetables and fruits) and durables (cereal, pulses, oilseeds and sugar).
And, this is not just limited to crops. High temperatures can raise animal mortality. Even the prices of dairy, poultry and fishery products are becoming increasingly sensitive to rising temperatures.
Most perishable crops are short-cycle crops (for example, vegetables which can be harvested every two to three months). These crops have traditionally been more sensitive to heat waves than others, and this sensitivity is rising. We find that the average correlation between temperatures and the price of perishables has risen from 20 per cent to 60 per cent over a decade, marking a three-fold increase. Durable crops are long-cycle crops (for example, cereals which are harvested every six-12 months). Together with animal proteins, they have traditionally been less sensitive to temperatures, but their sensitivity is growing, with the correlation rising from 10 per cent to 45 per cent over a decade, marking an even bigger five-fold increase.
This, then, brings us to another important question. If the sensitivity of food production and inflation to temperatures has risen over time, what role do rains and reservoirs play?
To answer this, we need to get technical. We bring out our trusted food inflation model, which can help us parse the role of temperatures on food inflation better, alongside other variables that also impact it. These include reservoir levels, the government’s minimum support prices for agriculture, and a variable that picks up supply-side food price management steps. We find that nimble steps by the current government to buy or sell from government granaries, import or export, and then quickly transport food items across the country have helped lower food inflation over the last decade. Clamping down on hoarders has helped too. We capture all of these supply-side management steps with a dummy variable which switches on in the last 10 years.
Our model is a robust one (with a R-squared of 80 per cent), doing a good job of predicting food inflation. But strangely enough, when we include temperatures in our model, it doesn’t sit too comfortably with the other variables. It messes up their importance. Perhaps, the temperature variable contains all the information which the reservoir variable holds. To check for that, we keep the temperature variable in the model but remove the reservoir variable. And this does the trick. It vastly improves our model and its forecasting power (the model’s R-squared goes up to 90 per cent).
What does all of this mean? Temperatures are far superior than rainfall in explaining and forecasting food inflation. In fact, once temperatures are included, there is no value in analysing rains and reservoir levels. There could be a couple of reasons for this. One, with irrigation facilities improving, the low rains have been less of a problem, especially in areas like north-western India, known as the food bowl of the country. Two, with reservoirs and temperatures having a 50 per cent correlation, our sense is that a lot of the meaningful information contained in the reservoir variable gets picked up by temperatures. Three, there is a non-linear relationship between temperatures and food inflation.
So, what are current temperatures saying about the outlook for food inflation and rural demand? There is some good news here. The El Niño weather phenomenon from last year, typically associated with low rains and high temperatures, has made way for La Niña, associated with cooler temperatures and stronger precipitation. Temperatures have fallen over the last month (compared to the Mar-Jun period). If this sticks, food inflation could fall quickly, taking headline inflation close to 4 per cent, which is RBI’s target, by March 2025. With temperatures cooling after a severe heatwave earlier this year, we expect the RBI to start easing rates in the fourth quarter of 2024.
While this is good news at a time when temperatures are normalising from high levels, it is worth keeping it in the back of our minds that over the medium term, rising temperatures could become a big problem for inflation management. The impact of weak rains can be managed by better irrigation facilities, but there is no magic wand to manage the impact of rising temperatures.
The writer is chief India economist, HSBC
