Patchy monsoon could lift inflation, hurt rural economy: S&P

New Delhi: A weak southwest monsoon could spike India's inflation to 5.1% in FY27, hurt rural demand and put pressure on sectors ranging from agriculture and microfinance to tractors and two-wheelers, even as the broader economy and banking system remain resilient, S&P Global Ratings said in a report released on Monday.

The India Meteorological Department (IMD) expects the 2026 southwest monsoon at around 90% of the long-period average (LPA), while emerging El Niño conditions are likely to intensify during the season, raising the risk of deficient and uneven rainfall.

The twin impact of weak rains and rising agricultural input costs due to geopolitical tensions could hurt farm incomes, lift food prices and slow rural consumption. S&P expects higher food and energy prices to push headline inflation to 5.1% in FY27, likely prompting the Reserve Bank of India (RBI) to maintain a moderately tight monetary policy stance. Food accounts for about 40% of India's consumer price index basket, making inflation particularly sensitive to disruptions in farm production.

India's retail inflation accelerated to 3.93% in May, rising from 3.48% in April, driven by higher food and fuel prices.

“There is merit in inflation outlook here as weak monsoon has potential to increase inflation past 5% this year. This will get clearer once we reach september. This rising tendency supports a rate hike view, in my opinion. Also, core [inflation] has been going up and won't come down," said Madan Sadnavis, chief economist, Bank of Baroda.

Last month, the RBI's monetary policy committee kept the repo rate unchanged at 5.25%, citing geopolitical risks, supply-chain disruptions and weather-related uncertainties.

Most vulnerable

The S&P report identified agrochemicals, tractors and two-wheelers as the most vulnerable sectors, noting that these segments recorded around 10% volume declines during previous weak monsoon years, including 2009, 2014, 2015, 2018 and 2022. Rural-focused FMCG companies may also face softer demand, although the overall impact is expected to remain limited.

While agriculture contributes around 18% of India's gross value added and employs nearly 40% of the workforce, S&P noted that the economy has become less dependent on the farm sector over the past three decades as manufacturing, infrastructure, finance and technology have gained prominence.

India’s economy expanded 7.7% in FY26, while agriculture grew 3%, helping cushion the impact of a weak monsoon on overall economic activity.

In the power sector, annual hydroelectric generation could decline by 10-15%, with some states witnessing a 20-30% fall. However, S&P said the impact on the national power system would be limited as higher coal-based generation and a modest increase in solar output could offset most of the hydropower shortfall.

The report said banks are likely to see slower rural credit growth and modest deterioration in asset quality, particularly in agriculture-linked portfolios, but diversified loan books, prudent underwriting standards and government support should limit the impact on earnings. Agriculture loans account for only 12.9% of total bank credit, while rural and semi-urban lending constitutes around a quarter of banks' loan books.

Microfinance institutions, however, remain more exposed because nearly 80% of their loan portfolios are rural, with significant exposure to agriculture and allied activities. S&P said although regulatory safeguards and stronger underwriting have improved the sector's resilience, persistent inflation and weak farm incomes could weigh on borrowers' repayment capacity.

Limited impact on finances

On the fiscal front, S&P said a mild rainfall shortfall would have only a limited impact on government finances, but a prolonged dry spell could force the Centre and states to expand food and fertiliser subsidies as well as rural employment programmes, potentially complicating fiscal consolidation efforts.

Despite the near-term risks, the rating agency said structural improvements—including wider irrigation coverage, higher crop insurance penetration, increased minimum support prices, fertiliser subsidies and stronger rural household finances following two favourable monsoons—should help limit broader credit stress across the financial system.

cOn 29 May, the IMD revised its southwest monsoon forecast for 2026 to 90% of the long-period average (LPA) rainfall of 87 cm, down from its earlier estimate of 92%, citing El Niño conditions.

India witnessed its driest June in more than a decade, and the fifth-driest since records began in 1901, with southwest monsoon rainfall at 39.8% below the LPA. The country received 99.5mm of rainfall during the month, compared with the normal of 165.3mm.

On 30 June, the IMD said that India is likely to receive below-normal rainfall in July, at less than 94% of the long-period average. The southwest monsoon, which contributes 70% of the rainfall in the country, has already covered most parts of the country and is expected to cover the remaining parts in the coming days. The monsoon hit the Kerala coast on 4 June, three days after its normal onset date of 1 June.