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posted on 10 September 2015

El Nino: An Inconsistent Geopolitical Agent


The defining characteristic of El Nino is sustained above-average temperatures in the middle of the Pacific Ocean. Traditionally, Peruvian fishermen recognized the phenomenon when the catch would decline as weak trade winds led to warmer waters around the west coast of South America, decreasing the nutrients in the water and thus the number of fish it could support. Now, a much more regimented system takes measurements of ocean temperatures throughout the Pacific. The Oceanic Nino Index looks at temperature anomalies in the region known as Nino 3.4 - between 5 degrees north and 5 degrees south latitude and between 120 degrees and 170 degrees west longitude. El Nino is declared if the average sea surface temperatures there are at least 0.5 degrees Celsius (0.9 degrees Fahrenheit) higher than normal for five consecutive overlapping three-month periods.

The El Nino in 2015 was widely anticipated but was considerably delayed. A weak El Nino was first announced in March, after which it gradually strengthened as sea surface temperatures continued rising during the next several months. Currently, forecasters with the National Oceanic and Atmospheric Administration's Climate Prediction Center give a very high probability (greater than 90 percent) for El Nino lasting through the end of 2015 and a high probability (85 percent) of it lasting into spring of 2016. Forecasts show that the strength of this El Nino will remain high through the winter.

A monster El Nino and its potentially extreme weather effects make for good headlines. However, it is important to remember that an El Nino only increases the probability of certain weather patterns; it does not make them a foregone conclusion. Still, historical El Nino events indicate what the probable weather patterns will be and how they can and will affect the global economy.

The El Nino weather pattern likely contributed to many of the ongoing droughts around the world, such as those in Central America and Southeast Asia; dry conditions in these regions are typical in El Nino years. El Nino also might have contributed to the weaker-than-normal monsoon season in India. As autumn (September-November) approaches in the Northern Hemisphere, the droughts in Indonesia, Malaysia, Vietnam and Thailand, among other countries, are likely to continue. El Nino also increases the likelihood that the season will be drier for parts of Australia and southern Africa. In contrast, areas on the western coast of South America can expect much wetter conditions than normal. As the Northern Hemisphere moves into winter (December-February), the predominant weather patterns include continued dryness in many Southeast Asian countries, particularly Indonesia, while parts of North America will experience more rainfall and other areas on the continent will have warmer temperatures. If this El Nino extends through March-May, the weather pattern could bring continued rainfall in North America and alter the 2016 monsoon season.

Secondary Effects

Weather patterns have obvious effects on industries such as mining and agriculture. Droughts reduce agricultural output, and heavy rains can hamper mining operations. Either situation can lead to a short-term increase in commodity prices, especially for those commodities that have their output restricted. Copper from South America and palm oil from Southeast Asia are two such commodities that are especially vulnerable in El Nino years.

However, because potential price increases are not limited to just a few commodities, El Nino years also tend to bring about inflation. But just like the weather itself, El Nino's effects on inflation are not universal. The International Monetary Fund conducted a study released in April 2015 showing that El Nino conditions can correlate to some level of inflation in many countries, albeit relatively low - less than 1 percent for most countries. Inflation is not necessarily a detriment for many countries right now. Some countries, particularly indebted Western nations looking to reinvigorate their economies, are even seeking inflation.

In the IMF study, the correlation between El Nino and increases in inflation was highest in Japan, South Korea, Chile, Thailand, India and Indonesia. By examining these countries, we can predict how they might react to these small, but significant, inflation rate raises.

Japan, an economy that has been stagnant for decades, now sees higher inflation as the first step toward economic growth. Japanese Prime Minister Shinzo Abe is struggling to see success in hiseconomic plan nearly three years into his term. For Japan, the IMF study attributes only a 0.1 percent inflation increase to El Nino, but with inflation in Japan essentially at zero, even this smallest bump could help, though it would likely be temporary.

According to the IMF, inflation in South Korea will increase by 0.44 percent after four quarters in response to El Nino. With inflation currently at 0.7 percent, Seoul would not necessarily need to raise interest rates to curb inflation. Interest rates were actually lowered earlier this year to mitigate anydeclines in the tourism and retail sectors. An inflation increase of even 0.5 percent might actually be seen as a blessing to the Central Bank of South Korea, whose inflation target is 2.5-3.5 percent.

At 5 percent, Chile's inflation rate is not excessive but still higher than it has been all year. Santiago is worried about slipping into a slow-growth, high-inflation trap, especially as copper prices remain low and Chinese demand wanes. There has been some speculation about interest rate hikes, but analysts expect them to remain steady through the end of the year. The IMF study found El Nino's impact on Chile's inflation to be less than 0.4 percent even after four quarters - a small impact relative to the overall inflation rate. Thus, El Nino's most prominent effects on Chile are not likely to come from inflation. Rather, Santiago will focus on El Nino's heavy rains that are expected to disrupt the mining sector.

Meanwhile, Thailand, already dealing with the effect of low energy prices, is actually undergoing a period of deflation at a rate of roughly 1 percent. Combined with other factors, El Nino's additional 0.55 percent inflation could help bring Bangkok out of its deflationary spin.

India is in almost the opposite position. Raghuram Rajan, the governor of India's central bank, has sought to lower India's high inflation. Aided by low commodity prices, inflation has fallen to roughly 4 percent. However, this has not necessarily translated to renewed domestic demand. The public still believes inflation rates could rise again, and even a small increase of approximately 0.6 percent that could be attributed to El Nino could reinforce that belief. Prime Minister Narendra Modi remains in a difficult position, trying to attract foreign investment while bolstering domestic demand.

With inflation rates hovering around 7 percent, Indonesia will be hurt if El Nino boosts its inflation between 0.6 and 0.9 percent. However, El Nino will influence Indonesia more broadly as well.

Geopolitical Overlap: Indonesia

As El Nino increases the likelihood of continuing dry conditions, Indonesia is an example of El Nino's overlap with geopolitical trends. The country is in the midst of creating structural economic change. The geographically disjointed archipelago nation is struggling to recentralize political and regulatory powers to make a more stable and transparent environment for investors. To establish a value-added economic model, Jakarta needs more foreign investment to support the transition, though some recent policies have made it more difficult for foreign companies to invest in certain sectors.

President Joko "Jokowi" Widodo is more than a year into his five-year term, and Stratfor forecast earlier this year that his administration would have "halting but tangible success" in streamlining and centralizing the country's policies as well as funneling more money into necessary infrastructure projects. Infrastructure spending in the 2016 targeted budget is set to increase by almost 8 percent over 2015's spending, to roughly $24 billion - Indonesia's largest infrastructure spending plan to date. But Jokowi must also balance these goals with sustained low energy prices (even with a potential small short-term bump from El Nino effects, we expect them to remain low), high inflation and a need to maintain social spending for energy and food subsidies.

Jakarta is also trying to downplay the effects of dry conditions on Indonesia's upcoming rice season. Despite the government's claim that it will still be able to meet domestic demand for rice, the public is already skeptical. Historically, El Nino years have caused a spike in rice imports; almost 6 million metric tons of rice were imported in 1997 during another El Nino, compared to less than 1 million metric tons imported in 1996. Furthermore, chicken and meat traders, who use rice bran as a locally produced component of animal feed, already went on strike demanding that the government help to alleviate scarcity issues in their sector, hinting at potential unrest in the future.

A drought, especially one that continues several months into next year, would force Jokowi to divert attention and resources to social issues at a time when he is trying to garner political and bureaucratic capital to promote key projects and reforms. Should the situation worsen, the bill for potential food imports may not match the costs of some of the long-term infrastructure projects, but it could strain the budget in the short term, as El Nino would hamper Jakarta's ability to focus on the other, more structural changes needed to reach its economic and political goals.

"This article was originally published by Stratfor, a leading global intelligence and advisory firm in Austin, Texas."

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