How Extreme Climatic Conditions are Disrupting India's Economy

From extreme heat in the summers, to rains in the monsoon leading to floods, to extreme cold in winters, climate change and its accompanying extremities are rapidly changing the moderate, tropical temperate zones across India and South Asia. These changing climatic cycles also have a direct effect on the economy and its circular flow.

Changes in the prices of food, energy, and other essential goods have conventionally been analysed through the lens of shifts in economic policies, disruptions in supply chains, or geo-political tensions. However, the persistently worsening climate crisis has emerged as a powerful driver of inflationary pressures, unveiling an entirely different causal narrative. 

What was once perceived as an environmental issue today lies at the heart of economic instability. The ripple effects of climatic change are vast and sparking cascading sectoral disruptions are evident from agriculture to energy and supply chains – leading to prolonged inflation and escalating costs for households. We delve deeper into the multi-layered economic impacts of climate change, exploring how it disrupts key sectors, intensifies inflationary pressures, and necessitates urgent policy intervention to safeguard stability and growth.

As crops fail, harvests are destroyed and food prices skyrocket which strain household budgets. This chain reaction extends beyond agriculture, disrupting global supply chains and energy production, further inflating the cost of essential goods. The outcome? A sharp surge in headline inflation, imposing an unnecessary and totally avoidable economic burden on people’s daily lives.

India’s climate vulnerabilities and regional disruptions

Drought-prone states like Maharashtra and Karnataka, due to continued spells of dry weather, witness declining yields for staple crops like sugar, onions, and rice. Droughts and floods disrupt water availability and other critical inputs, causing sectoral price spikes and creating inflation volatility, particularly in water-intensive and natural-resource-based industries. 

Similarly, disruptions to transportation further contribute to raising the cost of logistics due to events like river droughts that hinder trade, hence overstretching the economy. A recent study suggests more than 77% of Maharashtra’s farmland is vulnerable; this destabilises farming livelihoods which further leads to headline inflation induced by increased food prices. 

While excessive rainfall disrupts regions like Uttar Pradesh, erratic monsoons endanger Kharif crops, squeezing further household budgets that already are on the brink. In states like West Bengal and Odisha, erratic weather conditions continue to destroy crops year after year, worsening supply chain disruptions that translate into price increases. 

Even Punjab and Haryana, which once were the pillars of India’s agricultural economy, are strained by these rising temperatures and inconsistent rains, limiting our wheat and rice output.

The figure above highlights India’s vulnerability to natural disasters, showing a significant rise in events such as floods, storms, and extreme temperatures over decades. This trend poses severe economic, social, and environmental challenges, impacting agriculture, infrastructure, and human lives. 

Manufacturing in crisis: Heat waves, pollution and economic slowdown

The manufacturing sector in India is under siege, caught in the crossfire of escalating climate hazards. From soaring heat waves to stifling smog, the challenges are piling up and so are the consequences. The HSBC Purchasing Managers’ Index (PMI) for manufacturing: in May 2024, it plummeted to a three-month low of 57.5, as intense temperatures caused disruption on production schedules and supply chains. And it’s not an isolated blip; these numbers are part of a troubling trend of climate-driven disruptions that’s becoming all too familiar.

Cities like Pune, Ahmedabad, and Bangalore are grappling with a double-edged sword: intense heat stress on one side and erratic rainfall or droughts on the other. These compounding climate impacts don’t just throw operations off balance rather lead to soaring costs which erode profit margins and delay deliveries.

And then there is urban pollution, the silent killer of productivity. In Delhi, the annual smog festival during October and November does not only choke lungs but brings to a grinding halt the movement of goods and forces industries to pause many workers who are on daily wages. 

With their income disappearing, they are pushed to live off their savings, further marginalising an already vulnerable population. Similarly, Mumbai and Kolkata aren’t far behind, with air pollution acting as an invisible handbrake on industrial activity.

The result is an economic slowdown with a snowball effect. The fallout comes out in terms of factory shutdowns, supply chain paralysis, and a workforce drained by health issues. 

The case for climate data in economic forecasting

To understand and address this growing challenge, integrating climate data into economic models has become an absolutely critical idea in today’s world. Key variables such as temperature, precipitation, soil moisture and the frequency of extreme weather events are no longer an outlying consideration. These elements are central to anticipating supply-side inflationary pressures stemming all the way from agricultural losses to fluctuating energy demands and disrupted production networks. Incorporating these climate dynamics into economic models enables policymakers to move from a reactionary response to a proactive one. 

Dynamic climate based economic models, which simulate the interplay between climatic shifts and economic activities which eventually leads to policy interventions are a powerful tool which shouldn’t be ignored. These models allow for scenario analysis, which further helps to evaluate strategies like investments in renewable energy infrastructure or even the adoption of climate-resilient agricultural practices, such as drought-resistant crop varieties.

For example, by projecting the economic benefits of precision irrigation systems, such models can inform policies that balance immediate inflationary pressures with sustainable long-term objectives serve as an early warning mechanism for impending calamities, enabling the government to take measures in a way to ensure timely preparedness.

Also read: Inside Modi Govt’s War Room to Whitewash Global Indices

Take electricity demand, per say: soaring temperatures push up the need for cooling which leads to overwhelming power grids and driving up energy costs. At the same time, water shortages disrupt hydroelectric power generation, and extreme heat cuts into the efficiency of thermal and nuclear plants, shaking up energy markets and let’s not forget the human factor after all, outdoor workers struggle to maintain productivity under sweltering conditions, leading to shorter work hours and higher costs.

These aren’t just isolated incidents; they’re part of a broader economic story of supply chain disruptions, rising input costs, and inflationary pressures. Tackling climate change just doesn’t become a narrative about saving the planet, it’s about safeguarding our economies from spiraling instability.

Global lessons in climate-integrated economic policies

Global examples do provide valuable lessons. The European Central Bank (ECB), for instance, has integrated climate risks into its monetary policy by assessing the carbon footprint of its corporate bond holdings, aligning financial operations with climate goals.

Likewise, the International Monetary Fund (IMF) emphasises climate risk in its macroeconomic surveillance, analysing vulnerabilities that impact fiscal sustainability. Several other central banks worldwide are implementing commendable changes to their economic models, reflecting a forward-looking approach that highlights the need for coordinated, systemic solutions to an issue that transcends borders and sectors.

The effects we often overlook extend into critical areas of economic activity, influencing industries, markets, and livelihoods in profound ways. One such subtle yet significant effect is how hot weather keeps consumer prices elevated.

As temperatures rise, supply chains struggle to keep pace with demand, creating persistent price pressures. This is reflected in the Consumer Price Index (CPI) –measures inflation and deflation – which often remains stubbornly above desired levels, signalling that the cost of everyday goods and services is far from stable.

The economic ripple effects don’t stop there. The central bank, in its effort to rein in these price pressures, is forced to maintain or hike the repo rate, as seen in the chart’s bottom panel. Higher interest rates tighten borrowing costs for businesses and individuals, further constraining economic activity. This creates a dual strain-soaring costs on one hand and reduced financial access on the other.

For households, this dynamic feels like an unspoken tax, silently eroding purchasing power. It disproportionately impacts those least equipped to bear the burden, widening economic inequalities and diminishing consumer confidence. The interplay between rising prices and strict monetary policy paints a sobering picture of how climate-induced weather patterns can stifle growth and weigh down an economy’s ability to thrive.

The case for climate data in economic forecasting

The Reserve Bank of India (RBI) has recently acted to create data repository to integrate climate risk information but it must step beyond cautious measures and embrace bold decisive actions to tackle the climate crisis with the urgency it demands.

Failing to do so risks aggravating economic vulnerabilities, as unchecked climate risks can ripple through financial systems and undermine stability and growth. While initiatives like green deposits and disclosure frameworks are promising, they represent only the first steps in addressing the profound financial challenges posed by climate change.

Consider the European Central Bank, which has seamlessly woven climate risks into its monetary policy, or South Africa’s central bank, celebrated for its advanced climate frameworks. Their proactive stances mitigate long-term economic disruptions, while India’s hesitancy leaves critical gaps that could compromise investor confidence and macroeconomic resilience.

The development of a green taxonomy or mandatory climate disclosures which in principle are commendable efforts but the sluggishness intensifies this risk, leaving the financial system exposed to the substantial impacts of environmental degradation.

Take green deposits, for instance. Today, they are a niche financial tool, but their potential to channel investments into renewable energy and sustainable ventures could redefine economic priorities which could drive innovation and end up creating new growth sectors.

Similarly, mandatory climate disclosures go far beyond regulatory compliance – they too are a strategic necessity for attracting foreign investment that could stabilise capital flows which signals India’s readiness to withstand climate-related economic shocks.

Also read: The Multifaceted Nature of Macro-Economic Challenges in Front of the New RBI Governor

This isn’t just the RBI’s responsibility, though. The government has made commendable strides, from scaling up solar and wind energy to pioneering green hydrogen initiatives and even introducing a groundbreaking taxonomy for green steel.

These measures are critical not just for reducing emissions but also for shielding the economy from escalating costs tied to environmental inaction, such as rising energy prices and supply chain disruptions. Fiscal and monetary policies working in tandem could spark transformative economic growth which are deep rooted in sustainability and resilience.

India’s position among the top 10 countries in the Climate Change Performance Index (CCPI) demonstrates that sustainable growth is not only achievable but essential for long-term economic competitiveness. However, this recognition is a not a true reflection rather a self-serving prophecy; there are multiple other complacency risks which undermine progress and leave the economy exposed to climate-induced financial shocks which shouldn’t be overlooked. 

The RBI and the government have a pivotal opportunity to go further. Integrating climate risks into stress tests, scaling up green finance, and ensuring that even micro-enterprises are part of this transition are not just environmental imperatives, they are essential to safeguarding the economy’s future. When bolstered by public-private partnerships and innovative technologies, these actions could protect India from the ever-evolving economic consequences of climate inaction while paving the way for a more prosperous, sustainable future.