The only silver lining in India’s worst-ever quarterly gross domestic product contraction was the agriculture sector. Between April and June, when the economy contracted by 23.9%, the sector posted a growth of 3.4%.

But this silver lining could also fast fade off as the spectre of climate change haunts the agriculture sector. The Reserve Bank of India’s annual report, released on August 25, took note of this looming danger.

In its annual report, India’s central bank stated that the country is witnessing more intense droughts, downward shifts in average rainfall as well as a higher frequency of cyclones. In 2019 alone, eight cyclones along with sharp volatility in rainfall led to “an increase in the extent of crop area damaged.”

The report also highlighted how global warming or a sharp rise in temperatures has “likely caused a decline in crop yields, undermining farm income”. At the same time, groundwater has eroded with around 52% of the wells in India witnessing a drop in water levels between 2008 and 2018.

This is the first time that India’s central bank has taken note of climate change in its annual report, according to Saudamini Das, a professor at the Institute of Economic Growth. “The issue of climate change needs to be taken seriously,” Das said. “According to my estimates, around 3% of the GDP will be spent on countering it’s adverse impact.”

Experts’ concerns are not unfounded as flooding has become a recurring event in many states over the last few years. Divya Karnad, assistant professor of environmental studies at Ashoka University, said, “It has become obvious to organisations, such as the RBI, that the pattern of our monsoons has changed.” She also observes that the irregularity in the rainfall has made it “a force of destruction”.

This severity of climate change can have dire consequences for India’s agri sector, inflation, and the overall economy, especially in these tough times.

Farmers carry wheat crop in Birbhum district of West Bengal after cyclone Amphan. Photo credit: PTI

RBI’s warning and ripple effects

If the headwinds mentioned in the RBI’s annual report do take a toll on the agri sector, it would mean more bad news for India’s beleaguered economy.

The adverse impact of climate change on the agriculture sector can have a bearing on the central bank’s decision to fix the policy rate, which is one of the important tools for spurring economic growth.

Das states that tropical countries like India will continue to suffer from climate change and this will subsequently lead to a reduction in food production as crop yield drops. If the food production falls and uncertainty in the agri-sector rises, the RBI’s job of controlling inflation and boosting the economy could become even harder.

“Long term impacts of climate change on food prices can be substantial,” warns Ram Ranjan, associate professor at the department of economics at Shiv Nadar University. “Climate change is causing soil erosion, land degradation, desertification, increasing frequency of droughts and warming temperatures, all of which will pose food security challenges in the long term.”

In fact, the central bank is currently battling price rise as retail inflation soared in July due to a spike in food prices. With the retail inflation rate remaining above the upper target of 6%, the central bank did not cut policy rates to reduce the cost of lending, which is necessary to revive growth during the current economic downturn.

It is not just inflation, the spiraling impact of climate change can also dent India’s weakened financial system.

Financial risks

“Given that the impact of climate change on India is expected to be one of the severest globally, the need for an appropriate framework to identify, assess and manage financial risks arising out of climate risk has become an imperative,” the RBI warned in its annual report.

The agriculture sector contributed around 15% to India’s economic growth in the financial year ending March 2020 and accounts for 12.6% ($154 billion) of the overall credit of banks.

It means a jolt to agriculture can have a direct impact on the health of India’s financial system. “Farmers are likely to default on loans taken for agricultural equipment and inputs such as tractors, motor pumps, seeds and fertilizers,” explains Ranjan. “Additionally, crop losses would lead to political pressure on banks to write off loans or offer loans at unsustainable interest rates.”

Before mentioning it in the annual report, the RBI had also released an article on climate change as a part of its bulletin in April. The article highlighted that the physical damage of climate change would include “damage of balance sheets of households, corporates, banks, and insurers triggered by a weather-related event causing financial and macroeconomic instability”.

While acknowledging the problem is the first step towards solving it, managing this new challenge in times of Covid-19 slump, will be a big litmus test for the RBI.

This article first appeared on Quartz.