Strong El Niño arrives, but overall impact on Asia is expected to be moderate

Overview

The report discusses the impact of a strong El Niño on the Asia-Pacific economy and equity markets. Morgan Stanley believes this El Niño event is likely to intensify into a very strong event in the fourth quarter of 2026 and last through early spring 2027, typically bringing drought and high temperatures to India, ASEAN and Australia. Nevertheless, the report believes the impact on overall Asian growth and inflation will be milder than in historical cycles, owing to higher food inventories, declining food CPI weights, some policy buffers, and the support that the industrial and capital expenditure supercycle is providing to regional demand.

Core views

The core views are: first, the macroeconomic impact is not evenly distributed, with India and Indonesia most exposed on the growth side and Thailand, the Philippines, Malaysia and Australia moderately exposed; second, inflation risks are more substantive than growth risks, as food prices, energy and fertilizer costs could drive inflation higher in parts of Asia; third, monetary policy risks favor earlier or more rate hikes, particularly by RBI, BI and BSP; fourth, at the equity-market level, a strengthening El Niño reinforces preferences for Industrials, Resources, Technology and North Asia, while increasing downside concerns about earnings revisions in Consumer, Services, South/Southeast Asia, Australia, India, Indonesia and the Philippines; fifth, climate adaptation and resilience themes may attract greater investor attention.

Analysis framework

The report examines six dimensions: climate forecasts, agricultural production and trade, growth sensitivity, inflation transmission, central-bank policy responses, and equity-market allocation. Macroeconomic exposure is measured mainly using agriculture's share of value added in GDP, agriculture's share of employment, and agricultural trade balances; inflation exposure is assessed using food CPI weights, starting inflation levels, food reserves, food subsidies and other food-price drivers. The equity strategy section maps climate risks to sector and regional allocations and identifies potential beneficiaries of climate adaptation as well as potentially affected stocks.

Methodology notes

• macro_exposureEl Niño growth exposure framework

  Growth exposure assessment

  Agriculture's share of GDP, agriculture's share of employment and agricultural trade balances are used to assess each economy's growth sensitivity to El Niño.

• inflation_exposureFood CPI and inflation pass-through framework

  Inflation transmission assessment

  Food CPI weights, current headline inflation, food inventories, subsidy policies and other food-price cycles are combined to assess the strength of weather-shock transmission into food and headline inflation.

• climate_forecastECMWF ensemble precipitation forecast

  Precipitation forecasting methodology

  Precipitation forecasts come from the European Centre for Medium-Range Weather Forecasts' ECMWF ensemble forecast; economy-level figures represent monthly total precipitation as a percentage of the 1991–2020 ERA5 climate baseline.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• India macro and equities

  Highly exposed

  Strengths

  Irrigation, technology, mechanization, buffer inventories and policy intervention capacity have improved from the past.

  Weaknesses

  Agriculture accounts for approximately 18% of GDP and supports 43–45% of employment; the 34.8% food CPI weight makes rural income, consumption and inflation highly sensitive to the monsoon.

  Comparison

  Viewed as the most exposed economy on the growth side among Asian economies.

  Risks

  If the rainfall deficit exceeds 15%, agricultural growth forecasts face downside risk, inflation forecasts face upside risk, and RBI may begin raising rates earlier.

• Indonesia macro and equities

  Highly exposed

  Strengths

  An important agricultural and palm-oil producing and exporting economy.

  Weaknesses

  Agricultural and employment exposure are relatively high, while rainfall forecasts are weak in 2H26.

  Comparison

  Second only to India in growth exposure.

  Risks

  Food prices are already high and inflation is near the upper end of the target range, so BI may need to tighten further.

• Philippines macro and equities

  Moderate to high inflation exposure

  Strengths

  Policy can still address second-round effects through rate hikes.

  Weaknesses

  Its food CPI weight and starting inflation level make it more vulnerable to food-price shocks.

  Comparison

  Among the more exposed economies alongside India, Thailand and Malaysia in terms of inflation risk.

  Risks

  El Niño could push up rice prices alongside oil prices; BSP is expected to raise rates by another 75bp this year.

• Thailand and Malaysia macro

  Moderately exposed

  Strengths

  Thailand and Malaysia are important net agricultural exporters with a degree of trade-income support.

  Weaknesses

  Relatively high food weights and agricultural-export exposure leave them vulnerable to rainfall shortages.

  Comparison

  Less exposed on the growth side than India and Indonesia, but more exposed than other lower-exposure Asian economies.

  Risks

  Drought could affect agricultural production, exports and food inflation.

• Australia macro and equities

  Moderately exposed

  Strengths

  Agriculture accounts for a relatively small share of GDP and employment.

  Weaknesses

  Wheat production and exports are more sensitive to El Niño shocks, and a positive Indian Ocean Dipole could amplify drought conditions.

  Comparison

  Classified as moderately exposed because of wheat exports despite agriculture's relatively small overall share.

  Risks

  Earnings revisions have already weakened, and El Niño could cause further downside.

• North Asia equities

  Relatively favored allocation

  Strengths

  Low agricultural exposure and better alignment with preferences for Industrials, Resources and Technology.

  Weaknesses

  May still be indirectly affected by global food, energy and supply-chain volatility.

  Comparison

  Preferred relative to South/Southeast Asia.

  Risks

  If global input costs rise again, inflation and demand could still be affected.

• Industrials, Resources and Technology

  Preferred sectors

  Strengths

  Supported by the industrial and capital expenditure supercycle, climate adaptation investment and demand for infrastructure resilience.

  Weaknesses

  Some companies may still face logistics, water-resource and supply-chain disruptions.

  Comparison

  Preferred relative to Consumer and Services.

  Risks

  If weather shocks spread to production, transportation or energy costs, earnings sensitivity could come under pressure.

• Consumer and Services

  Relatively cautious sectors

  Strengths

  Some essential consumption may have defensive characteristics.

  Weaknesses

  Food inflation and pressure on rural income could weaken household consumption.

  Comparison

  The report relatively favors Industrials, Resources and Technology.

  Risks

  Higher food prices, rising interest rates and income pressure could suppress demand.

Key data

• NOAA probability of a very strong El Niño81%NOAA's estimate of the probability that this El Niño event will become a very strong event in the fourth quarter of 2026.
• Probability of lasting through early spring 202797%NOAA expects a high probability that the event will last through early spring 2027.
• Asia's share of global rice production89%Asia accounts for a high share of global production of key food staples.
• Asia's share of global wheat production44%Asia is also an important region for global wheat production.
• Asia's share of vegetable and seed oil production48%Indonesia and Malaysia are important related exporting economies.
• Change in Asian rice production relative to trend in El Niño years-2.4%The report cites historical experience showing that Asian rice production is typically below trend in El Niño years.
• Change in Asian wheat production relative to trend in El Niño years-2.9%The report cites historical experience showing that Asian wheat production is typically below trend in El Niño years.
• Change in Asian rice exports in El Niño years-2.5%The decline in exports is typically greater than the impact on production.
• Change in Asian wheat exports in El Niño years-7.1%Wheat exports decline more noticeably during El Niño events.
• India agricultural GDP growth forecastapproximately 2.5%YBelow the 4.1%Y average of the past five years.
• India food CPI weight34.8%Excluding beverages and food services, highlighting the importance of food prices to Indian inflation.
• India F27 headline CPI forecast5%YThe report forecasts Indian headline inflation at 5%Y in F27.
• India food CPI forecast6%YoY, 7% in F2H27Food inflation is higher than headline inflation and is the main source of upside risk.
• Expected BSP rate-hike magnitude75bpThe report expects the Philippine central bank to raise rates by another 75bp this year.

Impact & implications

For investment implications, a strong El Niño raises the tail risks to inflation and central-bank tightening in parts of Asia and could further weaken already soft earnings revisions in Australia, India, Indonesia and the Philippines. In regional and sector allocation, the report favors North Asia, Singapore and Japan, as well as Industrials, Resources and Technology; it is relatively underweight Indonesia and the Philippines and more cautious on Consumer, Services and South/Southeast Asia. At the thematic level, climate adaptation, cooling, grid modernization, climate monitoring and management technologies, insurance and other resilience solutions may become increasingly important.

Risks

• Uncertainty remains over the intensity and duration of El Niño and the extent to which it overlaps with key planting seasons.
• If the Indian Ocean Dipole turns positive, it could amplify drought in Australia and Southeast Asia, but could also reduce the impact on India.
• If geopolitical tensions push up fuel and fertilizer prices, food-inflation pass-through could intensify.
• Food subsidies account for a smaller share of GDP than in the past, so policy buffers may be weaker than during the 2015–16 cycle.
• Earnings revisions in Australia, India, Indonesia and the Philippines have already weakened, and weather shocks could create further downside risk.
• If central banks are forced to raise rates earlier or more aggressively because of supply shocks, additional pressure could emerge on growth and equity valuations.

What to watch

• Subsequent NOAA updates on El Niño intensity and duration.
• Changes in rainfall relative to historical averages in highly exposed economies such as India, Indonesia, Thailand, the Philippines and Australia.
• Planting progress for India's summer and winter crops, particularly whether the rainfall deficit exceeds 15%.
• Changes in production, exports and inventories of key agricultural commodities such as rice, wheat and palm oil.
• Food CPI, oil prices, fertilizer prices and second-round inflation effects.
• Policy responses by RBI, BI, BSP and BOT to supply shocks.
• Earnings revision trends in Australia, India, Indonesia and the Philippines.
• Investor attention to climate adaptation, cooling, grid modernization, climate monitoring and management, and insurance-related stocks.