Macroeconomic impact of droughts in a developing economy

Purpose This study examines and quantifies the role of droughts as a driver of macroeconomic instability in emerging commodity-exporting economies, using Argentina as a case study. The research seeks to bridge the gap between micro-level agricultural impacts and aggregate macroeconomic outcomes, assessing the extent to which climate shocks destabilize the economic cycle and pose systemic risks in the developing world. Design/methodology/approach Using quarterly data (2004–2021), we construct a Weighted Agricultural Precipitation Index (WAPI) that aggregates departmental rainfall deviations weighted by crop production shares. We then estimate a Structural Vector Autoregression model with block-exogeneity restrictions to isolate exogenous drought shocks, ensuring a unidirectional causal flow from climate to the macroeconomy. The dynamic transmission mechanism is evaluated using Impulse Response Functions and Forecast Error Variance Decompositions. Findings A one-standard-deviation drought shock causes a 4.5 percentage point (pp) drop in agricultural value added. This supply contraction triggers a 2.3 pp drop in export revenues, generating a 0.94 pp real effective exchange rate depreciation and contracting aggregate demand, culminating in a 1.06 pp decline in total Gross Domestic Product (GDP). Drought shocks account for 21.2% of total GDP volatility, confirming their systemic nature. Notably, consumer inflation remains contemporaneously unresponsive, buffered by severe income contraction in nontradables and active foreign exchange interventions. Research limitations/implications Droughts in commodity-dependent economies are structural determinants of business cycles rather than isolated events. This implies that climate resilience is inseparable from monetary and financial stability, requiring policies that manage balance-of-payments risks arising from supply-side climate shocks. Practical implications Given that droughts drive aggregate business cycle volatility, stability management must prioritize counter-cyclical international reserve accumulation to buffer export revenue losses. This precautionary measure should be complemented by fiscal risk-sharing mechanisms – such as disaster funds and climate-resilient debt clauses – and targeted investments in irrigation. Furthermore, relying on foreign exchange interventions to contain inflation during droughts is a short-term palliative that depletes Central Bank reserves, underscoring the need to redesign monetary and macro-prudential frameworks to explicitly manage systemic climate risks. Originality/value This article makes two fundamental contributions to the literature on macroeconomics in Emerging Markets and Developing Economies. First, it provides a methodological innovation through the development of WAPI, a geographically and economically granular water stress indicator. Second, it offers an empirical innovation by quantifying the dynamic propagation of drought shocks in Argentina. This analysis allows us to identify how exogenous climatic events shape business cycle fluctuations in the context of a developing, agricultural-commodity-exporting economy.