Does futures trading push up food prices?

Jun 03 2014, 04:58 IST
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SummaryConcerns over commodities futures trading pushing up prices are misplaced. There is little evidence of this and the need is to utilise futures trading indications for taking policy decisions

Futures trading is based on expectations of prices to prevail at a later date which, in turn, is based largely on all available data, including expected or known fundamentals-linked demand and supply of a product. Intuitively, the price which is discovered on the futures platform reflects this equation. The fundamentals include expected supplies, arrivals, logistical bottlenecks, leftover stocks, demand, etc. Global influences would play their role in case the product is traded outside Indiaeither exported or imported. When there is enough liquidity in the contract, the price discovery process is robust and the final price traded reflects the underlying reality.

The volume of trading on an exchange reflects the liquidity that is generated, indicating efficiency. The volume of trading cannot influence the price per se and what is important is the open interest which can be delivered on the exchange. Trading is also done by investors and speculators who move in and out based on minor price movements. Such trading cannot influence prices once the rules are set by the commodity exchange.

Open interestthe number of contracts outstanding at the end of the day and could be potentially delivered on the platform if held to expiry of contractmatters more. If the open interest is high and accounts for a large proportion of the commodity that is produced, then it can impose on the price as this is the quantity that can potentially be bought and sold on the exchange. Futures exchanges keep this open interest under control and fix position limits to ensure that no single trader or group has a limit of more than, say, 2-3% of the available product.

With these ground rules set, there has been an ongoing controversy that such trading led to high inflation, ever since futures trading was revived in 2003 . The best way to check if it so is to look at data from a time of really high inflation in India. Looking at the April 2014 inflation numbers, as per the WPI, the first impression is that the high increase in prices on a year-on-year basis was for products that were not being traded on the comexes.

High inflation was witnessed in case of moong (23.7%), potato (31.6%), rice (12.8%), jowar (12.4%), masur (12.3%) and urad (11%). None of these are traded on the NCDEX, which is the leading exchange for agro commodities.

In fact, the commodities which are traded relatively in high quantities

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