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 India?either 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 interest?the number of contracts outstanding at the end of the day and could be potentially delivered on the platform if held to expiry of contract?matters 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 on the NCDEX are: mustard, soybean, turmeric, etc. The inflation rates here low or negative: mustard (1%), chana (-14.2%), soybean (-1.2%), turmeric (0.5%). Clearly, it can?t be concluded that futures trading caused prices to come down!
In fact, the ratio of open interest in the near month (which is liable for delivery if maintained till expiry date) to total production was 1.1% for soybean and 1.5% for mustard. Such quantities cannot have any influence on the final price even if brokers work together.
Wheat has shown an increase of 4.6% in prices and is also traded on the NCDEX (around R100 crore a day). Here, the ratio of open interest to total availability (assuming 60% marketable surplus) was just 0.01%. The answer lies in the demand-supply imbalances as well as the tendency of the government to increase MSPs which has raised the price of, say, wheat where there is procurement.
Futures trading is reflective of the state of things to come as the price picks up all information as players look for signals all the time. It should be used to set policy. Intuitively, if we had trading in, say, onions, and the prices indicated a crop failure, the government could have stepped in earlier and averted a crisis by importing the same. As long as regulation is in place and exchanges have systems of market watch that work well, futures trading provides a very valuable input and should be spread across the entire farm commodity basket as it brings in efficiency. We need to get out of the mindset of whether the farmer is getting a higher price or consumer is paying a higher price. We need to get at the right price, which the market is delivering.
Madan Sabnavis
The author is chief economist, CARE Ratings. Views are personal
The Narendra Modi dispensation has taken over the reins in New Delhi. Obviously, this has brought focus on its major challenges. The regime change was largely facilitated by a tectonic shift of popular choice away from the Congress. Popular disaffection on sky-rocketing food prices has played a major role in this electoral upheaval.
Understandably, tackling inflation, and particularly food inflation, would have to be Modi government?s priority. Of all the factors that were seen as responsible for the runaway food prices, even during the UPA-2 regime, futures trading in agricultural commodities were a major one. Recognising this, the government constituted a committee led by the Planning Commission member Abhijit Sen. The committee?s finding was strange, with several members pulling in different directions. In fact, chairman Sen himself gave a separate note. However, the committee itself could not conclusively establish anything.
Given the viciousness of the soaring price line, the government formed an empowered committee led by Narendra Modi. The Modi committee examined the issues and recommended that since the linkage between futures trading and increase in prices cannot be proved either way, therefore ?discretion? should be the ?better part of valour? and futures trading in major agricultural commodities must be banned.
Debates on futures trading arose in the background of sharply spiralling food prices in the run up to the global financial meltdown; and subsequent climbdown of the world trade crisis of foodgrains from the second half of 2008. And, empirical evidence clearly establishes that global food crisis was not discrete and separate from the global financial crisis. In fact, both were intimately connected because of an increased level of financial investment in food commodities with downturn in the housing sector. Further, food crisis and soaring prices also got inextricably linked to the global crude oil prices, again due to major speculative activities of financial intermediaries.
However, this is not to say that soaring food prices had nothing to do with the ?real economy? factors. But that financialisation of food commodities and speculative flows therein are crucial is clear from the FAO data which showed scarcely any change in global supply and utilisation during the period of extreme volatility in food prices. Even World Bank research in 2010 recognised the role played by ?financialisation of commodities? in price surges and declines.
Futures trading have an old history in India beginning in 1875 for trading in cotton. However, that was for a completely different reason, mainly facilitating barter. The Constitution of
India places regulation on forward contract in the Union List. But there has been unprecedented change in the scenario since the beginning of the 21st century with futures trading in agri-commodities getting inextricably linked with global financial markets. The main argument for introducing this was to insulate very large numbers of marginal Indian farmers with very little surpluses from extreme volatility and facilitate hedging.
For this, futures prices have to be always less than spot prices. However, during this period of extreme volatility given the speculative investments, it has not always remained so. At times, futures prices have driven up spot prices. The technological and the communication infrastructure in India also remains woefully inadequate to ensure any transmission of useful timely information to our millions of farmers to ensure any market-linked cropping exercise to facilitate that increase in prices can benefit them. On the other hand, the consumers are evidently hit by such soaring prices in food commodities.
The only gainer appears to be the financial intermediaries. Given such a reality, there is a strong case for banning futures trading in agri-commodities.
Nilotpal Basu
The author is a CPI(M) leader
