Special: Futures in India to take a big leap

A section of politicians want futures trading in commodities banned. But experts say futures market is essential for India to catch up with the rest of the world. A heated debate is on in the booming commodity futures market.

Tur, urad, wheat, rice..

Will the list of banned commodities for futures trading grow day by day?

In the last two months, the debate is on. And the issue is as hot as chilli. Should India continue with futures trading in commodities? Is it responsible for price rise in agricultural commodities? Will ban on futures curb inflation?

Rising prices in essential commodities have virtually threatened the futures market in India.

Most politicians and a section of the industry associations want a complete ban on futures trading in essential commodities. A number of leaders of Prime Minister Manmohan Singh's ruling Congress party blamed futures for the state poll debacle in the agrarian northern state of Punjab.

A day after Congress's defeat, the Forward Markets Commission, India's apex regulator for commodities markets, banned new contracts in wheat and rice futures. In early January, the government had banned two pulses—tur and urad—from futures trading.

The rationale for the ban: curb price rise in essential food items.

Communist Party of India national secretary D Raja says it is high time trading in futures is banned in all commodities. "We feel futures trading encourages hoarding. It has led to the price rise in India," he avers. "It is not the farmers, but speculators and market manipulators who benefit from futures trading in commodities," adds Raja.

But so far, the reforms-friendly Prime Minister Singh has not indicated that his government wants to ban futures trading in other commodities. Instead, he has set up a panel led by Abhijit Sen, an economist from the Planning Commission to examine the merits and demerits of futures.

Traders and officials of India's leading commodity exchanges say the political charges that futures trading is abetting inflation are baseless.

For instance, they point out while rice futures are lightly traded, outstanding contracts in wheat totalled only 89,000 tonnes at the time of the ban, tiny compared with the annual wheat production of 72m tones.

"In fact, the futures prices for wheat had begun to fall even before the ban because India is anticipating a bountiful harvest. So we do not understand the logic for the ban," points out Ashok Mittal, country head, Karvy Commodities.

Experts like Mittal say the government's policy of interference has broken the backbone of the futures market in India. "With the government imposing new restrictions day by day, the futures market, instead of giving a boost to the agriculture sector, is on the verge of collapse now," he says.

The ban move has impacted market sentiments. The turnovers of agri commodities in India's three national bourses—MCX, NCDEX and NMCE—have been consistently falling ever since the FMC tightened screws on excessive speculations in some agricultural commodities.

Dealers fear the ban could virtually kill growing interest in the futures market. Online trading in agricultural futures is only four years old in India. But the turnover of commodity exchanges in 2006-07 financial year touched a whopping Rs 37 lakh crore (Rs 37 trillion).

It is not just the futures ban that is giving headaches to the exchanges. The government has not yet allowed foreign investment in India's commodity exchanges. Foreign players are waiting in the wings to get into the country's booming commodities sector. Already, Goldman Sachs has proposed to buy a 7% stake in the NCDEX last year while Fidelity International owns a 9% stake in MCX.

The Bill amending the Forward Contracts Regulation Act (FCRA) is pending, as a parliamentary committee had suggested some changes, including a ban on agri-commodity futures, before clearing it in principle.

With the Bill still to see the light of day, the toothless FMC is not in a position to introduce dynamic changes and new regulations. The FMC is ready with many regulations that will be issued once the Bill is passed.

 

Options trading and index-based futures are instruments that could provide depth to commodity futures. Such dynamic instruments can increase volumes and liquidity in the market. But, they will have to wait till the FCRA is amended.

Most importantly, the government has still not cleared the foreign direct investment guidelines for commodity bourses. Thus, many prospective FDI deals are pending for want of such guidelines.

The MCX has not been able to come out with an IPO simply because such guidelines are not in place. Commodity bourses have plans to establish spot exchanges to link farmers to markets and create competition for the state-controlled APMCs.

National Spot Exchange Limited Managing Director Anjani Sinha says currently, the APMCs are not interlinked and hence nationwide or statewide spot rates for agri commodities are not available. "Organised and transparent spot markets are the need of the hour. It is imperative that individual states bring in the necessary amendments to their respective APMC laws," he pointed out.

Experts argue that decisions such as agri-commodity futures can wait till the Abhijit Sen committee submits its report, but changes in the FCRA should be taken up with urgency to strengthen the FMC. The FDI guidelines should also be announced without any delay.

The market still lacks adequate infrastructure, such as accredited warehouses and assaying facilities. This makes it difficult for sellers and buyers to settle futures contracts by physical delivery of the commodity rather than by cash.

Madan Sabnavis, an economist at the NCDEX, says that if buyers could insist on taking actual delivery of the commodity, it would make it harder for speculators to manipulate prices in search of a cash profit.

Experts like him point out better regulation would help the market to grow and to introduce new products like options and index futures. The spot market for agricultural commodities, which are fragmented among 7,000 local markets or mandis, would also benefit from more centralised electronic exchanges.

Stock markets are choppy these days. And many say commodity is the best alternative investment to beat inflation. Even on the returns front, over a year, the MCX Metal index has outperformed the BSE Sensex and the MCX Agri Index is in line with the Sensex returns.

Chintan Modi, Vice-President, India Infoline Commodities say retail investors start with bullion futures and move to agri futures without understanding market fundamentals.

"But he says the problem arises when they do not exit their positions in time and end up taking delivery of steel ingots and kapas. Volatility still remains a worrying factor. Recently, mentha futures moved up and down by 11 per cent in a single day," Modi says.

But a section of traders and their associations are not happy with futures trading. Already, a number of associations belonging to rubber, pepper, wheat, rice and mentha oil have submitted proposals to the Finance Ministry asking it to ban online trading in commodities.

Adding fire to the demand, India's Parliamentary Standing Committee on Food and Consumer Affairs has called for a complete ban on futures trading in essential commodities like wheat, rice and sugar.

The committee has also opposed entry of foreign institutional investors in Indian commodities sectors, and especially the commodity exchanges.

It said the entry of foreign investors would only harm Indian farmers as futures trading does not benefit them in any way these days.

Member of Parliament Devendra Prasad Yadav, who heads the Standing Committee on Food and Consumer Affairs says futures trading in essential commodities such as sugar, coarse cereals and lentils should be banned immediately.

"We have studied the futures trading in commodities. And we have recommended that futures trading in essential commodities should be stopped," Yadav said.

Officials say political resistance to futures trading in commodities is a real fact in India. "It is mainly because politicians want to cash in on the farmers and agriculture sector for votes in elections," a senior official in the finance ministry pointed out.

He says the political resistance to futures trading in commodities can not stand for long, as globally forward trading in commodities is a huge business.

But Dr Ashwani Mahajan who is Reader, Department of Economics, PGDAV College, University of Delhi says price rise, especially in essential products, has been there in this country, but futures trading in the commodity markets has made the problem of inflation even more acute.

"If we have a look at the data of future commodity market its worth noting that due to the futures markets the prices of essential commodities have increased significantly and the same has affected the consumer badly. The more distressing is that the benefit of higher prices does not reach the farmers," he points out.

He says futures market in commodities on the lines of the share markets is an alarm bell for the people of this country. "This kind of system will make life difficult for the common man. We have to put limits on speculative activities. We cannot put the majority population's life at stake for speculators who are not even 0.1 per cent of the total population," says Dr Mahajan.

But not every one is as pessimistic as politicians and some economists. There are a growing number of traders across India who actually benefit from the futures trading in commodities.

Vinay Kadam, a pulses stockist in Vashi (Mumbai) is one such trader. He says fluctuating prices have had no impact on wholesalers. "I don't look at commodity futures for returns, but I do make profit. I trade only in pulses and don't mind taking or giving deliveries," he says.

The bigger issue before the government is whether futures trading should continue in essential commodities or not.

Minister of state for agriculture and consumer affairs Kantilal Bhuria says since futures trading in commodities is seen as one of the reasons for price rise, the government is studying whether futures should be altogether banned in essential food items.

"It is a combination of factors that has led to inflation. That includes futures trading in essential agricultural commodities. Government is keeping a close eye on the situation. If any abnormal movement in price rise is witnessed, then the government will not hesitate to take any action and can ban other commodities from futures trading," the minister says.

He says experts have given ample proof that prices of pulses and food grains have been rising in leaps and bounds due to forward trading in these commodities.

But despite criticism, experts argue that an efficient and well-organised commodities futures market is generally acknowledged to be helpful in price discovery for sellers.

Unlike the physical market like Mandis, a well-developed commodity futures market offsets the transaction in commodities without impacting the physical goods until the futures contract expires.

Leading economists have argued against intervention in the market and have flayed fears in certain section of the government that trading is the cause of inflationary rise.

According to Yoginder K Alagh, one of the experts in agri-economy, the government should go for capital account convertibility, curb overspending and lessen taxation burden.

"Once you liberalise the economy, there is no logic in intervening in it. One way to curb the inflation is to cut down money supply," Alagh told CommodityOnline.

Milk, he cited, as one of the most important remover of poverty in India. Instead of supporting the milk producers to produce more, if the government puts a ban on its export, what will the producers do with the excess milk?

And to employ those unemployed from government measures such as this, money is spent on employment generation schemes.

Traders like M R Shah says the government's ban on wheat exports shows double standards and poor foresight.

"On the one hand you dole out money to farmers committing suicide and on the other hand you create reasons for suicides. The government is pressing the panic button and has completely lost track of when to press it," he said.

Lower demand of wheat due to ban in exports means lower prices and the first and the only section that will be affected is farmers. Shah said such steps cannot have any impact on domestic prices. On the contrary, investments in commodities are considered a good hedge against inflation

Traders say cheap politics and coalition limitations are killing the market as government is towing the line to curb market forces rather than seeing the reality of consumption outsmarting supplies. At a rate of 9.2 per cent growth it is natural that demand will increase.

Shah said if run well, futures trading would help millions of farmers hedge against price risks and setting up of spot exchanges will help them more.

"Imagine a market with a few producers and a few thousand buyers. Will it have any liquidity?" Though it is natural the speculators also benefit from the markets, they cannot be blamed for inflation. If that were the case prices of items like onions, potatoes and tomatoes, which are not even traded on the futures exchanges, would not have witnessed the surge.

Across the world, investors these days regard commodities trading as the last bastion of pure capitalism on Earth.

They ask: Where else can you sell something you don't own, buy it back half an hour later, and walk away with 100 percent profit?

Probably, few investment vehicles offer the excitement, flexibility, and tremendous profit opportunities of commodities.

Opposition to futures trading might continue; but it is surely here to stay despite opposition from varied quarters.