Have the Futures Markets Delivered? Business Line, 15th Jan 2008

Four years into the operation of commodity markets in India, a pertinent question to ask, is whether or not they have delivered adequately. More so, because while there was considerable fanfare with which these markets were resurrected after much debate, there is a modicum of scepticism underlying their operations today. Some critics have even questioned their existence. The issue can be addressed by juxtaposing it with the objectives of reintroducing commodity futures in 2003. The market was to lead to efficient price discovery, involve more hedgers and bring home the benefits to farmers. How far have the markets redeemed themselves?Price influence
The year started off well for the market with business volumes increasing at a rapid rate. Subsequently, there was a ban on trading in wheat, rice, tur and urad ostensibly on account of their contribution to inflation. Interest in trading in agri products naturally ebbed as players were apprehensive of trading in this segment. Consequently, trading in agri commodities came down and the share of these products in total volumes traded fell to less than 20 per cent.
Today, interest is generally in metals and energy, which are safer avenues from the trading perspective as the perceived possible influence on prices is negligible, as price discovery is a global phenomenon. Hence, they make good trading and investment options.
Agri futures
Subsequent to the ban, the prices of wheat, rice and tur rose quite sharply in the market as supplies were lower. In fact, rice saw a sharp increase in price though it was not traded on the exchanges. While urad prices came down, this was indicated by the futures prices at the time of the ban. It is now quite accepted that futures trading was not responsible for inflation; and the market is awaiting the final word from the Abhijit Sen Committee.
Let us objectively evaluate how the markets have performed. First, price discovery has been quite efficient, especially for the agri products. Price signals that have been sent in case of wheat, pulses, spices and oilseeds have been fairly accurate. In the case of wheat, in both 2006 and 2007, accurate signals were sent, which were actually used by the government to raise the minimum support price (MSP) for the purpose of procurement.
Second, there is evidence that price volatility has come down in all the liquid contracts, which is but natural when large volumes are traded, where the noise levels are reduced.
Prices have also tended to converge in case of most contracts — which is the ultimate test of price efficiency in this market. Third, there are companies that are hedging on the exchanges as depicted by the ratio of hedger’s positions to open interest, especially in some agri products. Awareness
Fourth, the picture from the farmer’s side is mixed. Direct participation is negligible because of the barriers in terms of direct access, processes and contract size etc. But, the business of futures trading involves extensive price dissemination campaigns, which are out in full flow. Newspapers, TV channels, radio, usage of electronic ticker boards etc, have been used by the exchanges to popularise these prices among participants.
The regulator — the Forwards Market Commission (FMC) — has initiated extensive awareness campaigns with the exchanges to have programmes for the farmers where the intricacies of trading are discussed.
There are studies which show that farmers are using the prices to enhance their bargaining power. Last, by enabling deliveries, which could go beyond 50,000 tonnes every month, there is a parallel system in place for physical handling of the goods, which is significant as there are certain standards being set for the quality, handling and grading processes, which is currently underdeveloped and would take another five years to become all-pervasive. Therefore, the markets have satisfactorily redeemed the charter that was laid before them four years ago.
It must, however, be reiterated that futures trading is not a panacea for the ills of agriculture. Futures markets provide a platform for farmers to sell and/or hedge their price risk by enabling physical delivery. They are good indicators of expected cropping supplies and are, hence, useful for policy formulation.
Further, the price discovery process must be evaluated form the point of view of whether or not they reflect the fundamentals and not so much from the point of view of whether the farmers are getting a higher price. Caution required
This must not be missed because when we take sides we may arrive at erroneous conclusions when the result is not to our liking.
To draw an analogy from the traffic on the street, the futures markets provide signals of the steep bends ahead, but are not responsible for them. It is left to the motorist to take care. This is the spirit with which these markets must be evaluated.