Bring Farmers to the bourses: MInt 20th February 2012

With the commodity futures market reaching new levels, it is time to make this platform more meaningful

The commodity futures market has once again come into focus as it has become an interesting option for investors. However, the question to be posed is whether or not it has helped in fulfilling the objective of helping farmers to hedge, which was the motivation behind resurrecting this market.

The market had a turnover of over 1.5 times of the gross domestic product at market prices in FY11 while the equity futures market had a multiple of 1.3 and derivatives, including options, had a multiple of 3.8. However, curiously even today, the share of agri futures is just about 10%. India now has leading global volumes in bullion, comparable volumes in energy and non-precious metals, but not much in agri products. India by virtue of its size and population is a leading producer or consumer of all farm products, which sets the contours for potential of futures trading.

But the story has not quite gone the way it was conceived. There have been severe hiccups along the way with bans on trading in products such as tur, urad, wheat, sugar, soy oil and chana. The ostensible reason was that futures trading caused inflation—a theory that has been refuted. The Abhijit Sen committee showed that there was not enough evidence to prove that futures trading was related with inflation. The recent two years of inflation experience clearly points to the absence of such a relation as none of the traded products was part of the inflation numbers. This means that it is time to make this platform more meaningful with these preconceived notions being dispelled.

Presently, futures trading in farm products is predominantly on NCDEX and the most sought after products where price discovery takes place is the oil seeds complex (soya bean, soy oil, mustard), spices (pepper, cumin seed), chana, guar seed, sugar and wheat. Traders in commodities are hedging and given the efficient price discovery process futures have set benchmarks for the spot markets too. But the farmers are out of this scheme. Why?

First, there is absence of awareness. Second, they have limited access to these platforms. Third, their production levels are lower than that of the contract sizes. The exchanges can bring it down in case there is liquidity or else the contract flops. Presently, it is based on the economical size of delivery lots. Fourth, we do not have adequate warehousing facilities. Fifth, the warehouse receipt is not a negotiable instrument which can help in increasing lending to farmers who sell forward on exchanges. Sixth, there is limited liquidity in several products.

The approach, hence, has to be threefold. First, we have to enable farmers to trade for which we have to create structures and liquidity. To get in farmers we have to get in aggregators who pool the output of farmers and hedge on their behalf, which is not permitted by the prevalent regulation. Banks could pitch in as was recommended by the Reserve Bank of India (RBI) in 2005, but regulation does not allow for bank participation in this space. Banks are lending to farmers as part of their priority sector targets and, hence, it makes sense to hedge on their behalf as the ability of the farmer to repay loans depends on the ability to get the right price, which can be assured through hedging. Further, the warehouse receipt has to be made negotiable for banks to enhance lending. We need changes in the Forward Contracts (Regulation) Act, Banking Regulation Act and Warehousing Act.

Second, we need to create more warehouses because unless farmers have access to delivery centres, this will be a non-starter. Farmer awareness programmes are necessary, which the Forward Markets Commission (FMC) is doing along with the exchanges and should leverage the farmer clubs of Nabard, non-governmental organizations, cooperative banks, commercial banks, etc. Merely having programmes will not work, as there should be appointed nodal officers who take it forward. Hence, it has to be an initiative taken by the commodity market along with RBI and Nabard.

Third, liquidity is important and FMC should allow market-making, which has been successful in the capital and government securities markets. Next, we should get more retail participation, which can be done through enabling legislation that permits “commodity funds” much like mutual funds where individuals are able to invest through this route. Today, the collection of funds from the public comes under the purview of the Securities Contracts (Regulation) Act with Sebi as regulator. This needs to be resolved soon. Also the entry of foreign institutional investors into this field will help induce liquidity with corresponding riders placed on position limits and delivery.

Last, we need to allow options that are analogous to the minimum support price (MSP) of the government. Futures assures a price at the time of harvest and the seller cannot go back on this commitment. In case of options, one can exercise this right by paying a premium, which resembles a market related MSP offered by the Food Corporation of India where the farmer can choose to sell at this price.

We have reached a stage where the commodity futures market is positioned to move to a new level. But various laws have to be sewn together and regulators should start talking to one another.