Does futures trading push up food prices? Financial Express June 3rd 2014

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 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.