Monday, November 23, 2015

The irrationality of stock limits: Financial Express , Nov 9, 2015

Whenever the price of any agricultural commodity increases sharply, the standard response is to trace the problem to hoarding. It happened for sugar, tur, urad, soybean earlier, and more recently for onions in 2013 and once again for pulses in 2015.
The Essential Commodities Act is a tool that is invoked by the government periodically to impose stock limits on various holdings of commodities. This applies at the wholesaler and retailer ends, which can then also include exporters or importers to ensure that the scope for hoarding is reduced, which, in turn, brings down prices. Any violation can lead to seizure of the product beyond the prescribed limit and possible judicial action.
The government has invoked the stock limits for pulses and it has been claimed that by the release of such stocks, supplies have been augmented and prices have come down. A fundamental issue is the opacity of the concept of hoarding. Normally most crops have a single season harvest. Rice, maize, urad, moong, groundnut have two harvests but are primarily kharif crops. Wheat, chana, mustard are exclusively rabi, while soybean is only kharif. Once the harvest comes in, we have to wait for the next season before the fresh arrivals are available for consumption.
Therefore, the product has to be made available throughout the year across the country. For most of these crops except rice and wheat where the Food Corporation of India (FCI) has a procurement and storage system, there are virtually no carry-over stocks with imports being used to balance the requirement.
Now the fundamental question is that with the crop being harvested once and the requirement being throughout the year, it is but natural that someone has to hold on to the stock. Farmers do not have the holding power and sell at the time of the harvest. It is then the intermediates who get into action and move the goods through the country, dealing with wholesalers along the way, finally moving to the retailer.
Intuitively, the stocks are being carried by players who have to provide for warehousing, transportation, regular fumigation, insurance, etc, which, in turn, requires funding. Hence, while the intermediates are presented in an exploitative light in these conditions, the fact is that someone has to do these jobs.
Under normal conditions, the processes of stocking and releasing the product are seamless with minimum price variations through the year. However, once there is news of a bad crop—which is the case of tur, moong and urad this time—prices start moving up in advance and the dealers, who are also stockholders, take advantage of the situation and push up prices. Are they actually hoarding the product in a significant manner to increase prices or is this happening due to the normal market forces is a matter of debate. Hence, the distinction between regular stocking and hoarding is blurred, and every time there are expectations of lower production, the stock holding is interpreted as hoarding, which becomes illegal with penal action being taken.
Once the act of storing is treated as hoarding, then there is a major risk in the commodity futures market. A commodity futures market runs on the basis of credibility in price discovery, which, in turn, is enhanced by delivery.
While deliveries do not normally take place as it is inefficient being a high-cost affair, in India NCDEX has witnessed increased deliveries, which actually add weight to the price discovery process. In case of products like oilseeds (soybean and mustard) and pulses (chana), deliveries have been increasing with several mills using this platform effectively. If transactions take place based on price expectations, and deliveries are reckoned on the same, then the decisions taken are genuine and not based on pure speculative or day-trading forces.
With the government now coming down on hoarding, this market would be on weak grounds.
There is already news that some of the warehouses which stock commodities that are dealt with on futures exchanges have been raided and the stocks impounded. This is detrimental as genuine transactions involving hedgers would be set back. Stocks kept in the warehouses are being delivered and are a part of legitimate trading being in a transparent system.
The issue with imposing stock limits is that it gives rise to harassment of dealers and warehouses, which distorts the markets. It should be pointed out that no one stores a product just for the sake of it, and finally given the limited period where a product can be stocked, there are limits to which one can exploit a perverse benefit in these conditions. We need to use our judgement and differentiate between prices increasing on account of ‘hoarding’ and ‘genuine stocking’, which has an upside when the future is bearish for output. While profiteering will happen at the margin, other solutions like price ceiling can be a solution where the MRP can be fixed at the consumer end. The MRP can always be calculated backwards, as the procurement price in the previous season is known as well as the cost of carrying the stocks on a monthly basis, though admittedly given the plethora of qualities that exist for each product, a range looks more feasible.
At another level, there is a need to debate on the wisdom in having the FCI carry large stocks of rice and wheat with its open-ended procurement scheme, which has often triggered puzzles in the system where market prices increase due to low availability of wheat even while the country produces a high quantity, as most of it gets locked up with this agency. This anomaly has not really been highlighted, as typically the price of these two products should be stable to the extent of the MSP. But given that often millers complain of shortage in supplies, the culprit in hoarding happens to be the government itself. This needs to be corrected.
A run on hoarding is aggressive when prices are moving up sharply and affecting consumers. But, as has always been witnessed, such actions only cool prices to a certain extent, with the decline being in the region of 10-15% depending on the region concerned. In addition, the quantities seized have rarely been substantial to decisively increase supplies in the market. Therefore, attention should be more on augmenting supplies through production and right timing of imports and building buffers in all vulnerable commodities. The FCI can do this by having effective policies for releasing excess rice and wheat in its warehouses.

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