By Sreekumar Raghavan
Thinking of commodity Futures markets in India or even in advanced markets of United States and UK in 2008, one is inclined to quote the opening lines of Tale of Two Cities, the masterpiece by Charles Dickens. “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness……” It may be recalled that Dickens wrote the novel against the backdrop of French Revolution.
A revolution of sorts is indeed happening in India's commodity Futures market. The country's commodity trading market which expanded by 50 times in a span of 5 years from Rs 66,530 crore in 2002 to Rs 3,3753,36 crore in 2007, is now expected to grow at a steady pace of about 30% by 2010 and touch a volume of Rs74,156,13 crore since people's participation in such trade would continue, according to findings of Associated Chambers of Commerce and Industry(ASSOCHAM).
The worst part is that this same piece of statistics is used by policy-makers and opponents of commodity Futures to justify their argument that large amounts of speculative money flowing into Futures markets is causing the inflation graph to go northwards. The result: Futures trading stands banned and suspended in eight major commodities, including rice, wheat, rubber, soyoil, chana, and potato. There is more of such demand coming from different sectors for example; now spinning mills want a ban on cotton Futures. It is a different matter that prices of commodities that were banned from Futures did not fall as a result, it only moved up.
Not only in India, even US and UK commodity Futures are under fire for encouraging speculation and manipulating markets. According to a study by International Cotton Advisory Committee, the global cotton prices were manipulated by non-index trader-speculators who were responsible for driving the cotton prices up from June 2007.
Now, Commodity Futures Trading Commission (CFTC) even when denying there is any manipulation in commodity Futures markets, has strengthened its department of market oversight and has opted for more transparency regarding open interests and positions while New York Mercantile Exchange has imposed larger margins on several crude oil and electricity futures contracts.
UNDERSTANDING FUTURES It is still doubtful how many of our policy-makers, politicians and even academics are aware about how commodity exchanges function in the country.
“The way the debate had been raging with participation from different interest groups, it is clear that there is misconception about the role of commodity Futures and the real reasons for rise in commodity prices,” Atul Choksi, director, Kunvarji Commodities, said.
Ashok Jain, director of Contact India Commodities, was of the view that those who take part in discussions on commodity markets only have a parochial view of the market and limited knowledge of how Futures work. Naturally, then the first question to be asked about Indian commodity Futures is whether it is performing its major functions faithfully hedging and price discovery.
On this count, the Assocham report has given thumbs-up to Indian commodities sector. It said that Futures trading in commodities results in transparent and fair price discovery on account of large-scale participation of entities associated with different value chains. This reflects upon the views and expectations of a wide section of investors related to that commodity. It provides an effective platform for price-risk management for all segments of players ranging from producers, traders, processors, exporters/importers and the end-users of a commodity.
All the commodity players Commodity Market talked to agreed that both the functions are being taken care of by Indian commodity exchanges while some people expressed reservations. Ashok Jain, Contact India, said that the functions have been fulfilled only partially.
“For example, rising wheat prices was captured in Futures price increases before delisting. Also, several goldsmiths and agri-producers hedge on the exchange. Even India's largest vertically integrated copper producer and public sector Company Hindustan Copper Ltd hedges copper through Religare,” said Jayant Manglik, head (commodities), Religare Commodities.
OPTIONS In India, options trading in stock market indices and securities began in 2001. According to some analysts, in a volatile market traders can hedge their risks with options. India's exchange-based commodity trading, though at a nascent stage, is still mature enough to launch options. “Launching options is one of the tools to develop derivatives market. In its absence, a significant part of derivatives market is missing. Launching option contracts should not be delayed for any reason,” said Anjani Sinha, MD and CEO of National Spot Exchange of India.
S Venkat Raghavan of Altos Derivatives Institute has a different view. He said: “Options is mostly an OTC product worldwide and everywhere few options contracts have succeeded on Futures exchanges.”
FARMERS' PARTICIPATION One major drawback of Indian commodity Futures is the lack of farmer participation. This is a convenient stick to wield for those campaigning against this industry. These sample people also say that very few farmers are aware of the government's minimum support price (MSP) mechanism. The main problems in getting farmers' involvement are the margin money requirements, lack of awareness among farmers apart from the large contract size in exchanges, which keep farmers away.
“Obviously, redesigning contracts and lowering margin requirements will help even small farmers to participate in the Futures market. Since the agricultural crops are prone to weather vagaries, small farmers who produces small quantities with varying quality cannot enter into Futures market, which imposes stringent quality norms. With the easing of quality standard they can enter into market to make use of this,” said Ashok Mittal of Karvy Commodities.
Since the commodity exchanges have specified stringent norms to trade in Futures market like taking membership by providing sufficient identity proofs, which is not possible in Indian context, the only way to trade is to organise farmers' unions.
Quality/quantity related issues can be sorted out with the adoption of farmers' aggregation. Increase in position limits certainly increases the participation from varied sectors of the society be it producers or consumers or speculators. This facility widens the price discovery beyond certain horizons. Since the current position limits do not help big companies to hedge their entire risk, the participation from actual traders is coming down, Mittal said.
The designing of contract needs to be done with twin objective of making them useful to the real user as well as to create a subtle similarity with global market so as to generate interest of traders. A fine balance needs to be struck. Most of the contracts, especially in agri-commodities are designed either based on export market or are aligned with foreign specifications. It needs to be corrected to some extent in favour of properties of local produce, according to Atul Choksi of Kunvarji.
Naveen Mathur, head, commodities, Angel Broking, said introduction of options could lead to larger participation by farmers in commodity exchanges as the risk is lesser in options contracts compared to trading in Futures.
MUTUAL FUNDS, BANKS In Indian commodity Futures, mutual funds, hedge funds and banks have been allowed to trade. In United States, for example, their exposure was so high that it led to manipulation of markets and speculation in some hot commodities. However, commodity players are eager to involve banks and MFs in commodity trading with certain limitations so that it could bring the much needed depth and liquidity to our markets.
“Worldwide the size of commodities market is almost the four times the size of equities market. To create that kind of commodity Futures markets, we need active participation of banks and financial institutions, which would bring the required sophistication, technology and depth to the Future markets,” according to D K Agarwal, managing director of SMC Comtrade.
But there are those who argue that no limit on exposure should be set for MFs, banks, FIs and FIIs etc. “Since exchanges anyway have commodity-wise, client-wise and member-wise exposure limits, any limitation in exposures may limit the growth of this segment. However, the prudential norms used by equities segment and debt segment can be implemented for commodity Futures too,” according to Ashok Mittal.
Still a minority believe that MFs, banks will acquire the power to manipulate the markets because of their deep pockets. “It will give them the power to manipulate the market. If MFs and banks are allowed there should be a cap of 20% of open interest of the market,” said Gyanedra Gopal, asst vice-president, Commodities at Bonanza Online.
INFLATION Even though Abhijit Sen Committee report was inconclusive on the role of Futures market in creating inflation, it opined that there was no evidence to substantiate this allegation.
Major commodity players are of the view that in discussions about inflation, the Futures market should be de-linked and there is no point in further extending the debate along those lines.
Continued...
