Ban on Futures Trading of Farm produce
Battle Grounds of Futures Trade Banning
Farmers Vs Futures Trade
- The list of banned commodities
for futures trading is getting bigger day by day because
of the present hot political issue “Inflation”. The Left
allies and some of the NGOs said the inflation was caused
by the futures traders and mounted some campaigns against
the government. So the government banned tur and urad futures
in the last week of January 2007 expecting a price fall
in these commodities. Again on the eve of the Budget, the
Congress was routed in the Assembly polls in Punjab and
Uttarakhand. Thus on 28th February 2007 in addition
to his prepared Budget speech, the Finance Minister announced
the Government's decision to take wheat and paddy out of
the futures market.
- But unlike last time
when it banned the futures at one shot, creating difficulties
for traders, the government took a more practical step by
opting a gradual phase-out. The existing contracts will
expire on maturity and positions will be allowed to be squared
off. If any position remains after that, these will be taken
care of at the price on the day of settlement.
- Last year, the entry
of private traders created a competition and helped the
farmers in getting a price advantage of about Rs 100 above
the procurement price per quintal. This private traders
entry has not affected the the country’s overall stock position
at all. But in June 2006 there was a gossip among the Chicago
traders that there is a possibility of India importing around
10 lakhs tonnes of wheat. Where as the Agriculture Minister
strongly told that there would be any need for wheat imports
- At last, the Government imported about
30 lakh tonnes of wheat, at a price much higher than the
domestic price. Then the Government justified that the imports
would be unloaded and used in South India instead of transporting
from North to south India. But some analysts said that the
justification had been after the import and the decisions
on imports had been made much earlier in the year.
- Actually private traders
entry had nothing to do with this massive imports. But with
the electoral reverses and left allies campaigns the government
wanted to procure 15 million tonnes of wheat during the
season. So the Government had sent a message to private
companies not to enter the wheat market till the Food Corporation
of India (FCI) completes its quota. Instructions were also
given to Railway authorities not to book railway wagons
except for FCI. With the ban on both private trade and the
futures market, wheat growers had no option except accepting
the low procurement price offered by the FCI. Thus the coming
wheat procurement season threatens to be a hot one.
- Commodity futures trading
in India started some hundred years ago. Then because of
shift in economic policies almost the entire commodity futures
trading got banned. In the last decade, this has gradually
come back to life.
- Now some of the futures
market platforms offer operations through the Internet.
Some of them also provide warehousing facilities.
- Once after verifying
the quality and grade of the produce farmer store his produce
in these warehouses. He can visually ascertain the prevailing
spot price as also the futures prices in various languages
on the monitor.
- The farmer can decide
to sell at the current price, in which case he gets the
full amount in cash. Or, if he decides to sell at any convenient
future date, he gets an advance of about 70-75 per cent
of the current price as also a warehousing receipt, which
is a negotiable instrument.
- On expiry of the contract
date, the holder of the warehousing receipt is assured of
getting the contracted price. The farmers have no difficulty
understanding the scenario and would rather transact through
the futures market.
- Unfortunately, the mindset
still persists among many that the futures market is purely
speculative and leaves open the field to unscrupulous traders.
- There was a time when
the farmer was not aware of futures trades when speculations
could have been taken place.When the futures market is truly
opened to farmers, it takes on an entirely different aspect.
- The farmer produces
various types of crops and the existing socio-economic and
political framework makes it difficult for him to change
the form of his produce through value-addition / processing
and also to make his produce available in another location
where the prices may be better. The farmer is well aware
of the fact that the immediate post-harvest prices are low
it will rise in three to four months. But he cannot wait
to take advantage of this price rise.
- At the same time there
are traders and consumers who need the farmers produce in
other locations at a specified time in the future. Here
comes the futures market which matches the offers to sell
with the bids to purchase with an objective to avoid costs
of transport and storage. For the first time, farmers can
choose the price at which they want to sell their produce.
So it facilitates price discovery and risk-cover with greater
certainity. It can be misused, but to a very limited extent
under the present regime in the Indian futures market, which
provides for physical delivery in most cases.
- Normally traders in
a region surrounding a town would be the major players in
purchase of the product of that particular region. This
trade would typically be dominated by 10 or 20 traders who
often determine purchase prices. Farmers would have little
choice vis a vis the price at which they can sell or might
not even know prices elsewhere in the country.
- The powerful tool futures
market breaks the market power of these traders by its nature
of transparent, electronic exchange with nationwide access
which brings in new players. Physical proximity to the market
becomes a non-issue once an electronic exchange is in operation.
Also when both the trader and the farmer know the futures
price, it is harder for the farmer to get cheated.
Effects of futures trade bans on prices and
- Government imposed a
temporary ban on futures trading of agricultural commodities
in two phases from the start of the year 2007 where January
ban on urad and tur dal gave disappointments to the government
and the later ban at the end of February on wheat and rice
brought some smile to the government.Govt banned futures
trading in dal to curb inflation but prices have not fallen,
only risen in some cases. It continues to hover at levels
that prevailed prior to the delisting. While the average
ruling prices of urad (black gram) were around Rs 3,000
per quintal mid-January, the February prices continued to
remain at the same highs, sometimes crossing Rs 3,500.
- A similar case prevailed
when it came to tur (pigeon pea), which continued to sell
at an average price of Rs 2,000 per quintal in Maharashtra,
according to data provided by the Maharashtra State Agricultural
Marketing Board. The prices are about the same in most parts
of the country so the ban has come into question.
- Director of the Forwards
Market Commission (FMC) Anupam Mishra admitted that futures
trading of a commodity would not really impact their prices.
“The futures market provides a platform for price discovery
and risk management. It is nothing but a forecast of likely
demand and supply and prices at a future point of time.
It does not impact prices,” said Mishra. He, however, hastened
to add that the ban was effected because of perceptions
that markets and speculation were leading to the rise in
- The officials of the
FMC felt , the high prices, in all probability, are due
to a mismatch in supply and demand of these two commodities.
In fact, official figures also supports that. The production
of pulses has stagnated in the last few years, even as the
sown area under urad and tur in the current rabi season
has gone down by around 3 and 6 per cent respectively.
- It is reverse in the
case of wheat and rice ban as the wheat prices have started
falling. The downslide in wheat prices continued unabated
on persistent offerings by stockists against slowdown in
buying by rolling flour mills after Forward Markets Commission
announced the ban.
- Wheat dara (for mills)
remained in negative zone and prices declined to Rs 1,000-1,005
per quintal from Rs 1,020-1,035 per quintal while wheat
MP (deshi) drifted to Rs 1,200-1,550 per quintal from Rs
1,390-1,590 a quintal. Existing wheat contracts are expected
to continue till March 20.
- In line with wheat,
chakki atta, maida and sooji also quoted lower at Rs 1045-1055,
Rs 1045-1155 and Rs 1200-1220 per bag of 90 kg respectively.
Traders have forecasted a further decline in wheat prices
in the coming days.
- As far as rice price
is concerned it is steady as there is not much activity
in futures trading in the commodity.
- With this controversial
effects we can’t say solidly that futures trade is one of
the culprit for the inflation hike.
Post ban Analysis
Significance of Commodity volumes in the
- It is claimed that futures trading drives
up prices and thus inflation is also shooting up to all
time high. But an efficient and well-organised commodities
futures market is generally acknowledged to be helpful in
price discovery for sellers. It offsets the transaction
in commodities without impacting the physical goods until
the futures contract expires. Thus, a futures market encourages
competition by attracting traders who hedge their bets and
minimise risks on the basis of their own market information
and price judgment. As a result, the commodity market attracts
participation of hedgers who have a long-term perspective
of the market, and traders, or arbitragers who hold an immediate
view of the market.
Agriculture Production Vs Population
- At present the average
daily turnover of 23 commodity exchanges put together barely
crosses Rs 8,000-9,000 crore. Of this the share of fine
cereal grains (wheat and rice) is insignificant, ranging
below Rs 30 crore per day. As per 2006-2007 Economic survey
report presented on 27th February 2007, as on
December 31, 2006, gold, silver and copper recorded the
highest volumes of trade in MCX, while in NCDEX, guar seed,
chana and soy oil had the highest volumes of trade. Gold
accounted for the largest share (31 per cent) of trade,
followed by silver (19 per cent), guar seed (11 per cent)
and chana (10 per cent). Clearly, the volumes of commodity
futures in tur daal, urad daal, wheat and rice are insignificant
and does not figure in the rising price scheme.
- Moving in to more specific,
for example, the wheat trading volumes on Commodity exchanges
were very low with only 20,000 tonnes being traded in the
country, which produces around 70 million tonnes in a year.
- So the officials at
the commodity exchanges strongly argue that the speculative
activity is not the cause for fuelled inflation.
Difficulties in Futures Market
- As per the statistics,
production of pulses has stagnated for 12 years while wheat
output has remained static for almost seven years. Population
growth and a shift in food habits away from coarse grains
with the rise in incomes, has increased the consumption
of wheat over a few years. The share of agriculture in GDP
is declined to 18.5 per cent in 2006-07. The share of the
farm sector's capital formation in GDP dived from 2.2 per
cent in the late 1990s to 1.9 per cent in 2005-06.
- After an annual average
of three per cent in first five years of the new millenium
starting 2001-02, growth of agriculture in 2006-07 is only
2.7 per cent.Low yield per unit area across almost all crops
has become a regular feature of Indian agriculture.But the
population of India increases by 16.29 million(1.7 %) every
year over the current population of 1.4 Billion. Thus it
is strongly argued that the wide gap between the growth
rate of Agriculture production and population is the main
cause for the price hike, rise in inflation, governments
food grains imports etc and not the futures markets.
- The stagnation or declining
production is due to low investment, imbalance in fertiliser
use, low rate of seeds replacement, a distorted incentive
system, low post-harvest value addition etc.So the government
has to get down in to the real issue of boosting farm output
by increasing irrigation, introducing high-yielding crops
and land management. The ability to increase investment
in surface irrigation, groundwater recharge, restoring water
bodies and developing high yielding varieties will be other
key factors that will determine prospects in the medium
Addressing the problems
- On the otherhand if
the organised and reasonably transparent equity market is
so vulnerable to changes in the global economy, we have
to accept the dangers lurking in an underdeveloped commodity
market such as India's. In an economy of shortages, the
flow of huge speculative funds without strict safeguards
can compromise the interests of both producers and consumers.
- Quite apart from physical
deficit driving up prices, the leverage that margin trading
in the commodity bourses offers could have caused the recent
extraordinary spike in the prices of some essential food
- Every mature market
economy in the world has active commodity futures trading,
either on domestic exchanges or offshore exchanges. Every
successful agricultural economy in the world involves an
intimate role for commodity futures.
- As India grows into
a mature market economy, we have to learn how these markets
function, and build commensurate legal and institutional
structures. When faced with difficulties, the correct response
is to diagnose and solve problems, not retreat into 1970s
style economic policy.
- In addition, banning
futures exchanges will merely send this business underground
and overseas. For many decades, while the GOI thought that
futures trading was banned, it was actually flourishing
in a underground market.. In addition, hawala money is used
all over India to do trading on offshore exchanges.
- The correct response
lies in addressing problems, and not banning the market.
These difficulties can be further reduced by strengthening
public policy through introducing a system which is presently
active in stock markets.
- Position limit can be
fixed and an universal identity number can be given to all
market participants, and a central surveillance facility
needs to add up the position seen for a person across all
securities firms, in order to verify that the position limit
is not violated. Further, positions need to be aggregated
across family members, which requires corresponding sophistication
in the database for tracking family members.
- The sound functioning
of markets requires complex institutional structures, which
requires sustained efforts over decades on drafting of law
and regulations, building human capital, inspection capacity,
an appeals process, and arriving at a judicious blend of
competition, market design, policy and supervision.
- No doubt futures trading
has a sound theoretical basis. Price discovery and price
risk management are essential in an liberalised trading
environment and globalising markets. Because a healthy futures
market is an extension of a distortion-free physical market,
it is of utmost importance to address the issues of the
cash market, including production, quality and marketing.
Setting up sophisticated exchange platforms without strengthening
the agricultural production is the root cause of the problem.
Genuine stakeholders (primary producers and processors)
have been wary of this market.
- Futures trading is about
planning; it is about taking control of uncertainty. A farmer
who sells goods at a future harvest date, at a locked-in
price, is in a fundamentally superior position in terms
of planning. Banning futures trading is about forcing people
to not plan for the future. The sensible strategy is to
address the genuine difficulties of market design, regulation
and supervision, so that futures trading is able to play
its full role in a mature market economy. This requires
breaking with policy decisions made in the 1950s.
- In the Budget, the Finance
Minister announced the Government's intention to appoint
an expert group to study forward trading in commodities.The
group is headed by Prof. Abhijit Sen and the other members
of the committee include Mr Sharad Joshi, Member of Parliament,
Prof. Siddharth Sinha, IIM, Ahmedabad, Prof. Prakash Apte,
Director, IIM, Bangalore and Dr Kewal Ram, member— convener.
- The group must examine
the desirability and appropriateness of commodity futures
trading for the country, keeping in mind the growth potential
and emerging socio-economic conditions. It must recommend
how best to deliver real benefits to producers and consumers.
- Strengthening the physical
market, improving flow of information, distinguishing hedging
and speculative transactions, and treating hedgers and speculators
differentially are some aspects that deserve attention.The
committee, which will submit its report in two months, will
also consider appropriate measures to raise the participation
of farmers in futures trading and benefit from price discovery
through commodity exchanges.