Ban on Futures Trading of Farm produce

• 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 28^th 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 that year.
• 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 inflation

• 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 prices.
• 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

• 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. 

• 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 27^th 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.

• 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 term.

• 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 products.
• 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.

Conclusion

• 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.