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Informist, Tuesday, Nov. 12, 2024

 

NEW DELHI – The government must lift the suspension on futures trading in agricultural commodities as the ban has not been able to put a check on rising inflation, rather it has led to a scattered and higher price variance across mandis, said separate studies conducted by Birla Institute of Management Technology and Indian Institute of Technology Bombay. The study also recommended the government to hedge its exposure in the derivative market as it buys and sells large volumes of farm commodities. The two institutes studied the impact of the suspension of commodity derivatives on the agricultural ecosystem. 

In 2021, the government had imposed a ban on derivative trading in seven commodities--non-basmati paddy, wheat, chana, mustard seed and its derivatives, soybean and its derivatives, crude palm oil, and moong--for a year to check rising inflation. The ban was extended consecutively each year till December 2024. 

 

"Our study articulates that the belief that derivatives futures trading leads to price inflation may be misplaced," the study by Birla Institute read. The study found that prices of both suspended and non-suspended commodities remained high even after the derivatives trade suspension. Domestic as well as international factors influence the prices of commodities, it added. 

 

"We studied retail as well as wholesale prices released by the Ministry of Consumer Affairs over eight years to come to this conclusion," said Prabina Rajib, director, Birla Institute of Management Technology, during the presentation of the study. 

 

According to the study, while the difference in retail and wholesale prices of mustard oil was INR 9.13 per kg in the pre-suspension years, it rose to INR 11.91 per kg in the post-suspension years. Similarly, for soyoil, the difference in the pre-suspension years stood at INR 6.78 per kg, it is now at INR 10.09 per kg. 

The study by Birla Institute took into account data on prices of suspended commodities from January 2016 to July 2024, and concluded that the suspension led to an absence of reference prices for the physical market and in turn resulted in scattered and higher price variance across mandis. "We also saw that the volatility in mandi prices saw a significant rise as markets remained disintegrated in the absence of a domestic exchange. They were much more cohesive earlier as the exchange acted as the benchmark," Rajib said.  

 

Another fallout from the suspension was that the difference between retail and wholesale prices of edible oil increased after the suspension of derivative trade. "The government probably suspended trading at a time when the country needed it the most," said Sarthak Gaurav, associate professor, IIT Bombay, at the presentation. 

VOLATILITY TO STAY 

Commodity prices will be volatile amid exacerbating climate risk, export-import and tariff dynamics, and geopolitical risks, the studies said. India's commodity market ecosystem is becoming increasingly integrated with the world markets, increasing its vulnerability to external factors.  

 

Even in the face of supply-demand mismatch and price variations, worldwide commodity exchanges have continued to offer uninterrupted commodity derivatives contracts, Birla Institute study said. The study said that regulatory action cannot shield participants from price volatility as its capacity to intervene on the supply side is limited. 

 

"Commodities in any country are affected by global supply and demand. In fact, hedging provides for better stability in cashflow," Rajib said. The futures market is like a messenger, a harbinger of good and bad days to come, according to the researchers. Trade suspension is akin to shooting the messenger, they added. "This unprecedented suspension, unlike any other in the world, should have been done, if at all, after a thorough consultative process, policy recommendations," the study said. 

 

Moreover, most spot market players do not hold an overwhelming perception that the ban on futures trade reduced volatility in spot prices. "Volatility is specific to the time period of reference and sweeping generalisations are neither desirable nor prudent," the IIT Bombay study read. 

WIDENING INFORMATION GAP

While large agribusinesses have resources to gather market information, small players--traders, processors, exporters, and farmers--rely on the exchange to pick up price signals and analyse market scenarios. "The absence of which (exchange-traded commodity derivatives) have impaired the process of price discovery of prices for most stakeholders," IIT Bombay study said. 

 

The study found derivative trading gave stakeholders the benefit of price information, better price realisation, and risk mitigation through hedging. With the suspension of derivate trading, stakeholders reported a significant impact on financial stability and increased operational cost. "42 of the 46 (respondents) reported that their risk management practices were notably disrupted," the study read. 

 

Lack of a hedging platform has affected traders, farmer producers organisations, and farmers. "In our survey interactions, we found that without a futures market, farmers complain of being exploited in mandis," Rajib said. Mandis have thugs, cheaters, and racketeers who cheat on weight, oil content, and moisture content, the study quoted a farmer. According to experts, futures market can standardise spot market operations and bring in transparency. 

 

In addition, the futures market helps farmers make informed decisions on what to produce as they have the visibility of prices in the coming months. "However, a ban on futures trading eliminates this risk management tool, leaving FPOs (Farmer producer organisation) vulnerable to price fluctuations," the IIT Bombay study said.

 

However, for efficient price discovery, futures market should have a wide participation along the value-chain. "I sincerely believe that commodity futures market can effectively contribute to price discovery only when consumers, producers, traders, and aggregators use these markets to hedge their risk," said Sanjay Rawal, president, Commodity Participants Association of India.

 

GOVERNMENT HEDGE

The government is the largest buyer and seller of agricultural commodities in India. At least one-fourth of the domestic farm produce is procured by the government at minimum support prices and distributed for various welfare schemes. 

 

The study by Birla Institute says that this leaves government agencies exposed to price risk and inventory risk. To de-risk itself, the government will have strategies taking into account seasonal demand forecasts and support mechanisms that promote transport, warehousing, and stocking, it said. 

"There is a need to elevate to market-driven tools which will reduce the dependencies on these schemes," the study said, suggesting the government should itself hedge its risk in such exchanges.

 

Beyond the ambit of hedging price-related risks, derivative markets play a crucial role in developing the commodity market ecosystem. Exchanges facilitate warehousing capacity enhancement, quality checks, and offer better bargaining power for smaller players. 

 

Warehouse receipts have paved the way for efficient agricultural financing and post-harvest financing. Increased warehousing facilities across the country has saved farmers from distress sales and instilled confidence in agriculture, the study said. Exchanges can go a long way in onboarding farmers and farmer-producer organisations in digitising agricultural markets and bringing transparency to the ecosystem, the study said. End 

 

Reported by Afra Abubacker and Pallavi Singhal

Edited by Akul Nishant Akhoury

 

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