India fools itself with wheat, rice futures ban

India fools itself with wheat, rice futures ban
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First Published: Mon, Mar 05 2007. 11 49 PM IST
Updated: Mon, Mar 05 2007. 11 49 PM IST
India’s political class has perfected its response to bad news: Shoot the messenger and do something contrary to what’s needed to set matters aright. A case in point occurred last week, as wheat and rice futures dared to warn the government of an inflationary shortage in food production.
At the government’s behest, the market regulator summarily banned new contracts in both commodities on 27 February. Wheat and rice together account for almost 4% of the benchmark price index.
Farm produce has no doubt played a part in India’s inflation headache. Food-price inflation in India stands at 11% now, almost double the 6% pace a year ago. Even so, holding futures trading responsible for the spiralling prices is illogical and betrays a profound misunderstanding of the economic facts of life.
Take wheat. Last year saw the biggest decline in the commodity’s production globally in 10 years. Naturally, prices skyrocketed everywhere, including in India, the world’s second-biggest consumer of the grain after China.
India’s fledgling futures markets anticipated the price escalation. In August 2005, the futures contracts on the four-year-old Multi Commodity Exchange were signalling that a demand-supply imbalance was building. The government was complacent. Its own wheat stocks, which are used to supply the grain to fair-price shops, were at 14.5 million tonnes in July.
By October 2005, they had declined to 10 million tonnes—below safe levels—for the the first time in 10 years. Yet, it was only in February 2006 that the government decided to import wheat. By then it was too late. Wholesale wheat prices in India rose 54% between April and November. The government’s communist backers jumped at this chance and demanded an end to speculation. Agriculture Minister Sharad Pawar said on 21 February that futures trading was not responsible for the price increase; it was the gap between supply and demand. And yet, he said, if a ban in futures trading was demanded, they will succumb. “I don’t know for how long I will be able to resist.” A week later he wilted.
speculators may have prepared the ground for a correction. Encouraged by an optimistic outlook for prices, farmers planted more wheat starting October. Now, when they are two weeks away from the harvest, the regulator has pulled the trigger. Following the futures ban, wholesale prices may slide from their current level of about Rs10,400 a tonne. This is a big blow to the farmers who are feeding 1.1 billion people.
Planters are struggling to cope with rising costs of fertilizers, seeds, credit and labour; individual land holdings are shrinking with division of property in each generation. Productivity gains, such as those from high-yielding seeds developed in the 1960s, have hit a plateau. The futures ban will destroy a process of price discovery that is crucial if farmers are to have some control over their earnings.
Inflation is now at 6%. This needs to be brought down because a rate above 5% may hurt economic growth, according to central bank deputy governor Rakesh Mohan. It is, however, not certain if the ban on futures trading will tame retail prices. The government, the country’s biggest buyer of wheat, will benefit from the ban. It will now be able to procure the commodity from farmers at a pre-announced price of Rs7,500 a tonne, or 28% below the prevailing market rate. The gain to the government from this usurpation may be transient. If wheat becomes unprofitable, farmers will shift acreage to some other crop next year and the grain deficit will worsen, hurting consumers.
Wheat and rice futures will now be counted as collateral damage in India’s war against inflation.
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First Published: Mon, Mar 05 2007. 11 49 PM IST
More Topics: Money Matters | Commodities |