Very few people know that India is the largest producer of guar (cluster bean) seed and mentha (mint) oil, accounting for nearly 80% of the world’s production. These are also among the top eight commodities—guar seed, chana (chickpea), soya oil, pepper, jeera (cumin), urad (black gram), mentha and chillies, in that order—traded in the futures market for agricultural produce here.
These eight commodities together accounted for 84% of the commodity futures trade in 2006-07, before a ban was imposed on two of them (chana and urad; trading in rice and wheat had been banned earlier). In fact, guar seed alone accounted for a full fourth of trading volumes on the futures market. Rice, wheat, sugar and cotton, which together account for more than 50% of gross cropped area in the country, accounted for less than 4% of total trading volumes in the futures market.
The eight commodities have two common characteristics. One, while these are grown in a rather small area, they are commodities for which India is either the biggest importer or exporter, and therefore, a large player in the international market. Two, most of these commodities were earlier traded in heavily localized markets with large cartels controlling prices —mentha in Chandausi, Uttar Pradesh; guar seed in Jodhpur, Rajasthan; jeera in Unjha, Madhya Pradesh; pepper in Kochi, Kerala; soya oil in Indore, Madhya Pradesh and chillies in Guntur and Nizamabad, Andhra Pradesh.
Because these commodities are primarily traded in the international market, they attract large volumes in the futures market, from both speculators and traders. The cartels thrived by taking advantage of the fragmented spot market for most of these commodities as well as information asymmetry between producers and better organized traders.
Trading in the futures market has weakened the control of these cartels and has also benefited farmers through better integration of futures and spot prices of these commodities. For some of these commodities, there is also partial evidence of a reduction in price volatility.
However, the evidence has not been as positive where essential commodities and foodgrains are concerned. According to the analysis presented in the Abhijit Sen Committee report, of all the commodities analysed (and taking out outliers), no commodity shows deceleration in prices and five, chana, chillies, urad, wheat and rubber, show clearly that inflation did accelerate following introduction of futures. In all these five commodities, volatility increased in both the weekly and monthly Wholesale Price Index, or WPI, data.
The committee also noted, “Wheat prices did behave unusually and annualized wheat WPI inflation at 9.8% during the 30 months when futures trading was liquid (August 2004 to February 2007) stands in sharp contrast to inflation in either the previous 30 months (1.5%), or in the year subsequent to delisting (0.3%, y-o-y February 2008).”
Independent studies also came to similar conclusions. In a paper in Economic and Political Weekly (19 January) Golaka Nath and Tulsi Lingareddy find that both average price change and spot price volatility of urad, gram and wheat were higher by statistically significant margins between October 2004 and January 2007 compared with either the pre-futures period of January 2001 to September 2004, or between February 2007 and October 2007, when futures trading in some of these commodities was suspended.
A study by Indian Institute of Management, Bangalore also concluded that spot price volatility increased after introduction of futures in case of wheat and urad, and was associated with an increase in seasonality of prices, so that farmers gained less than traders. Also, there was a tendency for retail margins to increase, making the volatility increase even more for retail prices than for wholesale.
Among the essential commodities, rice, wheat and sugar prices are still largely controlled by the government, which acts as the monopoly buyer for rice and wheat. One of the reasons for the low procurement last year could have been that futures prices were trading higher by 20-25% compared with the prices offered by the government.
This may have led to large traders and hoarders holding back stocks anticipating higher prices, as signalled by the futures market, leading to lower market arrivals and procurement by government agencies, even though the wheat harvest was better than normal. This situation has been reversed this year in the absence of futures trading in wheat, and procurement has been a record 21 million tonnes so far.
This evidence suggests a mixed response to the futures market. As far as foodgrains and other essential items are concerned, the negative impact of the futures market outweigh its benign effects. These are items which affect a large majority of our population. The trading of these items in futures markets may lead to the transmission of internationally volatile prices. So, the ban on futures trading in foodgrains such as wheat and pulses should be continued.
However, for those commodities where there are substantial?benefits?through?increased?transparency?and?gains through hedging in international markets, futures trading should be allowed. The recent inclusion of soya oil and rubber and exclusion of sugar from the list of banned items in futures market defies logic. What is required is stable and informed decision-making from the government. Such ad hoc decisions only add to the confusion, helping no one.
Himanshu is assistant professor at Jawaharlal Nehru University and visiting fellow at Centre de Sciences Humaines, New Delhi. Farm Truths will look at issues in agriculture and run on alternate Wednesdays. Respond to this column at email@example.com