It has been several years since India began talking about allowing the trading of receipts for goods stored in warehouses, letting holders swap them like stocks and bonds and use as security to raise money.
This one change might transform the country’s fragmented commodities markets by infusing life into what Peruvian economist Hernando de Soto calls “dead capital”, or property that can’t be offered as collateral.
In India’s case, the figure for the underexploited opportunity may be an astounding $5 trillion (Rs205 trillion). And yet, simple as it is, the proposal for turning warehouse receipts into securities has taken ages to move through the labyrinth of policymaking.
The Warehouse (Development and Regulation) Bill, introduced in Parliament in late 2005, has yet to become law. The lower house has cleared it; the nod of the upper house is awaited.
For a resource-scarce country, it’s crucial to unlock the value trapped in goods stored in depots and vaults. More than a fifth of India’s total production of perishable agricultural commodities is ultimately wasted because supply remains scattered across small warehouses and doesn’t get matched up against present and future demand.
Making larger quantities of everything from potatoes to zinc available for trading in spot and futures markets will help price discovery and benefit both producers and consumers.
Jignesh Shah, chairman of Financial Technologies (India) Ltd, a Mumbai-based software company that four years ago set up what has now become India’s No. 1 commodities futures exchange, is excited about the change. “More structured finance will come into the commodities sector,” Shah says. “Exploitation—either distressed sales or distressed purchases—won’t happen.”
Reluctant to change
With 700 million Indians engaged in producing commodities, and one billion people in the country consuming them, spot demand is large and growing amid rapid expansion in the economy.
At the same time, with India’s reintegration into the world economy, the old socialist model of self-sufficiency—or self- denial—is collapsing. Foreign trade is on the upswing.
A corollary of the rising exposure to the global marketplace is a hesitant acceptance of commodity derivatives for risk mitigation. Futures, which have been permitted since 2002, after having been driven underground for almost four decades, have already come under scalding political attack.
Contracts in wheat and rice have been discontinued on unsubstantiated claims that they caused inflation in spot prices. Options, which are a hassle-free hedging tool because they transfer risk from buyers to sellers upon payment of a single insurance premium, remain banned for commodities. A new law is pending that has yet to be cleared by either house of Parliament.
The government has decided to keep big money, including local and foreign financial institutions, out of the futures market for now. That stymies these fledgling markets and narrows the constituency that would demand radical change in the spot market, which is where inefficiencies abound.
A large potential remains untapped because of this vicious cycle. If bullion, base metal, farm produce and oil and gas were to trade at the same futures-to-spot multiples in India as they do in more advanced economies, the value of the derivative transactions would be in the vicinity of $5 trillion a year, according to research by Financial Technologies.
That would make commodities futures trading in India twice as large as equity derivatives, which have become hugely popular since they were allowed in 2000. The reason equity derivatives were able to grow in India was because the spot markets were cleaned up first.
Hope at hand
Trading potatoes in India can reach the same level of efficiency as share trading—and capital can get unlocked at the same speed—if both the spot and the futures markets are given equal attention.
After turning the Multi Commodity Exchange of India into the world’s No. 3 bourse for bullion, Financial Technologies’ Shah has taken it upon himself to sort out the country’s messy spot markets. Shah’s National Spot Exchange of India has electronically linked about 1,000 of the existing 7,500 mandis, or agriculture produce markets. For now, it’s just sharing of price information; trading will begin after state governments grant regulatory approval. Ultimately, Shah wants to reach every corner of the country where there is a post office.
“This isn’t merely a business and it is not just social service either,” Shah said. “You can call it a social business.” It’s also a risky business. The authorities have been dragging their feet for a year now on deciding limits on foreign holdings in these exchanges. This lack of regulatory clarity is stunting fund-raising and growth.
Maximum foreign ownership in the country’s equity bourses has been capped at 49%. It’s illogical to make the rules any different for commodity exchanges. What’s just as bizarre is for policymakers to even be debating this issue.
A $5 trillion commodity bonanza is waiting to be shared among producers, consumers, speculators, arbitrageurs, exchanges and the taxman. The key to the treasure chest lies in making dead capital come alive.