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Will farmers benefit from futures markets?

Will farmers benefit from futures markets?
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First Published: Tue, Jun 03 2008. 11 22 PM IST
Updated: Tue, Jun 03 2008. 11 22 PM IST
The current trend of rising prices has put a question mark on the role of futures markets in fuelling inflationary tendencies in the economy. In the wake of consistent criticism of its inability to contain similar food price inflation last year, the finance ministry had set up a committee to examine whether futures markets influence inflationary trends in agricultural commodities. However, the report of this committee, eagerly awaited by all, did not come out with any conclusive answer to this question.
But why did the committee distance itself from coming to any conclusion on the role of the futures market on inflationary pressures? As the committee members agreed in their statements and in the report, this was because the futures market for agricultural commodities is relatively nascent in existence and, therefore, there is no significant statistical evidence to infer one way or another. But this may be inconsequential to the central issue of whether the futures market plays a role in affecting prices.
The supporters of futures trading have argued vociferously that there is no link between inflation and the futures market and, if anything, the futures market is only helping our farmers in the process of price discovery and risk hedging, thus leading to lesser volatility in spot prices. The only way farmers can benefit is through some transmission mechanism from the futures market to spot prices. This can either be through price discovery of future spot prices, enabling farmers to make informed cropping pattern decisions, or by increasing spot prices at harvest. Needless to say, if it is the transmission mechanism through which farmers can benefit, then it is clear that futures market prices do affect spot prices. If not, then the farmer is not benefitting from the futures market, which is only an arena for speculators to play.
However, there is very little evidence on the actual transmission mechanism and the direct or indirect benefit to farmers from futures trading. The annexure of the report contains the findings of the study done by IIM Bangalore for this committee. The results reported are revealing. Less than 2% of farmers reported that they were aware of the futures market, leave alone participating in it. (This is not surprising since less than 30% of respondents in the farmers survey of NSSO, 59th round, reported awareness of the minimum support price extended by the government after half a decade of its existence.) The sample in the IIM-B study, incidentally, was heavily biased towards large farmers of western India with average land holding of 9.8 acres and 85% literacy level. Contrast this with the fact that 84% of Indian farmers have less than 9.8 acres of land holding, as per the NSSO survey.
But what if these large farmers did decide to participate in the futures market for hedging? The study shows that even for these large farmers’ average holding capacity is less than 25 days, which is clearly insufficient for them to benefit from hedging. With poor access to credit and a preponderance of small and marginal holdings, most farmers need cash for consumption and at harvest time. The majority of farmers in this study also reported their primary source of information on prices was fellow farmers and the primary source of marketing village traders and brokers. It is too naive to expect farmers with less than 60% literacy and villages having less than 3% Internet penetration to keep track of screen-based futures market prices and benefit from it.
But if farmers are not participating in the futures market, who is? Primarily speculators, the study suggests. The IIM-B study, therefore, also surveyed a sample of traders and processors. Although a majority of them reported awareness of futures markets, less than half participated in them. Of these, the overwhelming majority participated as speculators, with a minuscule minority participating for hedging. For the majority, the basis of taking a position is simply a gut feeling or technical advice given by brokers, with no clear idea about the basis for futures prices.
It appears, then, that farmers have little to do with the futures markets and the evidence of its impact on prices of agricultural commodities is at best mixed. This disconnect between the physical market, farmers and the futures market is so wide that one cannot envision the argued benefits of futures markets ever reaching the farmers without adequate infrastructure in place. But, with the overwhelming presence of speculators, one might only gain evidence that the futures market does indeed influence inflationary?trends.
There is, therefore, clearly a need that the futures market be regulated, especially for essential commodities. In spite of the inconclusive nature of the committee’s report, the government decided to ban four more commodities (chana, potato, soya oil and rubber), in addition to those banned earlier, probably a political move to show that it is taking serious steps to douse inflationary pressures. However, this on its own is unlikely to be the best hedging strategy for controlling inflation for the government, especially in an election year. At least, that is the message from Bangalore.
(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.)
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First Published: Tue, Jun 03 2008. 11 22 PM IST