Futures trading in commodities has frequently courted controversy, specially when prices have risen. The Indian experience has been in line with that of virtually every other country, which tried commodity futures and which now are the leading markets in the world, such as the US, and where our own government hedges wheat.
The 133-year history of commodity futures markets in India has been littered with expansion moderated by regulation to reach the stage it has now— right on the verge of globalization. Commodities came to be accepted as an independent asset class globally just a few years ago. This acceptance started acting against itself. Like other asset classes where bull runs are glorified, more and more investors started investing in commodities getting good returns. Unlike other asset classes, the increase in prices of commodities was not appreciated by all. Soon a stage was reached where these investments, apparently, started dictating the price of the commodity — rather than demand and supply. Rhetoric about recession and depression started doing the rounds. Unable to find a way out, there has been talks of banning futures trading in agri-commodities in the belief that their prices will be “controlled”. Does that seem to be a logical reaction to the situation? Definitely not.
It is generally understood that futures trading in commodities is healthy if genuinely used for price discovery and hedging. Price discovery is not possible without a very large number of participants — in fact the larger number of participants the better the price discovery. For example, to narrow down on a fair price of a quintal of wheat, you would want as many players as possible to bid so that manipulation is impossible and a fair price based on market perception of demand and supply is achieved. For businesses which hedge, speculators are a necessity. Hedgers want to reduce or eliminate risk; this risk is actually transferred to speculators who move in and out of markets quickly, making profits and losses at different times. Without speculators, neither proper price discovery nor price-risk transfer is possible. This is true of all markets in the world, not just commodity markets. Because futures markets simply reflect the collective perception of the participants of the commodity price in the near future, banning futures is much like putting off the TV when your favourite team is losing — it will not change the result.
Prices of edible oil are high because, due to high prices of crude oil, more and more vegetable oils are being diverted for use as biofuels. Therefore soyabean, instead of coming to your table in the form of soya oil, is being used to make bio-fuels to power some machine. We have no control over it beyond modulating taxes and import-duties which we have already done, with limited impact. Wheat farmers worldwide prefer growing corn because returns are better due to their use in making ethanol. Commodity prices are rising but the reasons for that must be attended to, i.e. increased and more efficient production so that supply-side constraints are removed. The prices are fundamentally a function of demand and supply. Over production in Brazil and India has led to sugar prices being depressed worldwide. Ultimately markets are great levellers. Prices find their correct level in fair, well-regulated markets. As far as the efficacy of commodity markets is concerned, we have to look no further than the US — the commodity markets there have been around for 150 years, are as well regulated as ours and are considered essential. Markets provide buyers and sellers — if someone thinks the prices are higher than they should be, he is free to sell. Similarly those who think prices are artificially or temporarily low can buy. We have to learn to trust markets and must do everything to empower regulators to ensure a fair and level playing field. We have the most modern commodity exchanges, and international investors are lining up for a stake of the pie — because they recognize this is an idea whose time has truly come.
Markets provide informational efficiency. When wheat was listed, farmers had a ready on-screen reference from National Commodity and Derivatives Exchange and they even refused to sell to the government at the minimum support price (MSP) because they had the option to sell their produce on the commodity futures markets at higher prices. But after delisting, there was no longer a reference price which the farmer could check. Today farmers are led into selling below MSP because he neither has a futures reference price nor knows the MSP. It’s democracy at stake—in its own way. The producers as well as the consumers are citizens and voters in the country. The producers want the highest prices possible and the consumers want the lowest prices possible. Therefore it is necessary that all stakeholders participate extensively in the markets.
Those who do not participate are hurting their own cause. They must take part to get the benefits which they deserve for carrying risk and because it is their right to have access to markets which provide financial solutions to their business problems.
Jayant Manglik is head of commodities at Religare Commodities Ltd. Your comments are welcome at firstname.lastname@example.org