The bans on futures trading in farm products should go
The focus was on agricultural commodities where it was believed that a vibrant futures market would provide the right signals to farmers on what to grow and when as well as where to sell.
When the commodity derivatives market was opened up in 2002, which led to the creation of new online multi-commodity exchanges, the goal was to enable better price discovery. The focus was on agricultural commodities where it was believed that a vibrant futures market would provide the right signals to farmers on what to grow and when as well as where to sell.
It is known in the field of agriculture that there exists the cob-web syndrome. Farmers choose the crop to sow based on prices received in the previous season. Hence if the price of soybean was high in 2022, there would be an inclination to grow more of this crop. The result is over-supply, which depresses prices. Ideally, farmers should be looking at the futures prices, and if possible, sell the crop in advance if the price is favourable. Deliveries are enabled if the parties so desire or the contracts can be reversed before due date. Either ways, the price has been hedged. It has been observed that farmers often switch crops that require similar geographic and soil conditions.
It was with this objective that the Forward Markets Commission (now merged with Securities and Exchange Board of India, or Sebi) regulated the contracts; and commodity exchanges facilitated them among traders. NCDEX became the preferred exchange for farm products while MCX dominated the energy, metals and bullion markets. To begin with, progress was remarkable as NCDEX got in the value-chain participants to trade in products such as oilseeds complex, pulses, sugar, wheat, spices (jeera, chili, turmeric and dhaniya) and guar. While the goal was to reach out to the farmers ultimately, given access issues, price signals were picked up through intensive price dissemination processes set up by the exchanges. Subsequently, with Sebi formally taking charge of oversight of these markets, the push was given to bring in the farmer producer organizations (FPOs) to educate and enable them to play the role of aggregator to participate on these platforms.
However, there have been too many vested interests, which have led to political decisions being taken to ban futures trading. This has been a major setback for the markets because useful price signals have been lost. What started off as bans on tur and moong, have now been widened to cover chana, soybean, soy oil, mustard seed and wheat. In all these cases, there were robust price-discovery processes in place. Frequent bans lessen the credibility of the market as players tend to lose money when such decisions are taken.
In fact, deliveries have been robust in India unlike in other countries, even though delivery is typically an expensive proposition. But this has lent credibility to the system as it brings value-chain members on board. It also confirms that it is not a speculative market, as has been made out often by lobby groups. Ensuring deliveries has led to the development of a transparent logistics ecosystem, which includes systems of grading and standards, weighing, warehousing, assaying, among others. This has helped the government develop the electronic national agricultural market (eNAM), which is an electronic spot market.
The results of the series of bans has narrowed the basket of commodities that are now available. Volumes of trading in farm products for NCDEX had peaked at ₹16.64 trillion in 2011-12. Subsequently, there was a sharp and continuous fall to ₹8.70 trillion in 2014-15. An improvement followed in 2015-16 to ₹5.96 trillion, after which the downward descent resumed to ₹2.02 trillion in 2022-23. There is a need to reconsider these bans.
One thing which has been established by Sebi and the exchanges is that the regulatory processes are in place and are being followed to ensure that there is no space for manipulation of the markets. There are position limits in place to ensure that there is no cornering of the market and the price limits control volatility. Curiously, every time there has been a ban which blame futures trading for price increases, the exchanges have proved that the link does not exist, and also that after the ban, prices continue to move up as the supplies are low.
Agriculture continues to be an area that is vulnerable to shocks. Even a normal monsoon does not preclude certain areas and hence crops from receiving less rainfall, thus running the risk of lower production. The futures market picks up these signals. This is useful not only to farmers and value-chain participants, but also the government. A rise in futures prices before harvest indicates an expected shortfall in output and can trigger an appropriate response from the government in the area of imports or exports.
Therefore, there is strong reason to revoke the ban on futures trading in all products, which range from pulses to cereals and oils, to ensure that there functions a market-oriented system that provides the right signals. This will help the farmers, hedgers (value-chain players) and the government. Price hedging by farmers will also be useful for banks, which run the risk of building up bad loans if crops fail. Vested interests should not be allowed to prevail and politics should definitely be kept out of it. The farm sector is in need of booster reforms and removing the ban can be a good first step. The market players also need to be assured that while trading norms can be altered depending on the conditions (limits on prices and positions), the edifice will remain intact. This is too good a system to lose.
