Lower price bands defeat FMC's purpose of curbing volatility

The Forward Markets Commission's move to lower price bands to reduce volatility in commodity futures has proved to be counter-productive with many narrow commodities hitting circuit levels in early trade every day. This, according to experts, has led to genuine traders to keep away from the market.

With effect from February 18, FMC lowered the initial price limit to 2 per cent or 3 per cent, depending on the trade data provided by exchanges and its own market intelligence, but fixed the maximum limit at 4 per cent.

In other words, the price bands for various commodities were lowered to 2+2 per cent or 3+1 per cent from 4+2 per cent or 6+9 per cent earlier. Since the implementation of the new price band, many commodities like chilli, jeera, potato, barley, turmeric "" which have no linkage to global events "" have been consistently hitting circuit levels on either side.

Cause-effect relationship
The lowering of limits was due to sharp increase in open interest limits (position limits) of most farm commodities in order to attract greater participation from hedgers and genuine traders, according to FMC.

Upward revision in many commodities may have caused some manipulation in prices and hence, the regulator took a precautionary step to lower the price band.

FMC Chairman B C Khatua, justifying the lower price band, had earlier said, "Price band was reduced to offset the possibility of price manipulation on the back of higher open interest limits."

Also, FMC had considered the trade data provided by exchanges and its own market intelligence before finalising the new price band. However, many market participants have observed that the very aim of the regulator has been defeated with the new price bands.

"The volatility has indeed increased, particularly in chilli and jeera contracts," said Suresh Mantri, analyst, Ventura Commodities.

Chilli and jeera are the worst commodities to trade in as their price limits have been reduced to 2+2 per cent from 4+2 per cent basis, said Mantri.

Almost every day since the new price bands were introduced, chilli futures opened at circuit limits, either lower or upper, not allowing genuine traders to enter the contract, he said.

Chilli spot prices are around Rs 40-45 a kg and even if minimum daily variation in price by Re 1 is considered, it works out to above 2 per cent (the initial price limit for chilli) of the spot price, said Mantri. Normally, daily variation in chilli and jeera spot prices is Rs 1-3.

Opionion for experts
Some experts said the regulator should fix single circuit of 4 per cent on all commodities instead of bifurcating it into two parts, as it will allow genuine traders to enter or exit the market at the right time.

"Uniform price band of 4 per cent will make it difficult even for big players to manipulate futures prices via spot market operations, as is done now in some narrow commodities like chilli," said an analyst at a Mumbai-based brokerage.

According to P H Ravikumar, managing director and chief executive officer of NCDEX, price volatility has always been there in the past. But it is felt now due to lower price bands.

"However, we must give sufficient time for the market to adjust to the new limits," said another NCDEX official.

But the exchange is certainly reviewing the volatility under the new price bands and may approach FMC if it finds an upward revision is necessary, the official said.

"We are aware that volatility has risen after revision in the price band but we will have to give more time for the market to adjust," said Khatua.

The regulator will not hesitate to change the price limits "if market finds it necessary," he said.