Developing Commodity Derivatives Market- an important way to protect farmers' income

After witnessing an exponential growth since its inception till FY 2011-12, the commodities Futures market has seen contraction due to various reasons such as suspension in trading of few commodities, enforcement of stock limits in certain commodities from time to time, introduction of Commodities Transaction Tax (CTT), etc.

Mr Chandrajit Banerjee, Director General, CII, highlighting the importance of commodity markets in the economy said that the country remains one of the largest producers in the world for most of the agricultural commodities and there is an urgent need to safeguard the interests of the various stakeholders including farmers by providing them adequate hedging facilities through development of commodity derivatives market. He further added that, the move to bring the regulatory control under Securities and Exchange Board of India (SEBI) has paved the way for next level of reforms in Indian commodity markets that aim not only at deepening and widening of the market but also make it safer for every stakeholder including farmers to transact efficiently.

 

SEBI has allowed options contracts and has also allowed hedge funds to invest in commodities market. The objectives behind these measures are to deepen the Indian commodity derivatives market by allowing the entry of financial institutions and to widen it by allowing options with commodity futures contracts as underlying securities, observed the CII release.

To further support the initiative of SEBI, CII has recommended various measures which it feels, if implemented, would go a long way in helping the commodities market grow and become more vibrant and allow them to further benefit the entire commodities value chain and its participants starting from the farmer.

CII has recommended that Commodity Transaction Tax (CTT) be removed on agri-processed commodities and for delivery based non-agri commodity derivatives contracts. While the agricultural commodities have been kept out of the ambit of CTT, the levy of CTT on agri-processed commodities has created an anomaly and has drastically reduced the hedgers participation in such commodities on account of increased impact cost. It is therefore recommended to abolish CTT on Agri processed commodities which may help in establishing a more stable price regime in these commodities.

CII has divided its other recommendations into 3 parts with a focus on Ease of Doing Business (EoDB), Products and Participants.

Under Ease of Doing Business, CII has made the following recommendations:

First, for SEBI to allow the agri-commodity derivative markets to stay open till 8 pm on weekdays and to remain open on Saturdays as well to match the timings of Mandis. This will enable better integration of Spot market with Futures market thus avoiding the risk of participants resorting to 'dabba trading' and will make markets more efficient in terms of better price discovery, reduction in volatility and lower impact cost.

Second, the Daily Price Limits (DPL) on commodity futures contract must be relaxed. Restricting price movement on daily basis may jeopardize the very purpose of future price discovery and hedging (price risk management), as on application of DPL, future prices may be delinked from commodity spot market or in some cases, international prices, where DPL are not applied. Hence, it has been suggested that for the markets to function efficiently, the limits should be set at optimum levels.

Third, many market participants have physical market exposure far greater than the allowed hedge limits on the Commodity Exchange thus forcing such participants to either hedge the remaining quantity on overseas markets or remain unhedged. With near month limits being even smaller, hedgers are left vulnerable to the price movements and risks involved. CII suggests that the participants be allowed to hedge in all contracts up to the extent of the actual physical holding of the market participant.

Fourth suggestion is to permit banks to trade on commodity exchanges.

Similarly, under the sub-head Products, CII has made the following recommendations:

First recommendation under products is to re-launch the Forwards segment which will provide farmers with an alternative tool to get the best price for their produce and manage price risk more efficiently.

Second is to align the contract specifications with the quality traded in physical markets.

Third suggestion is to develop weather derivative indices along with other sectoral indices. Market participants, especially farmers, can use these instruments as a hedging tool against weather risk.

Fourth, it is suggested that continuous contracts should be launched throughout the year. As exports and imports of commodities goes on through out the year such a move would greatly benefit the various market participants who could use these contracts to meet their specific requirements.

Fifth, all e-Negotiable Warehouse Receipt (eNWR) based financing provided to farmers should be considered as priority sector lending and banks should be mandated to provide credit to the agriculture sector compulsorily through eNWR. A default guarantee structure under Warehousing Development and Regulatory Authority (WDRA) can give further confidence to banks and boost agri-financing.

Under the sub-head of Participation, it is recommended that in order to increase liquidity and depth in the commodity markets there is a need to allow institutional participation such as banks, insurance companies, mutual funds, portfolio management schemes, AIFs, etc. that can act as risk transfer agents for farmers.

Last but not least, awareness about the benefits of investing in commodities markets needs to be spread through education and other awareness campaigns.

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