Should commodity futures be banned?

DEBATE

It is important to see if the ban on futures trading in tur and urad will help restore their prices and whether it was futures that caused the hike.

Deepender Singh Hooda,
Lok Sabha MP,
Congress Party

Even a World Bank/ UNCTAD study found futures for wheat, non-basmati rice and sugar were unviable in India given the market ground rules.

Steven D Levitt's Freakonomics establishes an unconventional premise: if morality represents how we would like the world to work, then economics represents how it actually works. The crusade to promote futures trading in the name of the farmers' interest began in India after the 1993 Kabra committee's cautious recommendations, and gained momentum in 1998 with a World Bank-funded grant directed at reforming exchanges. Later, all the caution was thrown to the winds in the NDA budget of 2002-03, when the then FM announced expansion of futures and forward trading to cover all agricultural commodities.

Since 2002-03 we've seen unrestricted entry of speculative capital in futures trade in agricultural commodities. The total value of commodities futures traded in 2002-03 was Rs 100,000 crore, which increased to about Rs 22,00,000 crore in 2005-06. The farmers haven't gained through this, consumers have had to pay a lot more. Only middlemen and traders have benefitted.

Theoretically, such markets provide farmers, traders and processors a mechanism for hedging their risks and improving price discovery in their forward planning decisions. The classic application helps a farmer who is planting in November to know the price at which his produce will be sold at Baisakhi so that he may incur appropriate farming input costs.

While this agro-liberal utopia would work if we had a "perfectly free market" for our agro-products, that is neither true at the moment nor desirable. A free market would have: (1) No government intervention in setting procurement price floors (we have a strong MSP regime); (2) No or little governmental procurement at a pre-determined fixed prices (we have a substantial PDS); (3) Physical spot markets should not lag much behind the futures markets; (4) Government interventions should not restrict the normal flow of commodities (like between states), and so on.

Indeed, even a World Bank and UNCTAD study (Managing Price Risks in India's Liberalised Agriculture: Can Futures Markets Help?) had concluded that futures trading for commodities such as sugar, non-basmati rice and wheat are "non-viable" in India unless some of the market ground rules are changed.

Take the case of maize in Andhra where the MSP was announced at Rs 540 last season. The maximum reported price that farmers could secure was about Rs 600 whereas the futures trade was at around Rs 850. The early announcement of MSP here had increased the expectations of farmers who were happy to pre-sell their produce at a marginally higher price than the MSP to the middlemen who built their stocks under a pre-fabricated illusion of a negative supply-demand gap, which in turn led to higher prices for reselling and for consumers. The story on wheat is all too well known. Last year we saw big private companies cornering huge wheat stockpiles in the name of helping farmers get good prices (slightly above the MSP), and then prices hitting the end consumers hard (much above the MSP), and finally we ended up paying foreign traders up to Rs 400 more per quintal than what we paid to Indian farmers. The Haryana chief minister recently apprised the prime minister of an expected record-high wheat production this Baisakhi. Our farmers have responded astoundingly well to the demand pressures through their grit and toil. But even as you read this, the Cargills of the world are again securing their wheat stockpiles on account of forward trading while the Food Corporation of India's PDS stocks are awaiting the spring spot market MSP procurement. The bumper crop expectation should point to mild inflation for our consumers in the months ahead. But I'm afraid we should expect the opposite this summer, as the "futures" of our farmers and consumers have been forward traded already!

The "freakonomical" moral of the story: let's get rid of the current futures trading model for the essential commodities that have a propensity for undesirable exploitation in the current restricted agro-market reality and think of another model of forward trading that's suitable to the Indian MSP-PDS agro-regime that actually helps our farmer.

Madan Sabnavis,
Chief Economist,
NCDEX

Prices of moong,ragi, jowar, etc have risen even though there are no futures here! Lower supply of tur and urad made prices rise, not futures

There are two aspects to the recent delisting (a euphemism for ban) of tur and urad from futures trading. The first is that we should have expected something like this given the open hostility expressed by the polity and opinion makers in the recent past on futures trading. However, this was more like shadow theatre where we know something will happen though we are unsure about the "what" and "when" of it. The second is that we need to view this as an attack on the entire edifice of futures trading, which is disturbing.

The delisting of tur and urad could have been remotely justified if we can show that futures prices have led to an increase in spot prices or that something was amiss in the functioning of the market. On both counts, there is no such evidence as economic rules have prevailed.

Prices of tur and urad have moved in accordance with the supply conditions. Tur production was lower this year at 24.7 lakh tonnes as against 25.7 lakh tonnes last year, leading to higher prices. The difference between spot and futures is almost equal to the cost of carry, that is, if I were to hoard in spot and deal in futures to push up the price, the cost of hoarding (transport, storage, interest costs) is higher than the difference between the spot and futures price. Therefore, it does not make economic sense for anyone to hoard the commodity.

Ironically, urad futures have been running at a discount to spot prices for over three months. If the logic that futures prices affect spot prices is true, then spot prices should have come down, which did not happen as supplies are weak. Futures prices are based on supply expectations and are equal to the spot prices plus cost of carry. Now, urad's rabi crop and imports are to come in February and March which have driven the prices down. The same logic holds for rabi crops such as chana and wheat.

There has been disciplined trading in the market with open interest, which is indicative of what can be delivered, and hence potentially hoarded, being less than a quarter per cent of the total production and is spread across 500 clients and more than 100 locations. So there is no case of manipulation.

The delisting was ostensibly due to the palpable dominance of political interpretation or misinterpretation of inflation. Curiously, prices of moong, jowar, bajra, ragi, coriander, tea and others have moved up sharply but are not traded on the exchanges. So we need to accept that there have been crop failures and that we need to increase productivity to eschew these occurrences. Attributing the cause to futures trading is not a solution.

The other point we have missed is that ever since futures trading was reintroduced by the ministry of consumer affairs and relentlessly developed by the forward markets commission, the farmers have benefited from better prices. While it may be pompous to say that they have gotten all the benefits, they have certainly received a higher share in the consumer price. Look at tur: based on the government's data, the retail price of tur has remained unchanged at Rs 33 per kg for over a year. If the farmer's realisation has gone up as indicated by wholesale prices, quite clearly the farmers' share has improved.

Economic laws price products based on scarcity. We cannot really ignore the concerns of farmers in order to protect the consumer. We definitely need to let the market forces prevail and cannot seek refuge behind the curtain of banning futures to cover up fundamental inadequacies. Also, while regulation is necessary we must strongly disagree with any kind of ban which impedes the smooth functioning of the market.

To draw an analogy from the banking stable, if, hypothetically, we believe erroneously that inflation is due to high growth in money supply which has been fuelled by bank credit through the mortgage route, we will not ban lending to the housing sector, right?

The views expressed are personal