The Hindu Business Line : Regulate commodity futures

The NDA government started futures trading in commodities including foodgrains. Nominally, commodity futures are beneficial for the sellers, buyers as well as the economy. Sellers can get a higher price for their produce by selling it at a future date. Buyers can get an assured supply at a future date without having to bear the risk of price volatility. And the government gets an advance indication of the movement of prices and can plan accordingly.

But futures trading in commodities also runs the risk of being manipulated. The market for deliveries at a future date can be `captured' and the market artificially inflated by paying only the specified margin, say, 10 per cent. The players can then sell their futures contracts at a hefty margin. In such a situation, the idea of futures trading in commodities is turned on its head.

Economy ups and downs

The seller still gets a low price, the consumer pays a higher price and the economy goes through unnecessary ups and downs. Some observers feel that the present increase in the price of foodgrains is due to such speculation and have urged the government to ban futures trading of selected sensitive commodities. There is case on both sides. One's ability lies in creating a framework wherein one can secure the gains from the futures trading in commodities and avoid unnecessary speculative activity. The situation is similar to that in the share market, which too can be manipulated by speculators.

The Securities and Exchange Board of India has set strict guidelines on disclosures and the maximum permitted holding by a single buyer in a company to prevent such activities. These rules have made it difficult for even big players to manipulate the market.

Reverse intervention

Another way is for the government to make reverse interventions. It can hold adequate quantities of buffer-stocks and intervene in the commodity market if it believes manipulation is happening. Till some years ago, the UTI, LIC and other quasi-government agencies played such laudable role in the share market.

When, for example, the Sensex was at 4,600 levels in the Harshad Mehta period, these agencies sold their holdings and cooled the market. They bought heavily when the market collapsed in the post-Harshad Mehta scam period and prevented a total collapse.

These agencies had huge holdings of money and shares, which they used to stabilise the market.

Futures trading unproductive?

Another argument against futures trading in commodities is that it diverts the nation's wealth into unproductive directions. A large number of trades happen for the same consignment, trapping the country's wealth. But speculation is not wholly unproductive. The question is about the cost of obtaining indications of the future prices.

The large numbers of contracts are how the final price is settled. Some years ago the price of onions suddenly rose and the BJP lost power in Delhi. The Civil Supplies Ministry simply failed to assess the future price. Such a fate could have been avoided if a futures market was in operation then. Market gives better estimate of future prices than officials. Thus multiple trades for the same consignment cannot be said to be `unproductive'.

Compare the `cost' of these trades with the cost of exams that a student takes. The student learns nothing during the exams. Yet, huge amounts are spent conducting them because they give indication for making future investments in his education. In absence of exams, a student having potential in fine arts may be placed in a science class and vice versa and lead to a colossal waste of nation's wealth.

Similarly, futures trades, though nominally unproductive, give an indication of future prices and help the farmer select crops for the next season and make necessary investments.

Indication of future prices

Another benefit of futures trading is that indications of future prices are available to all players. The big players are always knowledgeable and have some inkling of the future price scenario. It is the small players who are taken for a ride in the absence of information. Futures trading in commodities make it possible for the small player to know about future prices and enable him to sell his crop at a higher price.

Many farmers are not in a position to avail themselves of such benefits presently but that cannot be held against the futures trading in commodities. The Government must pro-actively conduct workshops for small traders and farmers to make it possible for them to play in the market.

Yet another argument against futures trading is that the British Government had banned futures trading during the Second World War in order to stabilise the prices. The Government had imposed a similar ban during the 1962 China war. But these are exceptional circumstances. The market itself is closed during a war hence banning of futures markets has justification.

But that logic does not apply for normal circumstances. It would be unfortunate if the farmers and consumers are deprived of the benefits of futures trading in commodities. The Government should take measures to prevent misuse of this facility.

A SEBI-type regulator for the futures commodity markets must be created. Rules of disclosure and maximum holding should be put in place.

The government should hold adequate buffer-stocks and set up a specialised agency to prevent market manipulation by making reverse interventions. And training should be provided to the small players to benefit from this technological innovation.

(The author, a freelance writer, can be reached at bharatj@sancharnet.in)

More Stories on : Commodity Exchanges | Derivatives Markets | Commodities

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Regulate commodity futures

A deal cast in iron

Going overboard on tax sops?

Ireland, Continent's Celtic Tiger

Why we think inside boxes

Differentiation: The only path to managing expectations

Fighting corruption with words!

Social welfare

`Creamy layer' `Creamy layer' politics