The Hindu Business Line : Rising ‘political risk’ to commodity derivatives market

Online trading in commodity futures was launched in our country five years ago amid fanfare; and certainly, with hope and expectation that the new system of trading would help transform the moribund agricultural sector.

Indeed, it was held out by the proponents of the futures market that derivatives trading would exert a positive effect on the cash market; help it evolve, and deliver benefit to primary producers or growers. When online trading got introduced, there fortuitously was enormous appetite for risk among Indian punters.

Glib presentations, hyped up benefits and friendly trading systems and a somewhat weak regulatory oversight combined to drive a large number of speculators into the market. Real hedgers - producers, industrial consumers, processors and the like - were few and far between.

After about 3-4 years of voracious trading and exponential growth in trading volumes, there began to slowly emerge political and policy risks for the market. Most market participants - brokers, traders, investors - as well the exchanges refused to see the reality of growing policy risk to the market.

Much of the promise initially held out by the system of trading - purportedly with the twin objective of price discovery and price-risk management - has proved to be elusive. Problems in the capture of realistic market prices and related complaints are too well known to be recounted here.

Speculators have had a free run for last 4-5 years and captured the market opportunities, while many cash market players remained in the sidelines. There are also instances of established physical market players abandoning their traditional business and trying to make their fortune in paper trading.

Given their different status, hedgers and speculators ought to have been treated differently - in terms of margin and so on; but it turned out to be a market free-for-all. Large corporates have been apprehensive about entering the market about which they had limited knowledge; nor did the market the way it was run inspire their confidence.

Farm sector transformation

Worse, the promise of a transformation of the farm sector remained totally unfulfilled. If anything, the country’s agricultural sector is in worse shape than it was say 5-6 years ago. Demand-supply mismatch has widened; per capita availability is lower; and for the poor, prices are at unaffordable levels.

Cash market

It may be tempting to blame the global markets and domestic policy failures for the current sorry state of affairs of the commodity market. What the policymakers overlooked (were they simply ignorant? or could they be guilty of deliberately ignoring?) is that the derivatives market proceeds from the cash market. The cash market can exist without the derivatives market, but not vice-versa.

Without addressing the problems of the cash market, and on the fragile foundation of the cash market, an impressive superstructure of the commodity derivatives market was built in the form of modern exchanges. When the foundation is weak, the building on it cannot stay sturdy, although it might look attractive. The fact remains, the initial promise held out when the exchanges were formed and promoted has all but evaporated.

Some of the original promoters of the exchanges have actually sold-off their investment and exited with huge profit. So much for their long-term commitment to market development.

Given this kind of track record there was never a doubt that this market would sooner rather than later face political risks or policy risks.

Political risk

Business Line was the first and perhaps the only newspaper to have drawn attention to emerging political risk to this market. This was in late 2006. What happened beginning early 2007 is history.

Today, the political risk to the derivatives market stands considerably heightened. The Left parties, strong allies of the UPA government, have demanded a ban on online trading in commodities. The PMK in Tamil Nadu through its alliance partner, the DMK, an important constituent of the UPA government, wants futures trading banned.

Worse, even the Congress party leaders have begun to demand a prohibition on futures trading. For the Central government, the Congress party recommendation would be a virtual diktat. So, there emerges the strong possibility of a ban on futures trading in essential food items such as edible oil and oilseeds. There is a real possibility that the slew of decisions on trade and tariffs -ban on export and reduction in customs duty - taken by the Cabinet Committee of Prices late Monday night may be topped with a suspension of futures trading in essential food items.

Clearly, the policymakers allowed futures trading with good intentions. But willy-nilly they put the cart before the horse. It is the cash market - horse - which must drag the cart - futures market. Unfortunately, the government miserably failed in addressing the cash market issues. Futures trading is no panacea for the ills of the real economy. Agriculture deserves a more focused management in terms of investment and growth-oriented policies instead of the cosmetic derivatives trading.

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