The Hindu Business Line : Dealing with futures

Agflation (inflation caused by a rise in agricultural commodity prices) and its causes are the subject of heated debate, not only in India but elsewhere in the world too. Even the US — the champion of free markets — is now deeply concerned over volatile agricultural prices. The context is important — highly subsidised food is aplenty in the US, and close to 70 per cent of its major farm crops are intended for overseas markets — a near-ideal conditio n for free trade. The Commodity Futures Trading Commission (CFTC), the US market regulator, has indicated it may intervene in the agricultural markets because of the recent volatility. Several initiatives, including ways to improve the oversight of large financial participants such as hedge funds, are likely to be put in place soon. On his part, the American Farm Bureau Federation chief has complained of a lack of convergence between futures prices and cash market prices. He has singled out trading activity by funds as one of the factors pushing up futures prices. Discovery of real prices and transmission of price signals to stakeholders are a critical and integral part of commodity trading. It is nobody’s case that futures trading alone causes price volatility. Emergence of a real or perceived mismatch between demand and supply would cause prices to either rise or decline. But when the element of speculation is inserted — speculators have no genuine interest in the underlying commodity, but profit from anticipating price changes — the market undergoes a tectonic transformation. Specifically, ‘margin trading’ enables too many participants, even those with little knowledge about products and markets, to trade with tremendous financial leverage. Too much ‘paper trade’ unrelated to market fundamentals can cause undue price movements.

Even though the Prof Abhijit Sen Committee, set up to study the impact, if any, of futures trading on the wholesale and retail prices of agricultural commodities, evaded a direct answer to the question, it has unequivocally recognised that futures markets must work in tandem with the physical or spot markets. Whenever futures markets try to grow faster than the under-developed physical spot market of underlying commodities, the disconnect between the two widens. The inference is clear for the government: Strengthen the farm production base, as shortages encourage speculation. Quickly reform the spot markets. Treat hedgers and speculators differently in terms of margin requirement. Impose strong delivery conditions. Especially in the case of agricultural goods (many of which are in short supply), what our country needs is ‘delivery-based forward trading’, rather than paper-based derivatives trade.

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