The Hindu Business Line : Bursting the bags

TREMENDOUS EUPHORIA IN the trading community and among investors (read speculators) over the zooming volumes in commodity futures trading, in less than three years of introduction of on-line trading by nationwide multi-commodity exchanges, is but natural. While volumes doubled each year since 2001-02, last fiscal saw a near quadrupling of the trading turnover to an estimated Rs 5.7 lakh crore. The daily turnover now averages around Rs 6,000 crore. Such an expansion, admittedly from a low base, means the commodity derivatives market is racing to surpass the cash segment of the equities market. While it took long years for the equity market to mature, commodity futures trading seems to be in a tearing hurry to explode. It is only a matter of time before commodity derivatives leave the stock market behind in turnover. Robust economic growth, removal of controls and restrictions on commodity trading and the steady integration of the domestic with the international market have combined to change the risk perception among stakeholders. The flow of funds, currently largely unchecked, and the tremendous leverage offered by margin trading are creating hitherto unimagined opportunities for players.

At the risk of being a wet blanket, it must be stated that it is in such times — euphoric conditions, bright outlook and robust optimism — that caution is necessary. As derivatives are nothing but an extension of the cash or physical market, it is crucial to remain focused on removing the distortions in the latter. Specifically, investment in agriculture, both public and private, needs to be stepped up and the marketability of crops improved. Unlike the securities market, the commodity segment affects almost everyone — from primary producers (growers), processors to traders and others. Because commodity price movements touch the lives of everyone, a stronger regulatory regime is necessary to track prices and enforce remedial measures. The Forward Markets Commission (FMC), the regulatory authority for commodity futures under the Ministry of Consumer Affairs, needs to be given more autonomy, power and financial independence to ensure that the market grows in a healthy manner and without the scams that occasionally stymie the equities market.

There is demand that banks, mutual funds and foreign institutional investors too should be allowed to participate in commodity futures. While the merit of this demand as a long-term proposition is doubtless, in the current scenario too much money chasing too few goods can lead to market distortions. There is no guarantee that the benefit of high and rising prices caused largely by speculation would flow to the primary producer, even as consumer interest would be hurt. The core competence, indeed the dharma, of banks is to lend. At least for now banks must focus on this activity and minimise their non-performing assets. Commercial banks, in particular, have limited knowledge of commodity products and markets, and their dynamics. They cannot be savvy traders. To cover their risk in lending to commodity traders, banks must ensure the borrower hedges his price risk in a recognised futures exchange. For banks, the learning process must start now.

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