The Hindu Business Line : Why a fourth commodity exchange is needed

An efficient commodity futures market will attract a wider constituency of participants from the entire commodity value chain. In the long run, such a market can be an alternative to market interventions such as price stabilisation policies, and may improve revenue and expenditure forecasting through predictable and reduced subsidy bill of government, says SUDHIR KAPUR

A fourth commodity exchange is necessary to overcome many functional inadequacies of the existing online exchanges, particularly as mechanisms of efficient price discovery.

Recently there was an article in a business newspaper titled “Do we need a fourth commex?”, in which the author put forth his views on the need for a fourth commodity exchange. This was preceded by a series of news reports and discussions after an application for setting up a new commodity exchange was submitted to FMC under the public private partnership model of ownership.

The new exchange is expected to fill a gap in the commodity derivatives market space, as established by a recent PricewaterhouseCoopers study on the same subject.

The need for a market-based risk management approach, instead of traditional non-market-based risk management approach followed in post-Independent India, has also been established in this writer’s recent doctoral research dissertation submitted to the Indian Institute of Foreign Trade, New Delhi.

Price Discovery

A fourth commodity exchange is becoming increasingly necessary to overcome many functional inadequacies of the existing three national online commodity exchanges, particularly with respect to delivery-based settlement as a mechanism of efficient price discovery. Some of the reasons justifying the need for a fourth commodity exchange, besides providing competition to existing commodity exchanges are given below:

First, the three online exchanges MCX, NCDEX and NMCE, during the nearly four years of their existence, are yet to become a medium of efficient price discovery. There is a clear delinking of futures prices of commodities traded at these exchanges and the prevailing spot prices, thereby leaving arbitrage opportunities, because of which actual hedgers do not find these exchanges useful for managing their commodity price risks.

Instead, the large producers, consumers, importers and exporters in metal, oil and agro sectors are finding hedging at established international commodity exchanges such as LME, NYMEX and CBOT much more beneficial.

Second, the contracts traded at these exchanges are mainly those for which there already exists an established trading platform at International exchanges e.g. bullion, base metals, WTI and Brent-grade crude oil, agro commodities and like. Some commodities such as iron ore and coal, wherein India is a large producer, consumer, importer and exporter are not traded at these exchanges.

Also if these exchanges give greater attention to promoting India specific contracts such ONGC-based crude oil futures (rather than Brent and WTI based crude oil futures), it would bring additional advantage of shifting commodity trading to Indian shores.

Third, unlike the existing exchanges, which hardly promote delivery-based trading, the new exchange should aim to integrate warehouse delivery by providing an online trading platform so that it becomes a true platform for delivery-based hedging.

Arbitrage opportunity

Fourth, India’s geographic placement in the time zone between East and West provides a large arbitrage opportunity, which has not been tapped to true potential. Another commodity exchange may help using these opportunities better, thereby improving trading volumes of India specific contracts.

Since liquidity begets liquidity and higher the volume traded more efficient is the price discovery, another commodity exchange is likely to improve efficiency of Indian markets generally.

Fifth, no doubt a trend towards consolidation through mergers of commodity exchanges is an international phenomenon and it would be welcome if India also has specialised commodity exchanges, which trade in a limited number of India-centred commodity contracts.

However, the goal of limiting the number of commodity exchanges should be pursued only after Indian commodity markets have reached a reasonable level of maturity.

At this stage, when there exists a large unserviced gap, restricting the number of exchanges would only result in constraining the growth of commodity markets in India. Sixth, a commodity exchange under indirect control of government (MMTC is a Central Public Sector Enterprise) would assist the regulators in pre-empting any possible attempts of commodity market manipulation.

And, last, due to government ownership (even if indirectly through a CPSU), the proposed new exchange may spur the government for a more active role in the commodity markets by removing some of the legal and institutional constraints such as Essential Commodities Act 1955, Forwards Contract Regulation Act 1952, APMC legislations and Sales Tax laws of respective state governments, Warehousing legislations etc. and permitting options trading and the increased participation of Banks and FIIs in commodity markets.

Attract more participants

Thus, at this stage when the commodity markets in India are only at a nascent stage of development, the Government and the regulators should be facilitators to develop an efficient commodity futures market rather than promoting a monopoly of a small number of market participants.

An efficient market will attract a wider constituency of participants from the entire commodity value chain i.e. government, producers, marketers, importers, exporters etc.

In the long run, an efficient commodity market can be an alternative to market interventions such as price stabilisation policies and may improve revenue and expenditure forecasting through a reduced subsidy bill of the government.

Market participants, such as the processors and marketers, should also find Indian commodity exchanges attractive enough to manage the risks involved during the production and marketing processes, while international market participants, both importers and exporters, would be able to formulate a predictable commodity sourcing and supply strategy.

All this has potential to improve India’s share in international trade substantially.

(The author is a Fellow of The Indian Institute of Foreign Trade, New Delhi. E-mail: sudhirkapur_1@yahoo.com)

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