The Hindu Business Line : A panchayat on ‘futures’: Speculation, not findings

“Give commodity exchanges the benefit of the doubt”. So pleaded the Prof Abhijit Sen Committee, according to media reports (Business Line, April 30). The Sen panel was constituted in February 2007, mainly to study the impact of futures trading on commodity prices in the spot market.

If the media reports and briefing by Prof Sen are any indication, the panel has not reached any finding — but just speculated — on the main issue. In the end, the government, which has been eagerly awaiting the panel’s report from last April, must have ended up more confused than before, despite waiting for an extended period of one year for the panel’s findings — read ‘confusions’.

Different media reports, collectively read, said that the panel “has found there is a strong correlation between the spot and futures prices,” but not any link between the two — namely, the rise in the spot prices and the advent of futures trading. But how could there be strong correlation between two unrelated things?

The media has also reported that the panel did notice the price rise in the spot market for agro-products following the introduction of futures trading. The government also knew this and that is why it mandated the panel to study whether futures trading impacted the spot prices.

But the Sen team failed to find out whether it did. Instead, it speculated that the spot price acceleration of the increase in the post-futures period could be due to the recovery of the prices that had been relatively low in the immediate pre-futures period. Thus, the Sen panel has finally shared its doubts with the government, and not given any findings. Now, some interesting history, and more interesting facts.

The pressure exerted by the Standing Committee of Parliament on Food, Consumer Affairs and Public Distribution led to constituting the Sen panel. The Standing Committee report was presented to Parliament on April 27, 2007.

Dealing with the government’s case for forward trading in agricultural products, the Standing Committee cited the stunning National Sample Survey Organisation (NSSO) revelation that 71 per cent of the farmers in India had not even heard — yes, not heard at all — of the Minimum Support Price (MSP)! Of the remaining 29 per cent, 81 out of 100 did not know how to use the MSP mechanism, says the NSSO. That is, 94.5 per cent of the farmers, big and small, are either not aware of the MSP or do not know how to make use of it.

Poser to government

The Committee also got to know from the government that, as per a 1995 agricultural census, the number of marginal farm holdings was 2.81 crore and the number of small holdings was 3.97 crore and that both constituted over 80 per cent of the total farm holdings in the country. On this basis, the standing committee posed a neat question to the government: How could the farmers, 95 per cent of whom are not familiar with MSP, which has been around for over four decades, benefit by price discovery in the sophisticated futures market?

The government’s reply, pathetic though it was, read: ‘The farmers do not generally participate in futures markets, even in developed countries; but can, however, benefit from the price discovery functions of the futures markets.’

The result was that the standing committee’s query — how could the farmers, who were for decades not aware of MSP or what it means, read signals and price discovery in futures markets — remained totally unanswered. So, the standing committee got the government to ban futures trading in wheat and rice.

At this point, some data from the Report of the Expert Group on Agricultural Marketing Infrastructure and Policy (January 2007), whose first meeting Prof Abhijit Sen had attended and guided, are worth noting.

Relevant data

According to the Expert Group, small farmers cultivate 34 per cent of the total area and account for 49 per cent of rice, 40 per cent of wheat, 29 per cent of coarse grains and 27 per cent of pulses produced in the country. They sell their products in traditional village markets (shandies) which are held at some 21,000 places (going up to 47,000) throughout the country.

Some 75 per cent of the shandies are held once a week, 20 per cent twice a week and 5 per cent daily. A shandy covers some 14 villages, on an average. About two-thirds of the shandies are held about 16 km away from farms, 23 per cent at 6-15 km, and 9 per cent within 1-5 km. An estimated 36 per cent of the buyers walk to the shandies, 33 per cent use bicycles, and the rest (31 per cent) use other means.

Some 90 per cent of the total marketable surplus of remote areas are sold through this infrastructure, where cash is the medium of the transaction, banks being totally absent! Of the farm households, 51.4 per cent are financially excluded, the figure for small farmers being even higher at 53.71 (SAS Survey 59th Round NSSO, 2003). Does the government or the Sen panel expect these farmers to sell or buy futures on the MCX or the MCDEX? Why, then, pretend that they would?

Yet, see the surge in the value of agricultural futures on Indian commodity exchanges. In 2004-05 the value of futures contracts turned over was Rs 3.9 lakh crore; Rs 11.92 lakh crore in 2004-05; Rs 13.17 lakh crore in 2006-07; and for the five months till August 2007, they were worth Rs 4.12 lakh crore. This is several times the actual trade in agro-products.

Who played these futures? Not the farmers — 94.5 per cent of whom do not know the meaning of even MSP. If they cannot understand the simple MSP mechanism, how would they comprehend the complicated futures market? Who, then, bought and sold the commodity futures worth lakhs of crores of rupees? It is the paper money owners — the speculators.

So says an authority on futures: “A futures market without speculators would be like a country auction without bidders — and would work just about as well. In most markets speculators are many times more numerous than any other participants.” The only difference is that, in Indian commodity exchanges, there are only speculators, with no farmers seen in the trading ring.

Again, having earlier told the standing committee that even in the developed countries, farmers directly do not participate in futures market, how honest is the government in asking the Sen panel, within days, to work on the measures to increase the Indian farmer’s participation in futures market?

No distinction made

The government’s mandate to the panel which lumps together all commodities for the purpose of the spot-futures analysis is fundamentally erroneous. Commodities differ from one another.

For example, steel and cement are produced and sold every day. Sugar is produced for six to eight months and sold for all 365 days. But wheat and rice, generally grains, are produced in a matter of days and sold throughout the year. When the production is on one day and sales spread over the whole year, the capacity to hold the stocks becomes the essence of price-discovery.

Among the agro-products, sugar is better placed in this respect. Monthly sugar releases tend to match the demand, because corporates, funded by banks, are able to hold the sugar stocks for a calibrated release. That is not the case with rice. Or wheat. Prof Sen seems to have advised the government to continue the ban on wheat and rice futures. So, by implication, he has put these agricultural products in a different class.

Anyway, the recent aggressive anti-inflationary steps of the government have made market, spot or futures, itself irrelevant. Any debate about futures trading in commodities is a mockery when the government advises or threatens the steel or cement companies against prices rises. More. Claiming that ‘Indian data does not show any clear evidence of volatility in spot prices due to futures trading,’ the Sen panel has avoided considering how the spot and futures markets have behaved elsewhere, particularly in the US, recently. This will be the subject of the next part of this article, a very instructive one.

QED: Prof Sen told the media on April 23, 2008: “It is virtually impossible to make any statement, either this way or that, which would be acceptable to every one.” (Business Line, April 24). Thus, a panel set up to look for hard facts about futures has ended up as a panchayat to harmonise differing interest groups. Result: it has found nothing on facts. Instead, it has just speculated on futures.

(The author is a corporate advisor. His e-mail is guru@gurumurthy.net)