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Sharad Joshi

On May 4, Mr P. Chidambaram, the Union Finance Minister, announced in Madrid (Spain) that the Indian Government might impose a ban on the futures trading in agricultural commodities, if there is a public perception, true or not, that futures trading led to inflation. A motion for breach of the privilege was moved in the Rajya Sabha against the Finance Minister for making a policy statement outside the House while Parliament is in session.

On April 30, responding to the debate on the Finance Bill 2008-09 in the Rajya Sabha, the Finance Minister had made a statement to the effect that the Securities Transaction Tax (STT) is on all fours with the Commodity Transaction Tax (CTT). It became quite clear that Mr Chidambaram has rather woolly ideas about the working of the future markets. He also seems to nurse a grudge towards the futures markets and also towards the farming community, its main beneficiaries.

Any doubts were soon dispelled when the Forward Markets Commission, evidently on signals from the Finance Ministry, banned futures trading in four agricultural commodities — refined Soya oil, rubber, grams (channa) and potatoes — after business hours of Parliament on May 7. The objective of the ban was to curb the spiralling inflation over which the Government had lost all control. The Left parties, allies of the UPA that have the critical number of votes required to sustain or bring down the Government, have been vociferously demanding a ban on all trading in the agricultural commodities on the futures markets, if not the futures markets themselves.

An expert committee appointed under the chairmanship of Prof Abhijit Sen, a member of the Planning Commission, had submitted its report only recently. Clearly, the majority view was that futures markets had no built-in inflationary tendencies. It is to be noted that the May 7 decision had brushed aside the recommendations of the Sen committee.

In order to understand what the whole controversy is about, let us try to understand what commodity futures markets are and how they function.

Farmers, according to a schedule dictated by the monsoons, produce agricultural commodities. Most of the agricultural produce arrives in the market at about the same time. As a consequence, commodity prices sink during the the harvest time to their lowest level and start rising after that till the next harvest.

Unfortunately, farmers do not have the ability to store their produce and wait for prices to become more favourable. Similarly, during the harvest, prices are relatively higher at places farther away from the fields. However, the farmer does not have the capacity to transport his produce to such locations and take advantage of the higher prices.

As the counterpart of the farmer, who would like to take advantage of higher prices in future or at a different place, there are consumers, traders, processors who would like to take delivery of the produce at a future date or at another place rather than on the spot and at the time of the harvest.

Their objective is to avoid the expenditure of storage, preservation, and also the interest charges for storing the produce till such time. The futures market essentially performs the role of bringing these two parties together. Further, it offers a transparent system of matching offers and demands to discover the right price. Thirdly, it offers the contracting buyer or seller the assurance of receiving the contracted price.

The farmers are the main beneficiaries of the futures markets. Firstly, these markets give information at the time of sowing, the price that can be expected at the time of the harvest.

This helps the farmers to make an informed decision about what crop to sow. In the traditional system, this role was performed by the CACP, which announced the minimum support price before sowing started. Unfortunately, for decades the Commission has failed to satisfy even farmers’ minimal aspirations.

If the producers and consumers were the only parties interested in business, the volume of transactions would be very thin; the entire business transaction would be limited to a few months around the harvest time. In order to ensure greater volumes of transactions, greater depth and greater liquidity in the market, the organisers of the futures markets permit the entry of speculators.

Speculators are essentially traders who buy at low prices and sell when the prices start rising. They essentially lend stability to the agricultural prices and eliminate erratic volatility of prices. The mechanism of the futures markets can also provide an insurance against price risks through hedging operations. Most of the members of the Sen Committee had given the futures market a clean chit and strongly supported its working, particularly from the point of view of the farmers.

The Government was expected to start taking measures, based on the Sen Committee report, that would foster the participation of the farmers and improve the working of the existing futures markets to make it more farmer friendly.

Unfortunately, the ignorance of the working of the futures markets is too rampant, not only amongst the communists but also amongst the Socialists of the local variety. The May 7 decision, where a ban was imposed on the four commodities, came out of the compulsions of the politics of coalition and the unwillingness of the UPA to do anything that would displease its Left allies.

Let us examine the claim that the ban was motivated by the desire to curb prices. The facts do not bear this.

Right now, the prospects of an abundant potato crop look good and the farmers, particularly in Bihar and Uttar Pradesh, have begun to destroy their potato crop. Banning any kind of trade in potato at this point of time clearly goes against the interests of the farmers.

Banning of trade in refined soya oil follows a similar pattern. India imports edible oils in large quantities. Recently, the UPA Government had reduced the customs duty on edible oils to encourage imports to bring down domestic prices. In this situation, futures trading provides traders the possibility of hedging in order to cover the price risks.

Futures trading in rubber has been working very well with farmers’ participation increasing continuously. The ban on futures trading in rubber will be a setback for the rubber industry and producers. It is true that the channa (gram) prices have been going up in recent weeks. Since channa is a major Rabi crop, there is nothing unusual in this trend.

The ban on futures trading in the four commodities is unreasonable, ignorant of the realities of the futures markets and, possibly, disastrous for the futures trade. It is unlikely to have any impact on inflation. It is more political, as it is calculated to give the public an impression that the Government is not sparing any efforts to come to grips with the problems of scarcity and inflation.

Last, but not the least, the order issued by the Forward Markets Commission raises a very important question about the capacity of a regulatory body, subordinate to the Government, to take autonomous decisions that would be in the interests of the market. If the members of the FMC were genuinely interested in the welfare of the farmers they should have offered to resign rather than meekly endorse the ban order.

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