At a time when the Government is keen to fight inflation, readying to reform the commodity market and reduce the role of speculative capital, it is incongruous that a Finance Ministry panel should recommend that commercial banks and foreign institutional investors should be allowed to enter the commodities futures market. Currently, banks, mutual funds and FIIs are not allowed to trade commodity futures; and the market is none the worse for it.

Way back in 2006, the Gupta Committee report released by Reserve Bank of India argued in favour of allowing banks, MFs and FIIs to trade commodity futures. The policymakers kept the recommendation on hold, and for good reasons. India was not ready then for rabid financialisation of commodity markets whose activities touch the lives of almost everyone in some way or the other. This is especially true of sensitive agricultural commodities – food articles – that have a high weightage in consumer price index. The situation is no different even today.

India is a producing and consuming economy of a number of food products. Yet, there are some essential foods in short supply and the country is dependent on imports. Edible oil and pulses are two prime examples.

Our import dependence on crude oil (mineral oil) is as high as 80 per cent. Also, the country does not enjoy any genuine export surplus in most commodities. In such a situation, allowing more liquidity into the futures market – essentially by way of margin trading – can only result in an artificial rise in demand with concomitant impact on prices.

A more important question, of course, is the competence of banks to trade commodities that by their nature are volatile. The question to be answered unambiguously is whether banks have the product knowledge and market knowledge to trade; they may have the money though. Without proven research and commercial intelligence capability, there is a risk that banks may end up speculating in the market.

In any case, the core dharma of commercial banks is lending; and even in lending to brick and mortar projects, banks have accumulated huge NPAs (non-performing assets). Banks hold public money in trust and are in a fiduciary position. They should not waver from their core competency that is lending. There is definite risk if they start investing in commodities of which they know little. Instead of allowing banks to dabble in commodity trade, it would be appropriate that banks are directed to insist on borrowers who have exposure to commodities to hedge their price risks.

Allowing banks and FIIs to trade commodity futures is certainly not a priority at this point of time. Reform of the physical and futures markets, reducing the role of speculative capital (especially easy money in case of FIIs), improving regulatory oversight and bringing greater transparency in trading operations such as differentiating hedge contracts from speculative contracts and treating them differently are the way forward. The new Finance Minister would well to put the committee’s report in cold storage; and focus on genuine priority areas for the commodity market.

(This article was published on May 26, 2014)
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