Trouble spot

The merger of the Forward Markets Commission with the Securities and Exchange Board of India will resuscitate a commodity forwards market that has seen an exodus of investors recently. It’s a good first step but a lot more needs to be done to address the problems that plague this segment. The merger, a fallout of the scam at the National Spot Exchange Limited that had exposed the systemic risk in commodity exchanges, is in line with the recommendation of the Financial Sector Legislative Reforms Commission that had called for a unified financial regulator to regulate all financial products including equities, currencies, commodities, insurance, pension funds and bonds. With SEBI at the helm, the rules governing market intermediaries, trading and settlement, and investor protection are likely to be made more stringent; the enforcement of these rules is also expected to become more effective. This could help win back investor trust.

But the activity in commodity derivative exchanges in our country is skewed towards globally traded commodities such as bullion, energy and non-ferrous metals. While these account for more than 70 per cent of turnover, agricultural commodities make up for less than a third. This is largely due to the absence of organised nationwide spot markets for agricultural produce that can fix the prices of the underlying products on which the derivative contract can be based. The commodity futures market fails to serve its basic functions — of helping farmers protect themselves from the risk of price volatility and assisting in discovering the price — given that it is used mainly by traders for making bets on popular commodities such as gold and crude oil. Developing a national electronic platform where producers can trade goods with sellers is the next thing the Centre must implement. Rules governing warehousing of products traded in the spot market need to be formulated with greater care to avoid a repeat of an NSEL-type fiasco. The Budget announcement to create a unified national agriculture market is a step in the right direction. If sufficient thought is put into developing the contours of this market, it can help alleviate the price-discovery issue to a large extent.

The other reason why agricultural derivative contracts are unpopular is government intervention in regulating the prices of some products. Moving towards an entirely market-linked pricing will help attract a larger number of players and protect them from sudden swings caused by government interference. Removal of the commodity transaction tax is yet another step that the Centre should consider if it is serious about creating a strong market for commodity futures.

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