Implications of futures contracts ban on select commodities

Suresh P. Iyengar | | Updated on: Dec 21, 2021

Here is the BL Explainer on futures trading ban on select commodities, its benefits, controlling prices, and experts take on it.


What is futures trading?

Futures trading is an agreement between two people to buy or sell a commodity at an agreed price on a future date. As per futures contracts traded on an exchange, one party consents to buy a given quantity of commodity with specified quality and take the delivery on a specific date. A seller has to deliver the commodity. The exchange, which collects the requisite margin, guarantees for the quality of goods and financial commitment. Except for cash-settled energy contracts, all futures contracts are settled through delivery on the expiry of the contract.

What are its benefits?

Commodity derivative markets have an immense potential in the Indian economy as they enable price discovery, facilitate better risk management, act as a price barometer for agriculture commodities and help in price integration. However, the scale of participation in exchanges by corporates, hedgers and institutional investors has not increased as expected due to an uncertain regulatory environment, including an unexpected ban on the trading of certain commodities. On its part, SEBI has been undertaking policies for the development and further expansion of markets, increasing liquidity with broader participation and enhancing the ease of doing business. It has also continuously monitored the markets for any price aberration or irregularities.

Why has SEBI banned future trading in select commodities?

The consistent rise in the wholesale price inflation index has been a major concern for the government. Wholesale inflation, based on the Wholesale Price Index, jumped to 14.23 per cent in November from 12.54 per cent in October, primarily due to rise in food prices. It is at a three-decade high. This comes after the retail inflation in November spiked to a three-month high of 4.91 per cent, despite a cut in excise duty on fuels. The wide gap between WPI and CPI inflation reflects the price pressures on the inputs side, which are expected to pass through to the retail level in the coming months. The government is not convinced, despite a few studies, that rise in future prices is not causing inflation.

Will it help control prices?

Definitely not. Retail prices are not expected to decrease unless the supply side issues are sorted out. The unseasonal rain and recent cyclone in different parts of the country have caused major damage to road transportation besides crop damage. The high fuel cost has also pushed up prices. Incidentally, the supply of commodities cannot be improved through imports as the price of many commodities in the international markets are is also high. Also, cooking oil prices are high since global prices have surged on low production and supply issues.

Why are experts calling this a retrograde step?

Experience has proved that commodity prices in the spot market do not fall after banned futures trading. In turn, it affects investors’ sentiment, and they wind up their investment in other commodities that are allowed to be traded. The rise in prices of a particular commodity in the futures market sends signal to the policymaker on the impending shortage of that commodity. Futures price falls once the supply-side concerns are addressed.

Published on December 21, 2021
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