Govt should deepen, not clamp down on, forward markets

The recent sharp and continuous rise in guar futures once again raised the spectre of a ban on futures trade.

But as guar is a narrow commodity (low volumes of contracts) and not a daily-use item, the fear was not overwhelming.

Commodity futures have been perceived as the main villain driving up prices of some commodities relentlessly. But most often fundamentals of supply and demand have contributed to rising prices, according to commodity exchanges, brokerage firms and even a Government panel.

“There is a lot of uncertainty, especially in agricultural commodity futures,” said Mr Kishore Narne, Head, Currency and Commodity Research, Anand Rathi Commodities. He was referring to the possibility of a ban on futures trade, a tool the Government often uses whenever prices of a commodity rise to uncomfortable levels.

In May 2009, the Union Government banned sugar futures as prices surged.

But prices continued their upward momentum well after sugar futures were banned, indicating that the price surge was entirely due to fundamentals of supply and demand.

In February 2007, the Government banned futures trade in rice, wheat, black matpe (urad) and pigeon pea (tur) overnight without even giving a chance to investors to wind up their open positions.

Confidence lost

Two years later when the country was poised for a bumper wheat crop, the Government lifted the ban on wheat futures.

When they were banned, volumes of wheat contracts on the National Commodity and Derivatives Exchange were moderately good. But on resumption wheat futures languished with low volumes for a long time.

When sugar futures were resumed after the ban a similar trend was seen.

“Sugar was a good contract with good participation, especially from large mills. Traders and stockists were also there on the buy side. It was a matured contract,” said Mr Narne.

First the stock limits came, followed by the ban on sugar futures. Mills have not come back to participate in sugar futures.

“They have lost the confidence. Now some of them trade on international markets,” Mr Narne said.

Mr Naveen Mathur, Associate Director, Commodities and Currencies, Angel Commodities, said: “Blaming commodity futures for price rise is wrong. Open up the market fully and chances of manipulation by one set of market players will be minuscule.”

Turnover in commodity futures markets has been rising continuously. But derivatives markets will deepen only after Parliament clears the Forward Contract (Regulation) Amendment Bill.

This legislation will make the futures-market regulator, Forward Markets Commission (FMC), financially autonomous and allow launch of new-generation hedging products such as options. At present, the commission is a statutory body under the Ministry of Consumer Affairs, Food and Public Distribution.

Recently, the commission's Chairman, Mr Ramesh Abhishek, said that the Forward Contract (Regulation) Actonce amended, would become a landmark law that would help change commodity derivatives trading in India.

Absence of liquidity is another major issue with commodity futures. Most often, even in some of the active contracts liquidity is seen mainly in front-month contracts while far-month contracts languish with low volumes and open interest.

Brokerage firms believe introduction of options would bring in more kinds of investors into the commodity derivatives trading.

With increased participation, liquidity is likely to improve and in turn lower the role of speculators in price discovery.

Speculators will become one of the many investor groups participating in derivatives trade, brokerage officials said.

Angel Commodities' Mr Mathur said: “Corporates wanting to enter into commodity derivatives trading look for liquidity in far-month contracts. But unfortunately today liquidity is there only in near-month contracts.”

According to him, liquidity is important as it impacts entry and exit. Companies wanting to hedge risk want the ease of entry and exit, especially in far-month contracts.

Options contract is a hedging instrument, which offers a more flexible alternative to futures. Options are made for clients who look for limited risks such as farmers.

A Parliamentary Standing Committee that recently submitted its report on the Act has, among many suggestions, recommended allowing options in commodities. Options, according to Mr Mathur, can be opened up in international commodities such as gold, silver, crude oil and copper.

COMMENT NOW