Commodity futures shock

The Securities and Exchange Board of India (SEBI) recently banned futures trading on seven commodities — non-basmati rice, wheat, green gram, soybean and its derivatives, rapeseed-mustard complex, crude palm oil (CPO), chana — for a year. The directive also states that no new position will be allowed on the floating futures contracts for these commodities .

Though the regulator has not given any reason for this move, the common perception is that it was done to rein in the food inflation.

In 2007-08, too, the then regulator, Forward Markets Commission had suspended futures trading in rice, wheat, tur, urad, potato, sugar. While the suspension was lifted for other commodities, the ban on tur and urad remained.

In 2007-08 an Expert Committee under the Chairmanship of Abhijit Sen examined the link between inflation and futures trading. The Committee could not conclusively prove a linkage.

The government can now also set up a panel to examine the link. The disruption caused by the pandemic to markets and supply chains should be considered. Economists can examine whether a trading suspension is a rational move or creates a disruption in the markets. This ban has important implications for commodity ecosystem stakeholders.

Probable impacts

Futures trading in commodities took off in 2003, when electronic commodity exchanges with pan-India reach were launched.

The average daily turnover (single side) in the commodity futures market zoomed from ₹1,970 crore in 2004-05 to ₹58,298 crore in 2011-12. From 2013, the commodity futures market has risen and dipped and stood at ₹32,894 in 2020-21.

Also options trading, and new categories of participants like mutual funds were introduced.

Barring a few agricultural futures, namely soybean and its derivatives, rapeseed-mustard complex its derivatives on the NCDEX and CPO on the MCX, other contracts in the list of suspended commodities could not see much liquidity and trading volume.

Liquid futures contracts contributed to financialisation, and commodities emerged as a new asset class bringing in new investors.

So, this suspension will demotivate and compel them to search for a safer platform.

Second, futures exchanges must redesign their products and business development strategies as the threat of unplanned suspension of commodity derivative contracts would always loom large.

Third, assaying agencies leading in quality or grade certification and warehouse service providers in physical delivery may start re-looking at commodity businesses. They would need to forego the lion’s share in the pie of commodity futures businesses.

Fourth, price discovery, an essential function performed by the national level commodity exchanges, will be distorted and localised price pooling and formation process can lead to unorganised illegal trade practices. Additionally, the availability of a scientific and transparent source of price signals to the farm community will be unavailable.

Fifth, CPO or soybean futures that have been tracked by international market participants and established a linkage with the global north will no longer be available. Earlier experiences show that market participants may be wary of trading in these contracts even after the suspension is revoked.

To sum up, there was a need for more efficiency in regulating the commodity derivatives market, translating into the regulatory convergence through the SEBI-FMC merger in 2015. Sudden suspension of commodity derivative contracts should be avoided, and the recent suspension should be rolled back at the earliest.

Kushankur Dey is Chairman, CFAM of IIM Lucknow & Debojyoti Dey is Assistant V-P of Research at the MCX, Mumbai. Views are personal.

COMMENT NOW