Farmers need ‘options’ on futures trading

Madan Sabnavis | Updated on August 23, 2020

NCDEX contracts allow farmers to opt out of a futures deal. Seamless movement to spot exchanges should become possible

Futures trading in agricultural commodities was always at a disadvantage when it came to reaching out to farmers. The reason is straightforward. A farmer can sell the crop in advance at a known price on the exchange but if the price on the day of sale is higher, he cannot go back on the contract. An option gives the seller this right; but once it was allowed on the ‘futures price’, it became complicated for the farmer to comprehend. Therefore, the idea of getting in ‘options on goods’ which is not on the futures but the spot price makes a lot of sense and shortens the distance, as it were, between the farmer and the exchange.

NCDEX has launched three contracts, which is noteworthy. There is no reason why farmers should not go in for such trading as it is the same as the MSP (Minimum Support Price) with a small difference. On the positive side, the farmer can sell at a known futures price and in case the spot price on the day of settlement is higher, he need not go with the trade. This will eventually hold for all crops even where the MSP is ineffective. The downside is the loss of the option premium. These options can be made available across all commodities and geographies and have the potential to change the landscape of agricultural marketing.

NCDEX, a commodity futures exchange has a spot exchange, NCDEX e-Markets Ltd; together, these can offer integrated solutions for the farmer. Basically, the options transaction will protect the farmer against the downside like the futures price. However, if the spot price is higher on the settlement date, the farmer need not go ahead with the contract and should be allowed to seamlessly switch to the e-market platform and sell the product. The two exchanges should ideally connect the platforms for the farmer so that the optimal price is received. This is just what the farmer would want — the best of both the worlds.

Logistics support

The establishment of such contracts must be supported at the back-end by logistics which includes transport, storage, grading, assaying and packing. This will provide an end-to-end solution for the farmers. Simultaneously, the contract specifications must be aligned to the farmers’ output and while NCDEX starts with 10 MT as the specification, should ideally be of a lower quantity to involve class participation.

To make this successful, there must be an expansion of the delivery centres with all the infrastructure facilities to enable trading. Also, trading terminals must be made available in all connected geographies for participation to increase. Mass education is required which must be not just through lecture series which is the norm but by having trading facilities in the villages.

The brokering community can take a lead here and needs to be incentivised to do so. Having terminals in all the major towns around the delivery centre can have lower transaction charges to begin with.

The model looks good but the challenge of getting the farmer to use these platforms remains. Ideally, the top 10-20 trading centres in the top five producing States of wheat should have delivery centres as well as trading facilities. While the latter is easier to achieve, the former is not. For such a plan to work out, it is necessary for the State governments as well as WDRA (Warehousing Development and Regulatory Authority) to get involved because creating infrastructure can never be the job of a commodity exchange which is barely able to meet its commercial viability parameters given the complex nature of agriculture.

Governments — both Central and State — need to be geared to this reality because if they can create these structures, the financial commitments in the form of subsides can be brought down significantly over time as the market provides the best deals to the farmers.

The government has been proactive in terms of revoking the APMC laws and allowing farmers to sell across boundaries. But this will be ineffective unless access is provided, and hence even for the concept of e-Nam to work, such connectivity is necessary. The onus is quite clearly on States to make the ‘options on goods’ concept to work or else it can become another wasted exercise. Corporates should have free access to buy these goods on the platforms of commodity exchanges which will cut down on intermediation costs.

In fact, if the options on goods concept works out well, the government can reconsider the MSP and procurement concepts. Farmers could just be getting a higher price on the exchange and may not require such continued support.

The government could also become a buyer on the exchange platform to meet its buffer stocking norms. Such a market will allow for procurement across all States and not get restricted to those centres where the FCI operates.

There can be no argument against the commercialisation of agriculture. Given the strength in terms of production, India can be a major exporter of farm products. For this to happen we need to strengthen the links between production and sale; the present initiative of SEBI to let the exchanges launch options on goods is significant as it also closes on the other end involving sale.

The logistics chain is the weak link which must be developed through state action. This will require investment and incentives to set up warehouses and grading and assaying facilities. It will lead to creation of several jobs in rural India which is missing today and ensure that migration is curbed.

The government will also gain as the need to subsidise will come down and the process of procurement and storage of surplus grains is checked.

Hence, options on goods should be extended to all farm commodities as the potential to create this virtuous circle is huge. But for this to happen, state support is required right from the Centre to the panchayats. Given the ‘will’ seen today at these levels, it does look achievable.

The writer is Chief Economist, CARE Ratings. Views are personal

Published on August 23, 2020

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