Commodity futures ban: Whack-a-Mole game!

Volatility in prices of any tradable asset is normal. Being seasonal products and perishable in nature, volatility in agricommodity prices are even higher. The recent news of Maharashtra Onion Farmer Mr. Rajendra Tukaram Chavan covering 70 kilometer to sell 512 kgs of onions at Solapur APMC to realize Rs. 1 per kg is a distressing reminder of price volatility faced by farmers. Also the farmers are not alone at the receiving end of price volatility. Few years ago, in 2019, onion prices were hovering at Rs. 200 at the same Solapur market causing much heartburn to general public and even political parties. The same story of low prices for Mustard farmers is unfolding now. These are not isolated instances, but are manifestations of prevalent price risks being faced by producers and consumers of agricommodities in India.

Response to wide fluctuations in agri commodity prices have always been reactionary and lopsided.  When prices increase, Government of India undertakes a slew of measures –  ranging from imposing ban on export, reducing stock holding limits so as to increase supply in domestic market, and mobilizing government bodies such as APEDA, NAFED & MMTC to import the commodity to increase its domestic availability. However, such initiatives are typically kneejerk and undertaken only when either the price rise is highlighted by the media or the opposition parties raise the issue in the parliament. As compared to increase in commodity prices, the government has relatively less number of ammunitions to deploy when prices fall causing low price realization by farmers. Besides standing to buy agri commodities at MSP that too only for handful of agricommodities, GoI can do very little to alleviate the low price realization by farmers. Various governmental interventions to stabilize prices have limited impact and the boom to bust cycle in agricultural prices continue to recur at regular intervals much like the whack-a-mole game.

Hence developing market-based approach is far more sustainable and makes the system resilient enough to control price volatility to a large extent. In fact, every middle aged Indian would vouch for the immense benefits that have accrued since India moved towards market-based economy in 1992. Reintroduction of exchange traded commodity derivatives in India in 2003 was a significant step towards facilitating a market based mechanism for farmers, agri commodity processors, consumers and other value chain partners to manage their price risks. However, Indian commodity derivatives market has been stymied by periodic suspension of trading in many agri commodity derivatives. The latest suspension was announced 20th December 2021, with the suspension of seven commodities/commodity groups for one year with the same getting extended to one more year till December 20, 2023.  Such abrupt regulatory interventions usually impose severe cost to each and every commodity market participants and even more to farmers.

Commodity derivatives market offers three important value propositions i.e price risk hedging, price discovery and pricing benchmarks.  Commodity futures contracts help commodity producers, consumers and value chain partners to hedge price risks.  Futures contracts derive their value from the spot market. Futures and spot prices are intertwined with each other and tend to move in correlation and finally converge on the futures contract expiry date. Compared to price risk hedging function, price discovery is an equally important value proposition offered by various commodity exchanges.

Price discovery happens when the futures price is determined through interaction of many buyers and sellers who factor in domestic as well as global supply-demand conditions of a commodity and the related commodities, supply chain bottlenecks, geopolitical issues and a host of other factors. The discovered futures price plays an important role as consumers, producers and other VCPs formulate their business decisions based on the futures price. Over the time, the discovered price gains traction and becomes the benchmark price, gets reported in national and international data platforms and other varieties of the same commodity gets priced with respect to the benchmark price much like Cotton prices at ICE and  CPO price at BMD.

Considering the nascent stage of Indian commodity derivatives markets, in addition to discovering the futures prices, Indian commodity exchanges also invest significant effort in calculating and reporting spot price information in a timely manner. Commodity exchanges collect data from empanelled members from the main/additional delivery centers for a given commodity and calculate and report spot price at least twice daily.  The calculated spot prices are not only updated in websites of the exchanges, but are also relayed to all local mandies, discussed  and reported  in TV, various websites and  mobile apps, thus giving a credible signal to one and all regarding the spot price prevailing at the major market on that date. In fact, collation and calculation of spot prices on a daily basis is a unique value proposition offered by commodity exchanges as compared to exchanges offering only derivatives contracts on financial assets. For example, if one is interested to take futures contract position on say Infosys shares, the trader has access the Infosys spot price and futures price on a real time basis.  In case of commodity market, as the spot and futures market operate in isolation, the role of commodity exchanges in calculating and disseminating spot price information increases significantly.

Though APMCs/Mandi’s are major venues for spot trading of agri commodities, but for various reasons, APMCs have not been able to create a spot price benchmark.  Prices arrived at these APMC’s are influenced by factors such as local supply and demand, quality of the produce, applicable GST and more importantly cartels formed by middlemen to exploit farmers and consequently do not truly reflect the spot price  commodities.

Collation, calculation and dissemination of daily spot prices by Indian commodity exchanges fulfils a major void in Indian agri commodities ecosystem. By doing so, these exchanges convey a single spot price for commodities, and help the commodity value chain participants to anchor their fundamental expectations to the common reference point. It also facilitates making of “India Price” for that commodity. In fact one needs to ponder – why “Make in India” initiatives should only be restricted to tangible/manufactured goods? Setting Indian benchmark prices for commodities, specifically agri commodities should also be given equal importance considering the fact India is a major producer and consumer for many agri commodities and yet continues to be a price taker.

It is also pertinent to highlight here that commodity exchanges do continue to calculate and report the spot price even though futures contracts have been suspended. However without the presence of futures trading, spot prices contributed by the empanelled members’ tend to show greater dispersion. In other words, futures prices act as an anchor for market participants to formulate their spot trading activities which in turn reflects in a far more cohesive price contribution by empanelled members. Just to corroborate this surmise, daily price range (maximum price – minimum price) for mustard prices contributed by empanelled members 1 year before and 1 year after futures trading suspension (suspension  came into effect on 8 October 2021) is given below. As one can see the range of prices submitted by the empanelled members on daily basis shows greater dispersion after the suspension as compared one year period before suspension.

In other words, without the presence of futures market, spot price published by exchanges loses relevance and fails to act as an anchor for commodity value chain partners. Hence futures trading suspension has not only has aggravated the price risk faced by commodity value chain participants, but also significantly eroded the market’s ability to give credible price signal – a lose-lose proposition for all.

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Views are personal.

Prabina Rajib

Professor (Finance & Accounting)

Commodity Research Group

VGSoM, IIT Kharagpur

Moneycontrol journalists were not involved in the creation of the article.