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'Futures trading is not responsible for inflation'
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April 30, 2008 16:34 IST

The Indian government on Tuesday released the report from a Committee that studied the impact of futures trading on agricultural commodity prices.

The Committee under chairmanship of Prof. Abhijit Sen, Member, Planning Commission was appointed on 2nd March, 2007.

The other members of the committee were Sharad Joshi, Member of Parliament, Prof. Siddarth Sinha, IIM, Ahmedabad, Prof. Prakash Apte,IIM, Bangalore and Dr.Kewal Ram, Member, Forward Markets Commission, as Member Convener.

Following are the recommendations from the Committee:

(I) Negative sentiments have been created by the decision to de-list futures trade in some important agricultural commodities.

(II) The fact that agricultural price inflation accelerated during the post futures period does not, however, necessarily mean that this was caused by futures trading. One reason for the acceleration of price increase in the post futures period was that the immediate pre-futures period had been one of relatively low agricultural prices, reflecting an international downturn in commodity prices.

A part of the acceleration in the post futures period may be due to rebound/recovery of the post trend. The period during which futures trading has been in operation is too short to discriminate adequately between the effect of opening up of futures markets and what might simply be the normal cyclical adjustment.

(III) In contrast to the view that futures markets cause increases in prices, the bulk of the existing literature on the subject emphasizes that such markets help in price discovery, provide price risk management and also bring about spatial and temporal integration of markets, futures markets have the potential to bring about better price stability over a medium to long term although the literature on futures markets itself is rather divided on the subject of price variability.

Indian data analysed in this report does not show any clear evidence of either reduced or increased volatility of spot prices due to futures trading.

(IV) The ability of futures markets and contracts to provide instruments of risk management has not grown correspondingly and in fact has been quite poor.

(V) The proposed FC(R) Amendment Bill to upgrade the regulation and to improve the capabilities of the regulator need to be pursued vigorously.

(VI) Exchanges should act as self regulatory organizations capable of administering fair play, objectivity and customer orientation.

(VII) A study of the functioning of existing futures markets and contracts suggests that although the volume of futures trading in India has increased phenomenally in recent years, its ability to provide instruments of risk management has not grown correspondingly, and has in fact been quite poor. The reason for this is high basis risk in most contracts which keeps out potential hedgers and lends to greater dominance by speculators. This is a serious area which should be addressed both the exchanges and the regulator.

(VIII) Attracting speculators, arbitrageurs and other investors is no doubt important but that should not be the primary criterion while designing the contracts. The contracts designs should be such which serve the objective of risk management to farmers and other commercial users.

(IX) Efficient functioning of futures markets pre-supposes the existence of efficient spot markets. Currently the physical spot markets have large number of infirmities. Till these infirmities are removed, there will be difficulties in the functioning of futures markets.

(X) Collections from the transaction tax, if and when imposed on futures markets, should be earmarked exclusively for development of the required physical market infrastructure and farmers access to it.

(XI) There should be a consultative group both in FMC as well as in the exchanges comprising persons with proven domain knowledge of commodity sector.

(XII) At the apex level a Committee on Commodity market akin to the HLCC in the Capital Market should e constituted with Deputy Chairman, Planning Commission or one of the Member of the Planning Commission as his nominee as Chairman.(XIII) Futures prices indicate democratically observed price expectations at future date. Thus, given his capacity and availability of other enabling infrastructure such as warehousing, finance etc. he will be able to exercise his marketing option in such a way as to maximize his income realization.

(XIV) Reforming spot market should also be a top priority. Model APMC Act and operationalizing the same by appropriate set of rules and regulations needs to be expedited.

(XV) Banks and Financial Institutions which are at present not permitted to trade on Commodity Markets should, subject to approval by the Banking Regulator, be allowed to trade up to limits required for the purpose of devising customized OTC products suited to the needs of small and marginal farmers.

(XVI) National Exchanges are launching a pilot scheme of Aggregators' who will collect retail produce of the farmers and hedge it on the platform of exchanges on behalf of the farmers. Farmers Groups, Co-operative institutions, RRBs, CCBs, NGOs, State Agricultural Marketing Boards, Warehousing Corporations, Commodity Development Boards which work in the rural areas and thus have close association and trust of farmers should be allowed and encouraged to act as aggregators. The rules and procedures of futures trade in Exchanges should clearly lay down conditions to enable these entities to access the markets on behalf of the farmers.

(XVII) The setting up of national spot electronic exchanges by the national commodity exchanges is an attempt to create a national integrated market. To promote integrated national markets, central Government should take active steps to bring inter state spot trade under the regulation of a central authority rather than leave it to highly scattered APMCs. Entry 33 in the concurrent list of the 7th schedule of the Constitution seems to provide such a jurisdiction.

(XVIII) Conditions should be created so that farmers can use agri futures market to transfer their price risks. The contract designs should be tailored to meet the needs of the physical market.

(XIX) All regulators operating within the commodity markets space (like FMC, Warehouses, banking spot or APMCS) work in cohesion. The Government should ensure that a closely coordinated structure is put in place to achieve this.

(XX) It is of prime importance to create structure which enables dissemination of prices to the remotest corners of the country. This will ensure that benefit of price discovery of exchange platforms reach the farmers.

(XXI) In case of agri commodities only simple options may be allowed for some time till market attains maturity and operations and regulations and farmers attain adequate understanding of the market and of technique to use them. An assessment should be made of the possibility of agencies implementing MSP including FCI acting as the writer of 'call' and 'put' options in agriculture commodities.

This could reduce the cost of operations and incentivise market operations. The operation of MSP is like a zero premium option and options and MSP need not conflict. Whereas open-ended purchase could continue to be made at MSP as floor price, exchanges should be able to offer market based options at strike prices higher than the MSP. Farmers should be encouraged to participate in these put options for which FCI can be the options writer.

(XXII) There is a need to have a strong and resilient agriculture sector attracting investment for raising production and productivity. For this it is necessary to make agriculture a remunerative option. The vibrant agriculture markets including derivatives markets are the frontline institutions to provide early sign of future prospect of the sector.

Vibrancy in these markets give signal about commodities which deserves flow of investment. These markets deserve to be promoted for giving such signal.

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