Sucheta Dalal :Using market futures to check soaring prices
Sucheta Dalal

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Using market futures to check soaring prices  

Jun 26, 2006



Last week, the government scrambled to contain the possible political damage arising out of soaring commodity prices. Just as the drumbeat of protest over high food and vegetable prices turned more insistent, a Cabinet committee decided to allow import of sugar and wheat (including import by private players), while banning the export of pulses in order to cool prices. Will this resolve the problem? Maybe temporarily.

 

This is the first real test for the commodities’ futures markets after the government re-opened trading at the national level after a 40-year hiatus. Commodity futures today are traded through sophisticated, multi-commodity bourses in a fully automated trading environment and volumes are soaring. Turnover at these bourses quadrupled from Rs 5,11,000 crore in 2004-05 to Rs 21,00,000 crore in 2005-06. However the more important issue of strengthening the commodity regulator and the physical delivery system is moving at a slow crawl.

 

Consequently, there have been speculative excesses but these were restricted mainly to commodities such as guar gum and menthe oil that did not directly affect ordinary people (except the speculative buildup in urad dal). This time, prices of wheat, dals and pulses have spiralled up, along with those of milk, detergents, vegetables and oil. Clearly, not all of these are being traded in the forward market and part of the hike is due seasonal factors and higher fuel costs, but check with shopkeepers and petty politicians and they will all blame it on the satta bazaar (speculation in the forward market). Especially since forward trades in agricultural commodities such as rice, wheat and pulses have no physical delivery and prices of some of these essentials have doubled over the past few months.

 

The commodity futures regulator, the Forward Markets Commission (FMC) chairman, has said the increase in prices “is in sync with market trends.” But this is small consolation to those who are forking out higher prices for basic essentials. Indeed, India is the world’s largest sugar consumer and dictates prices. Rising sugar prices on the international market led to reports that Indian producers planned to increase their exports since it would fetch higher realisation. Similarly, India sets global price trends in oilseeds and gold as well, making us potentially a key world trading centre.

 

A bull market in commodities invariably causes anger and hardship leading to serious cost and inflationary pressures. Consequently, there are obvious political compulsions to dampen prices and commodity traders, as well as business and industry, would have to fall in line. The decision to prevent hoarding of foodgrains and the finance ministry’s proposal to import 10 lakh tonnes each of wheat and sugar and 45,000 tonnes of urad and gram is necessary and completely in line with such an effort.

 

• Put on hold all plans to permit FIIs into commodity futures trading

• Pass the pending Bill to strengthen the FMC and warehousing back-up

• And move on converting warehouse recipts into a negotiable instrument

 

Yet, this action is mere band-aid. Having reopened the commodity futures markets, the government will have to work at strengthening regulation and sequencing liberalisation plans. For instance, it must put on hold all plans to permit foreign institutional investors (FIIs) into commodity futures trading. Despite the world-wide hype about India’s rapid economic growth, we remain a poor country with a vast segment of the population below the poverty line. In the circumstances, it makes little sense to open ourselves to international capital flows and price trends in commodities, at least until we have improved systems and processes.

 

The Bill for a Forward Contracts Regulation Act that will strengthen FMC’s regulatory powers and promote the creation of a strong warehousing system for proper quality assurance is pending in Parliament. It must be passed quickly. There is a need for backward integration of commodity markets, with a greater role for banks, a strong warehousing back-up and direct linkages to farmers. This is something the FMC chairman, S Sundaresan, has been pushing for a long while. A proposal to convert warehousing receipts into a negotiable instrument is also hanging fire; this would allow banks to set up collateral management companies and make the physical delivery process more efficient. Once this happens, several banks see an opportunity for increasing credit to farmers, insuring their crop and optimising returns through better price discovery. This will allow improvement in market efficiency and help check speculative excesses.

 

http://www.financialexpress.com/columnists/full_column.php?content_id=131729

 


-- Sucheta Dalal



 



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