FuturesTradingin Agricultural Commodities

IstheGovernmentbanoncommoditiestradinglogical?
SandhyaSrinivasan CentreforCivilSociety ResearchInternship MayJuly2008

WorkingPaperNo.193 SummerResearchInternshipProgramme2008 CentreforCivilSociety

EXECUTIVESUMMARY On 7 May, 2008, the Indian Government announced the ban futures trading in four agricultural commoditieschickpea,potato,rubberandsoyoil.Inthemonthsthatfollowed,whetherornot futures trading contributed to the increase in prices was a hotly debated subject. Some claimed that futures markets benefit the farmers and dont contribute to price rises, while others argued thatspeculationhadledtopricedistortion.TheAbhijitSenCommittee,constitutedtoexaminethe subject, only said that a cause and effect relationship between future and spot prices cant be establishedconclusively.
The purpose of this paper is to examine the rationale behind the ban and study how logical the decisiontoimpose it is.The statedpurposeof the ban was to control inflation. However,of the fourbannedcommodities,onlythepriceofpotatodeclinedafterthebanduetothebumpercrop. Thebanresultedinahugelossoftradingvolumesforthefuturesexchanges,butdidntimpactfood pricessignificantly. Therisinginflationratehasbeenattributedtoanumberoffactors,includingtheglobalriseinprices of food and oil, the diversion of land for biofuel production, loose monetary policy in emerging economies,andtheadoptionofanexpansionaryfiscalpolicybytheGovernment. An analysis of spot and futures prices of the four banned commodities shows a high degree of positive correlation in the prices of the two markets. The prices are interdependent: the futures marketsgivessignalstothespotmarketsonthedirectioninwhichpriceswillmoveinthefutureand thefuturespricesaredeterminedonthebasisoftheconditions inthespotmarkets. Speculation maydrivepricesfurtherup,butaspeculatorexpectspricestoriseduetothemarketconditions,and doesntarbitrarilybetonapricerise. Foodpricesandinflationdatashowthatthebandidnthelpcurtailthepricerise.Banningfuturesis an illogical solution because it obstructs the development of a mechanism to regulate unhealthy speculation.Intheshortrun,higherfoodaidtothepoorisessentialtominimisetheimpactofthe food crisis. In the long run, the Government must invest in developing agriculture and providing better infrastructure in terms of storage and transportation, and the organisation of spot markets rather than adopting misguided schemes like the farm loan waiver. Tightening the monetary and fiscalpolicyinIndia,andremovingbiofuelsubsidiesintheUSandEUwillhelpeasefoodprices. Theextenttowhichtwomarketsinfluenceeachotherdependsonthelevelofintegrationofthetwo markets. Developing the spot markets along with the future markets and ensuring higher participation from the farmers is essential to integrate the futures and spot markets. When the participationbyconsumersandproducersofagriculturalcommoditiesinthefuturesmarketislow, thedebateoverthefuturesbanbecomesirrelevant.

 TABLEOFCONTENTS
INTRODUCTION....................................................................................................................................... 1 METHODOLOGY ...................................................................................................................................... 1 FUTURESTRADING.................................................................................................................................. 2 WHATAREFUTURES? ......................................................................................................................... 2 WHYFUTURESTRADING? ................................................................................................................... 2 HISTORYOFFUTURESTRADING ......................................................................................................... 3 GLOBALLY........................................................................................................................................ 3 FUTURESTRADINGININDIA ........................................................................................................... 4 BANONFUTURESTRADINGINAGRICULTURALCOMMODITIES ............................................................ 5 STATEDPURPOSEOFTHEBAN ........................................................................................................... 6 EFFECTOFTHEBAN ............................................................................................................................ 7 ARGUMENTS .....................................................................................................................................10 INFLATION.............................................................................................................................................10 CAUSESOFINFLATION ...................................................................................................................... 13 NEEDFORTHEBAN...............................................................................................................................15 EFFECTOFTHEPREVIOUSBAN.........................................................................................................18 POLICYSUGGESTIONS ...........................................................................................................................20 BIBLIOGRAPHY ......................................................................................................................................22

CentreforCivilSociety 1 FuturesTradinginAgriculturalCommodities

INTRODUCTION
Yearonyearinflationcrossedthe5percentlimittheUPAGovernmenthadsetforitselfinthethird weekofFebruary.InthethirdweekofMay,amidstrisingcrudeoilandfoodpricesglobally,inflation aspertheWholesalePriceIndex(WPI)was8.1percent.FiguresfromtheOfficeoftheEconomic Advisor pegged WPI inflation for the week ended 7 June, 2008 at 11.05 per cent: a 13year high. Risingpricesoffoodarticlesincludingmilk,cereals,tea,edibleoilsandcertainmanufactureditems likesoapsanddetergentspushedinflationto11.42percentfortheweekended14June,2008.1 AccordingtoHSBCreports,foodconstitutes60percentoftheconsumerpricebasketinIndia.In effect,anincreaseinfoodpricesleadstoanincreaseinotherpricesaswell. Foodsecurityisanimportantelectoralissueinmostdevelopingeconomies,andintherunuptothe elections,theUPAGovernmenthastakenanumberofmeasurestoappeasethevoters.Inorderto rein in inflation, the Government cut import duties on edible oils, introduced Commodity TransactionTax(CTT)of0.0017percentonfuturestransactionsintheBudgetforthisfiscalinthe lastweekofApril2,imposedSecuritiesTransactionTax(STT),bannedtheexportofpulsesandrice (exceptbasmati)andbrieflybannedtheexportofedibleoils,apartfrombanningfuturestradingin agriculturalcommodities.3 The purpose of this paper is to ascertain whether or not the Government is taking the right measures to solve the prevailing food crisis and control inflation. More specifically, the paper attemptstofindoutwhetherthebanonfuturestradingislogicalbystudyingthepricemovements in the spot market and the futures market to see if theres a clear cause and effect relationship betweenthetwo,andbydeterminingthecomponentsofinflation.

METHODOLOGY
A number of reports, newspaper articles and journals were perused. The spot prices for the four banned commodities were collected from the Multi Commodity Exchange (MCX) website, and graphsweremadeusingmonthlyaveragesofthedailyclosingprices.Forfuturesprices,theclosing priceoffuturescontractswiththreemonthexpirycycleswereused,andthedatawassourcedfrom theMCXwebsite.Yearonyearinflationwascalculatedusingwholesalepricesforallcommodities collectedfromthewebsiteoftheOfficeoftheEconomicAdvisor,whichuses19931994asthebase year.FieldtripsweremadetothevegetablemarketsinAzadpur,SarojiniNagarandINAColonyto assess the vendors understanding of price determination and awareness of futures markets. Reactionsofindustrybodiesandfarmerunionstothebanwerecollectedfromnewspapers,official websitesandemails.

Inflationsoarstonew13yearhighof11.42percent(2008,June27).PTI.Retrievedfrom http://www.livemint.com/2008/06/27120050/Inflationsoarstonew13year.html 2 Quidproquofor4monthfuturesban:LowerCTT&StrongerFMC(2008,May12).ENSEconomicBureau. Retrievedfromhttp://www.ncdex.com/News_Press/assets/660113May08_01_ind_express.jpg 3 Anoldenemyrearsitshead(2008,May22).TheEconomist.Retrievedfrom http://www.economist.com/finance/displaystory.cfm?story_id=11402856

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CentreforCivilSociety 2 FuturesTradinginAgriculturalCommodities

FUTURESTRADING
WHATAREFUTURES?
Futuresarestandardisedfinancialcontractstradedinafuturesexchange.Afuturescontractisan agreementtobuyorsellacertainquantityofanunderlyingassetatacertaintimeinthefutureata predeterminedprice. When futures contractsaretraded, thereisnt necessarily anactual delivery of goods.Thetrader only speculates on the future direction of the price of the underlying asset, which may be a commodity, foreign exchange, bonds, money market instruments, equity or any other item. The terms "buy" and "sell" only indicate the direction the trader expects future prices to take, i.e. he wouldbuyitifheexpectsthepriceoftheunderlyingassettoriseinthefutureandsellifheexpects ittofall.Futurescontractsareusuallyclosedbymakinganoppositetransaction,i.e.thebuyerof thecontractsellsitbeforetheexpirationdate. Thepriceatwhichthecontractistradedinthefuturesmarketiscalledthefuturesprice.Futures contracts have onemonth, twomonth and threemonth expiry cycles, and they usually expire on thelastThursdayoftherespectivemonth. Therearetwosystemsthatmaybefollowedinthesettlementoffuturescontracts: FuturesRollingSettlement:Attheendofeachday,alloutstandingtradesaresettled,i.e.thebuyer makespaymentsforsecuritiespurchasedandthesellerdeliversthesecuritiessold.InIndia,futures exchanges function on the T+5 settlement cycle, wherein transactions are settled after 5 working daysfromthedateonwhichthetransactionhasbeenentered. Weekly Settlement Cycle: This system provides the traders a longer time frame to speculate becausethesettlementismadeattheendofeachweek. Therearethreecategoriesofparticipantsinthefuturesmarketspeculators,whobetonthefuture movement of the price of an asset; hedgers, who try to eliminate the risks involved in the price fluctuationsofanassetbyenteringfuturescontracts;andarbitrageurs,whotrytotakeadvantageof thediscrepancybetweenpricesindifferentmarkets. Whilehedgersparticipateinthemarkettooffsetrisk,speculatorsmakeitpossibleforhedgerstodo sobyassumingtherisk.Arbitrageursensurethatthefuturesandcashmarketsmoveinthesame direction.

WHYFUTURESTRADING?
Over the past two decades, food prices have been more volatile than the prices of manufactured goods. The uncertainty of commodity prices leaves a farmer open to the risk of receiving a price lowerthantheexpectedpriceforhisyield.Attimes,thecroppricesfallsolowthatthefarmeris unabletorepaytheloan.Inadequatepriceriskmanagementisoneofthemostimportantreasons forpoorfarmersremainingpoor.4

FoodandAgriculturalOrganisationoftheUnitedNations(2006).AgriculturalManagement,Marketingand FinanceWorkingDocument12:Anintroductiontomarketbasedinstrumentsforpriceriskmanagement(p.1).

CentreforCivilSociety 3 FuturesTradinginAgriculturalCommodities Price risk management refers to minimising the risk involved in commodities trading. Through futures contracts, the risk may be shifted to speculators or traders who are willing to assume the risk. A hedger would try to minimise risk by taking opposite positions in the futures and cash markets.Sincethetwomarketsusuallymoveinthesamedirection,theprofitsofonemarketwill coverthelossesintheother.Inthecaseofacommodityseller,likeafarmeroramerchant,futures contractsofferprotectionfromdecliningprices. Price discovery refers to the process of determining the price level of a commodity based on demandandsupplyfactors.Everytraderinthetradingpitofacommoditiesexchangehasspecific market information like demand, supply and inflation rates. When trades between buyers and sellersareexecuted,themarketpriceofacommodityisdiscovered.AccordingtoV.Shunmugam, Chief Economist at the Multi Commodity Exchange of India Ltd., commodity futures help policy makerstakebetterpreventivemeasuresbyindicatingpricerisesbeforehand.5 Apartfromthebasicfunctionsofpricediscoveryandpriceriskmanagement,futurescontractshave a number of other benefits like providing liquidity, bringing transparency and controlling black marketing. Futures contracts can easily be converted into cash, i.e. they are liquid. By buying or selling the contract inordertomakeprofits,speculatorsprovide the capital required for ensuring liquidityin the market. They provide certainty of future revenues or expenditures, hence ensuring concrete cashflowsfortheuser. Futures markets allow speculative trade in a more controlled environment where monitoring and surveillanceoftheparticipantsispossible.Hence,futuresensuretransparency.Thetransparency benefitsthefarmersaswellbyspreadingawarenessaboutpricesintheopenmarket. Futuresalso help instandardisationof quality,quantity and timeof delivery,sincethese variables areagreeduponbytheparticipantsandspecifiedinthefuturescontract.

HISTORYOFFUTURESTRADING
GLOBALLY Futures trading in commodities is said to have originated in Japan in the 17th century for silk and rice.6 The Dojima Rice Exchange in Osaka, Japan, is said to be the worlds first organised futures exchange,wheretradingstartedin1710.7 Strategically locatedatthe base ofthe Great Lakes,closetothe farmlandsandwellconnectedby railroad and telegraph lines,Chicagobecame acommercial hub inthe 1840s. Inadequate storage
Rome,Italy:Kang,M.G.,Mahajan,N.RetrievedMay30,2008,from http://www.fao.org/AG/Ags/subjects/en/ruralfinance/pdf/ag_price_risk.pdf 5 Shunmugam,V.(2008,June2).Usingfuturestocontrolinflationarypressures.Mint.Retrievedfrom http://www.livemint.com/2008/06/02215059/Usingfuturestocontrolinfla.html 6 Babcock,B.,CommodityFuturesTradingforBeginners.RetrievedMay19,2008,fromhttp://www.rb trading.com/begin.html 7 West,MarkD.(2000,August1).Privateorderingattheworld'sfirstfuturesexchange(DojimaRiceExchange inOsaka,Japan).RetrievedMay20,2008fromMichiganLawReviewArticlesDatabasefromHighBeam Researchathttp://www.encyclopedia.com/doc/1G170742768.html

CentreforCivilSociety 4 FuturesTradinginAgriculturalCommodities facilities led to surplus or shortages in the markets, which in turn led to huge fluctuations in the commodityprices.Inordertohedgethemselvesfromtheriskofdecliningprices,grainmerchants, farmers and processors began entering forward contracts, wherein they agreed to exchange a certainquantityofaspecifiedcommodityforanagreedsumonacertaindateinthefuture.This wasbeneficialforbothpartiesinvolved:thesellerknewhowmuchhewouldreceiveforhisproduce and the buyer knew his costs in advance. However, not all such contracts were honoured. For instance,ifthepriceagreeduponintheforwardcontractwasfarlowerthantheprevailingmarket price,thesellerwouldbackout. On April 3 1848,the Chicago Board ofTrade(CBOT)wasestablished by 83 merchantstofacilitate tradeinspotproduceandforwardcontracts.Itwasonlyin1865thatstandardisedfuturescontracts were introduced. The Chicago Produce Exchange was established in 1874 and the Chicago Butter and Egg Board in 1898. In 1919, it was reorganised to enable future trading and was renamed ChicagoMercantileExchange.8 FUTURESTRADINGININDIA It is believed that commodity futures have existed in India for thousands of years. Kautilyas Arthashastraalludestomarketoperationssimilartomodernfuturesmarkets. However,organisedtradingincommodityfuturesinIndiacommencedinthelatterpartofthe19th centuryatBombayCottonTradeAssociationLtd.(establishedin1875).Thenumberofcommodity markets in the preindependence era was limited, and there were no uniform guidelines or regulations:tradedependedonmutualtrustandsocialcontrol. In 1947, the Bombay forward Contracts Control Act was enacted by the Bombay State. The legal frameworkfororganisingforwardtradingandtherecognitionofExchangeswasonlyprovidedafter the adoption of the Constitution by a central legislation called Forward Contracts (Regulation) Act 1952.9 Throughanotificationissuedon27June1969,byexercisingthepowersconferredupontheCentral GovernmentbytheSecuritiesContractsRegulationAct1956,forwardtradewasprohibitedinalarge numberofcommodities,leavingonly7commoditiesopenforforwardtrade.Thedeclineintraded volumes on stock markets led to the evolution of an informal system of forward trading by the BombayStockExchangein1972,butthiscreatedpaymentcrisesquiteoften.10 In1994,theKabraCommitteerecommendedtheopeningupoffuturestradingin17commodities, excludingwheat,pulses,nonbasmati,rice,tea,coffee,drychilli,maize,vanaspatiandsugar.There wereanumberofotherexpertcommittees,includingtheShroffCommittee,DantwallaCommittee and the Khusro Committee, which laid the foundation for the revival of futures trading. Many

FromWaterStreettotheWorld.(2007).CMEGroupMagazine(Summer2007Issue).RetrievedJune10, 2008from http://www.cmegroup.com/company/history/magazine/Summer2007/FromWaterStreetToTheWorld.html 9 AbhijitSenCommittee.(2008).ReportoftheExpertCommitteetostudytheimpactoffuturestradingon agriculturalcommodityprices(p.2).MinistryofConsumerAffairs,FoodandPublicDistribution,Government ofIndia 10 Kannan,R.(2004).AbriefhistoryofforwardtradinginIndia.RetrievedMay28,2008from http://www.geocities.com/kstability/content/derivatives/history.html

CentreforCivilSociety 5 FuturesTradinginAgriculturalCommodities reports, notably a UNCTAD and World Bank joint Mission Report India: Managing Price Risk in Indias Liberalised Agriculture: Can Futures market Help? (1996), advocated the repeal of the notificationprohibitingforwardtrade. AftertheSecuritiesLaws(Amendment)Billwaspassedin1999,theCentralGovernmentliftedthe prohibitiononforwardtradinginsecuritieson1March,2000. TheNationalMultiCommodityExchange(NMCE)wasthe firstexchangetobegrantedpermanent recognition by the Government, where futures trading commenced on 26 November, 2002 in 24 commodities. The Multi Commodity Exchange of India (MCX) was established in November 2003 andtheNationalCommodityandDerivativesExchangeLimited(NCDEX)commencedoperationsin December2003.11 Today, futures trading is permissible in 95 commodities in India. There are 25 recognised futures exchanges with more than 3000 registered members. Trading platforms can be accessed through 20,000 terminals spread over 800 towns/cities. The volume of trade in the exchanges in 200607 wasRs.36.77lakhcrore,97.2percentofwhichisaccountedforbythefournationalexchanges,viz. NationalCommodityandDerivativesExchangeLtd.(NCDEX),Bombay;MultiCommodityExchange (MCX), Bombay; National Multi Commodity Exchange (NMCE), Ahmedabad; and National Board of Trade (NBOT), Indore. The commodity exchanges are regulated by the Forward Markets Commission (FMC), which was established in 1952. In terms of value of trade, agricultural commoditiesconstitutedthelargestcommoditygroupinthefuturesmarkettill200506(55.32per cent).Since200607,bullionandmetalshastakenthisplace.BetweenApril2007andJanuary2008, agriculturefuturesamountedtoRs.7.34lakhcrore,23.22percentofallcommodityfutures.12

BANONFUTURESTRADINGINAGRICULTURALCOMMODITIES
On 5 May, 2008, at the Asian Development Banks annual meeting in Madrid, Finance Minister Palaniappan Chidambaram said, If rightly or wrongly, people perceive that commodity futures tradingiscontributingtospeculationdrivenriseinprices,theninademocracyyouwillhavetoheed that voice, suggesting the imposition of a blanket ban on trading in food futures in India.13 According to Bloomberg reports, Chidambaram said that the Government may suspend some contractsbecauseofpoliticalpressure. Wholesale prices rose 7.57 per cent in the week ended 19 April, 2008 from a year earlier, the Governmentsaidon2May,2008.Accordingtoasurveyof15economistsbyBloomberg,inflation

HistoricalBackgroundofCommodityFuturesinIndia.(2008).RetrievedJune3,2008fromRBG CommoditiesPrivateLimitedwebsite:http://rbgcommodities.com/history.html 12 AbhijitSenCommittee.(2008).ReportoftheExpertCommitteetostudytheimpactoffuturestradingon agriculturalcommodityprices(p.4&5).MinistryofConsumerAffairs,FoodandPublicDistribution, GovernmentofIndia; Numberofcommodityexchangesupdated:Kainth,G.S.(2008,May21).ImpactofFutureTradinginIndian AgricultureArticleSummary.RetrievedJune6,2008fromhttp://www.shvoong.com/socialsciences/1811901 impactfuturetradingindianagriculture/ 13 Chidambaramsproposalonbanningfoodfuturesdrawscriticism(2008,May6).PTI.RetrievedMay26, 2008fromhttp://www.livemint.com/2008/05/06172336/Chidambaram8217sproposalo.html

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CentreforCivilSociety 6 FuturesTradinginAgriculturalCommodities fortheweekended26April,2008was7.66percent.14On7May,2008,theGovernmentannounced abanonfuturestradinginfourcommoditieschickpea,potato,rubberandsoyoil. Indiasagricultureminister,SharadPawar,saidon12May,2008thatthedecisionwastakenbythe regulator of futures trading, the Forward Markets Commission. However, Forward Markets CommissionchairmanB.C.Khatuapubliclyopposedtheban.

STATEDPURPOSEOFTHEBAN
The report submitted on 27 April, 2008 by the Abhijit Sen Committee, a fourmember committee constituted to examine whether futures trading contributed to the unexpected spurt in prices of agricultural commodities, provided no conclusive answer. The committee members felt that the futuresmarketinIndiaisrelativelynascentinexistenceandhence,thereisnosignificantstatistical evidencetoinferonewayoranother.15 AccordingtoSen,memberofthePlanningCommissionandchairmanofthecommittee,Nocausal relationship has been established between futures trading and prevailing prices of essential commodities.16However,anotethatheincludedintheannexureofthereportsubmittedtothe Governmentissaidtohavearguedforcontinuationofthebanonfuturestradinginriceandwheat because the Government is a largescale buyer of such commodities. According to the note, spot marketpricesareobviouslyaffectedbyfuturesmarkets,whichisareasonablysoundconclusion giventhefactthatpricediscoveryisoneoftheprimaryfunctionsoffuturesexchanges.Thenote also said, It is clearly illogical to claim that futures trading will generally tend to improve prices receivedbyfarmersandyetmaintainthatfuturestradingcannevercontributetoinflationofspot prices.Theministerofstateforindustry,AshwaniKumar,saidthatthefreshbanwasintendedto rein in inflation expectations. We want to see if futures trading are really affecting the prices (trading),andsowewillhaveit(theban)onanexperimentalbasis,hesaid.17 The Left parties have been advocating a ban in 25 commodities, and insist that futures trading clearlycontributestopricerises. On12May,2008,theGovernmentsaidithasnoplanstobanmorefarmcommoditiesfromfutures market and hoped suspension of trading in soy oil, chickpea, potato and rubber would not be extendedbeyondfourmonths.18 Chickpeafuturessurged89percentinthepast12monthsonNCDEX,whilerubberrose41percent andsoybeanoiladvanced21percent.19However,therationalebehindbanningtradinginpotatoes

Attackoninflationshouldyieldresultsin8weeks(2008,8May).Mint.RetrievedMay26,2008from http://www.livemint.com/2008/05/22004322/2008/04/28001408/2008/05/08221217/8216Attackon inflationsho.html 15 Willfarmersbenefitfromfuturesmarkets?(2008,June3).Mint.Retrievedfrom http://www.livemint.com/2008/06/03232204/Willfarmersbenefitfromfutu.html 16 Singh,S.(2008,April24).Noevidencetolinkfuturestradingwithrisingfoodprices.Mint.RetrievedMay 27,2008fromhttp://www.livemint.com/2008/04/24003644/Noevidencetolinkfuturestr.html 17 Shastri,P.(2008,May12).AbhijitSensnoteonfuturestradingconvincedgovtonban.Mint.Retrieved May19,2008fromhttp://www.livemint.com/2008/05/12221031/AbhijitSen8217snoteonfu.html 18 Noplanstobanmorefarmgoodsfromfutures:Pawar(2008,May12).PTI.RetrievedMay27,2008from http://www.livemint.com/2008/05/12140732/Noplanstobanmorefarmgood.html

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CentreforCivilSociety 7 FuturesTradinginAgriculturalCommodities has been questioned because the prices had already been declining due to the bumper harvest whenthebanwasimposed.

EFFECTOFTHEBAN
Thefirstandmostobviouseffect,andtheonethatledtosomuchoppositiontotheban,wasthe reductionintradingvolumesforcommodityexchanges.AnalystssuggestedthataboutRs.300400 crore of business would be affected on a daily basis on NCDEX and NMCE alone, the two largest exchanges for trading in agricultural commodities. They added that the ban would dampen investorssentimentsapartfromaffectingtheturnoverandvolumes.20Thetotaltradingvolumefor thefourcommoditiesinthethreenationalexchangeswasvaluedatRs.15000croreamonth,almost 10percentofthetotaltradedvolume(estimatedatRs.164080croreamonth).21 Soyoil,chickpeaandpotatofutureshadbeenshowingadecliningtrend,whilerubberfutureshad been rising for a couple of weeks before the ban due to the rise in crude oil prices. Spot rubber priceshitarecordRs.120on7May,2008,butthebanimmediatelybroughtpricesdownbyRs.4.22 However,thepricesroseagaininJune,despitetheban. Inflation, measured by weekly WPI (Wholesale Price Index) data, has been rising despite all the measures taken by the Government.23 Minister for Commerce and Industry, Mr. Ashwani Kumar told the media on 8 May, 2008 that the measures against inflation will yield results in 68 weeks. Fiveweekshence,inflationratessuggestotherwise,withwholesalepricesrisingby11.05percent fromlastyearinthefirstweekofJune.Thefollowinggraphshowsweeklyinflationdatafor2008, withtheblacklineindicatingthedateonwhichthebanonfuturestradingwasbroughtintoeffect.

Abraham,T.A.(2008,May8).Indiabansrubber,soybeanoilfuturestocoolprices(Update4).Bloomberg. RetrievedJuly2,2008from http://www.bloomberg.com/apps/news?pid=20601087&sid=aW4M0.rLs4zA&refer=home 20 Freshfuturesbantocostboursesupto60percentofbusiness(2008,May8).PTI.RetrievedMay23,2008 fromhttp://www.livemint.com/2008/05/08170542/Freshfuturesbantocostbour.html 21 ForwardMarketCommission.(2008,June6).MarketReview:Fortnightlydisseminationofdatafrom 16.5.08to31.5.08(p.613).MinistryofConsumerAffairs,FoodandPublicDistribution.RetrievedJune20, 2008fromtheForwardMarketCommissionWebsite(http://www.fmc.gov.in/docs/mreview/16.5.08per cent20topercent2031.5.08.pdf) 22 Iyengar,S.P.(2008,May8).CommodityExchangesmayloseRs.600croreaday.BusinessLine.Retrieved June5,2008fromhttp://www.thehindubusinessline.com/2008/05/09/stories/2008050952210100.htm 23 ProvisionalwholesalepricesfromOfficeoftheEconomicAdvisorWebsite.RetrievedJune16,2008from http://eaindustry.nic.in/asp2/list_d.asp?Fcomm_code=1000000000&Fyear1=2008&Fopt_wmy=W
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CentreforCivilSociety 8 FuturesTradinginAgriculturalCommodities

ProvisionalwholesalepricesfromOfficeoftheEconomicAdvisorWebsite(Baseyear:199394)

Thefollowinggraphsshowthespotpricesforrubber(Kochi),chickpea(Bikaner),potato(Agra)and soyoil(Indore)from1April,2008to10June,2008. Ofthefourbannedcommodities,onlythepricesofpotatoeshavedecreasedsteadilysincetheban. However,sincepricesweredecliningevenbeforetheban,expertshavearguedthatthedecreasein pricesisduetothebumpercrop,andnotthebanontrading.

Spotpricesfromwww.mcxindia.com

In the case of chickpeas, the prices havent moved consistently in a particular direction. They declinedimmediatelyafterthebanbutbeganrisingagaininJune.Theyarenowhigherthanthey wereinJanuary2008andlowerthantheywereinApril2008.Chickpeaoutputhasincreasedover thepastmonth.

CentreforCivilSociety 9 FuturesTradinginAgriculturalCommodities

Spotpricesfromwww.mcxindia.com(Pricesper100kgs)

Rubberandrefinedsoyoilhaveshownapproximately31percentand11percentincreasesinprice respectively since the ban was imposed.24 The two commodities show a high degree of positive correlationwith crudeoilprices:a risein crude oil prices leadstoa shift from syntheticrubber (a petroleum product) to natural rubber, hence pushing rubber prices up; and there is a shift in demandfromcrudeoiltobiofuel,whichisproducedusingedibleoils.

SpotpricesinMay 2008 for rubber (per100kgs,Kochi),refinedsoy oil (per10kgs, Indore) andcrudeoil(Mumbai, per barrel)fromwww.ncdex.com

24

PricePoliticking(2008,June9).FinancialExpress.Retrievedfrom http://www.financialexpress.com/news/Pricepoliticking/320238/

CentreforCivilSociety 10 FuturesTradinginAgriculturalCommodities

ARGUMENTS
Therehavebeentwomainviewpointsexpressedinthemedia. Oneviewpointisthatthebanisantifarmerandnotantiinflation.Itisbelievedthatthemovewas purelypolitical,andthatfuturespricesdontcontributetoinflation.Proponentsofthisviewargue thatthefuturesmarketprovidesfarmersanopportunitytohedgerisksandreceivesignalsaboutthe future movements of prices. Futures contracts also help farmers avoid storage costs and the interestchargesforstoringtheproducttillthesaleismade.25However,accordingtoMr.P.K.Joshi, Director of the National Centre for Agricultural Economics and Policy Research (NCAP), It [the futuresban]hasnotmadeanyimpactonsmallandmarginalfarmers(>80percent)whohavelittle marketable surplus. It might have made some impact on traders dealing in bulk quantities. (Personalcommunication,16June,2008)AccordingtoDr.AbhijitSen,Mostofthem[thefarmers], especially the small ones, are geographically or physically far away from the market. There is a strongmarketinedibleoils,buttheyaremostlyfirms.26 Some sections of the media also argued that the ban will lead to a shift in business to overseas markets and an increase indabba (illegal) trading. However,FMC Chairman B.C.Khatua saidthat therewontbealargescalemovementtooverseasexchangesbecausemostoftheparticipantsin thefuturesmarketsareretailinvestors,butthebanmaycausethemarkettocollapselikeitdidin thecaseofjute.Healsosaidthatitwasnotrealistictoexpectlargescaleparticipationoffarmersin India futures markets when even USA and Canada havent achieved it. He argued that the suspensionofcommoditytradingpreventsregulationfromimproving.27 Theotherpointofviewisthatfuturestradingmerelyleadstounnecessaryspeculation,andpushes the prices up. Suneet Chopra, Joint Secretary of AIAWU (CPIMs All India Agricultural Workers Union) asserted that traders and hoarders buy out the products cheaply through future contracts and raise the prices artificially by creating false scarcity. He cites the example of global crude oil prices,whereaUSSenatePanelinquiryconcludedthathedgefundshadcontributedtothespurtin crude prices.28 However, in the absence of speculators, pricerisk would not be transferable and pricediscoverywouldnotbepossible,hencedefeatingthepurposeoffuturesmarkets.

INFLATION
Inflation is a significant and sustained increase in the price level of an economy. Generally, an inflationrateof35percentisconsideredhealthyforadevelopingeconomy.InIndia,inflationis calculated according to the wholesale price index on a weekly basis. Provisional WPI data is announced every Friday with a twoweek lag. Final data is announced after an eightweek lag.

Joshi,S.(2008,May21).Banonfuturestrading:antifarmernotantiinflation.BusinessLine.Retrievedfrom http://www.thehindubusinessline.com/2008/05/21/stories/2008052150360800.htm 26 Shastri,P.(2008,April19).Rice,wheatcanbeaproblem:Sen.Mint.RetrievedMay15,2008from http://www.livemint.com/2008/04/18235814/RicewheatcanbeproblemSe.html?d=1 27 Singh,S.(2008,June8).TheCommodityMarketisgettinghitfromallSides.Mint.Retrievedfrom http://www.livemint.com/2008/05/22004322/8216Thecommoditymarketis.html 28 Chopra,S.(2008,May14).Didagrifutureshaveaprematurestart?.TheEconomicTimes.Retrievedfrom http://economictimes.indiatimes.com/Opinion/Debate/Did_agri_futures_have_a_premature_start/articlesho w/3037768.cms

25

CentreforCivilSociety 11 FuturesTradinginAgriculturalCommodities Weightsofthecommoditiesarederivedonthebasisofthevolumeofthecommoditytradedinthe domesticmarket. While Consumer Price Indices (CPIAL: Consumer Price Index for Agricultural Labourers, CPIRL: Consumer Price Index for Rural Labourers, CPIIW Consumer Price Index for Industrial Workers, CPIUNME:ConsumerPriceIndexforUrbanNonManualEmployees)mayalsobeusedtomeasure inflation, but the WPI is the RBIs preferred tool of measurement. Inflation rates as per CPI estimatesareusuallyhigherthantheWPI.CPIsarecompiledonthebasisofthegeneralstandards andguidelinessetbytheInternationalLabourOrganisation(ILO).29

*Monthlyaverages;DatafromtheEconomicSurveyofIndia200708(p.60)

The use of the WPI as a measure of inflation has been questioned by many experts. It has been argued that the WPI is not representative enough and is inaccurate. Official figures often underestimate inflation due to price controls and lack of data. Delays in data collection lead to significantdifferencesintheprovisionalandfinalinflationfigures.30Forinstance,thefinalinflation figureforMarch2008was6.21percent,morethanonepercentagepointhigherthantheoriginal estimateof5.11percent. Currently,theWPIhas435items.AccordingtoaresearchpaperbyV.ShunmugamandD.G.Prasad, 100 of the 435 commodities have ceased to be important from the consumption point of view. Thesecommoditiesincludecoarsegrainsthatareusedformakinglivestockfeed.31TheAbhijitSen CommitteehasbeenupdatingthebaseyearoftheWPIfrom199394to200405,andexpandingthe
EconomicSurveyofIndia(200708).PricesandMonetaryManagement(p.6070).MinistryofFinance, GovernmentofIndia.RetrievedMay282008fromhttp://indiabudget.nic.in/es200708/chapt2008/chap42.pdf 30 Anoldenemyrearsitshead(2008,May22).TheEconomist.Retrievedfrom http://www.economist.com/finance/displaystory.cfm?story_id=11402856 31 Gapingholesincomputinginflation:Experts(2007,June6).PTI.RetrievedonMay25,2008from http://www.livemint.com/2007/06/06134833/Gapingholesincomputinginfl.html
29

CentreforCivilSociety 12 FuturesTradinginAgriculturalCommodities indextoinclude1200items.Ithasbeensuggestedthatinflationshouldbemeasuredbyamonthly allcommodity index since weekly data is only available for primary commodities but is difficult to obtaininthecaseofthemanufacturingsector.AmorerepresentativeWPI,whichtheGovernment has been working on for almost two years, will be introduced in October 2008.32 Currently, all agriculturalcommodities(includingprocesseditems)accountfor25.397percentoftheWPI.33

WholesalepriceindexfromOfficeoftheEconomicAdvisorWebsite(Baseyear:199394)

InNovember2007,headlineinflationincreasedintheUS,theEU,JapanandChina.Highfoodprices have pushed up inflation in many emerging market economies (EMEs), while high oil prices are aggravating inflation directly as well as indirectly by causing an increase in the demand for oil substitutes,whichleadstoanincreaseinfoodprices. In India, yearonyear weekly inflation breached the 6 per cent mark on 6 January, 2007, and remainedabove6percentuntilApril2007.Itwaswellbelow5percentfrom6September,2007to 9February,2008.WiththreatsofarecessionintheUS,risingcrudepricesandaglobalfoodcrisis, inflationcrossed7percentinthesecondweekofMarch2008,wasover8percentinthelatterhalf ofMay2008beforehitting11.05percentinthefirstweekofJune. InMarch,therupeehit42.66againstthedollarduetoinflationworries.TheIndianrupeefellby7 per cent against the US dollar between January and May 2008.34 Rising inflation has also had an adverse impact on the stock markets, with the Sensex (the Bombay Stock Exchanges Sensitive Index)fallingbelowthe14000levelon24June,2008.35 Theincreasingrateofinflationhasalsoaggravatedtheimpactofthefoodcrisis.
Shastri,P.(2008,May16).New,speedyversionofWPIstillmonthsaway.Mint(p.1&3) AbhijitSenCommittee.(2008).ReportoftheExpertCommitteetostudytheimpactoffuturestradingon agriculturalcommodityprices(p.10).MinistryofConsumerAffairs,FoodandPublicDistribution,Government ofIndia 34 Shastri,P.(2008,May17).Inflationrefusestobetamed,risesto7.83percent.Mint(p.1&3) 35 Staney,N.(2008,June25).Sensexsettosinkbelow13000soon.Mint(p.1)
33 32

CentreforCivilSociety 13 FuturesTradinginAgriculturalCommodities Despite the glum picture painted by these figures, a report by the Organisation for Economic Development and Cooperation (OECD) said that India had managed food inflation better than fourteen other developing nations, though food inflation in India is higher than that of developed nations.Pricesoffoodarticlesrose5.8percentinIndiafortheperiodFebruary200708.Experts saidthatrecordfoodgrainproductionestimatesof227.32milliontonsduring200708,anincrease of10.04milliontonsfromthepreviousyear,helpedkeepinflationundercontrol.Accordingtothe report,recentyieldshocksinpulsesandoilseedshavecontributedtotheincreaseinfoodprices.36

CAUSESOFINFLATION
Rising inflation has been attributed tothe increase in global oil and food prices due to temporary supply shocks. Although the Indian economy has largely been shielded from the fuel price rise throughGovernmentsubsidies,the56percentincreaseintheaveragepriceoffoodinthelast12 months has contributed significantly to inflation. In fact, global food prices have been rising for threeyears.37 Ithasalsobeenarguedthatincreasingfoodpricesarearesultofamoneyfuelledcyclicalboomdue toloosemonetaryconditionsinemergingeconomies,whichhasboosteddomesticdemand.Tighter monetary conditions would have caused rising food prices to be offset by declines elsewhere, keeping inflation under control.38 With inflation at 11.42 per cent and the prime lending rate at 12.75percent13.25percent,39therealinterestratesareextremelylow. Rising iron and steel and cement prices have also played a significant role in contributing to WPI inflation. The component for iron and steel shot up from 287.4 on 1 March, 2008 to 344.1 on 8 March, 2008. The weakening dollar has caused investors to shift to oil, metals and agricultural commodities.40 The rise in steel prices has been attributed to increased demand and lack of investment.Theglobaldemandforsteelhasrisensignificantlywithalargenumberofinfrastructure projectslikebridgesandhousesunderwayinIndiaandChina,andahigherdemandforautomobiles andappliancesinthetwoeconomies.Theinvestmentsinnewsteelplantsinthepastdecadehave beenratherlow,whichhascausedthepriceofhotrolledsteelsheettoriseby$170intheUS(from $850atonneinAprilto$1020inMay).Highpricesforironoreandenergyhavecausedanincrease inthepriceofmakingandtransportingsteel.Lowerimportshavecausedashortageofthemetalin theUS,andhaveledtoanincreaseinprices.41 The reasons cited for rising food prices include the diversion of land to biofuel production; the droughtinAustraliaandUkraine;andtherapideconomicexpansioninIndiaandChina,whichstrains globalfoodmarketsthroughincreasedimportsandexportbans.InanarticleintheNewYorkTimes,
Indiasfoodinflationlowestamong15nations(2008,May30).TheFinancialExpress.Retrievedfrom http://www.financialexpress.com/news/Indiasfoodinflationlowestamong15nations/316629/ 37 Basu,K.(2008,June7).Allhandsonthedeck.TheHindustanTimes.Retrievedfrom http://www.hindustantimes.com/StoryPage/StoryPage.aspx?id=74d17ad50bc849348820 74054c8acd42&&Headline=All+hands+on+the+deck 38 Anoldenemyrearsitshead(2008,May22).TheEconomist.Retrievedfrom http://www.economist.com/finance/displaystory.cfm?story_id=11402856 39 Lending/DepositRates.ReserveBankofIndiaWebsite.RetrievedJuly2,2008from http://rbi.org.in/home.aspx 40 Shastri,P.(2008,May17).Inflationrefusestobetamed,risesto7.83percent.Mint(p.3) 41 BaileyS.&CroftsD.(2008,June26).Arcelorchiefseesglobalsteelshortageasdemandincreases.Mint(p.8)
36

CentreforCivilSociety 14 FuturesTradinginAgriculturalCommodities Dr.AmartyaSensuggestedthattheglobalfoodproblemisnotbeingcausedbyadecreaseinworld productionorbylowerfoodoutputperperson,butbyacceleratingdemand.42Hoardingbyfarmers andmiddlemenhasalsoledtotheescalationofprices. The hugely subsidised US and EU policy of replacing petroleum with biofuel to cut pollution has been widely criticised, since biofuel is more expensive then petroleum in real terms, and bio ethanol only yields about 10 per cent more energy than the amount required to produce it, accordingtoBritishGovernmentfigures.43Theprevailingfoodcrisismaybeaconsequenceofthis policy,sincetheproductionofbiofuelinvolvestheuseofagriculturalcropslikecornandsoybean. The increase in crude oil prices has also pushed fertiliser prices up, especially nitrogen fertilisers, becausenaturalgasisakeycomponentintheirproduction.Thishasfurtheraggravatedthefood crisis. Certainsectionsofthemediaarguedthatthefoodcrisisisanoutcomeofanincessantpushtowards the Green Revolution agricultural model and the trade liberalization policies advocated by the World Bank, the World Trade Organization and the International Monetary Fund. Forcing developingcountriestodismantletariffsandopentheirmarketstoglobalagribusiness,speculators andsubsidizedfoodexportsfromrichcountrieshaveledtothediversionoflandfortheproduction ofglobalcommoditiesoroffseasoncropsfordevelopedmarkets.Alongwithstructuraladjustment policiesandanumberofbilateralfreetradeagreements,thesemeasureshaveledtothecollapseof the system that developing economies had created to protect local agricultural production.44 However,expertshavearguedthat the boom that India has seen since 1993 is largely because of the open and marketoriented policies started in 1991. It may be true that by keeping the economyclosed,wewouldhavefewercrises.Buttoliveinperpetualpovertyto avoid occasional poverty (since the word crisis applies to the latter) would be foolishstrategy.45 It has also been suggested that the Governments expansionary fiscal policy: the pay hike to the bureaucracy,thefarmloanwaiverandincometaxcuts,duringaperiodofhighinflationarypressure hasstokedinflationandcreatedahugefiscaldeficit.46 However,globalfoodpriceshavedeclinedoverMay2008.Wheatistradingataninemonthlowin internationalmarkets,andricehasbecomecheaperaftertheJapaneseGovernmentreleasedsome ofitsfoodstock(mostofwhichithadimportedfromtheUS)intotheglobalmarket.Accordingto

Sen,A.(2008,May29).Beyondtheusualexplanations.Mint(p.23) Bentil,K.(2008,June6).TwelveStepProgramtoPoverty.TheDailyTimes(Malawi).Retrievedfrom http://www.policynetwork.net/main/article.php?article_id=919 44 Makingakillingfromthefoodcrisis(April2008).GRAIN.RetrievedonJune3,2008from http://www.grain.org/articles/?id39 45 Basu,K.(2008,June7).Allhandsonthedeck.TheHindustanTimes.Retrievedfrom http://www.hindustantimes.com/StoryPage/StoryPage.aspx?id=74d17ad50bc849348820 74054c8acd42&&Headline=All+hands+on+the+deck 46 Rajadhaksha,N.(2008,June25).RevolvingDoorisJammed.Mint(p.22)

43 42

CentreforCivilSociety 15 FuturesTradinginAgriculturalCommodities the CGD (Centre for Global Development an American think tank) blog, Indias rice and wheat cropsmayincreasebyover10milliontonsfromlastyear.47

NEEDFORTHEBAN
An analysis of spot and futures prices of the four banned commodities shows a high degree of positive correlation between the prices. A cause and effect relationship, however, is difficult to establish.Theblacklineindicatesthedateonwhichthebanwasbroughtintoeffect.Thecharts showthatthebanhasntbeeneffectiveinreininginthepricesofthefourcommodities.Analysisof preandpostfuturesdatabytheAbhijitSenCommitteedidnotindicateaclearincreaseordecrease in the volatility of spot prices due to futures trading. The report categorically stated that futures tradingcantbeheldresponsiblefortheincreaseinspotpricesbecausetheevidencewas,atbest, ambiguous.48 The high level of correlation between the spot and futures markets is due to the presence of arbitrageurs, who ensure that the two markets move in the same direction by exploiting any discrepancyinthepricesofthetwomarketstotheiradvantage.However,itisntpossibletofind outthenumberofhedgers,speculatorsandarbitrageursparticipatinginthemarket.

Rajadhyaksha,N.(2008,June3).Foodandeconomics101.Mint.Retrievedfrom http://www.livemint.com/2008/06/03222114/Foodandeconomics101.html 48 CommentsonDraftReportofECCFT(AbhijitSenCommittee).Retrievedfrom http://www.livemint.com/2008/05/22004322/2008/04/28001408/2008/04/29235240/603156D2686A4A5C A11A359A81BBF41DArtVPF.pdf

47

CentreforCivilSociety 16 FuturesTradinginAgriculturalCommodities

*Datainmonthlyaverages;Source:www.mcxindia.com

CentreforCivilSociety 17 FuturesTradinginAgriculturalCommodities Most attempts to establish causeeffect relationships between the futures and spot prices have beeninconclusivebecauseparticipationinthefuturesmarketsisnttotal.Pricedeterminationinthe spotmarketisbaseddemandandsupply,andtheawarenessaboutfuturemarketsislow.Fieldtrips to sabzi mandis (vegetable markets) showed a severe lack of basic facilities like storage, which forcesthemtosellleftovergoodsataloss.Often,theirproducegetswasted.Thefreezernextto Azadpur mandi, which is Asias largest vegetable market, is only used for storing icecream and importedgoodsbecausethevendorscantaffordtostoretheirproducethere.Apartofthegoods getspoiltwhentheyaretransportedfromthefarmtothemandi.Mostfarmersdonthaveaccess warehousingfacilitieseither.Whilethefuturesmarketshavedevelopedsteadily,thespotmarkets arestilllargelyunorganised. Sincefuturesmarketsperformthefunctionofpricediscovery,itwouldbeinappropriatetosaythat futurespriceshavenobearingwhatsoeveronthespotprices.However,establishingtowhatextent onemarketisdependentontheotheris far moreimportant.Futurespricesarenotindependent variables.Speculationhasabasis.Ifaspeculatorbelievesthatthepriceofacertaincommoditywill riseinthefuture,itisduetocertainconditionsprevailingintheeconomy.Speculationmaymagnify therateofincreaseinprices,butitisntpossibleforspeculationalonetopushpricesup.Unhealthy speculation is said to be driving prices up, but when farmer participation in the future markets is low,thereisessentiallyadisconnectbetweenthetwomarkets. The total contribution of the four banned commodities to the WPI is approximately 0.8 per cent (potato: 0.256470 per cent, soy oil: 0.178380 per cent, rubber: 0.150800 per cent, chickpea: 0.223650percent).49Infact,shareoffoodarticlesintheWPIhassteadilydecreasedoverthelast fewdecades.Eveniffuturestradinghadbeencontributingtowardsinflation,theimpactontheWPI wouldnthavebeenverysignificant.Infact,primaryarticlesconstituteonly22.03percentofthe WPI(199394),andtheweightassignedtofoodarticleshasdeclinedconsiderably.50Sowhydidthe Governmentimposetheban?

49

AbhijitSenCommittee.(2008).Table2B:AnnualisedTrendGrowthRateandVolatilityofWPIofSelected AgriculturalCommoditiesinwhichFuturesaretraded.ReportoftheExpertCommitteetostudytheimpactof futurestradingonagriculturalcommodityprices(p.10).MinistryofConsumerAffairs,FoodandPublic Distribution,GovernmentofIndia 50 OfficeoftheEconomicAdvisor.HandbookofIndustrialPolicyandStatistics:TimeSeriesTables(p.69). MinistryofCommerceandIndustry,GovernmentofIndia.RetrievedJune25,2008from http://eaindustry.nic.in/new_handout.htm

CentreforCivilSociety 18 FuturesTradinginAgriculturalCommodities

WP IWeig hts
Manufac tured A rtic les Indus trialR aw Materials F .P .,L ight& L ubric ants L iquor& Tobac c o F oodA rtic les 0 10 20 30 40 50 60 198182 197071 196162 195253

Source:OfficeoftheEconomicAdvisory,MinistryofCommerceandIndustry

The motive behind the ban may have been purely political: an attempt to appease the voters, perhaps, in the run up to the elections. It may also have been an attempt to affect the market sentimentinordertocurbinflationaryexpectations.Eitherway,foodpricescontinuetostayhighin Indiadespitetheban.

EFFECTOFTHEPREVIOUSBAN
InJanuary2007,theGovernmentbannedfuturestradinginwheat,rice,turanduradinanattempt tocontrolinflation.Theincreasinginflationrateswereattributedtogreaterpricevolatilitydueto futurestrading.However,the12foodgrainsincludedintheWPIbasketonlyhaveaweightof5.01 percent.Ofthe12items,rice(2.449070)andwheat(1.384080)havethehighestweights.51 Thebanwasheldresponsibleforthereductionintradevolumesofthefutureexchangesbymany sectionsofthemedia.However,sincethesefourcommoditiesonlyconstituted6.65percentofthe total agriculture futures traded in 20060752, the Abhijit Sen Committee concluded that the ban probably had an adverse effect on market sentiments, rather than directly contributing to the declineinfuturetrade. Thefollowingchartshowsthatinflationrosedespitetheban,anddecreasedlaterintheyearwhen theRBIhikedinterestrates.However,Dr.Senfeltthebanshouldnotberevokedforcommodities like wheat and rice due to the significant role that the Government plays in the market for these commodities.Hefeltfuturesmarketscantworkforcommoditieswhereeventhespotmarketis highly controlled. In an interview with Mint, he said, The fundamental problem with futures
AbhijitSenCommittee.(2008).ReportoftheExpertCommitteetostudytheimpactoffuturestradingon agriculturalcommodityprices(p.6&10).MinistryofConsumerAffairs,FoodandPublicDistribution, GovernmentofIndia 52 AbhijitSenCommittee.(2008).ReportoftheExpertCommitteetostudytheimpactoffuturestradingon agriculturalcommodityprices(p.5).MinistryofConsumerAffairs,FoodandPublicDistribution,Government ofIndia
51

CentreforCivilSociety 19 FuturesTradinginAgriculturalCommodities tradinginfoodgrainsisthatthehugedifferencebetweenglobalpricesandIndianpriceswillalways reflectonandcontributetotheinstabilityinlocalprices.53

WholesalepriceindexfromOfficeoftheEconomicAdvisorWebsite(Baseyear:199394)

Shastri,P.(2008,April19).Rice,wheatcanbeaproblem:Sen.Mint.RetrievedonJune9,2008from http://www.livemint.com/Articles/2008/04/18235814/RicewheatcanbeproblemSe.html
53

CentreforCivilSociety 20 FuturesTradinginAgriculturalCommodities

POLICYSUGGESTIONS
Spotpricesandfuturespricesareinterdependent.Whilethefuturesmarketprovidesindicationsto the spot markets on the direction in which prices will move in the future, the futures prices are determinedonthebasisoftheconditionsinthespotmarkets.Speculationmaydrivepricesfurther up,butaspeculatorexpectspricestoriseduetothemarketconditions,anddoesntarbitrarilybet onapricerise. Althoughfuturesmarketsmayinfluencespotprices,banningthemwillonlycausespeculationand will take on a new form dabba trading, which cant be regulated, although the number of participantswillprobablybelowerduetohigherrisks. Banning futures is not a logical solution to rising prices. It obstructs the development of a mechanismtoregulatethemarketsanddiscourageunhealthyspeculation.Futuresmarketsshould bedevelopedalongwithspotmarketsandintegratedeffectivelytobringaboutgreaterparticipation from the producers and consumers of the underlying assets. One may argue that the market mechanismtakestimetocomeintoeffectandthatthisisntaneffectivesolutionintheshortrun. However, commodity prices show that banning futures hasnt been a viable shortrun solution either. Oneofthepolicysolutionsthathavebeensuggestedisusingthemonetarypolicytocurbinflation. InIndia,realinterestratesarelowerin2008thantheywerein2007.TheRBIincreasedtherepo rate (the rate at which the Reserve Bank lends to other banks) twice since January 2008. The Federal Reserves interest rate cuts following the subprime crisis in the US pose a hurdle to tightening the monetary policy: higher rates will attract more capital flows, hence defeating the purposeofanincreaseininterestrates.On24June,2008theRBIraisedthekeylendingrateand thecashreserveratio(CRR)by50basispointseachto8.5percentand8.75percentrespectively.54 Inthefollowingweek,SBI,UnionBank,IndusIndandCentralBankhikedtheirprimelendingrate.By thefirstweekofJuly,thefourpublicsectorbanksBankofIndia,DenaBank,AllahabadBankand VijayaBankandICICIandHDFChadalsoannouncedanincreaseintheirlendingrates.Butwith bankdepositratesat9.5percentandyearonyearinflationat11.42percent,realinterestratesare negative.55 Anothersolutionistorevaluethecurrency.Expertshavewarnedthattryingtoescapeinflationas wellasanincreaseinrealexchangeratesisnotpossible.However,revaluingthecurrencymaylead to greater investment by fuelling expectations of further currency appreciation. Overvaluing the currencywillleadtoacurrentaccountdeficit. Joachim von Braun, Director General, International Food Policy Research Institute (IFPRI) asked governmentstoadoptemergencymeasuressuchashigherfoodaidtothepoorest,abolitionofbio fuel subsidies and export bans, and support to small farmers.56 While this would take care of immediatefoodsecurityandkeepfoodpricesundercontrolinthelongrunitwillcontinuetobea challenge.
54 55

Roy,A.&BhoirA.(2008,June25).RBIraiseskeyrate,reserverequirement.Mint(p.1) Bhoir,A.&Roy,A.(2008,July7).Interestratesonsavingsaccountslikelytorise.Mint(p.1) 56 Shastri,P.(2008,May17).Inflationrefusestobetamed,risesto7.83percent.Mint(p.3)

CentreforCivilSociety 21 FuturesTradinginAgriculturalCommodities AccordingtoareportinTheGuardian,aWorldBankstudyrevealedthatbiofuelshadcausedglobal foodpricestoriseby75percent.Usingplantderivedfuelsduringafoodcrisisthathaspushed100 millionpeoplebelowthepovertylineworldwidewillonlyaggravatethesituationfurther.57 In India, the oil price subsidies are not sustainable in the long run because they keep demand artificiallyhighandcauseahugefiscalburden.Iftheeffectoftheoilpricerisesispassedontothe economy,inflationwillrisefurther,aswillfoodpricesduetohighertransportationcosts. The recent spurt in food prices is believed to be the result of temporary supply shocks. They are expectedtoeaselaterthisyearbecausehigherpricesarelikelytopromptanincreaseinsupply.In theshortrun,subsidisedfoodforthepoorisessential.Inthelongrun,theGovernmentmustinvest more in agriculture to provide better infrastructure rather than implementing misguided schemes like the farm loan waiver. Waste minimization through proper warehousing is the first and most logicalstep. Thebanonfuturestradingmaynothaveaffectedthefarmersmuch,sinceonlyaverysmallnumber directly participate in the futures market. But the ban didnt control inflation either. Greater integration of the spot and future markets by encouraging higher participation by the farmers is necessary,sothatthefuturesmarketsperformthefunctionofpricediscoverymoreeffectively,and theintendedbeneficiariesareabletousethemarkettohedgerisks.Intheabsenceofintegration, thedebateaboutthebanonfuturestradingbecomesirrelevant.

Chakrabortty,A.(2008,July4).Secretreport:biofuelcausedfoodcrisis.TheGuardian.Retrievedfrom http://www.guardian.co.uk/environment/2008/jul/03/biofuels.renewableenergy
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CentreforCivilSociety 22 FuturesTradinginAgriculturalCommodities

ACKNOWLEDGEMENTS
IdliketothankmyguideVarunKhandelwalforhisinputs.IdalsoliketothankmyfriendHimanshu KapoorforhissupportandMr.P.K.Joshiforhisguidance. Lastbutnottheleast,IthankeveryoneatCCS.

CentreforCivilSociety 23 FuturesTradinginAgriculturalCommodities

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