Does a ban on commodities futures trading help govt solve inflation woes?

Ahead of the kharif harvest, several industry associations, particularly those working in the field of edible oils and oilseeds value chain have urged the government to restart futures trading that has been suspended for almost eleven months now.

The argument given by the associations and other stakeholders is that absence of a well-functioning futures market has denied them the chance to hedge their risks despite sharp fluctuations in the international markets.

The associations said in the past few months, global edible oil markets have fluctuated by 10-12 per cent in a day. However, it has been seen that whenever international edible oil markets moved up sharply it was not passed on to domestic consumers as futures acted as a buffer.

“The government banned mustard futures somewhere around December 2021 and till May 2022. Since there wasn’t any pullback in open market prices of edible oils, it proves that futures markets provide stability to domestic prices and contrary to belief help in curbing speculative activity,” they added.

The Central Organisation for Oil Industry and Trade (COOIT), the Mustard Oil Producers Association (MOPA) and also the Solvent Extractors Association (SEA) all three in separate letters to various authorities said that futures markets all over the world are allowed to function smoothly in adverse conditions.

“India is ‘price taker’ in the edible oil market and not ‘price maker’ and hence banning edible oil futures does not have any impact on spot prices,” the associations said.

The bodies said that at present farmers and other players in the value chain are sitting on 8-8.5 million tonnes of oilseeds stocks, while the next kharif crop is expected to be around 13 million tonnes of major oilseeds. And if rabi also turns out to be good then India should be looking at oilseeds supplies of around 35 million tonnes by March 2023.

“Opening the futures markets will ensure that farmers get a good price for their produce,” the bodies added.

The demand has also found widespread support from several sections of the intelligentsia and others.

No link between futures ban and prices

A recent study of two commodities for which futures trading has been banned done on behalf of the NCDEX Investor Protection Fund found that there was no evidence that derivatives trading led to higher prices or suspension of their futures had any impact on bringing down the price volatility.

The study was done on mustard and chana by Prof Nidhi Agarwal from IIM-Udaipur, Tirtha Chatterjee of Jindal School of Government and Public Policy and Karan Sehgal, a research scholar.

It found that price movement in commodities with no futures is uncontrolled and likely to be more volatile than commodities that have a footprint in the derivatives segment as they are bound by position limits, margin requirements and daily price limits.

“The analysis showed that mustard oil prices would have had a similar trend even without suspension,” the study showed.

Rather, the study found that before the suspension of the futures market, it had a dominant share of 64 per cent in uncovering the true price of mustard seed. “This role ceased because of the ban,” it added.

A similar finding was also for chana.

Both mustard oil and chana were suspended from futures trade on August 16 and October 2021, which was later extended for one year starting from December 20, 2021.

Since the commencement of derivatives trading in agriculture commodities, the futures have been banned multiple times on one pretext or the other, the most common being impact on inflation.

Though there have been numerous committees and panels constituted in the past which have found no linkages between price rise and futures markets, successive governments have always found commodity futures as being the easiest scapegoat to blame for rising inflation.

Banned at the drop of the hat

Data shows that in the 15 years, commodities futures in different items have been suspended multiple times, some of which have not been revoked to date.

In some commodities like common rice, tur and urad, the futures have not been revoked ever since their banning in 2007.

Data shows that futures contracts for one or more commodities get suspended for a period ranging from a few months to one year. This has been happening almost every year since 2007.

More recently, between August 2021 and December 2021, the market regulator suspended futures trading in chana, mustard seed, soybean, refined soy oil, Crude Palm Oil, moong, wheat and paddy (non-basmati).

The latest round of bans seems to have hit NCDEX the hardest, where these commodities were traded the most.

According to a report by NCDEX, the aforementioned commodities contributed almost 54 per cent of the total deposits in the exchange between April 2021 and July 2021 (before the suspension of the commodities), with chana being the highest with 40 per cent of the total deposits.

In terms of delivery also, the suspended commodities contributed around 55 per cent of the total deliveries from the exchange platform, with chana again being the highest at 29 per cent.

Because of the suspension, the quarterly average daily volume of the exchange has fallen from Rs 2,310 crore in FY22 to Rs 960 crore in FY3, which is a fall of nearly 58 per cent, the report said.

Past Panels

Ironically, futures trading in commodities has been banned at the drop of a hat despite numerous past committees and panels finding no direct linkage between such trading and price rise.

In 2008, a high-powered panel constituted under the chairmanship of the Planning Commission member Abhijit Sen did not find any clear evidence of either increased or reduced volatility of spot prices due to futures trading.

Thereafter, a Parliamentary Standing Committee on Food, Consumer Affairs and Public Distribution (2011) said that futures trading does not impact the prices of agricultural commodities. It said that ideally there should be a convergence between spot and futures markets under a uniform regulatory framework for the optimization benefits of these reforms.

A Reserve Bank of India (RBI) study of futures markets (2009-10) since the start of such trading in India concluded that commodity prices in India are influenced more by other drivers such as demand-supply gap, degree of dependence on imports and international price movements.

There have been other reports and studies too that have found little evidence of futures trading pushing up or driving down commodity prices.

Regarding complaints about the low participation of farmers in these exchanges, reports show that of late, several farmers have become part of the futures derivatives markets through the Farmer-Producer Organizations (FPOs).

In NCDEX alone, since 2016, reports show that around 440 FPOs representing around one million farmers have been on-boarded.

Out of these 440 FPOs, 155 representing over 430,000 farmers have successfully used the exchange platform to hedge the price risk for over 100,000 tonnes (valued at close to Rs 488 crore) in 18 commodities till July 2022.

Why ban?

So why these markets are always viewed with suspicion and scepticism by policymakers when it comes to controlling inflation or price rise in agriculture commodities?

That too when such markets have come under the direct regulatory oversight of the stock market regulator Securities and Exchange Board of India (SEBI) in the last few years, which has greater credibility than the previous Forwards Market Commission (FMC).

“Futures markets are essential for better price discovery and liquidity into the commodity trade and can be great tools to hedge risks, but in practice, they are still underdeveloped in India as compared to their western counterparts. Also, there are still big questions as to how many and how much small farmers benefited from these platforms,” Dr S Mahendra Dev, Director of Mumbai-based Indira Gandhi Institute of Development Research (IGIDR) told Business Standard.

He said the supporting infrastructure to further help futures markets to grow like warehouses receipts, testing labs etc are not up to the mark and not fully developed yet.

Also, with regards to farmers actually participating through FPO; their number is still far less than the actual number of FPOs operational in the country.

“Unless all these things are developed and made up to the mark, policymakers and the government will continue to view commodity futures as being a speculators paradise and club of few select people,” Dev said.