What commodity markets need

The commodity futures markets has seen volumes and trades decline in 2012-13. After the imposition of CTT, volumes can rise only if derivative profits and losses will be allowed to be set off against business income and if banks and financial institu

The decade-old commodity futures market is set to end this financial year with it worst-ever performance in terms of growth in volumes and number of trades. Till March 6, this financial year, daily average volumes on five commodity bourses taken together fell 4 per cent while total annual volumes were 5.8 per cent lower compared to the 50 per cent growth in the last three years.

One reason for this could be that commodity prices have been on a decline. The number of trades were lower by 7 per cent against last year’s growth of 70 per cent and little less than average 50 per cent growth in the last three years.

This fall in volumes and numbers of trade has happened for the first time since online nationwide commodity exchanges started trading in late 2003-04.

In 2007-08 when most commodities, especially crude oil and metals were at their peak, Indian futures market grew only by 8 per cent in volumes and 2 per cent in trades. However, in 2008-09 - the year of global financial crisis - volumes were growing 34 per cent while the number of trades was higher by 49 per cent.

In this perspective, this fall in volumes and trades this year is worrisome.

Market regulator Forward Markets Commission (FMC) has maintained a tight hold over agri futures to curb slightest possibility of speculation. However, the fall in volumes is more because of lower trades in non agri commodities, especially in bullion which constitute 60 per cent share. Except bullion, all segments have seen volumes gain in 2012-13 so far but due to lower bullion volumes resulted in overall fall in volumes. For brokers who had started relying on commodities as their major source of income as equity volumes fell find themselves in a spot once again.

The decline in volume has happened even without the Commodity Transaction Tax (CTT), which will only be implemented after the budget is passed by the parliament. With the introduction of CTT, more trades will move out of the official market and there could be a reduction in trading activities on the bourses. Nearly 400,000 trading terminals and over a million persons are directly getting their bread and butter from this business.

What does this market want?
For further growth, the market needs more players, more tools and depth. This can only happen when the bill seeking to amend the Forward Contract Regulation Act (FCRA) is passed by the parliament. FMC will get autonomy and much needed powers after the bill is passed while more tools like option trading and index trading can also be introduced only after the bill becomes an Act. Not to mention, Indian institutional players and banks are now likely to get permission to trade or hedge their positions in commodity derivative market only after the regulator is strengthened.

If that happens, the market will get fresh tonic to grow further.

Will that happen?
The finance minister, in his budget speech, spoke about need for reforms in all financial markets like currency, securities and debt along with his plan to strengthen capital market regulator Sebi and insurance regulator Irda. In commodities, he imposed the new tax - CTT.

He spoke about amendments in Irda and Sebi Acts but he did not refer to the FCRA bill. The reason for the skip could be that the finance ministry is not the administrative ministry for commodity futures market which falls under consumer affairs ministry.

However, he mentioned that trading in commodity derivatives will not be considered as a ‘speculative transaction’, but said nothing on allowing set-off of commodity derivative gains and losses against business losses and gains. This set-off is given for equity derivatives, while the commodity market needs it more to motivate hedgers to come into this market. The real purpose of commodity futures is hedging commodity price risk.
 
What is needed urgently?
If the FM is saying that commodity transactions are not speculative, then setting off of derivatives trades will be good for traders. Besides, banks and Indian institutions should be permitted as early as possible. Till both these happen, the Rs 170 trillion commodities futures market will not grow rapidly from here.