Editorial: Reversal is not enough

Ending the ban on futures trading in four agricultural commodities — rubber, chana (chickpea), potato and soyabean oil — is a welcome indication of the government’s intent to resume agricultural marketing reforms, halted under pressure from the Left. But the government is still in two minds, it would seem, because the bar on derivatives trading in four other farm commodities, including rice, wheat, urad and tur (arhar), continues even though the current market scenario is the same for these items as well.

Futures transactions in the major agricultural commodities were put on hold when the government was worried about inflation. The ban did little to bring down prices, which continued to rise for several more weeks, till the demand-supply balance changed. Output increased, and a slackening of demand followed the economic slowdown. Rubber prices were a case in point. These ruled at Rs 115-120 per kg when futures trading was suspended in May, but kept climbing to Rs 140. Since then, they have softened to touch the present low of Rs 60-65 per kg, chiefly on account of the demand recession and the meltdown in crude oil prices which have made synthetic rubber cheaper. It would seem therefore that futures trading neither caused the prices of these commodities to rise nor did its ban result in reversing the price rise. The Abhijit Sen committee that went into the effect of the futures trading on prices had come to the same conclusion.

That said, the resumption of futures trading is likely to have limited impact because it has not been accompanied by measures to rid agricultural commodities of the curbs on stocking, trading, exports and imports. Such restrictions come in the way of futures trading playing its role in price discovery and in price risk hedging. Many agricultural products are covered under the minimum support price mechanism where the government, rather than market forces, determines the bench-mark prices. The storage limits imposed on some of the major commodities are low, deterring the trade and user industries from building the inventories needed for their legitimate business operations. Soyabean processors in Maharashtra, for instance, are allowed to hold stocks of only one-sixth of their last year’s crushing capacity. Wheat traders have to report their stocks regularly to the state and central authorities, if they buy more than 10,000 tonnes. The result is that genuine players in the commodities sector, be they producers, traders or consumers, tend to stay out of futures trading and this perhaps ends up creating more instability in the market.

Admittedly, the argument breaks down when it comes to unprecedented trading volumes in minor and insignificant commodities like guar gum and zira (cumin seed). Those wary of the potential ill-effects of futures trading also point to the fact that a part of the global spurt in petroleum prices was the result of speculative money flowing into this commodity; hot money going into a market that is already seeing rising prices can accentuate the trend. It has been argued as a counter to this that prices in futures markets do not necessarily influence those in the spot market, but that flies in the face of the argument that futures trading helps price discovery. It is not illogical to believe that there can be circumstances when futures trading adds to price volatility. However, the risk is outweighed by the benefits, especially when it comes to commodities that have a large production base and are also traded freely in global markets.