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The proposal to impose Commodity Transaction Tax (CTT) on non-agri commodities is unwelcome given that the current market is skewed towards non-agri products. India's agri-commodities space is in a mixed zone. Frequent bans on trading of some agri-commodities like tur & urad dal, wheat, sugar and more recently guar have eroded investors' confidence in the segment. Further, required changes in the FCRA (Forward Contract (Regulation) Act) (to introduce new products and encourage new participants), form the crux of political issues. Add to this, the much-needed changes to the Banking Regulation Act, which would allow banks to proxy hedge their clients' positions against which they have lent funds.
Also, the knowledge gap is stark and well defined. Sales teams of intermediaries understand hedging well but may not be equally familiar with agri-commodities - unlike the comfort developed with bullion, metals and energy. Enough pricing information is also available for sales teams from the internet about globally traded non-agri commodities, However, agri-commodities in India have been insulated from the global markets and the pricing factors are inconsistent, opaque and dependent on man-made taxes. Conversely, the users of agri supply channels frequently have little clue about hedging. Exchanges will have to make sustained efforts to educate market participants to get actual users to this platform. Further, few warehouses are currently accredited to store listed agri-products, which keeps a large part of the market out of the exchange futures platform as this material can neither be delivered nor used as collateral for trading.
Absence of large players also makes the agri-commodities market easy to manipulate because the largest producers and consumers simply cannot participate effectively in the market. A simple example could be that of sugar where India's annual sugar production is around 25 million tonnes (MT). A large sugar producer produces about 1.1 MT a year or 100,000 tonnes per month. The near-month client limit is just 8,000 tonnes, which means that they can hedge just eight per cent of their production - which also means that they might as well not hedge! Of course, there is a provision to hedge against physicals but the process requires too much paperwork and explanations. End result: no participation on the exchange-traded platform.
The current policies also discourage small players from participating in these markets because the lot sizes in several agri-commodities are just too big for them. For example, the lot size for soya refined is 10 MT. At the current price of about Rs 700/10 kg, just one lot is Rs 7 lakh, which needs a 10 per cent margin, i.e. Rs 70,000, which is too much for a small trader.
Also, a Rs 1 movement equals a gain/loss of Rs 1,000, which is considerably large for a retail trader. The solution is simple: Mini contracts. Delivery lot size can be 10 MT but the trading lot size should be one MT.
Then there is the matter of all broker members - big or small - having the same member limit. Thus, large players are unable to leverage their size and clients suffer because of this. This is also one important reason for low volumes in the agri-commodities segment. Clearly, the way out is to fix member position limits on the basis of number of branches or total number of clients or even the number of dealers employed.
Finally, one key issue which, if resolved, will multiply the amount of deliveries in the agri commodities futures platform: the seller should not need to pay mark-to-market if 'pre-pay in' of material has been done. Recently, we were able to convince a farmer to deliver cardamom on the exchange but it took long to explain the exchange rules to him about his needing to pay mark-to-market when he was ready to give delivery right at the time of making the sale on the exchange platform. Of course, this is complex as the exchange has to give mark-to-market credit to the counter party if the trade goes in their favour. But, if we have to get farmers on to the market then this issue will have to be resolved.
The author is president - retail distribution, Religare Broking
