Hedging risks

Suspension of futures trading has not helped

Despite a campaign by various agri-commodity bodies to get the ban on futures trading of key farm products quashed, the Securities and Exchange Board of India (Sebi), which is also the commodity market regulator, on Tuesday decided to extend it by another year. The crux of the arguments put forth by agri-commodity bodies was that the bar on futures trading has done more harm than good to the commodities sector by denying the stakeholders an opportunity to hedge their price risks. A well-functioning futures market is necessary for the producers, traders, processors, importers and exporters of agricultural products in order to get reliable cues on the likely price trends and make informed decisions. The members of the farmer producer organisations (FPOs) also normally rely on price signals from the futures market to decide whether to sell their entire produce in the post-harvest peak marketing season, when the prices usually hit the bottom, or to keep some stocks for sale at a later date to realise better returns.

Sebi suspended the derivatives trading of several mass-consumed farm goods, such as staple cereals like wheat and paddy, pulses like chana (gram) and moong (green gram), and some oilseeds like soybean and mustard and their oils and by-products, in December 2021. The most pertinent determinant for maintaining the ban on commodity derivatives trading should, obviously, be whether it has served its intended objective of taming inflation or not. The answer, prima facie, is in the negative. The overall food inflation has remained high despite the suspension of futures trading. This is corroborated also by the findings of some scholarly studies which have shown that the prices of agri-commodities have continued to fluctuate, quite widely in some cases, even without being allowed to be traded through commodity bourses.
 

The spot prices are governed, by and large, by the demand-supply dynamics. The derivatives market provides only the signals about their future trends. A parliamentary standing committee, as also the high-powered panel headed by late Abhijit Sen, had failed to find any conclusive evidence to blame futures trading for any spike in the spot prices of farm goods. The parliamentary panel, attached to the Ministry of Consumer Affairs, Food and Public Distribution, in its report presented way back in 2011, had gone even to the extent of suggesting a meaningful convergence of spot and futures markets under a uniform regulatory framework as part of agricultural marketing reforms.

That said, the bitter truth also is that futures trading is not immune to exploitation by speculators, especially those with deep pockets. The market regulator, therefore, needs to always remain vigilant to foresee the threat and take pre-emptive action by way of suitable changes in the margin amounts and open interest limits, especially for the exploitation-prone commodities. Fortunately, the current market regulator, unlike its predecessor, the Forward Markets Commission, is vested with sufficient powers to do this job effectively. What is needed in India is the development of an efficient and globally competitive agri-derivatives market to serve as a reliable instrument of price discovery and risk hedging with least danger of being hijacked by speculators. Suspending trading in the agri derivatives market for an extended period could undermine the whole sector, limiting its ability to grow and compete in global markets when the opportunities arise.