India's 1st rainfall derivatives contract starts on May 29: What to expect

A look at the challenges and benefits

Agriculture commodities derivatives exchange NCDEX (National Commodity and Derivatives Exchange) has announced the launch of India’s first rainfall-based weather derivatives contract, called ‘RAINMUMBAI’, allowing businesses to hedge against losses from too much or too little rainfall. 

It’s like any other derivatives contract — except that instead of the price of a commodity or stock you will be hedging against the amount of rainfall that Mumbai is likely to receive over a given period. Another crucial difference is that the contract is based on 30-year historical rainfall data in Mumbai for 1991-2020, sourced from the India Meteorological Department (IMD). 

There are four contracts, aligned with the four monsoon months of June, July, August and September. And trading starts today (May 29).   

The NCDEX, according to its Managing Director and Chief Executive Officer Arun Raste, has taken 30 years’ monsoon data for each day of the four months. The average rainfall for any particular day is known as the long period average (LPA) or normal rainfall for that day.  When the daily LPA from June 1 to September 30 is added up, starting from 1991, it becomes the monsoon season LPA. Based on this calculation, the LPA for Mumbai comes to around 2,206.7 millimetres (mm). 

Now, suppose as per this calculation, the LPA is 10 mm for June 1, but the actual rainfall the year on which the contract is based is just 5 mm, then this means that there is a negative deviation of 5 mm. If the deviation is more than the LPA rainfall, it gets added on to the base of 2206.7 mm and if it is less than the average rainfall of the day, then it gets subtracted.  

This same method is adopted for the closing of each day. The additions or subtraction to the previous day’s value becomes the spot price of the next day. 

Where it begins 

“We have taken the four-month average rainfall over Mumbai which is around 2206.7 mm as the base and not zero as we did not want the value to become negative once the actual deviation is added or subtracted,” Arun Yadav, product head of NCDEX said. 

Once the contract expires on the last day of each month, the value that is arrived at after adding or subtracting the deviation from the 30-year average LPA for four months (2206.7 mm), which then becomes the settlement price of that month’s contract.

Then comes the tick size. For each 1 mm deviation, the contract specifies ₹50 as the tick size. 

For instance, if at the end of the month, the total rainfall, after adding or subtracting the daily deviation from the 30-year average, comes to 2,152 mm, the difference of 54.7 (2,206.7-2,152) mm is multiplied by ₹50, which then becomes the payout.

If the difference is higher than 2,206.7 mm, it becomes the profit for the buyer and if it is less then it is the loss. 

As the contracts continue, the closing number of one month becomes the opening of the next month. So for one month, the contract gets settled completely on the last day of the month. The contract for September then encompasses all the four months LPA. 

The exchange has also provided an online calculator which has each month’s LPA for Mumbai starting from June to help the trader calculate the expected closing value for each month. 

“Suppose a buyer looks at the June LPA rainfall for Mumbai which is 539.7 mm and feels that rainfall would be 10 per cent more, then he could derive the expected closing value through the calculator and place his trades accordingly. The reverse happens for a seller,” Yadav explained. 

Raste explained that a member cannot have more than 20 per cent exposure.  

An individual cannot have more than 40,000 lots. Then there is a 10 per cent ‘margining’ — all aimed at ensuring that too  much speculation does not take place. 

Banks, other players 

If rainfall is excess or more than normal, it could lead to crop damage. If that happens, then in addition to farmers, banks too will suffer by way of rising non performing assets as farmers will be unable to repay loans. Or if the rains are erratic, the cost of production goes up. Here too there is a possibility that the ability to repay loans is constrained. 

In both cases banks can become potential customers and hedge their NPA risks. 

Another scenario is power supply. Around 40-50 per cent of Mumbai’s power comes from hydropower. If rainfall is less than the average, the water level in dams will run low and power generation will suffer. So companies may like to hedge whatever income risk they have. 

Citing another example, Raste said in a city like Mumbai, excess rain can lead to waterlogged roads. This could hit app-based taxi aggregators, public service providers etc, who could use the RAINMUMBAI to hedge their risk and protect themselves against potential losses. 

How different is a weather derivatives contract from an insurance product, when both are meant to hedge risks against adverse weather? 

Raste said that while an insurance product such as a crop insurance scheme involves intermediaries such as assessors (the government, in case of crop insurance) there is no such thing in a weather derivative.  Also, insurance payouts happen with a lag while derivatives are paid out on the day of settlement. 

“The rainfall index in Mumbai doesn’t ask what your loss is. It asks what the rainfall is, and settlement happens automatically. It has nothing to do with the government or administrative machinery. Also, crop insurance is only for farmers — but there are many other sectors impacted because of rainfall; nobody protects them,” Raste said. 

Outsiders welcome 

He said farmers, who bear the brunt of climate change, too can benefit from the product through Farmer Producer Organizations (FPOs) or cooperatives registered on the NCDEX. 

Can a Mumbai-based rainfall derivatives product be of any use to a trader sitting, say, in Indore (Madhya Pradesh)? 

Raste said he too can hedge his risk by estimating the actual rainfall that would happen in his region based on the trajectory of the monsoon. 

“When I say Mumbai rainfall, look at the spread of the monsoon. The monsoon hits Kerala somewhere in the first week of June. Seven to ten days later it reaches Mumbai. Then 10-12 days later it reaches MP or Rajasthan, and another five days later it reaches Delhi. There is a gradual pattern. By the time it reaches Mumbai, you can already establish whether rainfall is patchy, erratic, excess, or normal. So Mumbai is, in that sense, a midpoint. Secondly, if it rains in Mumbai, in the catchment areas like Nashik, Pune, Surat… all of them get impacted similarly.” 

Someone sitting in Indore or Ahmedabad can also look at the Mumbai rainfall data, estimate whether the same pattern will 

continue and decide what needs to be hedged. 

Suppose Mumbai normally gets 2,000 mm rainfall and Indore gets around 1,500 mm. There is a pattern, which can be estimated. 

Futures plans 

In 1997 Chicago launched a heat index and snowfall index and later moved into micro contracts for specific cities. 

The NCDEX, Raste says, does not plan to go granular at present but has started working on another product that is based on the North-East monsoon that starts from December and ends in March and is largely confined to the southern states. 

‘RAINMUMBAI’ is based on the South-west monsoon. 

A heat contract is also in the pipelines, to be based around the peak summer months of April or May with a northern city as the 

reference point. 

Globally, weather-based derivatives have been in vogue since the Chicago Mercantile Exchange (CME) launched temperature- and snowfall- based products in 1997 and 1999. 

“But, when it comes to rainfall, the NCDEX will be the first globally. Actually NCDEX studied their products and then said snowfall is not useful for India, so we looked at rainfall,” Raste said.  Raste said that in order to make the product fool-proof, the NCDEX closely studied the rainfall pattern of two years — 2024 and 2025 — before launching. Plus it has interacted with over 150 research analysts and scores of banks, companies, farmers, and agriculture input firms to refine the product. 

“NCDEX Rainfall Indices can become a transformational risk management tool for Indian agriculture, agri-finance and rural markets by creating a scientific framework to hedge weather-linked economic losses,” said Vijay Sardana, a markets risk management expert. 

“However, for large-scale adoption, India must improve data transparency, taluka-level granularity, real-time dissemination, 

legal enforceability of settlements, and integration with crop insurance and banking systems.” 

“The success of weather derivatives will depend on trust in weather data, robust regulatory oversight, farmers’ active role in Agricultural Produce Market Committees (APMCs), and active participation from banks, insurers, agribusinesses, and commodity markets. India must also build strong and credible climate-risk analytics capabilities so small farmers can convert weather uncertainty into manageable financial risk,” he added. 

 

• Ticker symbol is a unique set of letters to describe a company’s stock on the exchange
• Underlying asset is an index or stock enabled for trading on futures
• Tick size is the minimum price fluctuation allowed in a futures contract

Source: IMD surface rainfall, Automatic weather stations (AWS) observations at Santacruz and Colaba