The Indian government has taken further steps towards curbing inflation. Vishala Sri-Pathma investigates the impact this will have on the commodities market
In an attempt to stem inflation, India’s
government is taking an aggressive stance on food and steel
prices. The recent ban on numerous agricultural commodities
(chick peas, soy oil, potato and rubber) by the Forward Market
Commission (FMC) is in addition to last year’s
halt on wheat futures. It comes after inflation hit 7.57% in
April, which is far from the official comfort zone of 5%.
The ban has caused a fair bit of controversy, because the
decision comes after a report released from a
government-appointed panel claimed that there was no conclusive
evidence connecting futures trading and spot price
Abhijit Sen, a member of India’s Planning
Commission, chaired the panel, looking at the impact of futures
trading on retail agriculture prices. The report suggests that
the market, "doesn’t indicate in any way that
these commodities are responsible for any price
It is not as if the government is opposed totally to the
futures market. The Securities and Exchange Board of India
(SEBI) is considering applications for creating a platform for
exchange-traded currency futures. This will enable both
exporters and importers to hedge their position against
currency volatility, facilitating capital markets.
In addition, several state governments have issued licenses
to the National Spot Exchange (NSEC), allowing for an
electronic trading platform. In an attempt to attract more
hedgers to the market, the platform will allow farmers to sell
small quantities of produce.
The recent rise in inflation, coupled with the shortages in
food supply, have been described as a "grave crisis" by
India’s finance minister, Palaniappan Chidabaram.
Analysts have sighted the correlation between speculative
trading in commodities and rising food prices as "weak", saying
that the fundamental drivers are poor harvests and growing
"It is more of a political gesture to show the public that
they are taking measures," says Ali Lakdawala, an analyst at
AnandRathy, an Indian securities firm based in Mumbai. "India
is in the middle of an election season, so the government wants
to seem like it is doing as much as they can to address the
However, banning futures trading only leads to policy
uncertainty for both farmers and investors in commodities,
harming investor sentiment.
India’s main commodity exchanges –
National Commodity and Derivatives Exchange and MCX –
have grown rapidly since they were established in 2003. The
delisting of some commodities from the exchanges last year has
caused a fall in agricultural futures trading.
In 2004 agriculture made up almost 70% of total trade on
India’s commodity exchanges, but it has dropped to
less than 25%, with bullion and metals accounting for the
Lakdawala is intrigued why certain commodities were chosen.
"Chick peas and soy oil had good volumes, but it’s
unclear why the ban was imposed on rubber and potatoes.
Similarly for wheat, the commodity got banned when the prices
were between $24.28 and $25.44. After a slight dip, the prices
have shot up again to similar levels. Thus the impact of the
ban remains debatable."
He attributes the basic problem to a widening gap between
supply and demand, which still remains unresolved. "The ban has
definitely dented investor confidence in trading commodities.
With India and China being the major consumer of soy oil in the
world, local consumption is rather dependent on imports," he
Lakdawala feels it will restore the confidence of investors
when the ban is lifted. "But once the market matures and
commodity options are introduced, we could see volumes increase
further, particularly when investment banks and hedge funds
enter the arena."
There is clearly huge growth potential in the Indian
commodities market, which runs the risk of being stunted if
further hindered by political moves within some sectors of the
government that even the prime minister does not support.
Despite efforts by various exchanges and trade associations,
policy makers appear to lack understanding of the functioning
of derivatives and the role they play to the economy.
Development of the agricultural sector in India is dependent
heavily on information relating to price and risk, both of
which can be provided by the futures market. The futures market
has brought about price discovery and risk management, which
have been the two fundamental drivers of growth in this sector.
Any business or government that does not participate in the
futures market, may well be at a disadvantage.
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