Commodity Futures in India

Author(s): Kamal Nayan Kabra

Source: Economic and Political Weekly , Mar. 31 - Apr. 6, 2007, Vol. 42, No. 13, Money,
Banking and Finance (Mar. 31 - Apr. 6, 2007), pp. 1163-1170
Published by: Economic and Political Weekly

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 Commodity Futures in India
The turnover of the commodity futures market has grown exponentially in a
short span of time. With a skewed market participation that largely favours speculators, the
futures market leaves a lot to be desired as an effective instrument of risk management
and price discovery for the benefit of the growers, traders, processors, and other
stakeholders in the physical trade. Policymakers have overlooked wider considerations
involving the discipline of checks and balances. Owing to the massive size and non-zero-sum
game character of these markets, they are likely to introduce a series of unsettling
macroeconomic effects, such as a possible redistribution of incomes from the
small players to the big speculative financial market entities. The article concludes with
a reference to the factors that could have been behind the snags afflicting the
present commodities futures policy, and suggests how the needs of the real economy
can be satisfied by strengthening the forward trade that is firmly anchored
in the physical trade of the farm commodities under reference.

KAMAL NAYAN KABRA

conditions for the involvement of farmers are unlikely to have

Introduction improved with the formation of commodity exchanges, since
these were and remain urban-metropolitan entities, largely
s a result of the revival of commodity futures in a big dominated by traders, brokers, speculators and big hedgers. The
way in 2003, the nature of commodity trade in India has Khusro Committee on Forward Markets highlighted the deep
ndergone a sea change. Going by trade volume and also structural-institutional roots of the cultivators' lack of capability
possibly as an identifiable influence on the price-making pro- to take advantage of the futures trade, with the exception of the
cesses with respect to the traded commodities, both the futures large growers of Saurashtra region of Gujarat, where there has
market and actual merchandising have undergone a big change. been a long tradition of futures markets [GoI, Ministry of Civil
The disproportionately large size of the former compared to theSupplies 1980, p 1 1]. There is little reason or evidence to suggest
latter underlines the financial market character of the futuresthat any marked change has come about to enable direct parti-
trade. Not surprisingly, for the majority of the futures traders,
cipation in the futures market by an overwhelming majority of
the physical commodities seem to be, in effect, no more than the agriculturists. Given this background, it may be noted that
the denominator in terms of which the deals are expressed, as tho present revival of the futures trade in the year 2003 was
they switch from one commodity to another very easily as preceded by frequent policy changes permitting or banning this
demanded by their financial calculus - a case of instant businesstrade.2 It is also widely known that illegal, informal futures trade
substitutability! A mind-boggling amount of financial resourcesin various commodities, involving multiple risks for the parti-
have been deployed in these markets. Consequently the form, cipants, has continued to prevail, and even now it cannot be
purpose, volume and modus operandi of the commodity trade, claimed that no such thing exists, as the reports regarding the
activities of the Forward Markets Commission testify [GoI,
along with its role and impact on the economy at the macro, sector-
specific, regional and local levels and in socio-economic terms, Ministry of Consumer Affairs 2005-06, p 80].3 Many restric-
no longer retain their conventional patterns associated largely tions on such trading were re-imposed in 1962 for political and
with physical merchandising. Hence there is a need for a fresheconomic reasons. It was shown by the Khusro Committee that
look at the futures markets and the policy decisions that led to by 1953, regulated futures markets were established under the
their present enormous size, especially in view of the recent auspices of 30 recognised associations in 15 commodities, which
controversy regarding their role in accentuating inflationary included all the principal commodities in which there was a
pressures in 2006-07. Prior to attempting such an examination,tradition of futures trading [GoI, Ministry of Civil Supplies
it may be pointed out that trade in general and commodity futures1980, p 71]. The abiding interest of businesspersons and specu-
in particular have not attracted much academic attention and lative elements in the futures trade is highlighted by the same
remain a somewhat opaque area of the economy. committee when it says that "speculative trading in banned
commodities" was camouflaged as non-transferable, specific
II delivery contracts" (ibid). The point that seems to emerge is that
Revival of Commodity Futures Market in this traders-speculators dominated activity the actual growers
of farm goods were hardly in a position to take advantage of
India is among the few countries where forward markets the futures markets for their post-harvest market risks or pre-
developed spontaneously in the later part of the 19th century, sowing market intelligence. Thus, for a variety of reasons,
basically as an activity of traders and financial interests, with under India's pre-structural adjustment statist policy regime
hardly any role of and place for the actual cultivators. The there was only a very small presence of legally permitted

Economic and Political Weekly March 31, 2007 1163

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futures trade, confined as it was to just six commodities in (ibid). These facts indicate the relatively greater and growing
21 small exchanges, regulated under the amended Forward popularity of commodity futures. Thanks to the all-India network
Contracts Act. of terminals, it has become so easy for the small 'mandi' traders
Following the far-reaching changes in the country's policy
and other players across the country to buy and sell commodity
regime in the 1990s, the issue of futures trade liberalisation too
futures by 'investing' a small amount of margin money. The small
came to the fore, and in 1993, the issue was referred to a traders along with big ticket financial market players, brokers,
committee.4 The committee recommended by a majority view to day traders, some large hedgers, who may or may not keep the
permit futures only in a 17 commodities and unanimously opined contracts outstanding until the time of the settlement, are the
against granting permission for futures in wheat, pulses, non-major deal-makers. It is difficult to estimate the number of
participants and the total amount of financial resources used for
basmati rice, tea, coffee, dry chillies, maize, vanaspati and sugar,
on the basis of a case-by-case review of the suitability of each purposes of futures trading. A very high degree of leveraging
commodity in the light of its present and likely position in the is possible on these markets. One comes across estimates of the
coming years [GoI, Ministry of Civil Supplies 1994, pp 33-63].
financial resources used for futures ranging between Rs 5,000
But the committee suggested substantial liberalisation of forwardcrore5 to Rs 1,00,000 crore, though it is difficult to have a more
trading linked to physical trade and actual deliveries for meeting
precise estimate, especially in view of rather perfunctory super-
the bona fide needs of those connected with production, trade vision of these markets in which the Know Your Customer (KYC)
and processing of various commodities (ibid, p 83). As we see
rule is yet to be enforced.
later, this is the kind of liberalisation that can really serve genuine Owing to the factors mentioned earlier, farmers remain, by and
hedging interests and can avoid the excesses of the kind observed large, outside the arena of futures trade. The organisation, struc-
recently following the revived futures. However, when the second
ture and modus operandi of the futures exchanges militate against
phase of liberalisation was taken up in 2003, the National the participation of farmers, since they are located in the metros
Democratic Alliance government issued a notification permitting
and conduct their computerised trade in English. In any case
futures trade in 103 commodities [Lingareddy 2006, p 212]. This
the marginal, small and medium farmers, with small and often
extension of the futures trade was carried out without simulta- non-viable operational holdings, are often net buyers of food
neously setting up a strong, revamped regulatory agency and an and devices like warehouse receipts may not enable them to
appropriate enabling law to support such an agency. It may beparticipate in the futures.6 The complexity of the futures and
noted that presently a Bill is pending before Parliament to strengthen the large size contracts (for instance, 10 tonnes contracts for
the Forward Markets Commission and permit options tradingall farm goods, except spices, which have three tonnes
(a pre-eminently suitable instrument for speculative contracts) contracts) also tend to rule out the participation of the
and a loan of $ 100 million from the Asian Development Bankoverwhelming majority of resource-poor cultivators. Partici-
has been contracted for supporting enlarged and regulated pation by the cultivators through their cooperative marketing
futures trade. apex organisations too has not been explored so far to test
the viability of this option. This, however, is based on the
Ill assumption that the farmers need an instrument like the
Nature and Form of Futures Trade futures, which cannot be taken to be self-evident. The kind
of factors that increase the clout of the big and institutional
Shortly after the above-mentioned notification, as many asplayers,
24 as well as brokers (who operate both on their own
commodity exchanges, three national and 21 regional, were
as also on behalf of their clients, and have fairly large and
recognised. These exchanges started offering contracts of varying
regular access to bank finance) would largely hold good for
sizes, including in essential foodgrains, edible oil seeds (includ-
the arbitrageurs as well. These players operate simultaneously
ing many imported oilseeds), gold, silver, other metals, crude in a number of inter-related market centres in order to take
oil, sugar and some spices. While the national exchanges advantage
are of the gap between the spot and futures prices.
multi-commodity exchanges, the regional ones are offering single
Similarly, players who operate in a number of financial markets
commodity contracts (though attempts are afoot now to convert (and some of them may well be having an interest in physical
some of these into multi-commodity exchanges). Except for 3 as well owing to the recent permission to the big companies
goods
per cent of the futures trade handled by the regional exchanges,
to buy directly from the farmers by the amendment of the state
by December 2006, the rest of the turnover has been concentrated
level agricultural marketing acts by as many as 18 states, under
in the three national exchanges [GoI, Ministry of Finance 2007,
pressure from the centre as a part of its agenda to extend the
p 81]. Until last year the share of these exchanges was 93 per
economic "reforms" to the farm sector as well), and have a long
cent of the total, underscoring the marginality of the regional
tradition of being in the futures and other financial markets,
exchanges [Gol, Ministry of Consumer Affairs 2006, pp 73-75].
have an inherent upper hand vis-a-vis thousands of small
Available information shows relatively small participationparticipants
of lured in by on-line trading. In brief, the emerging
around 15 per cent of the turnover in some exchanges by the futures markets are characterised by multifaceted asymmetries
hedgers [Pitalwalla 2006, pp 43-44]. Modern trading practicesbased on uneven economic position and knowledge. Many small
like on-line trading, standardised contracts, warehouse support,
players are unlikely to find the resources to enter into contracts
up to date clearing arrangements and wide dissemination of daily
for precious metals and would in all probability be ill at ease
price changes have replaced the antiquated open-cry method dealing
on in crude oil and metals futures.
the floor of the exchanges. One major national exchange operates
Heavy concentration of futures market turnover in two national
10,000 terminals in 450 towns all over the country, comparedexchanges and in some commodities, high degree of price
to 650 members in 460 towns that the National Stock Exchangevolatility, unpredictable and abnormal relationship between the
has. Another commodity exchange has 800 members in 400 cities
ready and futures prices, great disproportion between the

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actual physical availability of certain commodities in a given above cast a doubt on the tenability of the proposition that "A
year and the magnitude of futures transactions. The latter was large number of different market players participate in buying
found to have exceeded the former by 10 and 12 times for and selling activities in the market-based on diverse domestic
urad and gram respectively, and by over 230 times for guar in and global information, such as prices, demand and supply,
recent times [Kabra 2006, p 55], giving rise to suspicions of climatic conditions and other market-related information. All
circular trading in these commodities. These trends also show these factors put together result in efficient price discovery as
the insignificance of stakeholders in the physical trade and a result of large number of buyers and sellers transacting in the
point towards the possibility of manipulation by means of futures market" [GoI, Ministry of Finance 2007, p 82, emphasis
tactics such as squeeze and cornering (though one cannot be in the original]. Quite simply, the large number of market
dogmatic on this possibility owing to inherent difficulties of participants seems to be too thin a basis for drawing such an
detecting them). The timing, level and volatility of price changes inference, since much depends on the basic interest that
around the time of closing and around the beginning of new the participants have in the traded commodity, currently and/
contracts also point to the absence of reckonable countervailing or as a matter of established practice. These are large empirical
participation by growers, processors and consumers, and the questions and so far, as far as one knows, no one seems to
inherent weakness of the regulatory processes (to be discussed have investigated these issues at the field level. There is no
below). That there is a very small proportion of actual physical stipulation in the Indian commodity exchanges for the par-
deliveries may be treated as a clinching indicator of the overly ticipants to establish their bona fides as actual merchandising
speculative character of these markets as they have come to interests.
operate in India. It may be noted that tur and urad pulses were taken out of the
A combination of these factors, both by way of omission and purview of the futures in January and wheat and rice were made
commission, made for the huge popularity of the futures market. to follow suit at the end of February. The curbs are supposed
This is reflected in the phenomenal growth of turnover of futures to be temporary and the issue of the futures in farm goods has
contracts in a short period of three years (see the table). During been refereed to an expert committee. A bill is pending in the
the current fiscal, between April and December, the total turnover Lok Sabha to permit options and derivatives and the participation
was of the order of about Rs 28 lakh crore, which amounts to of gigantic financial entities from abroad into the over-corpulent
a daily average turnover of over Rs 12,000 crore; by December, futures markets in India.7
the number of contracts of the three major exchanges were around
525 lakh [GoI, Ministry of Finance 2007, p 81]. The hyper growth IV
of futures trading has reached such a high pitch that in October Questionable Claims
2006, daily average trade in chana in just one exchange at
Rs 399.46 crore, which outdid the daily turnover of a blue chip What are the effects of the hyper growth and "financialisation"
share like Reliance (Rs 131 crore) (Amar Ujala, October 27, of the commodities trade (also its "corporatisation"), the resulting
2006). The GDP of India at current prices for 2006-07 is estimated wild fluctuations in futures and the upward pressure on spot
at around Rs 41 lakh crore, and the volume of futures trade prices? Do these price signals say anything meaningful about
this year up to December has already touched around 90 per cent the emerging fundamentals to guide the real economy, especially
on an annual estimation basis. The volume of the future trade that of the growers? Over any given trading day, the futures prices
has already surpassed the turnover of the 150-year old stockmove in a wide range, and over time, the same trait continues
in an accentuated manner. Generally spot prices follow the lead
exchanges. Not only this, even the size of the actual physical
of the futures prices, though the spread between the two, does
trade, i e, ready markets trade, in all the commodities taken
together contributes around 13 per cent of the GDP (Tenth Five- not show any particular trend. With limited, if any participation
Year Plan, quoting the NAS, Vol II, p 905, Hindi version), which by the growers, and marginal presence of the hedgers (except
seems to have been dwarfed by the turnover of the commodity some large entities), these prices are viewed as the handiwork
exchanges. Insofar as far as some agricultural commodities with of too much money playing around with relatively small quan-
tities of the commodities referred to in nominal terms. Even in
futures contracts are concerned, the share in futures is practically
in inverse proportion to the weight of these commodities in the theory, the informational efficiency or adequacy of these prices
national income. Jeera, guar, chana, soya oil and seed, mentha are suspect. It has been stated that "The ability of a futures
oil, masur, Burmese urad and wheat have attracted futures contracts
exchange to function properly depends in part upon the ability
of the exchange and the regulator to ensure that the prices of
running up to five digit figures, exceeding the figures for those
commodities in which we have had a continuous tradition of the contracts traded on the exchange reflect supply and demand"
futures trading (such as castor seeds, pepper, turmeric, jute, (a World Bank assisted study titled 'Report on the Commodity
cotton). It can be inferred, thus, that the sidelining of the real
merchandising sector vis-h-vis the largely speculative futures Table: Turnover on Commodity Futures Market
trade is an inherent feature with significant implications for the
Year Turnover
macroeconomic fundamentals of the economy. It has been Rs Crore Per Cent of GDP
maintained that "As a lot of fund money is chasing commodities,
2003-04 129,364 4.6
prices have disconnected themselves from fundamentals"2004-05 571,759 18.3
(Economnic Times, December 15, 2006 quoting the commodity
2005-06 2,155,122 61.0
2006-07 (April-December) 2,739,340 90.0*
head of a large financial institution). Given the above, it is difficult
to visualise the effect of real fundamentals on the decisions of
Notes: These data relate to total notional turnover and not
the participants, whose interest in and familiarity with the com- * Based on full-year estimation.
modities traded remains non-established. The factors mentioned Source: Gol, Ministry of Finance (2007), Economic Survey

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Exchanges in India'). The observed features of the futures market
in terms of its huge volume, many-sided concentration and the
absence of real trading interests, especially regarding agricul-
tural goods are enough to suggest that the price discovery would
be poor in terms of what financial analysts call "strong-form
efficiency", reflecting instantly and fully both public and private
information [Pilbeam 2005, p 249] .Thus, the kind of conditions
and practices of the futures markets we have mentioned in the
foregoing suggest that futures prices would hardly be able to
have even an arms' length relationship with the present and
future production and demand conditions. Obviously the price
discovery role of the futures market has been exaggerated,
especially by implicitly attributing to these prices the properties
of social or shadow/accounting prices, reflecting macroeco-
nomic current and future conditions. In fact, even the extent to
which these (farm goods) prices become known to most of the
farmers is far from clear. Non-substantiated assumptions seem
to have been made regarding the informational efficiency of
these prices, which result from the interplay largely among
financial-speculative interests (as there is no mechanism to
ensure that at least one party to the contract has real, substantive
interest in the physical commodity or that at least the closure
of the deal would involve physical delivery). Even the theory
of futures trade recognises the prevalence of contracts between
speculators themselves for "assuming speculative positions"
[Pilbeam 2005, p 335] and in around 99 per cent cases there
is no physical delivery since traders enter in to reverse trades
and where there is a regulatory compulsion for physical
delivery, they can walk out of it by making payment of a
penalty (ibid, p 336). Thus there seems to be little reason and
a thin basis for relating the decisions of the futures operators
to the real market factors and trends with respect to the
goods of agricultural origin. It is clear that public policy on
the futures market took the price discovery function to be
axiomatic,
Coming to the price risk management (PRM) function, let us
first see what in fact is the nature and extent of the price risks
faced by the growers of farm goods in India. Insofar as farm
goods in India have been given increasing minimum support price
(MSP) every year and the general long term trend in the markets
and MSP have been of an upward movement, can one argue that
there is any palpable price risk that has to be managed?8 True,
everything is not hunky dory regarding agricultural marketing
in rural India. There are lingering post-harvest problems con-
cerning adequate storage, movement to the market or mandi town
or the distress caused by pressing immediate need for cash or
the inadequacies of the government' s procurement arrangements.
These are not the kind of issues for which the futures can provide
an answer. Of course, there are seasonal dips, but that is not an
unknown or unpredictable feature of the farm goods market, at
least directionally. While such seasonal price troughs tend to
cause an acverse change from the growers point of view, the
more powerful market entity, namely, the traders, generally
benefit from the busy season dip and lean season increase in
prices. Thus the PRM process by means of these contracts is called
upon to meet two opposite needs, and the actual outcome may
perhaps satisfy none, since it is determined by the overactive and
resourceful speculative forces, the major players, with their own
calculus and predilections. It is difficult, therefore, even on a
priori grounds, to see how the futures can reconcile the needs
of largely non-participating growers and marginally present
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hedgers from among the traders processors. Here one need not
go into the availability of other instruments that can be used for
the purpose with greater effectiveness. Enough literature exists
on the methods of improving the marketing of farm goods.
The observed functioning of the futures market with extensive
volatility and its domino effect on the spot markets have contrarily
become another unwittingly courted source of unsettling
influences on the farm goods market. It may be noted that we
have seen little evidence of adverse effects of the futures in gold,
silver and internationally exchange-traded goods like crude oil
and metals.
While failing to discharge its assumed role, as seen above, hyper
growth of the futures has produced many other adverse economic
and social effects on the economy. In the absence of any sys-
tematic empirical investigation of the issue, we may have to go
by some press reports about certain effects of the futures. These
reports show that some organisations of traders, who hardly ever
demanded the futures in the first place, are now actively opposing
the futures, since many have burnt their fingers participating in
them. They have complained of massive losses they were forced
to book (Jansatta, May 28, 2006). Similarly, egg producers have
felt the pinch of abnormally high maize prices manipulated by
the futures trade (The Hindu, December 22, 2006). The Standing
Committee on Food [Lok Sabha Secretariat 2006] of the Lok
Sabha has also opposed the continuation of futures in farm goods.
The currently observed excessive increases in the prices of wheat,
pulses, edible oils, spices, etc, have been attributed to speculative
explosion in the futures [Kabra 2006]. There have been reports
that volatile price behaviour of the futures in mentha oil has
harmed actual merchandising interests and exports, leading to
losses, as well as weakening our reliability in the export markets
(Open Letters to the Forward Markets Commission by TV 18
commodities control.com). The Kabra Committee raised ques-
tions about the opportunity cost of the deployment of our financial
savings in the futures markets, especially the "diversion of money/
finance to sustain a bullish run on prices and entail a heavy
opportunity cost in terms of real industrial investments foregone"
[GoI, Ministry of Civil Supplies 1994, p 12]. Its opportunity cost
in terms of foregone real sector investment and employment can
well be imagined.
V
Preconditions for Checks and Balances
The preceding discussion about performance of the future
market during 2003-06 suggests questioning of the theory of th
futures markets as it is popularly expounded and extolled. I
appears that the theory is based on certain clearly spelled o
assumptions about the nature of the commodities fit for futu r
contracts, the nature of the markets in which the contracts a
traded, the role of participation in providing depth an
liquidity, balanced participation by contending forces, the r
and mode of functioning of the commodity exchanges, and
system of self-regulation supervised and supported by
empowered public regulatory body. If these assumptions a
granted, the theory seems, a priori, quite sound and u
exceptionable [UNCTAD 1993; Sparks Company 1993; Pil,bea
2005]. What the theory does not indicate is that simply by
instituting commodity futures in each and every commodi
market, one can hope to be assured of the expected outcom
The whole process and its results "are in the realm of
possibilities and their actual realisation is contingent upon the
fulfilment of a set of conditions" [GoI, Ministry of Civil Supplies
1994, p 9] specified in the theory itself. The literature on the
subject specifies a number of conditions for effective use of the
futures market for any commodity, i e, without any explicit
differentiation between commodities of different kinds. First, the
commodities traded must be homogeneous, fungible, interchange-
able, storable with a long enough shelf life, with "terminal market
facilities and infrastructure that are strategically placed and
adequate for the delivery functions of the futures contracts"
[Sparks Company 1993]. Second, they must be free of govern-
ment control and regulation. Third, the number of independent
buyers and sellers, free to enter and exit both physical and futures
trade must be large enough to prevent, on both the sides of the
market, the emergence of oligopolistic structures. Fourth, effec-
tive supervision and control of the exchanges is essential to obtain
sound and fair outcomes. Fifth, free flow of information to all
market participants is essential, for the prices in the futures to
fully reflect available information. Sixth, both physical and
speculative interests must be present in the market in large
numbers in order to ensure that no single group or firm or a cartel
of some allied firms dominate the market and decisively
influence its course [GoI, Ministry of Civil Supplies 1994, pp
9-10; UNCTAD 1993; pp 4-7; Sparks Company 1993]. The
account given above, and the commodity-wise analysis given in
various reports are enough to indicate that these stringent con-
ditions do not apply to most of the commodities, and certainly
not to the markets for farm products. In fact, the conditions for
the effective discharge of the avowed functions of the futures
are, by and large, uniform for all kinds of goods and no special
conditions have been suggested in theory for the ensuring the
suitability of the futures for the goods of farm origin. For reasons
of space we cannot go further into this issue. Suffice it to say
that various committees appointed by the government from time
to time have done a detailed examination of various farm goods
on a case by case basis and have rarely found these goods suitable
for permitting the futures.
The basic point is: the dominance of the speculator-financial
interests in the futures gets accentuated by structural and insti-
tutional weaknesses and barriers preventing participation by the
cultivators. This factor was highlighted in the Khusro Committee
Report [GoI, Ministry of Civil Supplies 1980]. It argued, "very
few cultivators actually derive such benefits by direct use of a
futures market for the following reasons. Very few producers
raise crops which are large enough to compel them to think in
terms of hedging. Generally, the producers sell the bulk of their
produce immediately after harvesting and do not carry any sizeable
stocks. Most of the producers are illiterate and unfamiliar with
the complicated technique of hedging" (p 11). Even in Saurashtra,
where there has been a long tradition of futures, it is the large
farmers who make direct use of futures for hedging purposes.
With growing concentration of land and growing non-viability
of most farms, it is difficult to visualise how can the participation
of the growers wider in the present context. It is inherent in the
character of the futures markets that "like other financial instru-
ments futures and forward markets can be used for both managing
risks and assuming speculative positions" [Pilbeam 2005, p 335],
and there is nothing to prevent the speculators trading among
themselves without the presence of real merchandising interests.9
It would be facile to suppose that even without their participation,
the outcomes of the futures market can be beneficial for the
Economic and Political Weekly March 31, 2007 1167
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farmers or small traders who stock and supply the cereals to the
consumers all round the year. Moreover, given the growing size
and dominance of the financial sector in market economies all
over the world [Magdoff 2006; Foster 2006], it is not unlikely
that the futures will remain largely a domain of speculators, a
category without whose presence the futures market cannot
operate; even higher margin requirements may not prove enough
to deter speculative deals. It is true that in some countries, such
as the US, the regulators specify lower margin requirements for
the actual physical interests than those prescribed for the specu-
lators in order to facilitate the participation of the former. But
in India neither there has been any such stipulation, nor does
it seem likely that it can be enforced with success as the ex-
perience with detailed controls and regulation in the pre-1991
era has shown. The huge size of the black economy finances,
and the ease with which it can play in the futures markets (since
there are almost no attempts to prevent tainted moneys from
entering the futures) are fuelling further the growth of the
futures trade.
The relevance of futures trade in an already inflationary economy
(except as a means to unwittingly intensify inflationary pres-
sures), has also been questioned by the Khusro Committee.10
The need for PRM arises when the price movements are unpre-
dictable or are divergent and adverse and not as a result of all
kinds of price changes. Thus it can be said that the results that
the theory of futures market predict cannot become operational
in India, since the preconditions for delivery of the hypothesised
ideal outcomes simply do not exist for the products from the farm
sector. The market for wheat, rice, coarse cereals, pulses and
edible oils are segmented. To an extent, wheat and rice may be
an exception. But these two major cereals fail to meet the other
conditions, especially the one relating to absence of public
intervention. So long as food security in India remains precarious,
owing to low per capita availability, fluctuating levels of pro-
duction and internationally low comparative yield levels, low
overall per capita consumption, etc, and the need for meeting
the challenge of hunger and malnutrition continues to concern
public policy, the state has to remain an active player in the
regulation and control of production, pricing, distribution and
storage of these major cereals. Thus both for reasons of national
food security as also for ensuring food security at the household
level, the food economy is not and is unlikely (in the foreseeable
future) to be free of public regulation and controls. The com-
patibility of futures with the objective of ensuring food
security at the micro-level is open to serious questioning. Also
the need to maintain buffer stocks for national food security
would continually demand public policy interventions in
the food market and render these commodities non-suitable
for futures.
VI
Basic Flaw in Regulatory Mechanism
Given the theoretical non-tenability and actual history of
ineffectiveness of self-regulating markets as shown powerfully
by Karl Polanyi (1975, pp 68-76), the spontaneous emergence
of forward markets and of commodity exchanges to tide over
the difficulties arising from counter-party risks in over-the-
counter trade was supplemented by legal arrangements by
successive governments. As argued earlier, in India, the task of
successful regulation is highly unlikely to be effective, since
the basic conditions for effective futures for most farm goods VII
do not exist. The effectiveness of forward markets is a contingent Alternative of Liberalised Forward Contracts
outcome and not a necessary one consequent upon the initiation
of such markets, as seen above. This factor underscores the roleWhile the present policy regarding commodity futures has
of public policy choices concerning products for which futuresbecome highly controversial, there are no systematic studies of
are permitted and the regulatory conditions for keeping the the outcomes generated by these hyper active markets. Many
contracts on track. It is also well understood that the more popular writings and protests by sectoral interests and political
influential and bigger the players in the futures market (suchparties have attributed a part of the responsibility of the sharp
increase in the prices of many agricultural goods to speculative
as big brokers, financial funds, etc), the greater are the chances
that they are a part of the management of the exchanges. Theseexcesses visible in the enormous turnover of the futures market,
features of the exchanges tend to cloud the objectivity with
and a good part of it concentrated in farm goods. As the gov-
ernment has suspended futures contracts in some farm goods,
firmness with which self-regulation can be effective. In any case,
there is no mechanism to ensure that ready markets are it notcan be taken to be at least a grudging acknowledgement of
swayed under the domino effect of the much larger and more this tendency. However, at the official level, the massive turnover
frequently and extensively reported price movements ofof thethese markets has been mentioned prominently as a positive
futures markets. However, there is no guarantee that the development, as though an achievement by itself, in official
two sets of prices always and necessarily move in the same publications like the Economic Survey. In fact, the Econonlic
direction. Moreover, the distance between the two prices is devotes nearly half of a chapter to the commodity (futures)
Survey
also quite variable. Similarly, the socio-economic objectivesmarkets,
to suggesting the possibility at an a priori level of the
be served by preventing unhealthy futures market effects theoretically posited benefits, subject to installation of a proper
simply do not form a part of the motivation and agenda of
regulatory system. No real field level gains have been attributed
the exchanges, whose basic interest lies in increasing theirto this policy of liberalised commodity futures. 12 The high volatility
turnover.
of the futures has also cast its shadow on spot prices. The sluggish
Can a state-instituted, empowered agency such as the growth
Forward of the farm sector has been with us for quite some time
Markets Commission (FMC) ensure that the markets remain true
but without such a sharp increase in prices, especially in the
consumer retail markets.
to their theoretically enjoined task? In any case if the commodities
traded in the exchanges do not satisfy the conditions essential
Our analysis of the working of the futures market suggests that
for successful futures trade, the scope for the regulator to decision to adopt en block futures trading failed to
the policy
ensure such ideal outcomes does not exist. Had such possibilities
take into account the needs, limited market capabilities (in terms
offutures
existed, one would not have seen what has happened in the command over resources, skills and knowledge, access to
markets for mentha oil, guar gum, Burmese urad, wheat, etc,
finance) of those very sections for whose benefit statedly the
during 2005-06 and the current year, forcing the authorities
futures to
were permitted. It seems possible to surmise that the
impose a ban on futures in some commodities. For speculators,
introduction of the futures in commodities such as gold, silver,
commodities are no more than pegs to hang their dealscrude
on, but
oil, etc, does not seem to have upset the ready markets
the spot markets have no reasons and basis for not reacting to have attracted hedgers as well in reasonably good
and possibly
the futures prices, unless manipulated. The point is not numbers.
that spotBut even a quick reflection would probably suffice to
indicate
prices are insensitive to futures prices or can be insulated from that unlike the case of bullion, for the farm sector
commodities the real economy interests are in a far too weak
their influence. The point seems to be that there is little possibility
of the futures market setting prices that can serve thea needs ofcompared to the financial sector operators. As we have
position
PRM and price discovery relevant for actual physical traders and is little reason to expect the futures to serve price
seen, there
growers. Nor are there any instruments of regulation discovery
that can and PRM functions for farm sector goods. The so-
influence the futures market to yield such prices (equivalent to discovery function has little relevance for farmers
called price
the shadow or accounting prices) as are consistent with the
in their present conditions. The decision to open up farm com-
objectives of public policy or the needs of the real economy. This
modities to futures trade ignored the expert advice-based on an
makes the task of regulation difficult, and the few measures that of the suitability of different commodities for exposure
examination
are taken are usually too little, too late, and some of to futures
them are markets. The decision-makers did not seem to have
largely non-enforceable. l realised that the infrastructure for involving farmers located in
It may be recalled that it was recommended that priorrural
to areas
the in the futures trade did not exist. The fact that the
extensive revival of liberalised forward markets and permission
iron grip of moneylenders pre-empts the sale of a good part of
for futures market in a number of commodities, the old the
law farm
must output coming to the market (the well known pheno-
first be amended in order to equip the regulator with sufficient
menon of interlinked commodity, credit and labour markets,
powers and clearly specify of the lines along which regulation
along with their segmentation) almost rule out the possibility of
has to be carried out, since the sequence of policy changes
the use are
of hedge markets by the farmers, except probably by big
material to their success [GoI, Ministry of Civil Supplies 1994,
farmers and plantation interests, that is, if one were to abstract
p 79]. However, the law was not amended and the new fromBill
the question of an even playing field vis-a-vis the specu-
introduced in 2006 seems more inclined to open the floodgates,
lators. For instance, a simple device like a warehouse receipt for
both by way of new and far more speculation-prone instruments
enabling one to hedge in a distant metropolitan futures exchange
(such as options and derivatives and large financial is a rather elusive entity in the Indian farm sector. If a contract
market players from across the world) than in strengthening
has tothe
be concluded by physical delivery, one can well imagine
regulatory functions by going in for greater autonomy ofthe
thedifficulty
FMC and heavy transactions cost it would involve. Thus
[Lok Sabha Secretariat 2007]. in addition to the non-fulfilment of the technical conditions for

1168 Economic and Political Weekly March 31, 2007

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effective use of the futures market for farm sector commodities, a few months away from the day of the deal and thus insulate
there is also the difficulty of farmers to participate in the futures themselves from the risk of adverse and unanticipated price
market. movements. It is possible to make these transactions transferable,
It has been a practice in some countries to distinguish between but only with certain safeguards, including commodity exchange
hedgers and speculators by stipulating different terms and and public agency-based supervision and regulation. A major
conditions for buying and selling futures contracts. This can condition that needs to be strictly enforced is that short contracts
possibly work to a certain extent when the differences between are not permitted as initial contracts, necessitating that only an
the capability of the two sets of players are not too vast and a actual physical commodity interest is permitted to sell a
level playing field can be created by different margin and forward contract. A warehouse receipt or some such instrument
licensing fees, etc. But, in addition to the large differences in then has to be an essential prerequisite for a forward contract.
India that render the different terms and conditions ineffective It is hoped that this condition can prevent disproportion between
for creating a level playing field, the experience with differential speculative and real economy interests. Many other instruments
treatment of different sets of market participants has not been and policies can also take care of the PRM needs of real economy
too satisfactory owing to our administrative culture. It is true players, as and when they arise, e g, crop insurance and pre-
that this kind of approach has been adopted in some countries, sowing contracts for the sale of the produce at predetermined
but the largely unorganised nature of the actual producers, the prices. If the use of price signals is to be encouraged for guiding
small mandi town trade in farm goods and the excessively production, technology and cropping pattern decisions of cul-
large size of the cash rich financial markets with a fairly large tivators from the point of view of the growers objectives, as
presence of an unaccounted component, are likely to render this also macroeconomic considerations, computation of shadow and
method of overcoming the weakness and low level of partici- accounting prices and their guaranteed availability to the grow-
pation by the real interests ineffective. However, none of these ers by public policies and procurement, open market operations
measures can compensate for the basic fact of absence of the and price stabilisation funds can also be tried. The point is: the
preconditions for initiating successful futures market. The Indian market as an institution has certain capabilities and advantages
experience of the last three years illustrates this. in a certain ideal context but cannot always and necessarily
The above account may create a misleading impression that deliver irrespective of the circumstances in which it has to
we are arguing that there is no need for non-spot trade in farm operate. With enormously well-endowed financial markets,
goods. For a variety of reasons, contracts for deferred delivery looking out for profitable avenues for the M-M' kind of op-
serve some necessary economic and business needs of the entities erations (that is use of money to make a larger amount of money),
connected with farm sector commodities. But an extensive commodity futures can and often do give counter-productive
prevalence of such transactions is hampered by counter-party outcomes as the real physical trade interests are easily overpow-
risks. Furthermore, the small number of possible trade partners ered by the financial segment of the deals. Enough technical
advice is available with the public agencies in India to enable
restricts the liquidity and depth of the market, leading to a limited
number of price offers. It is such felt needs that led to elemental,them to go in for liberalised forward markets for ensuring the
healthy working of deferred delivery contracts, locking in prices
spontaneous evolution of exchange-based deferred delivery trade
and even availability to meet the needs of growers, traders,
practices. They became known as the forward trade. The
processors and exporters.13 Thus it can be concluded that had
original public policy attempt was to regulate the forward markets
in order to ensure that these trades do not degenerate into the policymakers taken note of the specific conditions relevant
speculative trades, especially when the contracts are trans- to agricultural commodities, the interests involved in their
ferable ones, while reducing counter-party risks of adverse actual production, marketing, processing and export, and the
selection, especially for the transferable specific delivery availability of instruments more attuned to the needs of real
contracts. It is observed that in course of time the distinction economy players, costly missed opportunities and the mis-
between forward and futures contracts (left undefined in the adventure in the form of freewheeling futures markets could have
Forward Contracts (Regulation) Act) became blurred and thebeen avoided. WM
futures trade came to the fore, often acquiring the character of
Email: kamalnkabra@yahoo.co.in
wagering contracts to be squared up by making and receiving
payments.
Let us recall the well-established distinction between these two Notes
kinds of transactions. According to the theories of financial
[I thank Tulsi Lingareddy, Asmita Kabra, some officials connected with the
markets, a forward deal is concluded by the actual delivery of
regulation of the futures markets and some commodity market players for
the underlying asset and profit or loss can only be realised on helpful discussions. They, however, are in no way responsible for the views
the maturity of the contract. On the other hand, profit or loss and analysis presented here.]
can be reali ed prior to the maturity of the contract in the futures
1 Most of the studies of these markets in any case deal mainly with the
markets and practically no futures deal results in an actual mechanism, techniques and organisation of the futures trade, generally
delivery [Pilbeam 2005, p 336; Gol, Ministry of Civil Supplies based on illustrative hypothetical examples, mainly it seems to justify
1994, pp 14-15]. Various committees that were asked to examine its positive risk management and price discovery role. They remain
this issue tried to deal with the question of preventing the forward basically mechanical-descriptive accounts. There are also studies by
deals from becoming a cover for speculative futures contracts. financial sector experts in the tradition of chrematistics. that is, the
science of wealth and money, using very sophisticated quantitative
What is pertinent in the present context is that it is possible to
methods of optimising returns under a variety of assumed conditions,
have a fairly liberalised forward trade regime with respect to but without placing the problematic of these markets in the context of
goods of agricultural origin in which the real economy interests the overall macroeconomy, with appropriate significance attached to
can enter into transactions for making and/or taking deliveries the real economy and the issues connected with differential capacities

Economic and Political Weekly March 31, 2007 1169

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 and participation of different sections of society, etc, and their connection market" (Box 4.5, p 82). It seems the Survey has ducked all these
with the livelihood processes that constitute the kernel of the economy, questions relevant for appreciating the policy decisions concerning
whether financial or real. Even the experience of the period 2003-06, the futures markets.
so notable in terms of the sheer volume and the unsettling impact 13 The Cochin Oil Merchants Association argued that futures in coconut
on the price level, has not yet started finding a place in macro- oil will be an ideal buffer for the millers against the seasonality of copra
economic analyses of the Indian economy operating under neoliberal availability and the delay between coconut procurement and copra
policies. availability (Shyam G Menon, 'A Case for Coconut OIL Futures', The
2 See, Dantwala Committee Report [GoI, Ministry of Commerce 1966: 26] Hindu Business Line, October 3, 1994, p 3).
for an account of the frequent changes regarding the prevalence of the
forward and futures trade.
References
3 Following the February 2007 ban on futures in wheat and rice it was
asserted by a functionary ofia mandi parishad in UP that such speculative
Foster, J B (2006): 'Monopoly-Finance Capital', Analytical Monthly Review,
contracts would continue unofficially (Economic Times, March 2,2007).
December.
It may be mentioned in passing that the illegal prevalence of any activity
GoI, Ministry of Consumer 4ffairs (2006): Annual Report, 2005-06,
can hardly provide any ground for its legalisation, especially given the
New Delhi.
tendency that many would desist from participation in illegal transactions.
GoI, Ministry of Commerce (1950): Report of the Expert Committee on the
4 That the move formed a part of the agenda of liberalisation can be seen
Futures Markets (Regulation) Bill, 1950 (Chairman: A D Shroff),
from the terms of reference of the Kabra Committee, GoI, Ministry of
New Delhi.
Civil Supplies, 1994, p 1.
- (1966): Report of the Forward Markets Review Committee, (Chairman:
5 This conservative estimate, based on back of envelop calculation, is
M L Dantwala), Delhi.
based on the feedback from a group of brokers and commodity futures
Gol, Ministry of Civil Supplies (1980): Report of the Committee on Forward
traders. It seems that owing to the practice of operating in many financial
Markets, (Chairman: A M Khusro), Delhi.
markets, the trade circles are not in a position to give a separate estimate
- (1994): Report of the Committee on Forward Markets, (Chairman: Kamal
of the amount of resources deployed exclusively for the commodity
futures. Nayan Kabra), New Delhi.
GoI, Ministry of Finance (2007): Economic Survey 2006-07, New Delhi.
6 It has been reported that according to the latest NSSO results, 6 per cent
Kabra, Kamal Nayan (1995): 'Futures Trading: Be Selective' Economic
of the cultivators account for 40 per cent of the farm lands (The Sunday
Times, September 23.
Post, November 19, 2006).
7 The Forward Contracts (Amendment) Bill, 2006. - (2006): 'Futures Trading and Galloping Prices', Mainstream, August,
pp 25-31.
8 This is not to say that the MSP fully and adequately covers the risk arising
- (2006): 'Volatile Futures', Hard News, September.
from the movements in the prices of the farm inputs. But it is
Lok Sabha Secretariat (2006): The Forward Contracts (Regulation) Amendment
nobody's case that the futures can deal with the problem of the sufficiency
of the MSP. Bill, New Delhi.
- (2007): Report of the Parliamentary Standing Committee on Food,
9 Pilbeam Keith (2005, p 335).
New Delhi.
10 Khusro Committee [GoI, Ministry of Civil Supplies 1980]. It reads,
Lingareddy, Thulasamma (2006): 'Commodity Futures Trading', Alternative
"when everyone is expecting a price rise, both trendwise and seasonally,
Economic Survey, India:2005-2006: Disenpowering Masses, Daanish
it may be thought that there are no dissenting opinions. All opinions
Books, Delhi.
would seem to converge over a price rise. It is thought that under these
Magdoff, F (2006): 'Debt and Speculation Explode', Analytical Monthly*
circumstances if speculators enter the futures market, they would also
Review, November.
be buyers rather than sellers and their buying activity may further
Menon, Shyam G (1994): 'A Case for Coconut Oil Futures', The Hindu
aggravate the price rise.The futures prices will then stand above the
Business Line, October 3.
spot prices and would be rising over time" (p 4). One suspects that
in the year 2006-07, the Indian futures markets in farm commodities UNCTAD (1993): Technical and Regulatory Conlditions Influencing
could have undergone a similar process.
Participation in, and Usage of Commodity Exchanges by Both
Buyers and Sellers of Commodities, report by UNCTAD Secretariat,
11 For graphic details of how the futures ran wild with speculation and the
Geneva.
FMC could remain a mere spectator, see the open letters written by Tulsi
- (1993): A Survey of Commodity Risk Management Instruments, Geneva.
Lingareddy, available on commoditiescontrol.com.
Sparks Company (1993): Risk Management in Southeast Asia, Final Report,
12 The Economic Survey, 2006-07, reports extensively on the commodity
Joint UNCTAD/World Bank Study, Memphis, Tennessee.
futures in the Chapter on Capital and Commodity Markets (pp 70-83).
Pilbeam, Keith (2005): Finance and Financial Markets, second edition,
The clubbing together of the two markets seems suggestive of the pre-
Hampshire, Palgrave Macmillan.
eminently financial character of the futures markets. However, treating
Pitalwalla, Yassir A (2006): 'Bullish on Commodities', Business World,
commodity futures as the commodity markets without reference separately
August 29.
to the actual merchandising segment is strange indeed! It is interesting
Polanyi, Karl (1975): The Great Transformation, Octagon Books, New York.
that instead of showing how the futures trade has impacted the economy
Rodriks, D and A Subramaniam (2004): 'From "Hindu Growth" to Productivity
this year and in the preceding two years of their operations, Economic
Surge: The Mystery of the Indian Growth Transitin', National Bureau
Survey goes on to refer to some theoretical works positing likely
of Economic Research, mimeo, Cambridge, MA.
outcomes, provided an "effective architecture for regulation of trading
and for ensuring transparency as well as timely flow of information
to the market participants" can be put in place. It recognises that "price
behaviour of a commodity in the futures might show some aberration
reacting to elements of speculation and 'bandwagon effect' inherent in Economic and Political Weekly
any market" but believes in the self-correcting power of the market to
bring back the economy on the equilibrium path! There is little point Available from
in repeating these well-known positions; what is required is to show
Star News Agency
what have been the outcomes produced by these enormously large
Mahendra Chambers
volumes of trade for the real economy and the interests connected with
these traded commodities, that is, those in the spot markets and the Magazine Market
hedgers. What has been the relative place of the hedgers in these 146, D N Road
markets and who are the hedgers anyway "who have [a] long-term Mumbai - 400 001
perspective of the market" and what is their relative position vis-a-vis
"the traders, or arbitragers" who "hold an immediate view of the

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