The Government had appointed a Committee under the chairmanship of Prof. Abhijit Sen, Member, Planning Commission to study the impact, if any, on futures trading on agricultural commodity prices. The Committee was appointed on 2^nd March, 2007.  The other Members of the Committee were Shri Sharad Joshi, Member of parliament, Prof. Siddarth Sinha, IIM, Ahmedabad, Prof. Prakash Apte,IIM, Bangalore and Dr.Kewal Ram, Member, Forward Markets Commission, as Member Convener.  The Terms of reference of the Committee were as under :

(i)                   to study the extent of impact, if any, of futures  trading on wholesale and retail prices of agricultural commodities;

(ii)                 Depending on (i) to suggest ways to minimize such an impact;

(iii)                Make such other recommendations as the Committee may consider appropriate regarding increased association of farmers in the futures market/trading so that farmers are able to get the benefit of price discovery through Commodity Exchanges.

2.         The Committee held 10 meetings and finally submitted its report on 29^th April, 2008.  The Report of the Committee comprises of the following :-

(a)        Report as signed by all the 5 Members.

(b)        Four supplementary notes given by the Chairman, Shri Sharad Joshi, Prof. Siddarth Sinha and Prof. Prakash Apte.  These give individual views of the members in addition to common views embodied in the main report.

3.         The Committee noted the exponential growth in futures trading after its complete liberalization in 2003 when not only prohibition on forward trading was completely withdrawn but three new modern, state of art technology driven exchanges were also set up. 

4.         The  recommendations unanimously accepted by  the Committee are summarized as under :-

(I)                    Negative sentiments have been created by the decision to de-list futures trade in some important agricultural commodities.

(II)                 The fact that agricultural price inflation accelerated during the post futures period does not, however, necessarily mean that this was caused by futures trading.  One reason for the acceleration of price increase in the post futures period was that the immediate pre-futures period had been one of relatively low agricultural prices, reflecting an international downturn in commodity prices.  A part of the acceleration in the post futures period may be due to rebound/recovery of the post trend.  The period during which futures trading has been in operation is too short to discriminate adequately between the effect of opening up of futures markets and what might simply be the normal cyclical adjustment.

(III)                In contrast to the view that futures markets cause increases in prices, the bulk of the existing literature on the subject emphasizes that such markets help in price discovery, provide price risk management and also bring about spatial and temporal integration of markets, futures markets have the potential to bring about better price stability over a medium to long term although the literature on futures markets itself is rather divided on the subject of price variability.  Indian data analysed in this report does not show any clear evidence of either reduced or increased volatility of spot prices due to futures trading.

(IV)              The ability of futures markets and contracts to provide instruments of risk management has not grown correspondingly   and in fact has been quite poor.

(V)                The proposed FC(R) Amendment Bill to upgrade the regulation and to improve the capabilities of the regulator need to be pursued vigorously.

(VI)              Exchanges should act as self regulatory organizations capable of administering fair play, objectivity and customer orientation.

(VII)             A study of the functioning of existing futures markets and contracts suggests that although the volume of futures trading in India has increased phenomenally in recent years, its ability to provide instruments of risk management has not grown correspondingly, and has in fact been quite poor.  The reason for this is high basis risk in most contracts which keeps out potential hedgers and lends to greater dominance by speculators.  This is a serious area which should be addressed both the exchanges and the regulator.

(VIII)           Attracting  speculators, arbitrageurs and other investors is no doubt important but that should not be the primary criterion while designing the contracts. The contracts designs should be such which serve the objective of risk management to farmers and other commercial users.

(IX)                Efficient functioning of futures markets pre-supposes the existence of efficient spot markets. Currently the physical spot markets have large number of infirmities.  Till these infirmities are removed, there will be difficulties in the functioning of futures markets.

(X)                 Collections from the transaction tax, if and when imposed on futures markets, should be earmarked exclusively for development of the required physical market infrastructure and farmers access to it.

(XI)               There should be a consultative group both in FMC as well as in the exchanges comprising persons with proven domain knowledge of commodity sector.

(XII)              At the apex level a Committee on Commodity market akin to the HLCC in the Capital Market should e constituted with Deputy Chairman, Planning Commission or one of the Member of the Planning Commission as his nominee as Chairman.

(XIII)              Futures prices indicate democratically observed price expectations at future date. Thus, given his capacity and availability of other enabling infrastructure such as warehousing, finance etc. he will be able to exercise his marketing option in such a way as to maximize his income realization.

(XIV)           Reforming spot market should also be a top priority.  Model APMC Act and operationalizing the same by appropriate set of rules and regulations needs to be expedited.

(XV)            Banks and Financial Institutions which are at present not permitted to trade on Commodity Markets should, subject to approval by the Banking Regulator, be allowed to trade up to limits required for the purpose of devising customized OTC products suited to the needs of small and marginal farmers.

(XVI)           National Exchanges are launching a pilot scheme of Aggregators’ who will collect retail produce of the farmers and hedge it on the platform of exchanges on behalf of the farmers. Farmers Groups, Co-operative institutions, RRBs, CCBs, NGOs, State Agricultural Marketing Boards, Warehousing Corporations, Commodity Development Boards which work in the rural areas and thus have close association and trust of farmers should be allowed and encouraged to act as aggregators. The rules and procedures of futures trade in Exchanges should clearly lay down conditions to enable these entities to access the markets on behalf of the farmers.

(XVII)         The setting up of national spot electronic exchanges by the national commodity exchanges is an attempt to create a national integrated market.  To promote integrated national markets, central Government should take active steps to bring inter state spot trade under the regulation of a central authority rather than leave it to highly scattered APMCs. Entry 33 in the concurrent list of the 7^th schedule of the Constitution seems to provide such a jurisdiction.

(XVIII)        Conditions should be created so that farmers can use agri futures market to transfer their price risks. The contract designs should be tailored to meet the needs of the physical market.

(XIX)            All regulators operating within the commodity markets space (like FMC, Warehouses, banking spot or APMCS) work in cohesion.  The Government should ensure that a closely coordinated structure is put in place to achieve this.

(XX)             It is of prime importance to create structure which enables dissemination of prices to the remotest corners of the country.  This will ensure that benefit of price discovery of exchange platforms reach the farmers.

(XXI)            In case of agri commodities only simple options may be allowed for some time till market attains maturity and operations and regulations and farmers attain adequate understanding of the market and of technique to use them. An  assessment should be made of the possibility of agencies implementing MSP including FCI acting as the writer of ‘call’ and ‘put’ options in agriculture commodities. This could reduce the cost of operations and incentivise market operations. The operation of MSP is like a zero premium option and options and MSP need not conflict. Whereas open-ended purchase could continue to be made at MSP as floor price, exchanges should be able to offer market based options at strike   prices higher than the  MSP. Farmers should be encouraged to participate in these put options for which FCI can be the options writer.

(XXII)          There is a need to have a strong and resilient agriculture sector attracting investment for raising production and productivity. For this it is necessary to make agriculture a remunerative option. The vibrant agriculture markets including derivatives markets are the frontline institutions to provide early sign of future prospect of the sector. Vibrancy in these markets give signal about commodities which deserves flow of investment.  These markets deserve to be promoted for giving such signal.

(XXIII)         Four members have given their individual notes. The main point therein are as under :

  Prof. Abhijit Sen

 The recent experience with respect to wheat trade does provide some evidence, albeit inconclusive, in support of critics who argue that futures trading may be associated with factors that can impede the operation of the public system of grain procurement, storage and distribution.

Combining prudence with benefit of doubt, the best course of action would be to identify those commodities where there is possibility of futures trading affecting expectations that may influence inflation in essential commodities and insulate these from futures.  Therefore, the suspension of futures trading in the four sensitive commodities should continue and, in the case of sugar and edible oils, discussions with processors held on how much hedging benefits they currently derive from futures markets, and a decision taken accordingly.

 In the case of other commodities, it may be necessary to reassure the Exchanges of a long term commitment to fostering growth of these markets, subject to necessary corrections of the many weaknesses that have been identified in the Report with respect to contract design and excessive speculation. Even with continued suspension on futures trading in sensitive commodities, the scope for enlarging futures trading is still huge since, despite its recent rapid growth, the existing volume of futures trading for most agricultural commodities is still relatively low compared to international  norms  on  the  ratio  of  volume  of  futures  trading  to  production.   In addition, measures that will allow farmers to have genuine access to futures markets and benefit from them, most importantly the provision of adequate rural infrastructure and other enabling conditions, must be implemented.  Therefore, while foodgrains production is increased in Mission mode as per existing policy, the focus, as far as futures trading is concerned, should be on creating conditions for orderly growth and diversification in other segments of the market for agricultural commodities in a manner that will provide benefits to farmers and ensure more stability in crop prices.

 Shri Sharad Joshi

The direction of causality between futures and spot prices there is no indication of any unambiguous direction of impact. For some commodities post futures price inflation appears to have accelerated while for some it has slowed down. Similarly, the direction of causality also does not emerge in its clear unambiguous manner. It must also be kept in mind that this behaviour in the spot market is also subject to significant influence of supply factors.

The tirade against the futures markets started taking socialistic overtones and supporting the demand that would mark the return to the days of low-cost economy and imposition of negative subsidy on farmers. Those who were by mindset all against free-market started advocating a dual policy of globalisation. Full-scale globalisation for non-agricultural sectors, particularly industry and services and installation for agricultural commodity markets.

Prof. Prakash Apte

A thorough analysis of the available Indian data both in terms of behaviour of agricultural commodity prices pre and post futures trading and the direction of causality between futures and spot prices does not reveal any unambiguous direction of impact. For some commodities, post futures price inflation appears to have accelerated while for some it has slowed down. Similarly, the direction of causality also does not emerge in a clear unambiguous manner. It must also be kept in mind that price behaviour in the spot markets is also subject to significant influence of supply factors. Further, with progressive opening up of the economy including trade in agricultural commodities, Indian markets cannot be insulated from global factors. It is illogical to argue that futures markets are a channel for global factors to influence the domestic spot markets. In an open economy, global supply-demand related factors will impact on the domestic markets whether futures trading is permitted or not.

Similarly,   empirical analysis of Indian data does not lead to an unambiguous conclusion. Here too factors such as supply constraints and global trends and their effect on market participants’ sentiments has to be kept in mind.

It is a fact that there are infirmities in the working of spot markets and agricultural markets. But they may not be held as a reason to postpone indefinitely the initiation of measures to improve the function of spot and future markets. Instead of arguing that future trading interfere government procurement and functioning of PDS, It is time we initiate steps for Government to gradually distance itself from the direct contact between suppliers and consumers in agricultural commodities. Availability of adequate essential commodities to low income groups can be handled in other ways such as food coupons. Universal subsidization in any case does not enhance overall economic welfare.

Banning futures trading in agricultural commodities including basic food grains is not a desirable policy action. Policies to improve spot market functioning, enhance farmers’ knowledge of and access to futures markets, augment availability of adequate storage and financing against warehouse receipts and ensure transparent functioning of futures markets are certainly warranted but initiating such policies does not require banning of futures trading even in essential commodities.

Prof. Sidharth Sinha,

 Futures trading having an adverse impact on wholesale and retail prices cannot be used as a basis for continuing the delisting of futures contract on certain commodities.

There are of course weaknesses in the functioning of the futures market but they their improvement rather than banning.

An efficient futures market requires government and markets working together in a synergistic manner. Both the government and markets have to recognize the important role played by the other.  Governments can provide the legal, regulatory and infrastructure support to enable markets to function without manipulation and ‘excessive speculation’. On the other hand markets need to provide the government with efficient mechanisms to achieve its objective of ‘inclusive growth’.

In the process markets will fail sometime. But so do governments.

MP/