Date: 17/09/2022

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment; Inclusive growth and issues arising from it.

Key Phrases: Commodity Exchanges, Securities and Exchange Board of India, Forward Markets Commission, Trade Ban, Derivatives Market.

Context:

• The recent trading ban on seven commodities has led to a steep drop in volume and can do permanent damage to sentiment.
• The derivatives market helps farmers in price discovery, which brings into discussion its role in changing the market sentiment in commodity trade.

Background

• India derives one-fifth of its GDP and more than 40 per cent of jobs from agriculture.
• We are surprisingly callous about the way in which agricultural produce is priced, marketed and traded.
• Spot trading in most agri commodities is done in an opaque and decentralized manner in mandis, short-changing farmers.
• The trading of agricultural futures and options on stock exchanges is a way to address this lack of transparency in pricing; through backward linking of agri derivatives to spot markets.
• But policymakers have mostly looked at trading in agri derivatives with suspicion.
• Some commentators have even compared commodity exchanges to a gambling den.
• This archaic view has led to frequent bans on commodity trading, apparently to check price increases and protect consumers.

Ban on Trade

• There has been a string of such trading bans over the last two decades.
• In 2007, trading in derivatives of wheat, rice, tur and urad was banned, with only the ban on rice being lifted since then.
• Trading in sugar was banned in 2009 and lifted a year later.
• In 2008, a six-month trading ban was imposed on potato, rubber, and chana and soy oil.
• It was hoped that the stance towards agri derivatives would become more progressive once SEBI took over the regulation of commodity exchanges from the Forward Markets Commission in 2015.
• But the one-year ban on trading in paddy, wheat, crude palm oil, chana, soya bean, mustard and moong imposed shows that not much has changed.
• Commodity exchanges continue to be the scapegoat for policymakers wanting to be seen ‘doing something’.

Futility of ban

• The futility of such trading bans in controlling prices has been discussed and debated quite widely in recent days.
• The Abhijit Sen Committee which examined the influence of derivative trading on spot prices in 2008, did not find any conclusive evidence of a link between the two.
• The report noted that “Indian data analyzed in this report does not show any clear evidence of either reduced or increased volatility of spot prices due to futures trading.”
• If we consider the movement of CPI and WPI cereal and pulses indices, the trading ban in December 2021 did not have any influence on inflation in this category.
• Inflation surged sharply immediately after the trading ban, in January and February 2022, due to global supply shortage and increased demand on the reopening of the economy.
• The Ukraine incursion, of course, led to prices of agri products skyrocketing, exacerbating inflation, and proving the ban in December 2021 completely ineffective Presence of Derivatives Market
• In periods of crisis such as this, the presence of a derivatives market is of utmost importance for farmers and commodity users to shield them from price risks.
• Absence of futures and options on critical commodities in the initial period of the Russia-Ukraine crisis would have cost users dearly.
• The presence of a derivatives market helps in checking unbridled price increase since the short-sellers begin squaring their positions after a certain level, thus halting upward movement of prices.
• The knee-jerk trading ban in December has thus proved counter-productive in controlling prices.

Bleak future for commodity exchanges

• India’s trade in cotton and spices had made it one of the richest countries, before colonization stripped us of all the resources and skills.
• A transparent, deep and credible spot and commodity market can go a long way towards improving agri GDP, contributing to overall growth.
• But instead of taking steps to boost activity, traders and investors are being driven away from markets due to ad hoc policy actions.
• The average daily traded value on NCDEX, the largest commodity exchange in India, has dropped from ₹1,897.74 crore in 2021 to ₹970.10 crore in 2022.
• With some of the most liquid agri contracts banned, trading activity has plunged.

Cause of concern

• Of concern is the fact that agri trading in India had been sliding over the last decade.
• Daily traded value in 2022 is just 16 per cent of that in 2012.
• The credibility of commodity derivatives was eroded significantly after the NSEL scam in 2013; daily trading value plunged 38 per cent in 2013 compared to 2012; and has not recovered since.
• Regulatory uncertainty tends to impact trading sentiment and volume considerably.
• Sudden trading bans make traders exit permanently from the segment.
• Research shows that trading activity seldom picks up in commodities that have faced trading bans.

Way Forward

• As a first step, policymakers need to understand the futility in exchange trading bans in controlling spot prices.
• Prices can be controlled by regulating imports and exports and tariffs on external trade, stock holding limits and so on. Banning futures and options is regressive, very rarely used globally.
• Not only should the trading ban be revoked, SEBI has to communicate to all market participants that such measures will not be taken in the future. This is imperative to restore confidence among market participants and to bring them back to the bourses.
• Efforts need to be made to increase activity and participation in agri commodity futures and options. This can help serve as a powerful tool for helping price discovery in the spot market.
• And, most importantly, the eNAM project — which seeks to create a single national market for agri commodities through a pan-India electronic trading portal networking all the existing APMC mandis — needs to be expedited. The progress of this project, which began in 2016, has not been too good.
• A unified electronic spot market for agri commodities will create a strong base for agri derivatives.
• The electronic spot and futures market, together, can improve realizations and risk management for farmers and industrial users.

Source: The Hindu BL  

Mains Question:

Q. The recent trading ban on seven commodities has led to a steep drop in volume and can do permanent damage to the market sentiment. Comment. [150 Words].