Secondly, the specifications of the basis and deliverable grades of the international futures contract were too broad in regard to both quality of pepper and its origin. With deliveries allowed in several overseas countries like Bangkok in Thailand, elem in Brail, Kuching in Malaysia, Panjang in uncertainties for effective price making and efficient risk management for exporters in India and other pepper exporting countries.

It iscertainly not in the interest of the exporters of pepper to hedge in a contract where they may be constrained at times to receive deliveries abroad, when they actually need to procure locally for effecting shipments.

Even though delivery is really not contemplated against a futures contract, except in a residual sense for transactions remaining outstanding at maturity for one reason or other, delivery considerations weigh significantly in determining prices and maintaining the desired relation between the physical and futures markets. However, it would be difficult for a contract that allows deliveries of varying qualities in several countries of origin to perform properly the price discovery function and to maintain an appropriate relation with the prices in the physical markets of different countries.

Last but not the least, the recent introduction of the dollar unit of quotation has added to the risks and uncertainties of domestic players. Not only do they need to manage price risks, but also the risksof fluctuations in the rupee-dollar rate. The Clearing Corporation also faces the twin risks.

Incidentally, with the unit of trading (of 2.5 tonnes) being different from the unit of delivery (of 15 tonnes), it is feared that the contract may face both legal and practical problems in settlement of its transactions. Since delivery of goods is neither intended nor possible for transactions of less than five units, it is probable that such transactions may be construed as wagering deals and are likely to be void ab initio under the Indian Contract Act.

Practical problems may also arise at settlement through delivery on maturity of a delivery month, if some buyers or sellers hold outstanding positions that are less than the prescribed unit of delivery. All in all, the international pepper futures contract appears to be caught in a web of doubts and uncertainties. No wonder, it has failed to take off.

Castor oil futures Learning its lessons from the pathetic experience of other commodity exchanges, especiallythe IPSTA, the Bombay Oilseeds & Oils Exchange (BOOE) shrewdly avoided the pitfalls into which the international pepper futures contract found itself trapped into.

The quality specifications of the basis and deliverable grades of the international castor oil futures contract do not unnecessarily stray away from the domestically produced castor oil and permits deliveries in just about 10 centres - all within the country, of which six (including Kandla) are in Gujarat, three comprising Mumbai, Navi Mumbai and JNPT-Nhava Sheva in Maharashtra and one at Hyderabad in Andhra Pradesh. While restricting the delivery centres at the know places in the three adjoining States, BOOE has scrupulously avoided issue of deliveries at any overseas destinations.

The trading lot for the international castor oil futures has been fixed at as low as five tonnes and the prices quotations will be in Indian rupees per 10 kg. as per the local practice. Prime-facts, the contract therefore seems ideally and speculators. However,the unit of delivery (at 10 tonnes) differing from the unit of trading may create problems similar to those described earlier for the international pepper futures.

Moreover, the neglect of the existing castorseed futures contract traded at BOOE and the rigid quality specifications prescribed for the basis and tenderable grades of castor oil, not to speak of the prohibitively high security and margin deposits as well as transaction costs and absurdly low limit on daily price fluctuation (of just two per cent), raise serious doubts about the probability of success of the castor oil contract.

Hasten slowly

The problems with the coffee futures contract at Bangalore may not be far different from those of other newly openly futures. In any case, it is not our purpose to delve into the terms and specifications of all the newly opened futures contracts in order to identify their lacunae.

In fact, the few shortcomings of some of the contracts brought out here are merely indicative and illustrativerather than diagnostically precise and exhaustive. These essentially highlight the need for very careful scrutiny and analysis of the contract specifications by the commodity exchanges concerned and the regulating authorities before approving them finally and embarking on the course of regular trading in them. It is necessary to hasten slowly in the matter by involving all the potential players - hedgers, speculators and brokers - in the framing of contract specifications.

Uneconomic cost-benefit ratios

Aside from the unsuitable and inappropriate contract specifications of the newly started commodity futures, giving rise to considerable risks and uncertainties rather than serving as effective instruments for risk avoidance or risk reduction, the stringent admission and regulatory conditions, including exorbitant entrance fees and annual subscriptions; heavy security, initial and variable margin deposits ; absurdly low limits on price fluctuations and trading, cumbersome daily clearing and reportingprocedures involving large establishment costs; high brokerage and transaction costs as well as clearing fees, have all tended to raise significantly the costs of operating in the futures markets without any increase in the benefits flowing from such operations.

In fact, the low daily limits on price movements have already restricted the potential benefits from speculation to the day traders and jobbers. With not many hedge and speculative interests being attracted to these markets, the volumes have remained unusually small, escalating in the process the per unit fixed cost of transaction, let alone the variable cost which disappointingly increases progressively with the size of trading positions.

Above all, owing to low volumes, the difference between the bid and asked prices - a major element in the transaction cost - is also high. The resulting uneconomic benefit - cost ratios have actually created a vicious circle of high costs-low volumes-higher costs and still lower volumes, without anycompensatory rise in gains.

The market and regulatory authorities are justifying the high fixed costs and the stringent clearing and margin deposit system as necessary to avert the counter-party risks. The scams sin the stock exchanges in the recent past and the prevailing U.S. and Western practices in the leading commodity exchanges abroad are cited as additional strong reasons for introducing such stringent security systems in the newly opened commodity exchanges.

But the stock exchange specimen in which large corporate players and major financial institutions, both domestic and foreign, operate in a big way, is rather irrelevant for the commodity exchanges, besides the fact that the stock market regulations have virtually killed the growth of the capital market, especially the primary one and almost kept the individual investors at bay.

Moreover, the stock exchanges have still not introduce the derivative trading for risk management and are therefore far from comparable with the functioning of thecommodity exchanges, the raison d'etre of which is primarily the risk management.

As for the Western practices of clearing and regulation, it appears that it is rather too early to introduce these in the Indian soil at this stage. Far from reviving commodity futures, they have simply nipped them in the bud. To be fair, there is no gain saying the fact that our new commodity exchanges are still in the infant stage and are unable even to sit up, leave aside to crawl, walk and run. To tie them at this stage in severe regulatory knots is sure to stunt their growth in infancy.

It should also be recognised that market operators are actually not altogether averse to taking risks. After all, all businesses involve risks. Neither is hedging nor speculation in a futures market totally risk free. In these circumstances, and especially when the new commodity futures are yet to get off the ground, there seems no urgent need to raise the bogey of counter-party risks to introduce prohibitive admission rules and penalregulatory and clearing procedures.

The introduction of such systems can probably wait till the number of participants and the size of trading volumes improve considerably. Till then, such measures as weekly clearings, liberal price fluctuation limits (of five per cent, or even a little more) and reasonable limits on trading positions can suffice to regulate markets and ensure their steady growth.

One also needs to be reminded that at present speculators have several alternative cost and hassle free avenues of gambling like horse-racing, betting, card games, etc, aside from unofficial and unregulated futures trading (in which, surprisingly, participants seem to face counter-party risks without serious difficulty).

One can hardly hope to bring such unofficial trading in official channels (which should be one of the goals for reviving regulated commodity futures markets) by resorting to high entrance fees and harsh regulatory measures.

As it is, even the tax laws militate against speculative trading inrecognised exchanges. Clearly, a more liberal approach is called for to entice hedgers and speculators to the new commodity exchanges. For that purpose, bewildering though it may appear, it is essential for some time to throw caution to the winds and permit more free futures trading in commodities.

Lack of awareness

Last but not the least, none of the new commodity exchanges seems to have made any serious attempt at marketing its product. Commodity futures trading virtually died in this country nearly four decades back, sporadic activity in selected moffusil markets in minor commodities notwithstanding.

While the old generation conversant with the nuances of derivative trading has hardly survived through this period (the few survivors were unabashedly laid aside by the new management of the commodity exchanges whole framing contract specifications and trading bye-laws), the new generation in commodity trade and industry is scarely aware of the commodity futures market operations.

The need forcreating such awareness is all the more in the present times when nothing new is sold anywhere without neatly planned massive initial promotional efforts at marketing (includign test marketing) and widespread advertising through diverse media sources. Disappointingly, the new commodity exchanges embarked on their futures contracts without any road shows and other promotional efforts at creating wider awareness among the potential beneficiaries of such contracts.

Commodity futures trading, be it in the form of hedging or speculation, is a complex exercise. It requires vast efforts at gathering and analysing information on the factors - fundamental and technical - affecting prices in the physical and futures markets and their inter-relation. Many universities and academic institutions in U.S.A. and Europe offer regular courses in derivative trading and risk management.

Nothing similar in nature is provided anywhere in India. In recent years, the stock exchanges have developed their own training institutes;but the commodity exchange have failed to organise any training programmes. Even more than marketing, training is the basic pre-requisite for developing a successful commodity futures market.

In the absence of any training in the risk management techniques and price forecasting methodologies, it is not surprising that the new exchanges have failed to attract participants from the corporate world in commodities and financial institutions. Without their entry, it would be difficult to sustain futures markts in commodities in India during the next millennium in the face of impending globalisation adn intense international competition among world comodity futures markets. In that event, any talk of overtaking Chicago would remain a wishful thinking.

In conclusion To conclude, the failure of the new commodity futures markets, though alarming, is far from amazing. No doubt, the new markets were started in right earnest; but one cannot help feeling that they began with undue haste (though they took a long timeto establish) and without adequate requisite preparations. Too much emphasis was laid on computerisation rather than on the basics.

The contract specifications appear to have been rather improperly - either two broad to render the contracts bearish and biased against short hedgers, or too narrow to discourage sellers. the pre-feasibility studies (of techno-economic viability) were either not carried out, or if undertaken do not seem to have done correctly. The promotional, educational and training efforts which should have preceded the establishment of futures markets were conspicuous by their absence almost altogether.

Worse still, the entry and regulatory norms were framed on mutual mistrust and suspicion rather than faith. It was little recognised that business develops mostly on trust and faith. Suspicion breeds suspicion and creates scare and panic.

Institutions built on mistrust of their members are therefore unlikely to succeed. Paradoxically, there were little efforts at development of futurestrading as such. Instead, emphasis was wrongly placed on regulation and avoidance of counter-party risks, even though the Forward Contracts (Regulation) Act and the trading bye-laws of the commodity exchanges already provide enough powers in the armoury of the regulators.

The history of the sixties when the draconian regulations annihilated futures markets in major commodities appears to be repeated. Actually, since futures trading in commodities is being revived in this country after almost four decades and the generation familiar with such trading has ceased to exist, the authorities need to have taken steps to create awareness and promote the development of derivative trading in the new generation.

For that purpose, to begin with futures trading business be declared as "industry". Tax incentives should be offered. Profits on hedge and speculative business in commodities need to be treated on par with export profits, especially for dealings in recognised international commodity exchanges in India andabroad. Speculative losses should be permitted to be offset against normal business profits. Speculation should no longer be viewed as unhealthy, but considered as a vital economic activity performing the essential functions of price discovery and risk bearing.

Banks and financial institutions should be encouraged to participate in th equity capital of the commodity exchanges and their clearing corporations. Banks should also recognise `hedged' positions and offer liberal credit at concessional interest rates on stocks and forward sales in commodities covered by such positions. The era of selective credit controls is already over. The new era of commodity credit liberalisation needs to be ushered in with the opening of futures markets in commodities.

In short, efforts should be directed at developing commodity futures markets in reality, and not by paying a mere lip service to such development while concentrating all the time on introducing innovative regulatory measures. In fact, it is perhaps time toreplace the half century old Forward Contracts (regulation) Act , 1952 by a new Commodity Derivative Contracts (Development) Act.

That way a new vista would be opened in futures and derivative trading to enable the commodity trade and industry to operate in the near future in not only commodity futures, but also currency and financial (interest rate) futures to compete effectively with the overseas commodity players in the ensuring liberalised WTO era of the 21st century.

Immediately, the commodity futures markets should provide them with the necessary ground for training and learning. The commodity exchanges and the overseeing authorities must act with such an objective, if India were to play its rightful role in the world trade in commodities during the next millennium.

(The author is an independent consulting economist)