Commodity Futures Benefits Farmers, Not Just Traders

Updated: Aug 26 2002, 05:30am hrs
Commodity futures are used mostly by merchants and manufacturers and therefore, it is tacitly believed that its working must be harmful to the farmers. This belief is strengthened by the fact that, besides speculators, the futures market operators in most parts of the world consist of merchants, processors and manufacturers. Farmers are almost conspicuous by their absence. Hence, it is inferred that commodity futures leave farmers and consumers high and dry.

Unfortunately, it is scarcely recognised by those who represent the farmers interests that an economic activity benefits not only those who engage in it directly but also others indirectly or through multiplier induced effect. Paradoxical as it may seem, hedging by merchants in cotton futures benefits the cotton growers as well. As cotton marketing is seasonal and restricted to a few months of a year in each cotton growing region, while its consumption by mills is spread all the year round, merchants need to store cotton for long. Such storage involves considerable price risk. The presence of futures market provides necessary facility to cover the price risk through hedging. With adequate and efficient hedging facility, merchants actually rush to buy cotton as it arrives in the market. In the resultant scramble, cotton prices rise and the obvious beneficiary of the rise is the cotton grower. In the absence of a futures market, the farmer would have received a lesser price than what he actually received as a result of hedging by the merchant. Thus, even if farmers do not make use of the futures market in cotton, they can benefit from it indirectly when merchants hedge their purchases in it. What is more, there is no reason why large farmers or cooperative marketing societies of small farmers cannot directly make use of the futures market for hedging. After all, farmers too face the risk of price fall, when they decide to grow cotton and invest in its production. The farmers are aware of the likely cotton output and its cost, especially as the growing season advances. They can therefore, hedge their crop by selling equivalent futures during the growing or harvesting season. The farmers marketing societies can likewise hedge their members stock of cotton after the harvest. Apart from hedging in cotton futures, either directly or through options, futures markets serve farmers as a source of price information and therefore, assist them in determining their cropping pattern.

Futures prices are more transparent than the ready and inevitably influence the latter. Moreover, since futures prices are fixed through open, competitive bidding, they represent the true equilibrium levels. And insofar as ready prices move in unison with futures prices, even futures markets located far away assist farmers in securing fair prices for their crop, as futures prices serve as refrence prices. The examples given in this book are only illustrative and not exhaustive. But these are suffice to bring out the benefit of cotton futures to farmers and their cooperatives as also to the agencies like the Cotton Corporation of India (CCI), or the Maharashtra State cooperative Cotton Growers Marketing Federation.

CONCLUSION: All in all, it is naive to believe that a commodity futures market, be it for cotton or for any other farm commodity or plantation crop, is inimical to the interests of growers. Commodity futures is not a foe but a friend of the farmers. To be useful to growers, however, it is necessary to develop the futures markets organised by recognised associations so as to make them broad and liquid by augmenting its trading volumes and permitting options. The authorities concerned must take suitable steps towards these ends. At the same time, to encourage farmers and their cooperatives and other agencies to use the futures markets for risk management, the authorities may consider devising suitable incentives and concessions -- financial and otherwise -- to reduce significantly the transaction costs and risks (such as the basis and counterparty risks) associated with hedging operations, without adding any undue incidence of expenses on farmers.

Simultaneously, it is also necessary to allow options and on call as well as unfixed contracts in all commodities which would be of immense use to the farmers.

(Excerpted from the authors recently released book on Towards Development of Commodity Exchanges)