It is not always that expert committees submit reports with sharp dissenting views. It is even rarer to come across instances where the chairman of the committee himself has different takes on some aspects vis-?-vis other members. In that sense, the Abhijit Sen Committee report on commodity futures trading continues to create ripples even after submission.
Does futures? trading in essential commodities influence their prices? Going by the different positions within the Sen Committee, there is little doubt that there are multiple views in this regard. Indeed, many are inclined to think that futures trading does contribute to price volatility. It is unfortunate that commodity futures, at least partially, are being held responsible for the current spate of rise in prices of essential articles. The fact of the matter, however, is that they don?t.
It?s a welcome development that the Sen Committee did not propose any ban on futures trading, though this might have been the expectation of some. On the other hand, it has proposed continuation of the temporary ban on wheat, rice, urad and tur for some more time. This might give the impression that the committee feels that lifting the ban on these commodities at this point in time will have adverse impact on their prices. But is it really so?
Probably no. One of the main terms of reference of the Committee was to check whether futures trading contributed to rise in prices of essential commodities in 2006. The Committee has indicated that there is no statistical model available for establishing the causality between futures trading and the current rise in prices. In other words, the committee did not come across any concrete statistical evidence of futures trading resulting in price rises. If that is so, then why hold futures responsible for inflation and why the disappointment over them not being banned?
The current phase of inflation appears to have caught most offguard. As a result, one can see the tendency of holding practically everything responsible for the state of affairs. Futures trading, if allowed to occur efficiently, should actually help moderate price rises rather than aggravating them.
How do futures help producers of agricultural products? Suppose a wheat seller has entered a forward contract for delivering his produce at a future date. The contract has built-in price and quantity specifications. After entering the contract, the seller fears a loss. This can arise from fluctuations in prices of his product as he nears the delivery date. In order to cover the loss, he enters into a parallel contract as a buyer with a different price specification for ?hedging? against the probable price loss.
Futures offer producers the opportunity of guarding against price fluctuations arising from unforeseen developments. With appropriate ?put? and ?call? measures, future contracts can help address problems arising from supply disturbances. However, for many, futures imply nothing other than speculation. They fear that such speculative exercises exacerbate volatility and impact prices adversely.
Commodity futures are functioning effectively all across the world. However, like all efficient markets, markets for trading commodity futures also need to have capable regulators and well-established norms for trading. Transparency in transactions is crucial in this regard. This is a point that has also been emphasised by the Sen Committee. In the absence of an efficient regulator, it is difficult for futures markets to help producers ?discover? their correct prices. As the committee has rightly mentioned, there is a strong case for strengthening the Forward Markets Commission (FMC).
Over the last four to five years, futures trading has been allowed in a number of agricultural commodities. Commodity exchanges have been facilitating such trading. There haven?t been occasions, except in the recent past, when commodity futures have been accused of being inflationary. If such trading is intrinsically speculative and inflationary, then why should it lead to high prices only occasionally?
The problem is that with prices refusing to come down and inflation increasingly becoming a politically sensitive issue, the search for culprits has intensified. Futures trading is one of the latest to be accused. Indeed, it would be interesting to look at the price trends of commodities in which futures have been temporarily banned to see the extent of price rise before and after the ban. It would also be interesting to look at different episodes of large and small price rises in recent times for identifying the determinants behind such rises. One suspects that futures trading will not figure in the list. Rather than discouraging such trading, it might be a better idea to come down harder on other acts. The Essential Commodities Act (ECA) blocking movement of agri-produce across the country might be a good one to begin with.
The author is visiting research fellow at the Institute of South Asian Studies (ISAS) in the National University of Singapore (NUS). These are his personal views