One of the questions that commodity exchanges have to often field is an existential one. Why should commodity exchanges exist? Do they serve any economic and social purpose? What does price discovery and risk management (two key functions of commodity exchanges) mean to a common person? Why would a person who is not interested in investing in commodity derivatives be interested in understanding or using commodity exchanges? Here is an attempt to explain why.

There is no gain saying that inflation affects us all. But how many of us can use the wholesale price index (the common barometer of inflation) to make decisions for our homes? Instead if somebody tells us what the price of petrol is would be one month/two months down the line or what the price of sugar,wheat, pulses would be, would it help in making our budgeting exercise? For an answer to that question I would hazard a guess: yes. And that is precisely what commodity exchanges do. They provide us with forward prices of commodities.

Thus, without investing a single rupee in commodity futures an ordinary person is gaining from their existence.

It must be remembered that commodity exchanges reflect both rising and falling prices. So in December 2010, while there was talk about sugar prices rising (despite fundamentals indicating the opposite) when permission was granted for relisting of sugar futures, the futures prices started to indicate a falling trend for the month ahead (January 2011). And finally what did we found in January? Prices of sugar in the spot market went down. The futures market had correctly predicted the trend. That kind of information is definitely more valuable for household decisions than say a wholesale price index based inflation figure for sugar, which is available after a lag i.e. after the event has occurred.

While we are discussing falling prices let us consider another case, that of pulses, especially tur and urad. Anticipating low output even this year, importers (taking advantage of the policy allowing duty free imports of pulses) had imported pulses in December 2010 to be sold this season in the domestic market.

However, their calculations backfired and they were left with stocks of pulses because by the time their consignment landed in India the domestic prices were ruling lower than the price at the Mumbai port. Now why didn?t they use prices on commodity exchanges before making a decision to import the pulses? That is because tur and urad are not allowed to be traded on our commodity exchanges and therefore, there was no reference forward price to take cues from. If futures trading in tur and urad were permitted two things could have happened: the traders could have taken inputs from futures prices to arrive at their importing decision (rather than looking at the past prices).

Alternatively, they could have still imported their goods but sold it in the futures market i.e. got into an agreement for selling in the future and hedged their risk. This brings us to the second important economic function of commodity futures market: that of offering a risk management tool that can be used effectively by end- users of commodities to manage their risks. What commodity futures offer to hedgers is certainty. The importance of certainty in business decisions cannot be overstated. Consumers are affected directly by such business decisions as well therein tying the existence of commodity exchanges with consumer well-being.

The above examples are illustrative of the potential of using commodity futures even in an environment of falling prices. The utility of price discovery and risk management functions of commodity exchanges in an environment of rising prices is too facile to be spelt out. Who would not be benefited from knowing that the prices of onions would be higher in the near future?! Incidentally, onions are not traded on commodity exchanges. But potatoes are. So next time you want to know what the outlook on potato prices is, do steal a glance at potato futures on your preferred exchange.

The author is a senior economist, NCDEX. The views in the piece are personal