?Opening up commodities trade could de-risk economy?

The last year has seen significant increase in commodity prices across the board. Once again the commodity bugbear is being bandied about as a potential party-spoiler hindering GDP growth.

As a major producer or consumer of a host of commodities ranging from wheat, rice, cotton, gold and metals, it is imperative that we take immediate steps to de-risk our economy in a scientific manner and with tangible economic benefits. This can only happen if we can do what it takes to manage those risks at the macro level as well as through knowledge extension at the micro-level for suitable aggregation.

To start with, the risk we’re talking about is the quantifiable likelihood of loss or less-than-expected returns and not the potential upside of risk! Secondly, commodities would cover the entire raw materials universe like crude oil and metals like copper and though immense scope exists in de-risking our economy through these, I am mainly focusing on agricultural commodities for now.

Why? Because, given India’s large dependence on agriculture, there are increased risks for us, some of which go beyond economics.

In the unfolding global scenario, our agri-industry is in the process of integrating into the world markets with enhanced opportunities and attendant amplification of risk. Therefore, our commitment to comply with WTO requirements including subsidy issues and phytosanitary measures can affect our ability to meet domestic and international obligations and become a major factor in our quest for faster economic growth.

Locally, farmers are also grappling with higher input costs, previous debt payments and unscientific Minimum Support Prices and not all risks can be successfully managed. Finally, in the changing world order, our aim for economic dominance must result in economic benefit – and therefore our ability to be price-setters is also dependent on other infrastructural issues like logistics and our speed and efficiency in ensuring that the requisite information reaches the farmers themselves.

Of course, these issues would be tackled at different levels; for example hedging would be done by aggregators as is the case the world over, it is not expected that individual farmers need to get into this aspect of risk management.

While it is nobody’s case that risk can be entirely eliminated, it is certainly necessary to provide our farming community with enough tools to combat the new challenges efficiently. Hedging against future price risk is an obvious solution and the raison d’etre of commodity exchanges.

Currently, hardly anybody hedges and that is mainly due to two reasons – first, the concept of de-risking or hedging is not widely known and second, there is no incentive for hedging and in fact there are some downsides too.

A few proposals can be considered immediately – there should be tax, loan and credit benefits to farmers who hedge.

Futures exchanges have done their bit in providing an efficient platform for hedging; there should be full clarity that banning of listed commodities will no longer happen. Also, options should be listed forthwith.

There has been an argument that farmers may not understand the product; it is not fair to underestimate the intelligence of our farming cooperatives in a business that has been going on forever.

Options are easily easier to understand than futures and have limited financial commitment if bought; therefore there are no mark-to-market or margin issues. Most importantly, options give potential upside benefit to the buyer which is a facility simply not available in futures. Options as efficient price-hedging tools are used worldwide and essentially provide insurance to farmers.

And surely if the Government of India can hedge with options on CBOT, why not our own people? Similarly other derivatives can be introduced over a period of time for use by different participants of the agri-ecosystems, small and large.

Obvious risks which affect output, productivity and ability to meet commitments are the weather, freight and raw material costs and suitable derivatives on each of these should be made available. In sum, for effectively de-risking the economy care has to be taken that implementation at the micro level is diligently done.