India needs robust agri futures to insulate against volatile food prices against backdrop of uncertainty

The reason d’etre for commodity derivatives is two-fold: 1) The Efficient Price discovery due to the wide participation of the entire value chain and institutional participants 2) The Hedging of price risk that underlying commodity product throws up due to global demand-supply through the use of the derivatives.

futures and options, F&O, stock market, commodities
The importance of agri exchanges cannot merely be confined to hedging only, but also extends to price dissemination and market integration.

By Narinder Wadhwa

This year the various regions in Europe have been experiencing an abnormal rise in temperature and many cities’ temperatures crossing over 40 degrees!!! The world is having hotter, drier summers and warmer, wetter winters. We’re also having extreme weather like heavy rainfall and heat waves more often. Most scientists agree that this is caused by human actions that emit greenhouse gases like carbon dioxide. The climate is already changing and is expected to change even more, as a result of the number of greenhouse gases we have released into the atmosphere. This will be experienced as changes to our average weather and the frequency and intensity of extreme weather.

The world has already warmed by about 1.1C since the industrial era began, and temperatures are set to keep rising unless sharp cuts are made to carbon emissions. Climate experts warn that global warming has increased the frequency of extreme weather events. The unimpeded growth of greenhouse gas emissions is raising the earth’s temperature. The consequences include melting glaciers, more precipitation, more and more extreme weather events, and shifting seasons. The accelerating pace of climate change, combined with global population and income growth, threatens food security everywhere.

Agriculture is extremely vulnerable to climate change. Higher temperatures eventually reduce yields of desirable crops while encouraging weed and pest proliferation. Changes in precipitation patterns increase the likelihood of short-run crop failures and long-run production declines. Although there will be gains in some crops in some regions of the world, the overall impacts of climate change on agriculture are expected to be negative, threatening global food security. 

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Populations in the developing world, which are already vulnerable and food insecure, are likely to be the most seriously affected. Agriculture is one of the socio-economic sectors most sensitive to climate change, dependent as it is on soil characteristics, weather patterns and biodiversity. Climate change affects precipitation, water flows, humidity and temperature. The frequency and magnitude of extreme weather and climate events will increase, and the distribution and abundance of pest species and pollinators may change. These changes will influence crop growth, phenology and yields, ultimately leading to shifts in zones suitable for cultivation and land use changes. 

Uncertainties 

There are other geopolitical factors this year that have accentuated the uncertainties and global supply challenges like the Russian-Ukraine war that has disrupted the trade flows causing shortages. The interruption in the Black Sea wheat trade and high prices have raised serious concerns about rising levels of food insecurity, poverty, and instability around the world. Apart from being among the world’s leading producers of sunflower oil, this region is also a major producer of corn barley), rapeseed, wheat, and sunflower oil. Then, there are sanctions and blockages.

Global Trade

Nearly a quarter of food for human consumption is traded on international markets. The shortages or oversupplies can lead to price swings. Trade can dampen price volatility by buffering demand and supply across regions. Under such circumstances, an economy is generally left with two response options: risk management responses from governments by disbursing the buffer stocks through the public distribution systems thereby ensuring access to food for all, and second, risk management through market-based instruments like derivatives, e.g. forwards, futures, options, etc.

As price and event shocks impede the food value chain, producers and consumers require risk management options to combat such risks. In this background, the producers and consumers need a robust risk mechanism and reliable platform for discovering the prices. 

Agri Derivatives (Futures & also options)

The reason d’etre for commodity derivatives is two-fold: 1) The Efficient Price discovery due to the wide participation of the entire value chain and institutional participants 2) The Hedging of price risk that underlying commodity product throws up due to global demand-supply through the use of the derivatives. The various participants such as agricultural commodity processors, traders, millers and aggregators hedge their commodity price risk by using agri-commodity derivative products available on recognised exchanges in India. Prices for farm products rise and fall due to changes in the supply or demand fundamentals, real or perceived, for that product. Periods of tight supplies usually cause high prices. Periods of excess supply can cause low prices.

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Of course, the importance of agri exchanges cannot merely be confined to hedging only, but also extends to price dissemination and market integration. It has often been stated that the success of the commodity exchanges in India to emerge as platforms for price discovery, risk management and price stabilisation and integration across markets of course product innovation, uninterrupted trading in agri futures, liberalized attitude of policymakers and thereafter risk management will be embraced across the food value chain. 

Better risk management instruments, better product innovation, and efficient market infrastructure institutions are becoming increasingly important for India not merely to combat emergencies like pandemics or war: they are also important because India contemplates signing free-trade agreements (like the proposed Comprehensive Economic Cooperation Agreement (CECA) with Australia by the end of 2022) that will expose Indian food sector to greater external exposures and competition.

(Narinder Wadhwa is the National President of Commodity Participant Association of India (CPAI). The views expressed are the author’s own. Please consult your financial advisor before investing).

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