The National Commodity and Derivatives Exchange has inked a pact with the India Meteorological Department for launch of India’s first weather derivatives. V Shunmugam & Kailvalya Dhase explain how such derivative contracts can help farmers, businesses & financial institutions trade weather outcomes
l What are weather derivatives
DERIVATIVES ARE RISK-SHARING tools used by businesses, investors, and institutions to guard against future uncertainties. Their value depends on an underlying asset or variable, like a stock, commodity, or even the temperature in Delhi in May. Farmers can hedge wheat price drops, airlines can manage jet fuel costs, and exporters can protect against currency swings. Although financial, these tools serve a real economic purpose: transferring risk from those who bear it to others willing to take it.
Well-designed weather derivative contracts, supported by a rich ecosystem of participants empowered with data and analytical models, help farmers and businesses make better plans, reduce uncertainty, and support long-term investments.
To make weather tradable, it has to be measurable, time-bound, location-specific, and independently verifiable. It must be reduced to a number that both parties agree to before the trade and accept without dispute at the time of settlement. The most commonly traded weather variables globally include:
n Temperature, as measured by Heating Degree Days (HDD) and Cooling Degree Days (CDD), are simple indices that track how much daily temperature deviates from a set base.
n Rainfall or precipitation, where contracts are structured on cumulative rainfall (e.g., total mm over a month in a district), or deviations from long-term averages.
n Snowfall or wind speed is more common in advanced markets with exposure to ski tourism, construction, or wind energy projects.
l How are weather phenomena traded
WEATHER PHENOMENA are traded not as weather events but as numerical outcomes of weather data. For example, a rainfall futures contract might pay Rs 5,000 per mm shortfall if actual June rainfall in Nashik drops below the 100 mm threshold. The data source, such as the IMD or an approved private station, is agreed upon beforehand.
In parts of Rajasthan, informal markets still operate based on weather cues, like cloud cover and gut-based monsoon predictions, relying more on instinct than data. Weather derivatives provide structure to this by enabling stakeholders to trade quantifiable weather outcomes—such as temperature or rainfall—based on independently verified data, with predefined settlement terms.
l Insurance product vs derivative
INSURANCE CAN BE more helpful than a derivative when the loss is catastrophic, specific, and asset-based, such as storm damage to a warehouse or floods destroying inventory. It compensates actual losses after verification. Derivatives, by contrast, are suited to non-catastrophic, recurring risks, such as low rainfall or cooler temperatures, that affect revenues but not assets. Insurance safeguards property; derivatives shield cash flows. Together, they provide layered climate risk coverage.
l How stakeholders can use these
THINK OF A small bottling company in Gujarat. It typically sees a sales surge in summer. But what if May turns out to be unusually cool? The company faces a drop in demand, and no insurance policy covers that. By buying a temperature derivative that pays out if average May temperatures stay below 36°C, it creates a cushion to offset lost sales.
A farmer in Vidarbha, worried about delayed or patchy monsoon rains, might take a rainfall-linked hedge.
If rainfall is 30% below average, the derivative pays, helping him afford inputs for the next season or repay a farm loan.
For a bank issuing crop loans in Rajasthan, if the monsoon fails, repayments are delayed or defaulted. By holding a rainfall-based hedge against its loan portfolio, the bank can protect its balance sheet, making farm lending more viable. Weather hedging can be factored into the cost of credit, making farm loans cost-effective for lenders.
The common factor here is that each stakeholder transforms a difficult-to-manage, uncontrollable weather risk into a measurable financial asset that can be priced, traded, and settled through a clearing house.
l Deepen climate risk resilience
THE UPSIDE IS significant. A well-functioning weather derivatives market would:
n Enhance credit quality for banks and NBFCs by mitigating weather-related defaults.
n Incorporate real-time, market-based feedback into government policy, reflecting how stakeholders are pricing weather expectations.
n Deepen climate risk resilience, moving India from a disaster-relief mode to a proactive risk-sharing ecosystem.
Weather derivatives will boost demand for high-quality data (farm-level sensors) and predictive tools (modelling platforms), creating local investment opportunities in agritech, climate forecasting, and energy modelling ecosystems that enable more accurate, localised risk management and pricing. But for this to work:
n IMD and private providers must offer high-frequency, granular, reliable datasets for different regions.
n Institutional aggregators such as banks, NBFCs, insurance companies, and agritech platforms must create bundled, distributed products to connect individual users to the market.
Shunmugam is partner – MCQube while Dhase is a finance scholar at the National Institute of Securities Markets