The fall in commodity prices is good news for the Indian economy. This helps lower the overall prices and reduce the government’s spending on subsidies. The fall also helps companies that use the commodities in reducing their costs.
On the flipside, the falling prices of certain commodities—such as metals, etc—mean lowering of production by the producers. The costs of production are not declining and there is a crunch when it comes to profitability. Falling commodity prices can be good; but a continued drop in the prices could cause more damage than good to the Indian economy.
India has had a long and eventful history of commodities-trading with several instances of regulatory vacillation. The role of commodity markets has become even more enthralling with India moving toward greater trade liberalisation, including in the agriculture sector, and getting exposed to the volatilities of international markets.
Earlier, any FDI in commodity exchanges required an approval from the Union government and the Foreign Investment Promotion Board (FIPB). The UPA government, last year, retained the sectoral cap for foreign equity at 49% for commodity exchanges; but it also liberalised this sector by allowing investment in commodity exchanges under the automatic route. This was done to attract more foreign investment and make the existing commodity exchanges more competitive.
Considering the investment growth required by this sector, the RBI sub-committee of the Financial Stability and Development Council revived the issue of allowing financial institutions and FIIs to participate in futures trading. FIIs, banks and other financial institutions are now allowed to trade in all financial derivatives, such as currencies and equities. However, this permission was not extended to the commodities sector. RBI and the Forward Markets Commission (FMC) are expected to consider the proposal of the RBI sub-committee and allow participation by financial institutions in commodity markets.
In an attempt to bring reforms to the commodities market, the Forward Contracts (Regulation) Amendment Bill, 2006 was devised—however, this was replaced with the Forward Contracts (Regulation) Amendment Bill, 2008—to transform the role of the Forward Market Commission from a government department to an independent regulator (similar to Sebi) and also to provide better flexibility in the commodities market.
The bill was again introduced in the Lok Sabha on December 6, 2010—as Forward Contracts (Regulation) Amendment Bill, 2010—by the then minister of agriculture, consumer affairs, food and public distribution, Sharad Pawar, but has still not been enacted. The bill confers statutory powers upon the FMC. Further, the bill permits trading in all commodity derivatives and also options on goods and commodity derivatives.
One of the options being considered by the new government is merging FMC with Sebi. Alternatively, it may also pursue the long-pending Bill.
The government should also try and clear the pending proposal of explicitly allowing foreign investment in commodities broking and trading business. Since ‘stock-broking’ is a part of the eligible list of activities permitted to be carried out by non-banking finance companies (NBFCs) where 100% FDI under the automatic route is allowed, albeit subject to certain capitalisation norms, there is a confusion whether (like stock-broking) 100% FDI under the automatic route is allowed in commodity-broking and whether such foreign investment would also be subject to any capitalisation norms! The absence of clarity in the FDI policy on this aspect has led to foreign investors investing in this sector approaching the FIPB. Interestingly, there have been instances where such investments have been allowed on a case-to-case basis by the regulator.
Even though Indian companies are better placed because of the domestic economy improving, the expected infrastructure development, certain policy changes and clarifications can really get the ball-rolling for the commodity markets.
With the new government’s economic reforms in full swing, the industry watchers expect reforms in the commodity space, including clarity on the issue of FDI in commodities broking.
By Sidharrth Shankar
Assisted by Prakriti Jaiswal, associate, J Sagar Associates, Advocates and Solicitors
The author is partner, J Sagar Associates, Advocates and Solicitors
Views are personal
