The future of agri-futures

By: |
November 02, 2021 4:15 AM

Bans on trading come in the way of functioning of the market as price-discovery process gets affected

Therefore, often, there is a misunderstanding on the causation as there can be a two-way relationship.Therefore, often, there is a misunderstanding on the causation as there can be a two-way relationship.

The future of futures in agriculture has once again come into question with NCDEX not announcing new contracts in, first, chana, and then mustard. These two contracts were some of the more vibrant ones on the exchanges that had strong links with the value-chains. Chana went off the shelf in 2008, but had come back to a steady state. For mustard, this is the first time. There has been similar withdrawal of contracts of soya oil. In between, guar complex came under the scanner as did some spices. Where exactly are commodity agri-futures headed?

An objective of futures trading is gains reaching farmers, by establishing an efficient price-discovery platform. This has been achieved to a large extent on NCDEX, in products such as castor, chana, soy complex, mustard, guar, cumin, etc. While farmer participation is the final goal, the exchanges have been working with FPOs to bring these platforms closer. The benefit of price-discovery has permeated across the value-chain, and farmers can decisions on selling in the spot market or relying on the futures market. Edible-oil manufacturers as well as dal mills have traditionally found this mode useful for delivery too.

However, the history of futures trading in commodities has been punctuated with several bans, which is not a good development for the market as it affects confidence levels. Often, a contract that is banned may not return to the table, such as urad and tur which were very effective in price-discovery.

Even when the contracts are restored, traders hesitate because of the fear of bans. This fear arises because a sudden ban—as has been the case for chana (where the price was ruling lower than the MSP) or, more recently, mustard—involves losses for market participants with open positions as they must square off contracts before maturity. This pushes them away from the platform.

The same problem doesn’t exist for non-farm products, where price-discovery is via global markets. In case of agri-products, price-discovery is domestic and, hence, market participants walk the razor’s edge. The efficiency of the market is revealed when there is a symbiotic relation between spot and futures prices. Futures are defined as spot plus cost of carry. However, often, the spot can be driven by the futures-price if the latter is efficient as all information relating to the future of the crop gets imbibed in the price which, in turn, affects the former. Therefore, often, there is a misunderstanding on the causation as there can be a two-way relationship.

The way out is not to ban any contract, but make sure to correct any serious aberration through a combination of higher margins so that if at all the price is getting distorted due to market manipulation, the correction takes place immediately. Further, talking to potential wrongdoers is another way out, provided trading patterns noticed by the exchange reveals such tendencies. Position limits can be changed to ensure undue influence is not exerted by any set of traders. Banning the contract may not be the best way out.

Agri-futures, which have been driven mainly by NCDEX, have a checkered history with bans often pushing NCDEX back. There is a major regulatory push to futures trading from the point of view of hedging as well as reaching out to farmers. Bans on trading come in the way of functioning of the market as price-discovery process gets affected because liquidity is withdrawn. The farmers too don’t get clear signals and may start suspecting the market in general. Form the point of view of hedging companies, which have hitherto been covering their price-risk through this platform, they will see options dwindle and will go back to their old ways of carrying risk. This holds for edible-oil companies, mills that process pulses, users of pulses (sweet dealers), masala manufacturers etc. We need to move away from the ban mindset.

Independent economist & author of
Hits & Misses: The Indian Banking Story

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