Better discovery system raising commodity prices

Commodity exchanges, which have brought visibility to the futures market, have sometimes been identified as the reason for the recent rise in commodity prices.

The impression carried is that the knowledge of the futures market encourages hoarding. Let us try and examine certain concepts on the origin and purpose of commodity exchanges and the some of the ground realities experienced by us through our interaction with farmers through our agri-operations including rural malls.

In the 19th century, Chicago’s trading pits offered an organised venue for farmers and other suppliers of farm commodities which they could use to remove the risk of price fluctuations. Farmers were willing to lock in a value on their crop and willing to pay a price for certainty in exchange for high profits. It was a trade-off to ensure protection against price collapses - a form of risk elimination called “hedging”. This idea gave birth to commodity exchanges.

Are Indian farmers willing to pay a price for certainty? Given the amount of distress faced by the farmers, it would certainly be desirable. The advent of commodity exchanges brought innovations and improvements in transportation, warehousing, financing and promotion of inter-state and international agricultural trade.

To deny Indian farmers the long-term benefits of futures market s such as opportunity to obtain premiums for quality produce, insights from research which the big financial firms would bring in, and improved market efficiency when large traders come on board would be unjust.

The next question is: should consumers be left in the lurch when prices increase? Or, what is the role of the speculator in the whole cycle?
In India traditionally the trader in rural areas was the farmer’s only window to the external world. Only he was aware of the production and demand figures, likely future prices, and used the information asymmetry to his advantage. Until recently, mandis used to operate in a non-transparent manner. The entry of corporates through rural malls and other types of corporate presence and the advent of ICT contributed to a sea change in the attitude of these mandis.

What is the path ahead? It would be regressive to talk of curbing exchanges. Exchanges should offer new products to make “hedging” worthwhile but the products should not offer undue advantage to anyone participant. Also, a massive awareness campaign needs to be carried out. We need to create a transparent, quality-based procurement system so that farmers reap a premium from quality, which they were missing all along.

Thanks to commodity exchanges, the farmer does not have to be concerned about the financial stability of the buyer. Nor does the buyer need to be concerned about the progress of any farmer’s crop.

For the market to function, however, it cannot consist only of farmers seeking to lay off risk. There must be someone to take on risk. These are the “speculators.” Speculation provides an important way for the market to function efficiently, namely liquidity.

If it were not for speculators, farmers and government would have no easy and economical way to eliminate the risk of volatile prices. Speculators provide a ready and liquid market for these risks for a price. Speculators willing to assume risks for a price make it possible for others to reduce their risks. Competition among speculators also makes hedging less expensive and ensures that the effect of all available information is swiftly factored into the market price .

To attribute current price increases solely to speculators and the phenomenon of hoarding would be a mistake. Let us agree that if the Indian farmer is getting a better price it is due to the better price discovery system, a true reflection of the demand-supply situation. Futures trading is said to be a zero-sum game, or for every winner there is someone who loses an equal amount and so the consumer is affected.

What is the path ahead? It would be regressive to talk of curbing exchanges. Exchanges should offer new products to make “hedging” worthwhile but the products should not offer undue advantage to anyone participant. Also, a massive awareness campaign needs to be carried out. We need to create a transparent, quality-based procurement system so that farmers reap a premium from quality, which they were missing all along.

The author is Chairman & Sr MD, DSCL