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BUSINESS
Commodity trading playing a major role in Indian economy
By
Devajit Mahanta
The word ‘derivative’ originates from mathematics and refers to a
variable, which has been derived from another variable. Derivatives are so
called because they have no value on their own. They derive their value
from the value of some other assets. So, assets whose values are derived
from the price of some underlying assets like securities, commodities,
bullion, currency, interest level, stock market index or anything else are
known as ‘derivatives’.
The history of organized commodity derivatives in India goes back to the nineteenth century
when the Cotton Trade Association started futures trading in 1875, barely
about a decade after the commodity derivatives started in Chicago. Over time the derivatives market
developed in several other commodities in India. Following cotton,
derivatives trading started in oilseeds in Bombay
(1900), raw jute and jute goods in Calcutta
(1912), wheat in Hapur (1913) and in bullion in Bombay (1920).
However, many feared that derivatives fuelled unnecessary speculation in
essential commodities, and were ‘detrimental to the healthy functioning of
the markets for the underlying commodities, and hence to the farmers’. With
a view to restricting speculative activity in cotton market, the Government
of Bombay prohibited futures trading in cotton in 1939. Later in 1943,
futures trading were prohibited in oilseeds and some other commodities
including food-grains, spices, vegetable oils, sugar and cloth. By
mid-1960s, the government went on to impose a blanket ban on future trading
of the commodities. However, the other point in support of a closed market
is that Indian farmers, many of whom are illiterate, would make for lousy speculators.
That was, in fact, the logic used by the government in the 1960s to ban all
forward trading after a number of farmers defaulted on their contracts.
The ban on future trading in some commodities attracted severe criticism
from commodity market participants. The main argument forwarded against
such a policy was that fundamental inadequacies in the system cannot be
covered by banning futures which seeks to protect the consumer at the
expense of the farmer.
Growth in Volume of Agricultural and non agricultural Commodities supply
and demand are expressed in today’s price. There is no tomorrow and there
is no planning for tomorrow. Prices fluctuate from day- to- day and both
buyers and sellers helplessly reel under their impact. Futures trading are about
planning; it is about taking control of uncertainty. A farmer who sells
goods at a future harvest date, at a locked-in price, is in a fundamentally
superior position in terms of planning. Banning futures trading is about
forcing people not to plan for the future. Bowing to the pressures from
divergent sources the Indian government had set up a committee (Government
of India, 1993) under the chairmanship of Prof. K. N. Kabra in 1993 to
examine the role of futures trading in the context of the liberalization
and globalization process. The committee recommended allowing futures
trading in 17 commodity groups. It also recommended strengthening of
Forward Market Commission and amendments to Forward Contracts (Regulation)
Act, 1952, particularly allowing options trading in goods and registration
of brokers with Forward Markets Commission.
Finally, the Standing Committee on Food, Consumer Affairs and Public
Distribution (Government of India, 2006-07) has noted that since small
farmers do not participate in commodity futures markets, there is no need
for these markets. But the world over, futures markets are used by large
farmers, traders, banks and insurance companies that have an exposure to
the sector. India
is no different. As and when banks and insurance companies are allowed to
participate in futures markets, they can hedge their exposure to farmers
and give better terms to them.
Thus farmers can also benefit from price discovery that emanates from
commodity derivative trading.
(Readers can send their feedback at devajitmahanta@gmail.com>
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