What govt should do to make forward trading popular

Establishment and expansion of commodity exchanges in India has facilitated stakeholders with alternatives of spot market. Future and forward transactions are supposed to be an useful tool for commodity traders, processors and other stakeholders to hedge their position and ensure regular supply. Commodity exchanges are the platform where futures and forward transactions are carried out by market participants. In case of futures, the guarantee by exchange for delivery and settlement of dispute mitigates the counterparty risks. The same does not hold good for forward contracts as these are exclusively between two parties.

In a new avatar The recent move of the National Commodities and Derivatives Exchange (NCDEX) to start forward contracts in maize and sugar is a laudable move to develop the market and provide alternatives to market participants. The way these forward contracts are engineered by NCDEX, most of the risk factors associated with normal forwards have been mitigated. In the case of normal forward contracts risk factors, such as lack of regulation, bilateral trade, private transaction, less access to other sellers/ buyers, absence of provisions for dispute settlement, self-assessment of quality of underlying commodity etc, are associated. Most of these contracts do not result in price discovery. In case of NCDEX forward contracts, most of these issues have been taken care of. NCDEX forward contracts are regulated, traded on electronic platform and thus provide multiple options to buyers and sellers from across the country and provide option for quality assessment of underlying commodity. The platform acts as arbitrator with these contracts resulting in better price discovery.

Additional advantages A sudden change in commodity trading in the country is unlikely with the launch of NCDEX forward contracts, though. However, other commodity exchanges may also launch forward contracts and also, NCDEX will launch forward contracts for more number of commodities. If the exchange can make its members store commodities in exchange-approved warehouses, additional benefits from these contracts may reduce wastages while storing. Primary observation indicates that exchange approved warehouses maintain better quality standards compared to other warehouses. Participation of farmers in forward trading will bring more volume in exchange approved warehouses and thus, the extent of loss on account of poor maintenance of warehouses can be reduced to a greater extent.

Market response Despite,exchange-traded forward contracts mitigating most of the risk associated with normal forward contracts, the response to the launch of NCDEX maize and sugar forward contracts has been lukewarm. During the first 15 days of launch of these contracts, a total of 29 contracts for maize and 3 contracts of sugar were traded. These contracts accounts for a total volume of 1,060 tonnes of maize and 600 tonnes of sugar. In this period, maize contracts were traded for 8 days while sugar contracts were traded for only 2 days. These results seem to be discouraging compared with futures contracts in the respective commodities. Futures contracts of maize were traded on every trading day during the same period on the NCDEX platform and the number of contracts were as large as 13,317 for a total volume of 1,33,170 tonnes. Similarly, futures contracts of sugar were also traded on all days on the NCDEX platform during the period and the number of contracts traded was 5,565 for a total volume of trade of 55,650 tonnes.

Scope for FMC, Government The slack response to forward trading in maize and sugar calls for a thorough study by commodity exchanges and the Forward Markets Commission (FMC). A primary reason for such response seems to be lack of awareness among different stakeholders. The FMC in consultation with its various networking institute such as NIAM, is conducting training/ awareness programme on futures trading for farmers, officers of Agriculture Produce Marketing Committees and other stakeholders. On a similar line, FMC should promote not only awareness campaign in futures trading but trading on the electronic platform as well. The fundamentals of futures and forward contracts and working of commodity exchanges must be known to each stakeholder.

In order to promote futures and forward trading, the government should incentivise farmers to participate in commodity futures and forward by subsidising warehouse rent. Such a move will not only increase the participation of farmers on electronic exchanges but will also result in popularising the utilization of negotiable warehouse receipt.

The writers are associated with National Institute of Agricultural Marketing, Jaipur