On December 20, 2021, SEBI banned futures trading in seven agri-commodities for a year. In the past, SEBI had banned futures trade in a single commodity on a few occasions, but banning seven commodity futures at one go is unprecedented and unfortunate as well. Though the regulator’s press release did not mention, increase in prices of agri-commodities and food products are assumed to be the reasons behind the ban.
By and large, commodity prices are predominantly governed by supply and demand factors. Considering the fact that countries are increasingly getting integrated globally through export/import, compared to domestic supply-demand conditions, global supply-demand conditions are becoming the dominant force affecting domestic commodity prices. Hence, price increase for a commodity should be analysed in the proper context and making commodity derivatives trading a scapegoat for price rise appears to be rather imprudent.
Gyrations in agri-commodity prices burn holes in consumers’ pockets in some years, while forcing farmers to commit suicide in some other years due to plummeting prices has been a recurrent phenomenon in India. In December 2019, onion price reached ₹200 a kg in Delhi, tomato price skyrocketed to ₹120/kg from ₹45 within a span of three weeks in Kochi during November 2021. In October 2020, potato was ruling at ₹43/ kg while the same was ₹22 during October 2019, almost a 100 per cent increase year-on-year (y-o-y). In August 2021, Nashik farmers dumped tomatoes on the road as the wholesale price crashed to ₹2 a kg.
A pertinent point to be noted here is that none of these agri-commodities have been traded in derivatives exchanges. Hence, even before considering a ban on commodity derivatives, SEBI and the Government should have exercised other easily reversible options such as increasing margin and lowering open interest limits for commodity derivatives contracts, reduction of import duty, easing import quantity restriction, imposition of stock limit to increase supply.
If a ban is effected at all, it should be like a black swan event because such bans are detrimental to the Indian commodity market ecosystem in innumerable ways. India is the largest producer and consumer of many commodities in the world. Yet India is not a price setter for these, as it lacks a vibrant commodity futures market which is essential for price discovery.
London Metals Exchange
Base metal prices on the London Metals Exchange (LME) are used as the reference price by miners, smelters, refiners and consumers from all over the world. Not only do they use LME platform to hedge, but also use LME prices for negotiating physical deals. In its 135 years of history, even after witnessing two world wars, LME has banned commodity trading contracts only once — tin in 1985.
In fact, the turmoil associated with tin contract at that time was so colossal that it even threatened the very existence of LME. LME banned tin contracts but that too only when International Tin Council informed LME to suspend tin contracts. Of course, over the years, LME has witnessed occasional rogue trading activities and dwindling base metal inventory, raising doubts at its capability as a market of last resort, and myriad other headwinds. But it has remained steadfast in its pursuit of continuity of business, which in turn has contributed to its predominance as a market for global reference price.
Frequent bans on commodity derivatives contracts also hinder effort by exchanges to develop the market ecosystem i.e, spot market trading infrastructure, warehousing, quality assessment, spot and futures price dissemination to market participants in general and value chain participants in particular.
With widely available technology, even farmers from remote parts of India are able to access futures prices twice or thrice a day. With a ban, the farmers lose an important piece of price information. It can be said that the most ruinous impact of a ban is on the Indian farmers, the most vulnerable section of Indian economic value chain.
Onboarding FPOs
Indian commodity exchanges have made considerable efforts to onboard farmer producers’ organisations (FPOs). The significant growth in the market linkage of FPOs can be judged from the following figures. The number of FPOs using commodity exchange platform has risen from 64 to 399 during 2016-2021. These 399 FPOS come from 18 States. The number of participating farmers has increased from 1.2 lakh to 10 lakh, total traded quantity has increased from 11,000 MT to 1 lakh MT during the same period.
When commodity derivatives are banned, not only these groups lose hedging opportunity, they also lose the skill-set to hedge. It leaves one wondering whether SEBI or government ever bothered to quantify these losses before notifying a ban?
Another insidious impact of a ban is that once few commodities are banned, there is clamor from various groups to ban other commodities. These groups get emboldened by the ban and create various pressure tactics and vigorously put forward many half-baked and specious narratives. Though one may argue that this is not a major concern, but such cacophony does harm a nascent commodity derivatives market where investors’ education remains a major objective as well as a challenge.
For some major players in India, hedging commodity price risk has become an integral part of normal business. These players are not going to wait in bated breath for the ban to be rescinded so that they can resume their hedging activities in domestic exchanges. They have the means and wherewithal to go to any international exchange to hedge.
Once they start hedging in international exchanges, it becomes a point of no return. As it is, fledgling domestic exchanges suffer from poor liquidity, and as and when the ban is revoked, these exchanges will start from a much more handicapped position on many counts including liquidity.
In addition to these, on a larger context, such ban severely dents the perception regarding India’s ease of doing business environment
Finally, this ban does not serve any real purpose. Rather, the inimical impact of this ban on Indian commodity spot and derivatives market is written all over it. It is obvious, the genesis of this ban is a regulatory overreach to pander to populism keeping in mind the impending assembly elections. SEBI must revoke the ban. As a regulator, SEBI must create an enabling and nurturing environment for a free and fair market.
The writer is Professor (Finance & Accounting), VGSoM, IIT Kharagpur. Views are personal