A Amarender Reddy
Indian agricultural commodity derivatives have become an issue of the latest policy debate, as the one-year suspension of seven agricultural commodities derivatives is coming to end in December.
The introduction of new derivatives contracts in paddy (non-basmati), wheat, chana, mustard seeds and its derivatives, soya bean and its derivatives, crude palm oil, and moong was suspended for a year on December 21, 2021, by the Securities and Exchange Board of India (SEBI).
On August 26, 2022, the regulator, in consultation with the stakeholders, temporarily suspended the trading in all-cotton futures contracts of January 2023, and subsequent contracts of cotton futures on Multi Commodity Exchange of India Ltd (MCX), for revision of the contract specifications.
While the December move can be seen as a generic precautionary measure in the wake of raising inflationary concerns, the latter was a specific action to tackle the underlying physical market challenge. The recent measure, once again, brings forth the inherent challenges associated with the highly unorganized underlying physical markets that have been weighing down trading in domestic agricultural commodity derivatives.
Despite having more than a century-long history and the largest number of commodities (over 20) available for trading, the agricultural derivatives segment didn’t gain significant volumes on domestic exchanges compared to the of non-agricultural commodity segments (energy, precious metals, and industrial metals) during the last two decades.
Negligible share of Agriculture Commodity Futures
Consequently, the share of agricultural commodity futures in the total volumes declined steadily from over 60 percent in 2004-05 to about 8 percent in 2021-22, as per the SEBI Bulletin in August 2022. Further, the share of agricultural commodities in an options trade is negligible at less than 1 percent of the total volume of options traded. This is in contrast with global trends, where agricultural commodity derivatives accounted for the largest share among four major segments accounting for about 36 percent during the first half of 2022 and about 33 percent in 2021, per the estimates reported by the Futures Industry Association (FIA).
At the outset, the frequent regulatory interventions suspending trade in agricultural derivatives as a precautionary measure (similar to the one taken in December 2021) may be creating confusion among the market participants, but such restrictions have been largely confined to a few food commodities (rice, wheat, pulses, and select edible oils).
Apart from these select food commodities, a wide range of agricultural commodities (nearly 20) are available for trading on the domestic exchanges including guar products, cereals — basmati rice, maize, barley, bajra; commercial crops — cotton, gur; plantations – rubber, coffee; spices — jeera, turmeric, coriander, etc. Despite the availability of all these commodities, trading in agricultural derivatives didn’t pick up momentum.
Further, the participation of hedgers and value chain participants was only about 3-6 percent across the exchanges, while that of farmers/ FPOs was negligible at less than 0.1 percent during 2021-22, per the data provided in the latest SEBI Bulletin in August 2022.
The way forward
While the regulatory environment of commodity derivatives has evolved more progressively during the past decade or so particularly following the merger of SEBI-FMC, no such progress was seen in their underlying commodity physical markets. They remain highly unorganised and scattered constraining the aggregation and trade of commodities across the country.
One of the major problems of the underlying physical markets is meeting the quality standards of futures contracts. As majority of the farmers are small and marginal, they produce small quantities of different qualities and varieties of the same commodity. Under such a scenario, there is a need for adequate grading and standardization facilities to ensure the quality of the aggregated produce of commodities. There is also a need for ensuring adequate quality testing and certification facilities.
Another important problem is the availability of timely information on commodity fundamentals like demand and supply scenarios to facilitate the pricing decisions of market participants when trading in derivatives contracts.
While the Agriculture Ministry releases Advance Estimates of production for all major agricultural commodities, they are aggregate estimates of the commodity and may not indicate the quantity of specific variety and quality of the commodity that can meet the standards of futures contracts.
For instance, the official production estimates of cotton output in the country do not reflect the output of a specific variety traded in futures markets and the actual quantity may be much smaller leading to price variations between derivatives and physical markets. Further, information on the demand side is sparse with no official estimates available for many agricultural commodities tracking domestic consumption.
Hence, there is a need for creating agricultural information system providing comprehensive information on all the agricultural commodities accessible to all market participants. Recent government initiatives to expand warehousing facilities in the country are a welcome step, as they can potentially benefit both derivatives and physical commodity markets.
For domestic agricultural derivatives to become efficient, performing the functions of transparent price discovery and risk management, it is essential to address the long pending physical market challenges of the underlying commodities.
This article was first published in The Hindu Business Line as Not yet ready for Agri derivatives on November 15, 2022
About the Author
A. Amarender Reddy, Principal Scientist, ICAR-Central Research Institute for Dryland Agriculture, Hyderabad.
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