A. Amarender Reddy and Tulsi Lingareddy
The commodity futures trade has witnessed remarkable growth in India during the past two decades following the establishment of modern national multi-commodity exchanges with electronic platforms for online trading.
The average daily trade volume of commodity futures increased from around Rs 2,000 crore in 2004-05 to over Rs 24,000 crore in 2022-23, as per data released by the regulators, the Forward Market Commission (FMC) and the Securities and Exchange Board of India (SEBI). The commodity derivatives market was regulated by the FMC until it was merged with SEBI in 2015.
Trade in agricultural commodity futures, however, has been declining. The average daily volume stood at around Rs 900 crore, accounting for less than 4 per cent of the aggregate volume of commodity futures, in 2022-23. It was nearly 70 per cent in 2004-05.
Agricultural commodity futures trading was subjected to intermittent suspensions after Independence due to a recurring shortage of commodities. In the post-liberalisation era, based on the recommendations of the Kabra Committee (1993), the government allowed the revival of commodity futures trading in 1998. Three national exchanges — National Multi-Commodity Exchange of India, National Commodity and Derivatives Exchange Limited (NCDEX) and Multi-Commodity Exchange of India Limited (MCX) — were established in 2002-03 to provide online platforms for trading in commodity futures contracts.
At present, NCDEX and MCX are operational. The Bombay Stock Exchange and National Stock Exchange were also permitted to offer trading in commodity derivatives (futures and options) in 2017 with the integration of commodities and securities markets.
As a result, there has been a significant change in the trading pattern, with an evident shift from traditional agricultural commodities to non-agricultural ones — precious metals (gold and silver), energy commodities (crude oil and natural gas) and to some extent, industrial metals (copper, aluminium, zinc, nickel and lead). Trading in non-agricultural commodities dominates domestic exchanges, except NCDEX.
In October last year, SEBI extended the suspension of futures trading in seven commodities — paddy (non-basmati), wheat, chana, soyabean and its derivatives, mustard seed and its derivatives, crude palm oil and moong — till December 20, 2024.
Unorganised and scattered spot markets are a major reason for the low trade volume of agricultural commodity futures. About 80 per cent of India’s farmers are small and marginal; individually, they produce small quantities of various varieties and uneven quality of any commodity. Aggregating the produce and ensuring its compliance with the futures contract specifications in terms of quality becomes a big challenge.
Certification of quality and standards is essential for delivery at the designated warehouses of the commodity exchange. But most of the spot markets or mandis do not have adequate facilities for quality testing and certification.
Another major concern is the lack of adequate, timely and authentic information on fundamental factors like demand and supply of the commodities. Although the Ministry of Agriculture releases advance estimates of the output for major crops, they come almost at the end of the season. Such information is required well in advance for hedging purposes by the farmer-producers and other stakeholders in the commodity value chain, such as traders, processors and exporters.
There is very low participation of hedgers like farmers, processors, manufacturers, exporters, importers and traders, who are the actual stakeholders in the commodity value chain. The share of value chain participants was only about 2-5 per cent, while that of farmers or farmer producer organisations (FPOs) was less than 0.5 per cent across the exchanges in 2022-23, as per data published in the SEBI Bulletin (December 2023).
The main function of a commodity derivatives market is to help the hedgers in price risk management, while ensuring an efficient and transparent price discovery process. The poor participation suggests that the futures contracts are being largely used as financial assets for investment rather than hedging instruments to manage price risks in the spot markets.
The way forward
An efficiently functioning commodity futures market can play a key role in minimising market risks arising from seasonal price fluctuations in the spot markets. It is essential to create adequate grading and standardisation facilities, quality testing and certification, regulated warehousing etc. The majority of these steps are equally vital for the successful operation of a spot electronic agricultural market like the national agricultural market (eNAM).
Hence, there is an urgent need to undertake policy measures to ramp up agricultural market infrastructure and logistics across all major mandis. Assurance on the quality of the commodity can help in bringing the spot and commodity futures markets together, thereby facilitating price discovery.
It is crucial to ensure the availability of timely and comprehensive information on the demand and supply factors of the underlying commodities in the public domain. Raising awareness among farmers and other hedgers on technical knowhow of trading in the commodity futures market is also a must.
Commodity spot and derivatives markets
Commodity spot markets, commonly known as mandis, are the markets where commodities are traded on the spot.
Commodity derivatives markets are the markets where trade in derivative contracts like commodity forwards, futures and options are traded. Derivatives contracts offer protection against adverse future price changes. For example, to protect himself from low prices in the peak arrival season, a cotton farmer can buy a futures contract months before the harvest season and deliver at a prefixed price.
Contracts between the buyer and the seller to exchange the commodity of specific quality and quantity at an agreed price on a future date.
Standardised contracts of specific quality and quantity offered by commodity exchanges for buyers and sellers to take/give delivery of the commodity on a future date as specified in the contract. MCX and NCDEX are the major commodity exchanges in India offering commodity futures and options contracts.
Contracts give options to choose the right to buy or sell the commodity. There are CALL options and PUT options (commonly known as TEJI and MANDI). CALL provides the right to buy, while PUT offers the right to sell the commodity at an agreed price.
A. Amarender Reddy is Joint Director, School of Crop Health Policy Support Research, ICAR, Raipur, and Tulsi Lingareddy is Consultant Economist – Sustainable Finance, Markets and Agriculture.
Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organization.
The article was first published as Long road ahead for agricultural commodity futures in the The Tribune on January 22, 2024.
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Acknowledgment: This article was posted by Prasangana Paul, a research intern at IMPRI.