Commodity Futures need revolution in India

Commodity derivatives markets started in India in 1990s, The National Agriculture Policy, announced by the government in blog2000, advocated the development of futures markets so that consumers and producers of commodities could use these contracts to procure commodities at a more rational price than at the Minimum Support Price (MSP) set by the government, which came with a large cost to the exchequer. This set in place a drive of reforms in these markets, following the reform model that had lead to the development of the Indian equity markets previously.

In 2003 commodity futures contracts started trading on electronic exchanges with a nation-wide reach. Counterparty credit risk, that was a serious problem in the older exchanges, was eliminated using netting by novation at clearing houses similar to their more visible equity derivatives cousins. Total traded volumes of commodities derivatives increased by more than 100 times between 2003 and 2013, with agricultural commodity derivatives increasing by nearly 15 times

These markets have been subject to a great level of mistrust and criticism, and a slew of negative interventions from policy makers, politicians and other financial sector regulators. From outright banning of contracts to restrictions by RBI, SEBI, IRDA and PFRDA on participation by their respective constituencies in this market, the mistrust from policy makers about the commodity derivatives markets is pervasive. Most of these interventions do not identify a clear market failure that they are attempting to address.

The commodity markets in India in the two required roles: price discovery and hedging. A recent paper published by IGIDR evidence shows contrary to the general mind-set. It is often claimed, in India, that futures price movements are driven by market manipulation, because prices of these leveraged products can be manipulated with greater ease than spot market prices. If this were the case, futures prices would have a low relation to the actual demand and supply of the underlying commodity.

Some major bottlenecks from the report are:

  • Legal and regulatory uncertainty:
  • Settlement problems:
  • Problems of product structure:

I would be doing more post on the FMC that needs to be trusted more by the financial firms and the urgency that’s required.

Source :  IGIDR  ( Ajay Shah blog)

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