February 16,2004

SUCHETA DALAL 

Four new national commodities exchanges have recently been cleared to trade a slew of commodities in India, many of which (food grains for example) had been barred for trading for almost half a century. India is a monsoon dependent country where weather and crop uncertainties dictate whether farmers feel good or are sometimes driven to suicide.

There is very little use of forecasting techniques, leading to wide fluctuation in prices of agricultural produce as well as inputs such as fertilisers and pesticides. While the government tries to offer some support through procurement and subsidies, it is inadequate.

In these circumstances, the development of a commodities futures market offering an efficient price hedging mechanism cannot be adequately underscored as it would help farmers realise better prices and protect their income. To meet these objectives and to successfully chase a $600 billion business opportunity, the government cleared four ‘National’ commodities bourses — National Multi Commodity Exchange of India Ltd, (NMCE), National Commodity & Derivatives Exchange (NCDEX), National Board of Trade (NBOT) and Multi Commodity Exchange (MCX). This means that these four bourses have automatic approval for futures trading in almost all commodities. Today, the four exchanges are involved in an intense struggle for supremacy by trying to build volumes and capturing niche markets in specific

commodities. But badly regulated commodities trading can be a dangerous business, as was recognised by Prime Minister AB Vajpayee himself. At the launch of NMCE, he said, “I would like the regulatory system for commodities exchanges to be strengthened to create confidence among all stakeholders”.

This would logically entail a high level of automation, strict surveillance, dynamic regulation, investor protection, efficient clearing and settle- ment, preferably a trade guarantee mechanism plus warehousing facilities, logistics management, quality control and effective handling of warehousing receipts. Unfortunately, much of this has not happened. As is often the case, traders managed to persuade the government to allow trading to commence without ironing out many glitches and shortcomings.

The Forward Markets Commission (FMC), which is the commodity markets regulator, has not been upgraded and strengthened on the lines of the Securities and Exchange Board of India to handle its new responsibilities. Its exact regulatory structure has yet to be finalised and instead of developing it on the lines of the Commodity Futures Trading Commission of America, there is still talk about unifying it with SEBI.

What is probably more important is that FMC is to report to an economic ministry, which understands the impact and implications of reckless speculation and inadequate supervision on the economy.

Market sources point to another worry; and it is that FMC officials, used to traditional paper-pushing and primitive bourses, do not understand automated trading. Conversely, some professional and technology savvy bourses are clueless about the commodity markets and trading cycles. This has serious implications for regulation, surveillance and inspection of the markets and could catch the regulator napping when problems surface. For instance, brokers say that some exchanges are already busy generating bogus trading volumes through dubious market making activity, in an effort to report higher trading turnover. Unless stopped immediately, such activity could have damaging consequences.

The problem is lack of foresight in preparing for an automated national trading system before clearing several bourses to start operation. For instance, the Central Warehousing Corporation (CWC) would have a key role to play in the development of the commodities trading business and should ideally have played the same role as the National Share Depository Ltd. Instead, it has allowed itself to be roped in as a promoter of one of the national bourses, forcing other exchanges to search for potential in state warehousing companies to play the role.

The FMC should still rectify the situation by persuading and helping the CWC to exit its role as promoter of an individual exchange and instead take on the larger and more significant job of providing independent warehousing facilities to all the four national commodities exchanges. If the CWC is modernised and allowed to link up with state warehousing corporations, it would revitalise them and help create nationwide infrastructure for commodity trading.

Once the infrastructure is in place, the FMC can insist on commodities bourses offer true hedging facilities and stop them from turning into dens of speculation. Today, less than five per cent of the business of all bourses is delivery based; the bulk of it is mere trading and ‘market-making’.

Since the regulatory structure is weak, there are several other inconsistencies blocking development. For instance, both gold and rubber, which are potentially large volume businesses, require sellers to have sales tax registration under the Sales Tax Act in order to give delivery. Since every investor hopes to sell the yellow metal at sometime, this irritating roadblock should have been anticipated and eliminated before trading commenced. Similarly, hallmarking of gold has not been adequately developed and all the bourses trading in gold and gold futures do not have uniform standards of gold delivery. This means that gold purchased on one commodity exchange may not be deliverable on another, unlike in equity markets. The problem is that the regulator as well as the bourses are learning as they go along.

A vibrant commodities market is part of the agricultural reform process as it helps smoothen prices and the growth of the markets for agricultural produce, metals and some exotic derivatives. And commodity futures provide a price discovery and risk management tool to every participant in the supply chain from producers to consumers. But the involvement of farmers, who are important stakeholders, is especially important. Unfortunately, all bourses only pay lip service to training and educating farmers, while trading is almost entirely cornered by traditional commodity traders and speculators. It is important to remember that commodities trading, especially the futures and options markets were shut down for decades due to speculative excesses. Unless the FMC is upgraded in a hurry and focuses on development and supervision, history could well give us a repeat performance.

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