Sucheta Dalal :Where haste will make waste
Sucheta Dalal

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Where haste will make waste  

Apr 11, 2005


The big speculative spike in guar seeds in the past few days may be a blessing in disguise. Ever since agriculture minister Sharad Pawar refused to let commodity markets be under the supervision of the capital market regulator, there is a rush to amend the Forward Contracts (Regulation) Act of 1952 to make the Forward Market Commission (FMC) a powerful regulator, with administrative and financial autonomy and quasi-judicial powers. This is laudable and necessary and should be fairly easy, because of all the learning and experience available in empowering and developing the Securities and Exchange Board of India. What is worrying is the steady lobbying to open the markets to banks and Foreign Institutional Investors (FIIs) even before the regulatory system has been tightened. Or issues such as the dematerialisation of warehousing receipts made foolproof and the markets expanded to include actual users, such as traders, farmers and shop-keepers, through a massive outreach programme.


Globally, commodity markets are much bigger than stock markets and are closely tracked by the media. Apart from basic products such as grains, oils and metals, they trade in an array of sophisticated and even esoteric products, including the weather. Also, global commodity markets are more integrated with Indian markets than stock markets, because of flourishing international trade in sugar coffee, soya, etc. Several commodities traded actively in the national exchanges are also actively traded in the international markets and primarily influenced by international price movements. Savvy brokers such as Geojit Securities have been at the forefront of introducing new instruments and contracts in spices, as well as expanding overseas to get ready for international competition. CJ George, head of Geojit, says he is getting ready to live in a 24-hour trading environment. In the case of coffee, he says, volume in India goes up and trading becomes hectic after the London market opens. Geojit has obtained membership in one of the overseas commodity exchanges. But a few brokers like Geojit do not make a trend. At the moment, brokers themselves admit that commodity markets are dens of speculation.


All this is relevant to the government’s efforts to develop the commodity futures market. To take the market out of the clutches of traders and speculators, we definitely need to bring in a variety of players, including suppliers (farmers) and actual users (corporates) and banks, who would finance them. However, it is certainly premature to rush off and allow FIIs into the market, unless we take stock of ground realities. Our knowledge base is primitive and grossly imperfect. There is very little detailed reporting on commodity and metal markets in the Indian press, especially the English media. Most business journalists have little knowledge about what is happening to mining contracts and unexploited deposits of ore, precious metal and stones. The only language dailies that specialise in commodities are Gujarat and Rajasthan-based, but they too focus on local markets, due to constraints in gathering information.


There is also a big move by state governments to hand over lucrative mining contracts to the private sector under the garb of liberalisation. Many Indian and foreign corporate houses are lobbying hard to bag long-term mining contracts by bribing unscrupulous state politicians. There is little transparency in these deals and the general public is usually clueless about the implications of the natural reso-urces that are being negotiated away.


• Our knowledge base on commodity futures is primitive and imperfect

• Commodity trading systems have a long way to go in encouraging genuine users

• FIIs will swamp those trying to grasp the nuances of commodity derivatives


Commodity tra-ding systems also have a long way to go in encouraging genuine users to enter the market. In fact, the multi-commodity futures markets actively discourage delivery-based trading. One broker tells me NCDEX has taken all the possible steps to avoid deliveries happening in their platform, by making it as cumbersome as possible. He even alleges the exchange just promotes speculation and has no interest in promoting quality business. It has even chosen to dematerialise the warehousing receipt, which requires as much time as dematerialising a commodity. Consequently, manufacturing companies and farmers who want to give and take delivery as a part of genuine business needs are discouraged. And NCDEX is considered the biggest and best run of the bourses.


However, the bourses have their own problem. Central and state warehouses are not integrated with commodity futures exchanges. Also, a dematerialised warehousing receipt (WR), unlike the depository receipt, does not have recognition under any statute. There is also need for accreditation and registration of warehousing and to ensure that matching physical balances with the WRs are kept fraud-free. Until then, they would rather grow the business by encouraging speculative, rather than delivery-based trading.


In these circumstances, rushing to allow FIIs into commodity futures may be dangerous and premature. It will immediately skew the market and the knowledge base, by bringing in a set of sophisticated players with deep pockets, who will literally run over those still trying to grasp the nuances of commodity derivatives after a 40-year ban. While FIIs can take instant advantage of profit opportunities in India and effectively use their detailed knowledge of global crop, weather patterns and trade data, the same advantage will not be available to Indian traders until we have full convertibility and investment freedom. The pressure to open the markets is clear from the Reserve Bank of India’s (RBI) decision to set up a panel to look into the possibility of allowing banks to trade in commodity futures. This is bound to be limited to a role of financing, since RBI disallows banks from trading in capital market derivatives, even to the extent of hedging their cash positions. And is also dead against the growth of a market for interest derivatives.


-- Sucheta Dalal