Sucheta Dalal :Hot commodities huge potential weak supervision
Sucheta Dalal

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Hot commodities, huge potential, weak supervision  

Jan 24, 2005

Hot Commodities, is the title of the new book by Jim Rogers, a hugely successful money manager and author of two books, Investment Biker and Adventure Capitalist, who picks up investment trends during trips around the world.

Rogers says we are ‘‘in the midst of a long-term secular commodities bull market’’ that began in 1999. Hot prices for essential commodities are what we will see in the coming years. Translation: our hoarders (who operate hand-in-glove with government officials) will be supplemented by speculators, to drive up prices on the commodity futures exchanges. 

We have already seen the impact on sugar prices. A drought in sugar producing areas has lowered production this year, and since India is the world’s second-largest sugar consumer, global prices are rising in anticipation of large Indian imports. But domestically, both government and traders are convinced that speculation in the commodity futures market is driving sugar prices up.

The Shiv Sena in Maharashtra has already demanded that sugar be removed from the futures trading list. Its worry seems genuine, given the uncontrolled speculation that was witnessed in an obscure commodity like guar gum and the fact that cardamom cultivators in Tamil Nadu believe that market operators are deliberately depressing cardamom futures prices to prevent them from getting a fair price.

Rampant manipulation of commodity markets is exactly what led to a 40-year ban on futures trading. But the government forgot the past when it allowed three national, automated, multi-commodity stock exchanges to start operations without putting in place a powerful regulatory structure or deciding the future of 20 odd regional commodity exchanges. To be fair, the Congress-led government has inherited this confusion from the trader-dominated BJP government. It was also lulled by Agriculture Minister Sharad Pawar’s willingness to transfer commodity futures regulation to the finance ministry. The Cabinet had also cleared the move to converge capital market and commodity market regulation under the Securities and Exchange Board of India (Sebi). Personally, I think that is a bad move too, but more about that later.

Last Sunday, Agriculture Minister Sharad Pawar bowled a googly by expressing reluctance to transfer commodity futures regulation to Sebi. Reports about a meeting in Delhi last Sunday indicate that the powerful trader lobby has gathered forces and joined up with stock exchanges to lobby against the move.

Their solution is to update the FMC Act and beef up the staff to take care of the problem. But FMC’s staff cannot deal with complex financial derivates traded on automated exchanges. While they begin their learning process, trading turnover at these exchanges is already highly speculative and in excess of Rs 3,000 crore per day. But that doesn’t worry traders, who argue that Sebi does not have ‘domain knowledge’ about commodity cycles, crop trends or linkages with farmers, traders and other institutions that currently supervise physical trading. At the same time they want the introduction of even more esoteric derivatives products such as weather, insurance and freight futures.

While the government is caught in a bind because Sharad Pawar has declared that ‘he is in no hurry’ to hand over commodity regulation to Sebi — it is already rather late to be debating the supervisory structure. As Jim Rogers says, ‘‘Unlike financial paper, the underlying commodities, whose financial derivatives are traded on stock exchanges, touch the lives of all people; and, they represent a much bigger market.’’ Here are some numbers that he quotes in his book: ‘‘The annual production of just 35 of the most active commodities traded every day in New York, Chicago, Kansas City, London, Paris, and Tokyo is worth $2.2 trillion. The volume of dollars traded on the commodities exchanges is several times that of the common stocks traded on all US stock exchanges.’’ And he says, commodities dealings for many times more than that amount, take place outside the commodities exchanges.

Trading turnover at India’s commodity bourses is bound to grow rapidly and speculators who will spot bigger profit opportunities in badly regulated commodities are bound to switch over from the capital markets. In effect, what we have in the commodity markets today is the exact replica of the capital markets situation in the late 1980s and early 1990s. Former Prime Minister Rajiv Gandhi had announced the creation of Sebi, but broker lobbies prevented it from getting its statutory teeth until a massive securities scam blew up in its face in April 1992.

Things may be a little different in the commodities market. A bull market in stocks spreads happiness all around, but a bull market in commodities hurts ordinary people and raises raw material prices for manufacturers. So the alarm bells ring much earlier. Moreover, rising prices are political cannon fodder and elections have even been lost because of high onion prices.

Commodities markets are potentially too large and important to be handed over to Sebi, although there are strong arguments in favour of such a move. On the plus side, the market regulator has a lot of learning in place over the last 15 years. It has evolved market safety mechanisms, put in place stringent disclosure norms and margining rules that have withstood severe volatility tests. On the other hand, market supervision remains a serious weakness. Over the last few years, Sebi has passed confused and inconsistent orders that have been set aside by the appellate body or have also destroyed any scope of action against insider trading and price manipulation. Insider trading and price manipulation precedes every major corporate announcement (it happened again before Gujarat Ambuja’s announcement about the sale of a stake in ACC) and the market reacts to Sebi’s threat to investigate with derisive sniggers.

The commodity markets and their potential for future growth is too huge to be left to the mercy of Sebi’s weak supervision. Although the government is reluctant to set up yet another independent regulator, that is exactly what the commodity markets need. An independent regulator, which is not handicapped by bad precedents and many supervisory failures of Sebi is what is required. The regulator must come under the finance ministry, be based in Mumbai, the FMC should be merged with it and the board of this new regulator should have representation from the Consumer Affairs Ministry, the Agriculture Ministry as well as the rubber, spices and other commodity boards. Only then can India prepare for a large and vibrant commodities futures market, without waiting for a scam to push the government into action.

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-- Sucheta Dalal