Commodity Market

A commodity exchange is defined as a market where buyers and sellers trade commodity linked contracts on the basis of terms and conditions laid down by Commodity Exchange (UNCTAD, 2007).

The history of organized commodity derivatives in India goes back to the nineteenth century when the Cotton Trade Association started futures trading in 1875, barely about a decade after the commodity derivatives started in Chicago.  Over time the derivatives market developed in several other commodities in India.  Following cotton, derivatives trading started in oilseeds in Bombay (1900), raw jute and jute goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay (1920).  However, banning of option in cotton in 1939 to curb widespread speculation, stringent price control by government in mid 1940s, suspension of forward trading in several commodities like jute, edible oil, cotton etc. in 1960 due to fear of increase in commodity price, reflected the turbulence in the commodity market over the years.

Due to the importance of commodity production and consumption in India, it was necessary to develop the commodity market with proper regulatory mechanism for efficiency and optimal resource allocation.  Thus, after independence, the parliament passed Forward Contracts (Regulation) Act, 1952, on the basis of the recommendations of the Shroff Committee providing legal framework for organized forward trading.  The Act applies to goods, which are defined as any movable property other security, currency and actionable claims.  The Act prohibited options trading in goods along with cash settlements of forward trades, rendering a crushing blow to the commodity derivatives market.  Under the Act, only those associations/exchanges, which are granted recognition by the government, are allowed to organize forward trading in regulated commodities.  The Act envisages three-tier regulation: (i) The Exchange which organizes forward trading in commodities can regulate trading on a day-to-day basis; (ii) the Forward Markets Commission provides regulatory oversight under the powers delegated to it buy the central Government, and (iii) the Central Government – Department of Consumer Affairs, Ministry of consumer Affairs, Food and Public Distribution – is the ultimate regulatory authority.  The first organized future trading was by India Pepper and Spices Trade Association (IPSTA) in Cochin in 1957.  However, futures trade was prohibited in most of the commodities thereafter.  Since then both the Dantawala Committee (1966) and the Khusro Committee (1980) have recommended the revival of futures trading in agricultural commodities.

After the 1991 reforms, the government set up a Committee in 1993 headed by Dr.K N Kabra to examine the role of futures.  The committee recommended that futures trading in 17 commodities be permitted.  Further, National Agricultural Policy (2000) and the expert committee on strengthening and developing Agricultural Marketing (2001, Guru Committee) supported commodity futures trading.  In February 2003, the government revoked the ban and accepted most of these recommendations allowing futures trading in 54 commodities in bullion and agricultural sectors.  Responding positively to the favourable policy changes, several Nationwide Multi-Commodity Exchanges (MNCE) were up since 2002, using modern practices such as electronic trading and clearing.  The Forward Markets Commission (FMC) regulates these exchanges.

At present, there are 23 exchanges operating in India and carrying out futures trading activities in as many as 146 commodity items.  As per the recommendation   of   the    FMC,   the   Government of India recognized the National Multi-Commodity Exchange (NMCE), Ahmedabad, Multi-Commodity Exchange (MCX) and National Commodity and Derivative Exchange (NCDEX), Mumbai, as nation-wide multi-commodity exchanges.  NMCE commenced in November 2002 and MCX in November 2003 and NCDEX in December 2003.Unlike the stock markets, the commodity markets in India have a single product (only futures) and a single user (only traders including corporates). In this short span since commodity future commodity “futures” trading was permitted in 2003, the commodity derivative market in India has witnessed phenomenal growth. Indian commodity market expanded by 50 times in a span of 5 years from Rs 665.30 billion in 2002 to Rs 33,753.36 billion in 2007 registering a Compounded Annual Growth Rate (CAGR) of a little over 119.3% and is now expected to grow at a steady growth rate of about 30% by 2010 and touch a volume of Rs 74,156.13 billion due to the continued active and wide participation of traders (ASSOCHAM findings). [Indian Rupees One Billion is equivalent to approximately US Dollars 21.65 millions at the exchange rate of US$1=INR46.2].

However the linkage needed for long term robust growth of the markets, including wide participation and awareness of the markets and its functioning among policy makers and the opinion makers on the one hand and at the grass root level on the other are inadequate. Other constraining factors include the lack of well spread spot markets, availability of easily accessible research material and intelligence on market trends in respect of various commodities. Also, as in any other emerging markets, there is little research in commodity derivative sector resulting in poor understanding of dynamics of the commodity markets.

Existence of vibrant, active and liquid commodity market is considered as healthy sign for development of economy. In an emerging market context like India, the growth of capital and commodity future market would depend on effectiveness of derivatives in managing risk.  Like any other derivative, future contracts can be used as an insurance against unfavorable price fluctuation.  Questions concerning what constitutes commodity price volatility and how it should be measured have generated considerable debate.

 

Prof. Gurbandini Kaur
Faculty - Economics