See end of the paper forauthors’ affiliations

Correspondence to :

CHIDANAND PATILDepartment of Agri-BusinessManagement, University ofAgricultural Sciences,DHARWAD (KARNATAKA)INDIA

Commodity futures market in India: need, expansion, rolesand obstacles

S. VIJAYACHANDRA REDDY, G.P. SHIVASWAMY, CHIDANAND PATIL AND J.S.BINKADAKATTI

ABSTRACT : Trading in commodity derivatives on exchange platform is a device to attain price discovery andbetter price risk management, in addition serving macro-economy with improved resource allocation and generatingincome levels. India’s first organized futures market, Bombay Cotton Trade Association Ltd., being set up 1875.Since the inception (2003) of national online trading on multi-commodity exchange platforms, the trade volumeshave grown exponentially. The objectives of the present study were to study the necessities, expansion, roles andorganisational problems existing in the National Exchanges. Secondary data were collected from the official websites of Forward Market Commission (FMC) and National Level Commodity Exchanges related information for theperiod 2005 to 2010 and also from recognized journals and publications to facilitate effective information. The resultshowed that, the share of Multi-commodity Exchange (MCX), Mumbai recorded the highest turnover in terms ofvalue of trade during 2009, followed by the National Commodity and Derivatives Exchange limited (NCDEX) andNational Multi-commodity Exchange (NMCE), respectively. The risk associated with marketing of agriculturalcommodities can’t be disregarded in physical markets. The marketing should be made more broad-based by allowingbanks and others to participate in commodity futures by outline the rules efficiently as a result both producers andconsumers get benefits. The Forward Market Commission (FMC) should regulatory initiatives, to prevent marketmanipulation and ensure market integrity, financial integrity and customer protection. However, there are severalobstacles to be overcome to be decided for prolonged development of the market, possible only through comprehensiveand coordinated efforts by regulatory bodies and government involved in the commodity exchange activities.

KEYWORDS : Commodity future market, Obstacles, Turnover

HOW TO CITE THIS PAPER : Vijayachandra Reddy, S., Shivaswamy, G.P., Patil, Chidanand and Binkadakatti, J.S. (2013).Commodity futures market in India: need, expansion, roles and obstacles. Internat. Res. J. agric. Eco. & Stat., 4 (2) : 200-204.

Paper History :Received : 21.01.2012;Accepted : 17.08.2013

HIND AGRICULTURAL RESEARCH AND TRAINING INSTITUTE

A Case Study

A commodity exchange is defined as a market in whichmultiple buyers and sellers trade commodity -linked contractson the basis of rules and procedures laid down by theexchange. Commodity exchanges offer spot trade forimmediate delivery and forward contracts which result infuture market. Since the commodity exchanges provide aplatform for trading commodity-linked contracts, they reducethe transaction cost associated with finding a buyer or seller.Further, most importantly, the price risk management and pricediscovery are the two important functions of future marketsto promote more efficient locking of investment, productionand purchase plans for producer and consumer, storage,marketing and growth in employment opportunities. Ever sincethe initiation of economic reforms in India in 1991, enormous

efforts were made to open up futures trading in commoditymarkets which led to withdrawal of its prohibition in 2003.The total volume of futures trade ascended from Rs.16.37lakh crore in 2005 to Rs. 94.94 lakh crore in 2010 but thetrade in bullion and other metals has overtaken it since 2006-07. The Multi-commodity exchange (MCX), recorded thehighest turnover in terms of value and market share of tradeduring 2009, followed by the National Commodity andDerivatives Exchange (NCDEX) and National Multi-Commodity Exchange of India limited (NMCE), respectively(Table 1). The dependency on a few commodities for incomegeneration evidently exposes the traders and producers tocommodity price uncertainties in the global markets. Thevariations in commodity prices affect even the traders who

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are otherwise known to operate on fixed margins. The excessprice caused by speculation and possible hoarding could havesevere effects on confidence in global markets, therebyhampering the market’s performance in responding tofundamental changes in supply, demand, and costs ofproduction. More significantly, all these changes result inunwanted price fluctuations that can harm the poor and resultin long-term, irreversible economy break. To minimize this,clear rules for the participants should be developed anddispute resolution mechanisms should be in lay down. Ingeneral, participants in the Commodity exchange and futuresmarket may include financial institutions, farmers, grainmerchants, brokers, multinational corporations, foodprocessors, and speculators against the risk of adverse pricechanges. However, the trading mechanism depends on theefficiency of speculation, where speculators’ sole objectiveis to make profit in liquid markets and whereas in hedging, itprotects the participants from extreme crash in prices acrossdifferent markets in future trading (Purcell, 1991).

Objectives of the study:This research review paper is focused on the following

objectives:– To study the inevitability for commodities exchanges

in India for managing commodity risks.– To identify the expansion of commodity exchanges

in India.– To study the roles of commodity exchanges in India– To examine the obstacles for authorization of futures

trading in commodity exchanges.

Inexorableness for commodities exchanges in India:The physical markets for agricultural commodities in

India are highly fragmented, isolated and unorganised.Agricultural commodities are traded in wholesale marketswhich we call as regulated markets. Conventionally, fornumber of institutional reason there is a long chain ofintermediaries between the buyer and seller of agriculturecommodities. In widespread agricultural commodities maketracks through village merchants, commission agents,wholesale traders, processors and retails before they reachthe final end user. Each of these middle men is involved in

chain to perform different activities to make money frommargins (Thomas, 2003). Hence, price realization by farmersis low and the cost of intermediation is higher, this revealsthat account of market risk is involved at every stage of theproduce.

In open auction method, the prices of agriculturecommodities are decided either mutually between thecultivator and trader. This method lacks the transparency inprice discovery process. Ultimately there is no facility forreal price dissemination which will come in the way of pricediscovery process for agriculture commodities. In absenceof real price information, the buyers and sellers will beconstrained to give or take their own price. The limited storagefacility for agriculture commodities and lack of safeguardingcapacity of farmers frequently force the farmers to performthe distress sales and sales immediately after harvesting periodwhich will fetch low price during arrival seasons. This affectsthe trading in agricultural commodities.

The trade in agriculture commodities also involves therisk of loss, risk is another intrinsic component of marketingtransactions (Gangadhar and Naresh Reddy, 2008). The riskassociated with marketing of agricultural commodities can’tbe dispended, there are three types of risks associated withphysical market. They are :

– Price risk– Physical risk– Political riskPrice risk is loss likely to occur due of variation in the

prices of agricultural commodities which fluctuate not onlyyear to year but during the year, month to month andsometimes in a given day from hour to hour. The widefluctuations in price of agriculture commodities can’t be failto notice for the reason the factors affecting the demand forand supply of agriculture commodities continuously change.Unexpected rise or fall in price and this asymmetric behaviourtends to impose costs on any scheme meant for balancingprice fluctuations. All these expose producers to the dualproblem of lower returns and higher risks. Many times theprice for risk may be so high that may lead to total failure ofthe business. Therefore, price risk is one of the inevitableevils of physical markets.

Physical risk includes losses due to loss in the quantity

S. VIJAYACHANDRA REDDY, G.P. SHIVASWAMY, CHIDANAND PATIL AND J.S. BINKADAKATTI

Table 1 : Turnover on commodity futures markets (Rs. crore)Calendar yearName of

exchanges 2005 2006 2007 2008 2009 2010

MCX 633324 (38.67) 2025663 (58.13) 2730415 (74.71) 4284653 (85.11) 5956656 (84.01) 7895404 (83.15)

NCDEX 883209 (53.94) 1243327 (35.68) 774965 (21.20) 628074 (12.47) 805720 (11.36) 973217 (10.25)

NMCE 12107 (0.74) 111462 (3.20) 25056 (0.68) 37372 (0.74) 195907 (2.76) 180738 (1.90)

Others 108705 (6.64) 104033 (2.99) 124051 (3.39) 83885 (1.66) 132173 (1.86) 445366 (4.69)

Total 1637345 3484485 3654487 5033984 7090456 9494725Source: Ministry of Consumer Affairs, Economic Survey 2010-2011Figures in parenthesis indicate the percentage of total

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and quality of agriculture commodities during the process ofmarketing agriculture commodities which are being biologicalin nature, are bound to lose quality as well as quantity due tomicrobial activity. The loss in the quantity may also turn outdue to fire, natural calamities like floods, earthquake, insects,pests and fungi. The excessive moisture and temperature,careless handling, improper packaging, unscientific storage,theft and larceny will also lead to physical or volumetriclosses of agriculture commodities. It is also called as‘volumetric risk’. The losses due to these reasons are not onlylosses to overall commodities but also loss to society.Therefore, these losses must be minimised which is seen inspot market.

Political risk includes losses arising due to changes inthe policies of government restrictions, price controls, taxesand tariffs, levies, export-import policy, ban of movement ofagricultural commodities. These policy changes may affectthe calculation of place and field of players i.e. producers,consumers, stakeholders and finally lead to loss. It is alsocalled as ‘Institutional risk’. It is affecting one or a fewcountries owing to technological changes or the discoveryof new technology which alters competitiveness.

Many corrective measures have been instigating bygovernment from time to time to eliminate the limitations ofphysical markets. These corrective measures include initiationof policy reforms and creation of adequate storage facility.The forward market commission (FMC), the regulator forcommodity futures trading under the provisions of theForward Contracts (Regulation) Act, 1952 continued itsefforts to broad-base the market. The players of physicalmarket especially farmers, as hedgers, to counter balance thespeculative element in price discovery and increasing theawareness level of farmers and other market participants wasemphasized. The commission undertook various regulatorymeasures to facilitate farmers’ participation and promotedelivery in agricultural commodities, such as introduction ofExchange of Future for Physicals (EEP) and Alternate FuturesSettlement Mechanism, allowing higher position limits toNAFED to facilitate hedging and delivery by them tointroduction of early delivery system in selectedcommodities. In addition, efforts were made to develop anaggregation model in collaboration with commodityexchanges to promote the participation of farmers. The FMCalso undertook several regulatory initiatives to prevent marketmanipulation and ensure market integrity, financial integrityand customer protection. A price dissemination project wasalso initiated by FMC, under which spot and future prices ofagricultural commodities would be made available to farmerson real-time basis on electronic price ticker boards placed atAgriculture Produce Marketing Committee. Therefore, theefficiency levels attained as a result of such seamless spottransactions would result in major benefits for both producersand consumers. The spot exchanges will also provide a platform

for trading of warehouse receipts.

Expansion of commodity exchanges in India:The Indian economy is witnessing rising in commodity

derivatives, risk management and allocation of resourcesthrough commodity exchange trading and cash settlement ofcommodity futures had been banned since 1952 and until 2002commodity derivatives market was virtually non-existent,except some negligible activity on an OTC basis. The Indiacommodity market has undergone lots of changes due to thechanging global economic scenario, thus throwing up manyopportunities in the process. Demand for commodities bothin the domestic and international market is a key growth driverin the coming days. The “Bombay Cotton Trade Association”has set up the first Commodity Exchange in India and formallyorganized futures trading in cotton in 1875. Over the years,leading cotton mill owner and merchants were not blissfulwith the functioning of this exchange. This gave rise to a parallelexchange called “Bombay Cotton Exchange Limited” in theyear 1893. Over a period of time, a number of exchanges wereset up in different parts of the country with variouscommodities. The “Gujarati Vyapari Mandali” came intoexistence in 1900, which has undertaken futures trading inoilseeds for the first time in the country. The “CalcuttaHessian Exchange Ltd.” and the “East India Jute AssociationLtd.” were set up in 1919 and 1927, respectively for futurestrade in raw jute. Futures trading in cotton were organized inMumbai under the auspices of “East India Cotton Association”in 1921. Concurrently, several exchanges were set up in majoragricultural centres in North India especially in Punjab andUttar Pradesh (Hapur) engaged in wheat futures until it wasprohibited in 1921.Future trading in bullion started in 1920at Mumbai for the future trading in gold, silver and otherprecious metals. The Government of India has banned tradingin commodity futures during the years 1960 to 1970 in orderto have an effective control over the fluctuations of prices ofagricultural and essential commodities. As a consequence ofthis, all the commodity exchanges went out of business andmany traders started resorting to illegal and relaxed tradingin futures. On the recommendation of the Khusro Committeein 1980, Government reintroduced futures trading on someselected commodities including cotton, jute, potatoes, etc.As a part of trade and industry restructuring, the Governmentof India has appointed an expert committee on forwardmarkets under the chairmanship of K.N. Kabra in the year1993. Its report stated the need and recommended for thereintroduction of futures trading in 17 commodity groups,with a wider coverage and scope to more agriculturalcommodities. In order to give boost on agricultural sector, inAgricultural Policy 2000 envisaged trade reforms anddismantling of all controls and regulations on agriculturalcommodity market. In year 2003, recognising the importanceof futures trading particularly in management of price risk to

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reduce the wide fluctuations in commodity prices,Government of India again permitted futures trading. Atpresent, more than 90 commodities which are scheduled insection 15 of Forward Contract (Regulation Act, 1952) aretraded in different commodity exchanges in the country.

Roles of commodity exchanges in India:The commodity exchanges are defined as centres where

future’s trade is organised in wider sense. It is taken to includeany organised market place where trade is routed through onemechanism i.e. allowing the effective competition among bothbuyers and sellers. This action type exchanges are differentfrom wholesale market where trade is localized. The roles ofcommodity exchanges are :

– Security: Commodity exchanges primarily functionas centres for facilitating physical trade. These act as focalpoint for trade transaction and thus increasing the securitiesin trade transaction.

– Market information access: The price informationdisplayed by exchange provided a good reference point toassess the spot prices and negotiate with traders/agents. Inaddition, it created awareness among the farmers to track themarket and form an outlook on prices based on the availableinformation. Price discovery process provided them an ideaabout price movements. The price movement signals assistedthem in planning their spot operations effectively.

– Positions on exchange: This introduced awarenessabout new market system among participants along with amechanism for locking-in their desired prices. In addition, itprovided an essential feature of price signal that assistedplayers in taking decisions about operations in spot or localvillage market. The players will get benefited from pricesignals from futures market and decided either to store theirproduce for the longer period in the expectation of betterrealization from spot market.

– Local market operations: Information access andpositions on exchange have assisted players in deciding abouttheir physical market operations and store their produce forlonger period in the expectation of better price realization.In absence of futures market, farmers try to manage their riskby collecting the information from local mandis or villagemarket and accordingly planning their process. Though, theneed of cash, lack of storage options and vagaries of weathermay force them to sell their produce without utilizing thebenefit of price signals.

– Commodity exchange will help to make growthinclusive, it will act as a catalyst for bringing the new to theold world. Even small farmers can become part of the nationaland global market place, for inputs, credits and outputs.

Obstacles for authorization of futures trading incommodity exchanges:

Commodity futures market in India is still in a nascent

stage and is gradually picking up as compared to othercountries. Even though the commodity derivatives market hasmade good progress in the recent past years, the real problemfacing the futures market have not been resolved. Despitethe fact that, the number of commodities allowed for derivativetrading have increased, the volume and the value of businesshas zoomed, but the objectives of setting up commodityderivative exchanges may not be achieved and the growth rateswitnessed may not be sustainable unless these real problemsare sorted out as soon as possible. It is only after the inceptionof liberalization during 1991, the attitude towards futurestrading has changed considerably and its potential benefitsare now being recognized in the policy sphere. The majorproblems of the commodity markets are:

– Procedural hurdles like PAN card requirementburdensome paperwork etc. for opening a demat/trading/bankaccount is a major problem in commodity exchanges.

– Lack of technical support providers for farmerparticipation on commodity exchanges. The organisations likeNGOs, cooperatives, agri-business companies, and farmerorganisations have the ability to serve as technical supportproviders to farmers or participants in market.

– Communication: The commodity exchanges shouldcommunicate quick and complete information about thetransactions. There is a lack of transparency in transactionsand also awareness among various stakeholders includingfarmers. Market and price information needs to bedisseminated on regular basis to assist farmers in managingand planning spot market operations.

– Lack of on-line trading facilities in the large numberof exchange which provide space for market manipulation andmarket collapse and ultimately there will not be any protectionfor customer from the regulator bodies or governments.

– Legal restrictions: At present there are manyrestrictions on the movement of certain goods from one stateto another. It has to be removed so that actually national marketcould develop for commodities and derivatives. In addition,regulatory changes are required to bring about equality inoctroi and sales taxes etc. VAT has been introduced in thecountry in 2005, but has not yet been uniformly implementedby all the states.

– Integration of exchanges : There are too many (4national level and 23 regional) commodity exchanges.Although about 146 commodities are allowed for derivativestrading, in practice derivatives are popular for only a fewcommodities. Again, most of the trades take place only in afew exchanges. All the splits volumes make some exchangesunviable. This problem solved by consolidating someexchanges. The Government of India has announced itsintention to integrate the two markets. It is felt that union ofthese derivative markets would bring in economies of scaleand scope without having to duplicate the efforts, therebygiving a boost to the growth of commodity derivatives market.

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– The regulator: As the market activity pick-up andthe volumes rise, the market will definitely need a strong andindependent body, the Forwards Markets Commission (FMC)is under the Department of Consumer Affairs (Ministry ofConsumer Affairs, Food and Public Distribution) and dependson it for funds. It is essential that the Government should grantmore powers to the FMC to ensure an orderly developmentof the commodity markets.

– Commodity options: Trading in commodity optionscontracts has been banned since 1952. The market forcommodity derivatives cannot be called complete without thepresence of this important derivative. Both futures and optionsare necessary for the healthy growth of the market. Whilefutures contracts help a participant (say a farmer) to hedgeagainst downside price movements, it does not allow him toreap the benefits of an increase in prices. No doubt there isan immediate need to bring about the necessary legal andregulatory changes to introduce commodity options tradingin the country. The matter is said to be under the activeconsideration of the Government and the options trading maybe introduced in the near future.

– The warehousing and standardization: Forcommodity derivatives market to work efficiently, it isnecessary to have a refined, cost-effective, reliable andconvenient warehousing system in the country. Further, qualitytesting labs should be set up in each region to certify thequality, grade and quantity of commodities so that they areappropriately standardized and there are no surprise waitingfor the ultimate buyer who takes the physical delivery. Toresolve the problem, Rural Warehousing Plan has beenintroduced to construct new and expand the existing ruralgodowns.

Conclusion:The commodity exchanges in commodity futures have

developed into indispensable and they are found to be morecompetent in ‘price discovery’ and re-assigning the risk.However, successful commodity derivative trading identifyfor appropriate institutional support and awareness among thecommodity producers. The future is certainly glowing for theIndian commodities market. Once the much anticipatedinstitutional participation like NGOs, cooperatives,agribusiness companies enter the market, it will createspeculation, arbitration and hedging for all kinds of playersin the market. As the market matures and intensifies further,

we can hope to see the day almost immediately, when Indiancommodities market will provide a benchmark for tradersworldwide, especially in those commodities where India is amajor producer or consumer. The market has made vastprogress in terms of technology, transparency and the tradingactivity which bring liquidity and better price discovery forall players, especially for the retail investors who can stare atcommodities as an investment option. Attractively, this hashappened only after the Government protection was removedfrom a number of commodities and market forces wereallowed to play their role after solving all these problemsthrough administered price mechanisms.The management ofprice risk and resource allocation are going to attain greaterimportance in future with the promotion of free trade andremoval of trade restrictions in the domestic and globalmarket.

Authors’ affiliations:S. VIJAYACHANDRA REDDY AND G.P. SHIVASWAMY, Department ofAgricultural Economics, University of Agricultural Sciences, DHARWAD(KARNATAKA) INDIAJ.S. BINKADAKATTI, Department of Agricultural Extension, University ofAgricultural Sciences, DHARWAD (KARNATAKA) INDIA

LITERATURE CITED

Aggarwal, Ashish (2003). Bigger Than Stocks? Business world, Sept15, 2003.

Ahuja, N.L. (2005). Managing foreign exchange risk with derivatives,paper presented at the International Conference of Asia-pacificAssociation of Derivatives (APAD) held at IIM Bangalore, 27-30 July 2005.

Economic Survey 2009-10

Gangadhar, V. and Naresh Reddy, G. (2008). Problems and prospectsof commodity futures market in India, The ManagementAccountant, 43 (9) September 2008, New Delhi, INDIA.

Government of India (2003). Report of the task force on convergenceof securities and commodity derivatives markets (Chairman,Wajahat Habibullah).

Purcell, W.D. (1991). Agricultural futures and options: Principlesand strategies, Macmillan Publications, New Delhi, INDIA.

Pratiyogita Darpan Extra issue on Indian Economy.

Thomas, Susan (2003). Agricultural commodity markets in India; Policyissues for growth. Indira Gandhi Institute for DevelopmentResearch, Mumbai (M.S.) INDIA.

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