Commodity Futures in in Dai

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    Jignesh ShahManaging DirectorMCX India Ltd.

    SECTION 3 : MARKET TRENDS

    Government of India, in 2002-03, has demonstrated its commitment torevive the Indian agriculture sector and commodity futures markets. PrimeMinisters Independence Day address to the nation on August 15, 2002,which enlisted nation-building initiatives, included sett ing-up of nationalcommodity exchange among the important initiatives. The year 2002-03,certainly, was an eventful year in terms of regulatory changes and marketdevelopments that could set the agenda for development for the years tocome.

    Policy Initiatives

    Firstly, Government of India, in early 2003, has given mandate to four entitiesto set-up nation-wide multi-commodity exchanges. Secondly, expansion ofpermitted list of commodities under the Forward Contracts (Regulation) Act,1952 (FC(R)A). This effectively translates into futures trading in anycommodities that can be identified. Thirdly, 11 days restriction to completea spot market transaction (ready delivery contract) is being abolished. Fourthly,non-transferable specific delivery (NTSD) contracts is removed from thepurview of the FC(R).

    Above four policy decisions have the potential to proliferate futures contractsusage in India to manage price risk. National level exchanges would make

    availability of futures contracts across the nation in the most cost effectivemanner through technology and at the same time would improve the riskmanagement systems to improve and maintain financial integrity of futuresmarkets in the country. Expansion of list of commodities would make availablerisk management mechanism for all commodities where such a demand existsbut never made possible in the past. Abolition of the 11 days restriction onspot market transactions, and removal of NTSD contracts from the purviewof FC(R)A would effectively mean unhindered forward contracting amongthe constituents of commodity trade value chain.

    Forward contracting is an important activity for any economy to meet rawmaterial requirements, to facilitate storage as a profitable economic activity

    and also to manage supply and demand risk; forward contracts give rise toprice risk, so to the need of price risk management. Futures markets andforward contracts1 compliment each other for effective price discovery and

    Jignesh Shah is the Managing Director ofMulti Commodity Exchange of India Ltd

    and is the Co-Founder and the ChiefBusiness Strategist at Financial Technologies,which he evolved as a multi product andmulti market organisation. He is currentlypursuing digitalisation of Indiancommodity markets and its integration withglobal markets.

    Commodity

    Futures in India

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    pricing of forward contracts. Price risk in forward contracts canbe managed through futures contracts.

    Performance of commodity exchanges

    Year 2002-03 witnessed a surge in volumes in the commodityfutures markets in India. The 20 plus commodity exchangesclocked a volume of about Rs. 100,000 crore in volumes againstthe volume of 34,500 crore in 2001-02 -remarkable

    performance for an industry that is being revived! Thisperformance is more remarkable because the commodityexchanges as of now are more regional and are for fewcommodities namely soybean complex, castor seed, few otheredible oilseed complex, pepper, jute and gur.

    Interestingly, commodities in which future contracts aresuccessful are commodities those are not protected throughgovernment policies; and trade constituents of these commoditiesare not complaining too. This should act as an eye-opener tothe policy makers to leave pricing and price risk management tothe market forces rather than to administered mechanisms alone.Any economy grows when the constituents willingly acceptthe risk for better returns; if risks are not compensated withadequate or more returns, economic activity will come into astandstill.

    Wi th the value of Indias commodity economy being aroundRs. 300,000 crore a year potential for much greater volumes areevident with the expansion of list of commodities and nation-wide availabil ity. Opening up of the world trade barriers wouldmean more price risk to be managed. All these factors augurwell for the future of futures.

    National commodity exchanges and regional commodityexchanges

    Demutualization has gathered pace around the world and Indiancommodity exchanges are also looking into it. Existing singleand regional commodity exchanges have realised the possiblethreat that the national level exchange may pose on their future.Given the experience of the regional stock exchanges in India,commodity exchanges are becoming proactive to counter sucha threat. Commodity exchanges may not face the threat ofextinction because of the following reasons.

    (1) Commodity exchanges are trading in futures contracts onthose commodities, which have some regional relevance. I t isnot going to be as easy as a share of a company to get listed in a

    different exchange. (2) Delivery of commodity is a physicalactivity; delivery of shares is an electronic activity (3) Commodityexchange members are stakeholders in those commoditieswherein stock exchange members were never the owners of thestock to control where the stock should get traded. (4)Importance of commodity exchanges are linked to thestakeholders of that part icular commodity wherein success of astock exchange is more on transparency and low transactioncost.

    Above reasons are possibilities; national level exchanges couldwoo the existing commodity exchanges and their members to

    the national stream. Such exchanges and members are ofrelevance to the Indian economy as a whole and for the successof commodity futures in part icular.

    Nation-wide multi commodity exchanges and regulatorychallenges

    Forward Markets Commission (FM C) faces the highestchallenge with the onset of national exchanges and electronictrading. A national exchange in commodities would give rise tocommercial pressures from participants in terms of trade practicesfollowed by exchanges, regulatory measures by the regulatorand exchanges and arbitrational aspects pert inent to differencein governing laws among the states. FMC and the exchangeswould have to be equipped to deal with such pressures at theshortest possible time so that trade is not distorted. Other

    important aspect the regulator and exchanges should address isthe regulatory cost. Unless the regulatory cost is kept low,thriving parallel markets will never join the mainstreamexchanges.

    Impact of WTO regime

    India being a signatory to WTO may open up the agriculturaland other commodity markets more to the global competition.Indias uniqueness as a major consumption market is aninvitation to the world to explore the Indian market. Indianproducers and traders too would have the opportunity toexplore the global markets. Price risk management and quali tyconsciousness are two important factors to succeed in the globalcompetition. Futures and other derivatives contracts havesignificant role in price risk management.

    Indian companies are allowed to participate in the internationalcommodity exchanges to hedge their price risk resultant fromexport and import activities of such companies. Due to the

    compliance issues and international exchange rules, 90 percentof the commodity traders and producers are not in a position toparticipate in the international exchanges. International

    Commodity exchanges in India are

    expected to contribute significantly in

    strengthening Indian economy to face

    the challenges of globalisation.

    Indian markets are poised to witness

    further developments in the areas of

    electronic warehouse receipts

    (equivalent of dematerialised

    shares), which would facilitate

    seamless nationwide spot market for

    commodities.

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    exchanges have trading unit size, which are prohibitive for manyof the Indian traders and producers to participate in theinternational exchanges. Addressing the risk managementrequirements of the majority is of concern and the way to addressis through on-shore exchanges. I n a more liberali sedenvironment, Indian exchanges have significant role to play asvital economic institutions to facilitate risk management andprice discovery; price discovery would have greater link to global

    demand and supply which could assist the producers to decideon what crops they should produce.

    Way ahead

    Commodity exchanges in India are expected to contributesignificantly in strengthening Indian economy to face thechallenges of globalisation. Indian markets are poised to witnessfurther developments in the areas of electronic warehousereceipts (equivalent of dematerialised shares), which wouldfacilitate seamless nationwide spot market for commodities.Amendments to Essential Commodities Act andimplementation of Value-Added-tax would enable movement

    of across states and more unified tax regime, which wouldfacili tate easier trading in commodities. Options contracts incommodities are being considered and this would again boostthe commodity risk management markets in the country. Wemay see increased interest from the international players in theIndian commodity markets once national exchanges becomeoperational. Commodity derivatives as an industry is poised totake-off which may provide the numerous investors in thiscountry with another opportunity to invest and diversify theirportfolio. Finally, we may see greater convergence of markets

    equity, commodities, forex and debt which could enhancethe business opportunities for those have specialised in the abovemarkets. Such integration would create specialised treasuriesand fund h