Commodities Futures and Inflation

ABSTRACT

Indian markets recently thrown open a new avenue for retail investors and traders to participate: commodity derivatives. For those who want to diversify their portfolios beyond shares, bonds and real estate, commodities are the best option. They provide risk management facility. However, India, under pressure to cool inflation running near two-year highs, banned new wheat and rice futures contracts in its fledgling exchanges in February in a bid to check speculation and hopefully tame prices. This report presents a study to find out whether futures trading leads to increase in price of essential commodities like wheat and rice. It also analyses the various factors that are leading to the increase in price of these essential commodities. Some recommendations are given to control the increase in price these essential commodities.

INTRODUCTION

Commodities Futures trading is a class of Derivatives trading, in which futures contracts derive their value from the ruling price of underlying commodities. This is a mechanism by which participants can enter into transactions for purchase and sale of commodities at a price, where the performance of delivery and payment obligation becomes due on a future date.

Futures trading in commodities in India are governed by the provisions of the Forward Contracts (Regulation) Act, 1952. As per provisions of this Act, futures trading in commodities can be conducted only by such Commodity Exchanges, which have got recognition from the Forward Markets Commission (FMC) under Section 6 of the Forward Contracts (Regulation) Act and have got specific permission from FMC to launch futures trading in specified commodities.

HISTORY

Organized commodity derivatives in India commenced nineteenth century when the Bombay Cotton Trade Association started futures trading in 1875, barely about a decade after the commodity derivatives started in Chicago. As time progressed, 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). After the Independence, The Forward Contracts (Regulation) Act was enacted in 1952 and the Forward Markets Commission (FMC) was established in 1953 under the Ministry of Consumer Affairs. FMC acts as a regulatory body, which regulates the commodity markets in India. The mid 1960s witnessed an unprecedented rise in the prices of major oils and oilseeds as a result of sharp fall in the output. Futures trade was banned in most commodities to contain speculation, which the government attributed to rising inflation. During liberalisation, the Government set up Kabra Committee in 1993 to examine the role of futures trading. The Committee recommended allowing futures trading in 17 commodity groups. The Government accepted most of these recommendations. Indeed, it was a timely decision too, since internationally the commodity cycle is on the upswing and the next decade is being touted as the decade of commodities.

BENEFITS OF COMMODITIES TRADING

1. Price discovery: Futures markets provide a mechanism for buyers and sellers to interact with one another in an open market. They also have wider access to information and decision making. This results in efficient price discovery.

2. Forecasting and planning tool: Commodity future markets act as a price barometer to farmers. Future prices help the farmers plan their cropping pattern and investment on inputs.

3. Hedging: Futures markets provide the facility of hedging against price risks for the participants in the market. It acts as insurance for the loss.

4. Role of speculators: Speculators are those who does not produce or use a commodity, but risks their own capital in hopes of making a profit on price changes. Speculators do help make futures markets function better by providing liquidity. The participation of speculators willing to take the other side of hedgers' trades adds liquidity and makes it easier for hedgers to hedge.

5. Price stabilization: In times of violent price fluctuations, future’s trading mechanism dampens the peaks and lifts up the valleys i.e. the amplitude of price variation is reduced. It leads to integrated price structure throughout the country and helps in balancing supply and demand position throughout the year.

CURRENT SCENARIO OF COMMODITIES MARKET IN INDIA

The Forward Markets Commission (FMC) is the regulatory body for Commodity Trading in futures/forward trade in India. The Forward Markets Commission is responsible for regulating and promoting futures trade in commodities. The FMC has its headquarters in Mumbai and the regional office