Fifteen years after the launch of commodity derivatives trade through nationwide exchanges trading multiple commodities online, there is still a sense of under-achievement in terms of products and trading volumes. This feeling is palpable especially among major stakeholders and is wholly understandable.
The penetration of the derivatives market and adoption of price-risk management by those with direct exposure to commodities have been rather limited. A large number of primary producers, processors, industrial consumers, exporters and importers of commodities are still not on the exchange platform. In other words, such entities are still exposed to risks that arise out of price volatility.
No doubt, in recent years, the sector has witnessed some key developments. Primarily, the merger of the erstwhile regulator — Forward Markets Commission — with the autonomous securities market regulator, Securities and Exchange Board of India (SEBI), has taken the regulatory oversight to a higher level.
Other advances include the development and regulation of warehouses through a separate regulator, introduction of options contracts in select commodities and recognition of all exchanges as stock exchanges.
Clearly, SEBI is working to strengthen, deepen and widen the domestic market by encouraging exchanges to explore new products and new participants.
As a result, now there are multiple exchanges in the marketplace offering similar services, and competition among them is set to intensify gradually. This will be good for both the market and its participants who will have a choice. Obviously, the efficient ones among the market infrastructure providers will survive.
It is in this broad context that a group of commodity market participants recently discussed the need for structural reforms for global competitiveness. Reforms are critical in order to deepen and widen the market so as to capture value. Confidence of the market participants will have to remain high.
By their very nature, commodity markets are volatile and business entities with exposure to commodities have to manage their price risk through what is known as ‘hedging’. So, promotion of derivatives trading nationally for price-risk management ought to be a priority for policy-makers.
However, it appears some institutions are not on the same page as far as promoting derivatives trading nationally is concerned. The Reserve Bank of India has allowed business entities with ‘direct’ and ‘indirect’ exposure to commodity price risks to hedge in international exchanges. This conflicts with SEBI’s approach to promote domestic exchanges.
Another progressive step would be allowing commercial banks to trade commodities. This would surely deepen and widen the derivatives market as well as encourage more scientific price discovery. However, it is learnt that the RBI is not in favour of allowing banks to trade commodities, a position in conflict with SEBI’s. The RBI needs to spell out its reservations and apprehensions, and these need to be publicly debated.
If one needs more evidence of a lack of coordinated approach, it relates to allowing institutional participation in the commodity derivatives market. SEBI is in favour of allowing mutual funds (MFs) into the commodity derivatives space; but press reports suggest the Finance Ministry is wary of this. At least one pink paper has reported that the Department of Economic Affairs has expressed its reservations over the move.
The aforesaid instances do not augur well for the derivatives market. Policymakers and regulators need to be on the same page and ensure a coordinated approach towards market development.
Importantly, we need a ‘Trade in India’ campaign and do everything possible to facilitate trading nationally. This is especially critical at a time when markets are subject to huge uncertainties and risks.
On structural reforms, it is critical to address the reform needs of the physical market first. A healthy and transparent cash market alone can ensure a robust derivatives market. The physical market, especially of agricultural commodities, is surely crying out for policymakers’ attention.
Reforms in the administration of marketing yards (APMC mandis), improvement in rural connectivity and investment in infrastructure will go a long way in strengthening the physical markets for farm goods. As cash and derivatives markets are known to feed on each other, their operating ecosystem has to remain well evolved.
The writer is a policy commentator and commodities market specialist. Views are personal