The Forward Market Commission have asked NABCONS (Nabard Consultancy services ) to conduct fifteen state level and eighty five district level Awareness Workshops across the country on Commodity Futures to bring the concept closer to the farmers clubs, primary co-operatives ,governemtn officials, bankers , NGOs and other stakeholders. Your columnist was asked to deliver the inaugural address at the State level workshop organized by the Kolkata Regional office of NABARD on Friday the 5th march. As mentioned in these columns earlier, West Bengal and Uttarakhand continue to be the laggard states in the country insofar as reforms in the Agri- marketing sector are concerned. Forward markets and commodity Futures have so often been confused with ‘badla’ transactions that in general the impression is that this will give rise to speculation, and the prices of commodities will show a sharp increase.
This issue of AgriMatters is therefore going to look at some of the basic concepts of commodity futures, commodity exchanges and futures markets. The starting point therefore is to understand what a traditional market is and how it operates. In a traditional market the seller, the buyer and the physical commodity are all physically present, and when a deal is struck, a cash transaction ,(or in some cases, a legally binding promissory note is issued). This is also called a Spot market, and the contract is called a Spot contract. The advantage with this system is that the buyer can find the precise commodity that suits him, pays the money and becomes the owner of the merchandise immediately. This worked well when the scale and range of transactions was small, economies were localized and people in the market place knew each other by their first names. As transport logistics was a major issue, prices varied in every market . However with the advent of transportation, and now with the ubiquitous mobile phone and internet everywhere, price range is getting narrowed, and producers and consumers have a wider choice and better information both about product features and price regimes. In a futures market on the other hand, the contract is for delivery of commodity at a later , but pre-scheduled date. There is a contract, but the contract is for a specific performance in the future. This has been made possible with the aid of technology, standardization and financial instruments to offset the limitations of the traditional markets. Price uncertainty was the main factor, for an accurate estimation of demand and supply across a larger geographical area was not possible.
The problem was faced most acutely by the farmers in the American Mid West who had to dump cereals in lake Michigan if the Chicago grain market did not offer them a fair price, and it was difficult to take the produce back home. Thus emerged the Chicago Board of Trade and the futures market which gave both the farmers and the traders an opportunity to hedge their risks and get a certain degree of ‘probability in their transactions’. It must be noted that Chicago became the world’s largest cereal market, not only because agricultural production was done in the industrial mode over large tracts of land (something that was unheard of in the post feudal Europe), but also because of the railroad, which made it possible for all the produce to the brought together to a central point. Another contributory factor was the meat(beef) processing industry which required corn as feedstock for the cattle for 365 days a year.
Thus we can say that commodity exchanges are platforms where futures trade is organized in a wider sense to include any organized market place where trade is routed through a mechanism allowing effective competition among buyers and sellers. These days, most exchanges are electronic, and auctions are done in the most transparent manner. An exchange is different from a wholesale market, because in an exchange, a neutral body ensures that transactions between the seller and buyer is secured, and there are no defaults. In a wholesale market on the other hand, trade is localized, but effectively takes place through several individual transactions between different permutations of buyers and sellers. The same seller could sell the same commodity to different buyers at different prices and vice versa. However in an exchange, a transparent price discovery mechanism ensures that both the seller and the buyer have a fair and equal opportunity in the market place.
This is precisely the reason why the Government of India have established the Forward markets Commission to encourage the establishment of commodity exchanges , and encourage farmers organizations like co-operatives, farmers clubs, SHGs to participate in these transactions. Your columnist drew the attention of the participants to the difficult situation being faced by potato growers throughout the country on account of a bumper harvest. The problem becomes more acute in states like West Bengal where the cold storage capacity ranges from 45-50 lakh MT, but the production is more than 95 lakh MT. Thus the prices crashed, and government had to step in with a MSP mechanism, and special dispensation for exports to Bangladesh. However if the futures trade in potato was adopted, it would be possible for farmers to have rational price expectations, for cold storage owners to decide whether additional capacities should be created, for food processing units to decide where the plants should be located, and last but not the least for the consumers because a pan India potato price would then become a reality.
There would be another advantage if agricultural commodities were transacted on the exchanges. Your columnist feels very strongly that in the estimation of agriculture’s share in the GDP of the country, the contribution of Agri-related services does not receive its due share because a substantial segment is not recorded at all. The second is in the nature of a suggestion. Most traders in Agri commodities are reluctant to transact on the exchanges for they are apprehensive of being drawn into the tax net. Therefore most of their transactions are in the domain of the ‘grey economy’, and this is one of the reasons of the failure of the NDDB supported Safal national Exchange at Bangalore. Readers may recall that this column had reported on the positive interventions being made for horticultural producers of Karnataka, AP and TN by the SNX. The strong recommendation is that for the next five years, all transactions in agricultural commodities on the commodity exchanges should be made tax free. After all, transparency is the first step to efficiency and better returns !