commodity insights yearbook( part 1)

8/9/2019 Commodity Insights Yearbook( Part 1)

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2 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

Ab o u t C o m m o d i t y In s i g h t s

Ab o u t Pr i c e w at e r h o u s eC o o pe r s

Ab o u t M u l t i C o m m o d i t y Ex c h a n g e o f I n d i a

The Multi Commodity Exchange of India (MCX) and PricewaterhouseCoopers (PwC) joint effort Commodity Insights is a first-of-its-kind yearbook on commodit ies aimed at giving its readers rare insights into the entirecommodity ecosystem.

Commodity Insight s will have a plethora of useful databases on commodity markets arranged in a novel way sothat it is extremely useful to virtually all the ecosystem stakeholders as a one-point source for quick and easyreference.

Additionally, this unique publication attempts to deliberate on issues and concerns (with suggested solutions)that ought to be resolved for a healthy development of t he domestic commodity market. This will be in the formof art icles authored by change agents and thought leaders to provide a rich repertoire of analytical articles.

Thus, Commodity Insight s promises to be truly useful to not only all t he commodit ies market stakeholders, suchas traders, processors, consumers, banks, policymakers, analysts, and industry observers, but also others whomatter in this industry, giving them a year-long reference book that is both fascinating and engaging. Theyearbook aspires to be a benchmark resource for spreading knowledge about the commodity market.

PricewaterhouseCoopers (PwC), which measures its success by its clients, provides industry-focused advisoryand tax services to build public trust and enhance value for its clients and their stakeholders. PwC professionalswork collaboratively using connected thinking to develop fresh perspectives and practical advice.Complementing its depth of industry expertise and breadth of skills is PwCs sound knowledge of the localbusiness environment in India, with offices in Mumbai, New Delhi, Kolkata, Chennai, Bangalore, Gurgaon,Hyderabad, Ahmedabad, Bhubaneshwar and Pune. PwC is committed to working with its clients to deliver thesolutions that help them take on the challenges of the ever-changing business environment.

Multi Commodity Exchange of India (MCX) is a demutualised commodity exchange with permanent recognit ionfrom the Government of India to facilitate online trading, clearing and settlement operations for commodityfutures markets across the country. Since its inception in November 2003, millions of small and mediumenterprises, corporate houses, exporters, importers and traders have benefitted from this nationwide electronictrading platform through its efficient and transparent price discovery and price risk management. MCX ranksNo. 1 in silver, No. 2 in gold, and No. 3 in crude oil, natural gas, copper and zinc futures trading (by the number ofcontracts traded in 2008-09), according to FIA and data put up on exchanges websites.

I n t r o d u c t i o n


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C o n t e n t

FOREWORD

FROM THE EDITORIAL DESK

MARKET COMMENTARY

1. An Integrated Approach to Agriculture Marketing and FinancingBy Prof. Gopal Naik

2. Commodity Futures in India A Product of Globalisation and LiberalisationBy Mr. Lamon Rutten

3. Role of Mutual Funds in Commodity MarketsBy Mr. Venkateswaran R.

4. Banks on Commodities Futures Platform A Win-Win SituationBy Mr. P. V. Anant hakrishnan

5. Warehouse Receipt Finance for Farmers A Glimpse

By Mr. Nachiket Mor and Dr. Kshama Fernandes

6 Carbon and Clean Energy Markets the Potential in IndiaBy Ms. B.G. Ramola and Mr. Prashant Vikram Singh

7. Commodities Derivative Hedging: Portfolio and EffectivenessBy Mr. Kumar Dasgupta and Dr. Chiragra Chakrabarty

8. Role of Brokerage Industry in linking Ecosystem with the Futures MarketsBy Ms. Priti Gupta

9. Role of Banks in Indian Commodity Derivative MarketsBy Mr. Shailesh Sukhthankar

10. Agriculture Financing under OTC ProductsBy Mr. Venkatesh Tagat and Mr. Narendra Rathore

11. Commodity Exchange Technology Concepts Looking ForwardBy Mr. Dipankar Chakrabarti and Ms. Rachna Nath

12. India Needs to Usher in the Next Agricultural RevolutionBy Mr. Amitabh Jaipuria

Non-Agricultural Commodities

Agricultural Commodities

EXPERTS VIEWS

DATA FOR READY REFERENCE

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7

9

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34

42

49

53

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FOREWORD | 5

Dated 6th October, 2009

FOREWORD

Commodity markets in India have had a chequered but long history with the futures marketsremaining in virtual hibernation a large part of them in the unorganized form for overfour decades before they were resurrected in 1999-2000 as part of various reform measuresinitiated by the government. The market was opened up for futures trading in anycommodity without any restrictions. However, the commodity futures market came reallyinto its own with the advent of national electronic futures exchanges in 2003. In just aboutsix years since then the sector has embarked upon a remarkable journey of rapid growth andnational outreach, integrating the asymmetrically informed or ill-informed, fragmenteddomestic physical markets through effective application of information, communicationand technology (ICT) as well as connecting them with it through the creation of forward andbackward linkages. The Indian commodity futures market, comprising 19 commodity-specific regional exchanges and three national-level multi-commodity electronicexchanges, has staged a spectacular comeback with the total turnover increasing by acompounded annual rate of over 100 percent during this period.

What lay behind this whole turnaround from the hitherto status of the Indian commodity

markets as a price taker to be on the path of being a price setter has been the increasedstreamlining and convergence of diversified information on the market fundamentals of commodities through transparent interaction of various stakeholders of the ecosystem onthe organized platform. And this was largely achieved through the sustained awareness-creation and outreach efforts taken by both the exchanges and the Forward MarketsCommission besides coming up with innovative products, dynamically aligned from time totime in keeping with the changing market/stakeholders needs. The hallmark of theseexchanges lies in the level of efficiency of market mechanism, the maturity and the globally-competitive edge that they have managed to build into them in this short span of time,because of which the Indian commodity futures market has scaled the heights of globalreckoning.

Information on commodities that constantly flows into and out of the commodity marketsremains the key driver of the price discovery and risk management process for which theywere brought into being in the Indian economy. It also makes the exchange platforms usefuland effective for participation by various stakeholders from within the ecosystem, such asproducers, processors, hedgers and arbitrageurs. The domain knowledge and expertise of the previous generations which was largely lost in the decades of trading ban has been builtback to a large extent in this short span of time. This market which was known for itsinnovations including creation of a revolutionary trading and risk mitigation concept calledoptions is rising from the ashes like a Phoenix once again and will certainly occupy a placeof pride in the global comity of commodity markets within the next decade or so. It is thepromotion of market research and knowledge management through generation andmaintenance of market information, and building up of rational expectations in the market,which are of paramount importance to put it on the right path towards becoming the pricesetters for the global markets in many commodities.


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In this context, the initiative of the Multi Commodity Exchange of India (MCX) andPricewaterhouseCoopers (PwC) to bring out a yearbook on data and information related tothe commodity markets and their fundaments is both timely and a very welcome one. Icongratulate them for this initiative. I am confident that this inspiring effort of theirs will goa long way in encouraging extensive and intensive research into the Indian commoditymarkets as well as pave the way for transforming the countrys commodity databasemanagement towards excellence, becoming a constant, ready source for all kinds of references by various stakeholders including industry players, traders, market analysts,academicians, businesses, researchers and students. This, I am sure, will not only nurtureand strengthen the commodity markets to bring greater economic benefits to thestakeholders but also benefit the national development strategy for the economy as a whole.

I wish the publication all success. Happy reading.


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FROM THEEDITORIAL DESK | 7

It is our pleasure to come together on a joint platformto bring Commodities Insight s yearbook to enrich thewhole ecosystem consisting of varied stakeholdersr a n g i n g f r o m p o l i c y m a k e r s t oacademicians/researchers to media. Since the Indiancommodity markets came into being, not only media

and policymakers but also traders themselves havebeen scrambling for data that they could use to putprices and the market into an appropriate perspective.In the process, those whoever succeeded in garneringthe necessary data were enabled to achieve theirobjective while others who did not had to leave theirobjective behind due to this lack of information. As aresult, despite their impressive growth performance,the commodity markets lacked appropriate scrutiny bythe stakeholders to prove the worth for their existenceeven though they had started making inroads into thelives of both consumers and producers besideseffectively linking them with the financial markets.

Having reached several milestones in its journey tobecome Indias largest exchange, driven by it s strategicpartnerships with various other ecosystem players, itw a s t i m e f o r M C X t o j o i n h a n d s w i t hPricewaterhouseCoopers to bring in yet another globalbenchmark practice into the Indian commoditymarkets, fulfilling the role of empowering the marketparticipants and perfecting the process of pricediscovery on its platform. Participants and followers ofglobal commodity exchanges keenly await publicationof such material covering all the global fundamentals

year-wise in order to empower them to achieve their

objective of better decision making. Global commodityexchanges such as CME and CBOT, among others,periodically publish information on markets which isavidly followed by those to whom it matters most.Domestically, various sectors including infrastructureand financial services have their own examples that led

us on our way to providing a shape to this product .

While the raw market data was a key part of theendeavour, we gave our best to think innovatively tocompile and publish various useful and relatedvariables in such way that t he collection shall remain aone-stop shop for information that would be neededby all the stakeholders. Besides the datasets related tocommodit ies and their ecosystem, in our endeavour toflag the market growth and related issues we

approached experts, in respective domains connectedwith commodity futures, to analyse them and put t hemin an appropriate perspective for researchers andpolicymakers to fall back on them whenever the needarises which would otherwise be missing. We did ourbest to include all the related variables and flag thegrowth process and issues impeding the marketgrowth, along with the potential that it holds for thefuture, through a number of technical and non-technical articles authored by the invited experts.However, we are fully aware that improvement of thisonce-in-a-year effort will be a continuous affair and weassure users that we will take a giant leap to make theyearbook a far more enriched product when it isreleased from our desk next year.Standing (L-R): Mr. Sarvesh Ramachandran, Mr. Dhruv Madeka, Mr. Ankan Mondal

Seated (L-R): Mr. Kumar Dasgupta, Dr. Chiragra Chakrabarty

Standing (L-R): Mr. Nazir Ahmed Moulvi, Mr. Sujan Bhatt acharyya, Mr. Nit een JainSeated (L-R): Ms. Carol Daver, Dr. V. Shunmugam, Ms. Vidya Shintre

Fr o m t h e Ed i t o r i a l D e sk


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We would like to thank Mr. Jignesh Shah, Vice Chairman MCX; Mr. Lamon Rutten, MD and CEO MCX; Mr.Joseph Massey, MD and CEO MCX-SX; and Mr. KumarDasgupta, Partner Price Waterhouse; for theircontinuous encouragement and support towards thisinitiative of ours without which it would have been onlyhalf done. We would also like to thank Ankan Mondal,Sarvesh Ramachandran and Dhruv Madeka from PwCand Sujan Bhattacharya, Niteen Jain, Nazir AhmedMoulvi, Dr. Ritambhara Singh and Dhiraj Pandya from

Dr. V. ShunmugamChief Economist

Multi Commodity Exchange of India

Dr. Chiragra Chakrabart yAssociate Director

PricewaterhouseCoopers

MCX for the enormous efforts they put in, day in andday out, without which this book would have remained

just a concept. And finally, this message from the deskwill not be complete without thanking Ms. Carol Daverand Ms. Vidya Shintre, who efficiently marketed thisinit iative of ours and got the much needed financial asw e l l a s k n o w l e d g e s u p p o r t t o w a r d s i t saccomplishment.


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MARKET COMMENTARY | 9

The yesteryears

Forward/futures markets have come a long way sincethe days of the rice tickets in Japan and the firstorganised futures market in the form of the ChicagoBoard of Trade (CBOT) in the US. Forward contractswere the earliest form of commodity derivatives, andfutures contracts have existed for centuries in one formor the other.

In India, the earliest reference to futures can be found inKautilyas Arthashastra , and the trade shot intoprominence in the mid-nineteenth century when

trading in agricultural commodity futures in the USbecame organised. After the first recorded instance offutures trading in rice in 17th century Japan, it took offin the US with grain contracts on CBOT (the firstexchange to start there in 1848). Metals followed suitwith contracts traded on the London Metal Exchange(LME) in 1878. Thereafter a number of commodityexchanges facilitating futures trading in numerous agri-and non-agri commodities sprang up the world over.

In India, organised commodity derivatives tradingbegan with the Cotton Trade Associations debut infutures in 1875. Cotton merchants of Bombay took cuesfrom the US and the UK, and to regulate futures trading

the government in 1918 set up Cotton Contracts

Committee, which was soon (1919) replaced by CottonContract Board. Futures trading in oilseeds wasorganised with the setting up of Gujarati VyapariMandali in 1900 in Bombay. And, over the years, thederivatives market developed in several othercommodit ies in the country: raw jute and jut e goods inCalcutt a (1912), wheat in Hapur (1913) and then bullionin Bombay (1920). However, soon there were wide-spread fears that derivatives trading fuelledunnecessary speculation in essential commodit ies andwas therefore detrimental to healthy functioning of themarkets for the underlying commodities and,

therefore, to farmers. To curb speculative activity in thecotton market, the Government of Bombay barredoptions trading in cotton in 1939. This was followed, in1943, by a ban on forward trading in oilseeds and someother commodities such as food-grains, spices,vegetable oils, sugar and cloth.

As, post-World War II, the Great Depression had itsdevastating effects on economies around the worldduring 1939-45 and the British rulers imposed controlsover the financial markets, the Indian commodity futuresmarket slipped into virtual extinction. It disintegratedand went into a hibernation, only to continue negligiblyin the form of over-the-counter (OTC) contracts. Almost a

M a r k e t C o m m en t a r y

Futures trading plays a key role in the marketing of a number of important agricultural and non-agricultural commodities as it provides the industrial and farming communities with atransparent price discovery platform, which also enables them to hedge their price risk and pricevolatility. The growth of Indian commodities futures trading towards an efficient, transparent andwell-organised market has thrown open a window of benefits and opportunities to Indianproducers and traders. Besides the primary benefits of its twin economic functions of pricediscovery and price risk management, commodity futures trading has also played an instrumentalrole in integrating various fragmented components of the commodity ecosystem, thusdeveloping the overall infrastructure of agricultural commodit ies marketing in the country.

Indian Commodity Futures Markets Stil l Evolving


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decade later, Parliament passed the Forward Contracts(Regulation) Act, 1952 (FCRA) to regulate commodityfutures trading in the country.

With the process of liberalisation and globalisation ofthe Indian economy and consequent reforms in itsfinancial markets in the early 1990s, the Prof. K.N.Kabra-headed committee, set up by the Government in1993 to examine the role of futures trading, madeseveral recommendations including certainamendments to Forward Contracts (Regulation) Act1952 and strengthening of the Forward MarketsCommission (FMC). As it agreed to and acted uponmost of these recommendations, the Governmentallowed futures trading in all the commoditiesrecommended. The trade came into being afterremaining in hibernation for nearly four decades, asrealization that derivatives do perform a role in riskmanagement dawned. The timing of t his revival effort,from the four decades of restrictive governmentpolicies, turned out to be spot on, as the 1990sheralded an upswing in the commodity cycle, globally.FMC and the Government, on a fast-track mode,encouraged the idea of setting up commodityexchanges with state-of-the-art infrastructure andglobal best practices, and three national-level onlineexchanges the Multi Commodity Exchange of IndiaLtd. (MCX), the National Commodity and DerivativesExchange Ltd (NCDEX) and the National Multi-

Commodity Exchange Ltd (NMCE) were born.

At present, 24 commodity futures exchanges areoperational in India, which include 21 regional boursesand the three national-level players, with another threeproposed exchanges on the cards. With the state-of-the-art technology-powered modern, secure andefficient operational infrastructure these nationalexchanges are creating a near-perfect market situationwith a much wider participation from the ecosystemstakeholders in a large number of domestic and globalcommodit ies during local and international timings.

Since the reintroduction of commodity futures tradingin India in 2003, the bulk of trading has been taking placeon the three national exchanges. Despite being a latestarter, MCX overtook other domestic exchanges andcontinues to be the No. 1 commodity futures exchangein the country (by numbers/lots of contracts traded) witha market share of 85% as on August 31, 2009.

Speaking of the combined turnover of domestic

commodit ies exchanges, what began with a notionalvalue of Rs.1,29,364 crore in 2003-04 increased toRs.36,77,226 crore in 2006-07. However, following a

The current scenario

ban on some commodities in January 2007 and then inMay 2008 as well as imposition of higher margins andstringent norms for trading, the growth in tradevolumes slowed down to Rs.40,65,983 crore in 2007-08.Nevertheless, the Indian commodity futures marketstaged a comeback in 2008-09 with a sharp increase inthe turnover to Rs.52,48,956 crore, notwithstandingthe ban. As the percentage of Gross Domestic Product(GDP) at market prices, the total trade accounted for97.3% in 2006-07, which only marginally slipped to94.1% in 2007-08 but shot up to 106.4% in 2008-09. Inthe current fiscal, for the April 1-August 31, 2009period, the cumulative value of trade stands atRs.27,29,248.80 crore, a y-o-y jump of 31%. And a majorpart of it was due to a surge in the trade volumes ofagricultural commodities futures, which shot up by53.5% to Rs. 405,671.40 crore, followed by the trade inthe energy and industrial metals complex, which

jumped by 27.5% to Rs.22,89,316.20 crore. Aftersignificant declines in the trade volumes of agriculturalcommodit ies in the previous two consecutive fiscals i.e.2007-08 and 2008-09, the rise in agriculturalcommodit ies trade in the current year is noteworthy.

The Indian commodity futures market has emerged asone of the fastest growing markets with a combinedtrade turnover of around Rs.52.48 trillion ($1.14 trillion),and the phenomenal growth (110% compoundedannual average growth since the markets resurrectionin 2003) is largely attributed to continuous outreachefforts and all-round innovation by its national-levelelectronic commodity futures exchanges, whichincludes launches of a slew of new products suitable tothe fast-changing market dynamics and needs such ascertified emission reduction (CER), aviation turbine fuel(ATF), gold guinea contracts, and so on. As per FMCestimates, total turnover of commodity futures tradingis expected to cross Rs.60 lakh crore in the current fiscal(2009-10) and Rs.100 lakh crore by 2010-11, provided

the FCRA amendment Bill is passed.

Given the growth in tradingvolumes and increasing integrationof Indian economy with the rest ofthe world, the Indian commodityfutures market has begun to berecognized among the topderivatives exchanges of the world.


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MARKET COMMENTARY | 11

Given the growth in trading volumes and increasingintegration of Indian economy with the rest of theworld, the Indian commodity futures market has begunto be recognized among the top derivatives exchangesof the world. According to Futures Industry Association(FIA) and data put up by benchmark internationalexchanges, for the year ended March 31, 2009, MCXfares as the world No. 1 in Silver, No. 2 in Gold (followedby NYMEX and TOCOM) and No. 3 in Natural Gas, CrudeOil, Copper, and Zinc futures (by the number ofcontracts traded). Until August 31 of the current fiscal,MCX retained its leadership position with 85% of thetotal turnover of all the 24 exchanges.

There had been a significant decline in the volumes offutures trade in agriculture commodities. During 2007-08, it fell by 28.5% and the trend continued in 2008-09as well. And a major part of this fall in the trade volumesof agricultural commodities was accounted for byChana, Maize, Mentha Oil, and Guar seed, Potato, GuarGum, Chilly and Cardamom. The trade in these eightcommodities, which accounted for 57.9% of total futurestrade in agri-commodities in 2006-07, plummeted byover 66.4% during 2007-08 compared with the previousyear level. Further, this fall (in the eight commodities)exceeded the overall drop in futures trading volumes inall agricultural commodities together.

While the trade in non-agricultural commodities,especially bullion and crude, has increased in the pasttwo financial years, the same in agriculturalcommodities has declined. The share of agriculturalcommodit ies almost halved during 2008-09, due to thecontinued ban on several commodities. Futurestrading in Wheat, Rice, Tur and Urad was banned inMarch 2007 by the government following pressurefrom many quarters blaming the futures market for anunprecedented surge in retail prices of foodcommodities, though later the Abhijit Sen committeeappointed to find out the truth, found no direct linkbetween the price rise and futures trading. Theagricultural commodities vertical suffered anothershock on 7 May, 2008 as four other agri-commodities

Chana, Soy Oil, Potato and Rubber were bannedfor four mont hs until December 3, 2008 citing the samereason. Rice, Tur and Urad are still under ban, while theban on what futures was lifted on May 15, 2009. Lately,Sugar was also banned on May 27, 2009 following ashortage and the associated increase in its price.

Drop in agricultural commoditi es trading volume

Prevailing prices of banned agricultural commoditiesand the volatility that existed in their cash marketsclearly indicate that their trading in organised and well-regulated markets would have kept the volatility intheir prices under control than otherwise.

Abolition of CTT The Union Budget 2009-10 didaway with the Commodity Transaction Tax (CTT) of0.017% proposed in the Budget 2008-09. This will helpIndian commodity futures markets not only becomeglobally competitive but also develop into benchmarkmarkets, at the international level, by becoming pricesetters in many commodities (India is currently a pricetaker despite being one of the worlds largestproducers/importers/exporters of about 17commodities) through much wider participation. Themove will also help mobilise the resources that wouldhave otherwise been diverted to CTT towardsenhancing expertise and skills of domestic commodityfutures markets to international standards. Theproposed tax, had it been implemented, would havestunted the growth and maturity of a still-nascentmarket whose turnover is less than even half (only 40%in 2008) the countrys equity market turnover, whileglobally the corresponding figure is 5 to 10 times.

Regulator y and market developments

The passage of the FCRAamendment Bill, currently beingawaited, will clear the deck forintroduction of long-awaitedins t ruments in commodi tyderivatives such as options andindex-based trading, which willdeepen the market through widerparticipation of entities like banks,mutual funds, FIIs.


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Amendment to FCRA: The proposed amendment toFCRA will make FMC an autonomous regulator withfunctional and financial autonomy to play itsregulatory role more effectively alongside itsdevelopments responsibilities. The passage of theFCRA amendment Bill, currently being awaited, willclear the deck for introduction of long-awaitedinstruments in commodity derivatives such as optionsand index-based trading, which will deepen the marketthrough wider participation of entities like banks,mutual funds, FIIs. A large number of risk-averseeconomic stakeholders will likely be attracted towardsthe market with increased information aboutcommodities enabling hedging of price risk at muchlower costs (driven by increased liquidity). This will helpIndia emerge as a price taker with a transparent flow ofmarket information converging from a highly increasednumber of domestic and international participants. Thiswill also guarantee fair returns to farmers.

Regulatory measures: FMC has recommended areduction in central value added tax (cenvat) from 8%to 5%. It has also directed commodity exchanges tolevy non-compliance charges on high-value cashdealings. However, it stated, cash transactions up toRs.10 lakh will attract no charges, while traders willhave to pay 0.1% of commodities transaction value ifthey wish to sett le in cash. The move obviously aims todiscourage cash dealing in commodities.

Conclusion

Indian commodity exchanges have come a long way,with an impressive growth during the last six yearssince 2002-03 when the government embarked uponpolicy liberalisation. The three national onlineexchanges came into being, taking the erstwhileturnover of Rs.66,530 crore to Rs.52,48,956 crore in2008-09. As these exchanges grew over the past sixyears, they also took along with them the stakeholders,besides nurturing the ecosystem delivering both thefelt and the unfelt benefits of their existence to one andall in the commodities supply chain right from theproducer to the consumer. During this small yetremarkable journey, these state-of-the-art exchangeshave also crossed several policy hurdles to grow instature equivalent to their international counterparts,

seamlessly integrating with the entire financialmarkets architecture. They also did help spread risks inmajor commodities ecosystems across severalstakeholders thereby making the economy morecompetitive in the current rapidly globalising world.Being online with extended hours of operation, thesemodern commodity exchanges have also enabled theIndian industry manage risks as they flow from theirorigins crossing economic borders. It is a further policyboost and socio-economic-institutional change asdiscussed above that will take the Indian commoditymarkets to a much higher level of growth to help the

economy allocate its resources effectively as with thedeveloped economies, spread the risks thinly amongall the stakeholders, and wade through the fear ofglobalisation affecting our economic and politicalstability.


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EXPERTS VIEWS


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Agriculture sector development in India is very crit icaltoday than ever before as the sector still supportsnearly two-thirds of the countrys population eventhough its share in national gross domestic product isless than one-fifth, which creates a situation where alarge number of households have too small an incometo sustain their life. In addit ion, there are also seriousquestions raised about food security in the country.Any effort to improve rural condit ions on a sustainablebasis hinges to a large extent on how agricultureincome can be increased. These efforts will have to bein the form of policy instruments in the area oftechnology, markets, infrastructure and institutions.India has had a very successful technologydevelopment in the past in agricultural production ingeneral and particularly in crops such as cotton, maizeand vegetables recently. Even now, a number oftechnology options seem to be available at thelaboratory level waiting for appropriate market,infrastructure and institutional conditions for effective

adoption. Institutional conditions perform animportant function of providing easier financing to theagricultural sector through creating appropriateprocesses. All these factors are interrelated and unlesschanges in them are made in an integrated manner,they will not help in creating an enabling environmentfor faster growth. India has certainly lagged behind interms of bringing appropriate changes in markets,infrastructure and institutions in order to leapfrogdevelopment of the agriculture sector.

During the Green Revolution, a major reform wasinitiated when almost all the states brought inlegislation the Agriculture Produce Market Commit tee(APMC) Act to ensure an efficient system of trading

Agricultural Marketing and Financing i n India

agricultural commodities. This Act helped inestablishing nearly 7,500 regulated marketsthroughout the country and stipulating howagricultural trade should take place. The APMCs, set upin major production and arrival centres across thecountry, perform the crucial function of organisingagriculture trade and providing a meeting point forbuyers and sellers. However, during the past 50 years,no significant improvement has taken place in thefunctioning of agricultural markets. Though the APMCswere set up to protect farmers from exploitation ofintermediaries and traders, as well as ensure betterprices and timely payment for their produce, thesemarkets have become inefficient over a period of t ime.

Agriculture sector financing has so far mainlyconcentrated on production financing, leaving behindequally important marketing finance. During the GreenRevolution, cooperative institutions played a majorrole in providing production financing in many parts of

India. However, over the years, various policies of thegovernment weakened the performance of theseinstitutions creating a major vacuum in financingagriculture. This has enormously affected agriculturesector growth in the country. While considerableefforts have been made in recent years to improveagriculture financing through measures such as loanwavers, reduction in interest rates, mandating banks toincrease the share of loans to the sector, and KisanCredit Cards, among others, a large gap still remainsbetween provisioning and the requirement, forcingfarmers to fall back on the informal sector. The world

over agricultural marketing and financing developedtogether as complementary to each other. However, inIndia, they are dealt separately ignoring this attributeof complementariness.

An In t eg r a t ed Appr o a c ht o Ag r ic u l t u r eM a r k e t in g a n d Fin a n c in g

An integrated approach, in which efficient systems of e-spot trading, grading andquality certification, scientific warehousing and collateral management, crop/weather

insurance, and futures-benchmarked OTC offered forward contracting can exploitcomplementarities between agricultural marketing and financing, will help solvecurrent problems in these functions.

By Prof. Gopal Naik


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In recent years, liberalisation of agriculture trade inIndia as part of the globalization process has createdenormous pressure to reform the agriculturalmarketing system to be in tune with the rest of theworld both in t erms of quality and efficient handling ofagricultural produce. And this challenge has beenaccentuated because there has hardly been anyworthwhile reform undertaken in the countrysagricultural marketing for a long time now, whileelsewhere technology development, especially that ofinformation and communication, has been effectivelyused for improving the agricultural marketing system.In addition to technology development, severalprocess improvements need to be brought in to reducethe cost of transaction, which will help increase theprice realised by the grower and decrease the pricepaid by the consumer. Lower prices at the consumerlevel increases demand and higher prices at the farmlevel increases supply, and these two changes togetherresult in large volumes of production andconsumption, benefiting both consumers andproducers and, thus, contributing significantly to theeconomy.

Complementarities between agricultural marketingand financing help evolve an integrated approach toaddress the current problems in these functions. A

good marketing system facilitates easier financing anda good financing system improves efficiency inmarketing. The ultimate objective is to developmarketing and financing systems where pricediscovery takes place in an efficient manner, cost ofmarketing reduces, quality of produce improves,farmers are able to receive payments as well asproduction and marketing credit in time, transactioncost is reduced, and also risks are reduced. For thedevelopment of such marketing and financingsystems, the following requirements have to be met:

An efficient spot trading system An efficient grading system An efficient forward market An efficient insurance market An efficient warehouse receipt system An efficient Government support system

With these systems in place, a farmer will be able to getboth production and marketing credit as well as sell hisproduce efficiently. At the time of planting, once thefarmer takes his decision on the crop and acreage, heshould be able to avail of crop loan and crop yieldinsurance. With the crop-acreage decision, he has anestimate of crop yield that he should be able to sellforward through a forward contracting arrangement tobe established at an APMC. In fact, the farmer can make

New System for Agricult ural Market ing and Finance

the crop-acreage and forward contracting decisionssimultaneously based on the prices offered in theforward contracting arrangement. The forwardcontracting system will be tagged on to the futuresmarket, with the contract price derived from futuresprices. Farmers should be able to sell the crop to theextent of insured quantity. These forward contracts arethe over-the-counter (OTC) transactions available atAPMCs, organised by private players and are based onthe prevailing futures prices. This will be essentiallyretailing futures contracts to farmers. A farmer can usethe forward contracting facility at any time during thecrop production period. Based on the forward contractand yield insurance, the farmer should be able to takeadditional loans if he intends to do so. The forwardcontract buyer may have reinsurance arrangement tomeet the financial obligations in the event of a crop losswhich should not be recovered from the claim of thefarmers from the agency that had provided them withcrop insurance. This insurance may be given by thesame agency as the crop yield insurance which mayfacilitate faster processing. The Food Corporation ofIndia should buy the contract in case farmers areprepared to sell at the announced minimum supportprices. This futures contract, along with the crop yieldinsurance, enables farmers to get bank credit inaddition to the crop loan. Once the harvest is done, thefarmers can check the quantity and quality of theproduce. And they will have the following options (see

flowchart):

1. Deliver the contracted amount to the forwardcontract seller and sell the remaining amount inone of the following ways:

a. Wait for the better prices in the future: if thecurrent prices are not attractive and the farmerexpects the prices to go up in the comingweeks/months, he keeps the produce in awarehouse, gets a warehouse receipt, may ormay not go for a pledge loan from the bankcounter, sells at a later date and realises theremaining value.

b. Sell it in the forward market: The farmer feelsthat one or more forward prices are attractive.He keeps the produce in the warehouse, gets awarehouse receipt and forward sells it using theforward market and delivers on the contractmaturity.

c. If the current prices are att ractive, sells in thespot market.

2. The farmer buys back the contracts he has soldduring the planting time and uses any one of the

above three options keeps in the storage for asale at a later date, sells using the forward market,sells in the current spot market.


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This integrated system will provide the followingadvantages to the farmer:

Easy financing of crop production and marketing: Farmers can get crop production credit and marketingcredit through insurance, forward selling andwarehousing. At present, crop production loan is

available, but credit limit s are low. Farmers will still havethe option of going for crop loan in the existingarrangements, without going for forward contracting.However, farmers should be able to get more creditthrough forward contracting.

Risks are covered: Farmers can cover the yield riskthrough crop yield insurance and the market riskthrough forward contracting. Thus, this providescomprehensive revenue insurance to farmers.

Low transaction costs: As systems develop and reach

a steady state, the transaction costs in t his mechanismare likely to be low. A large volume of handling ingrading, warehousing, forward transaction andinsurance will facilitate t ransactions at a lower rate.

Price stability: With the forward contractingarrangements, there will be a better estimate of thesupply of commodities that would be used in thefutures market as forward contract sellers hedge in thefutures market to cover their risks. The additionalinformation flow into the system will lead to stability inthe prices.

This integrated system will work well if each one of itscomponents is made to work efficiently. And this willrequire participation of both the public and privateplayers as well as government support .

In the current marketing system, APMCs play a pivotalrole in spot trading. However, these primary marketshave not kept pace with the developments taking placein the international markets. Some of the deficiencies in

the existing agricultural marketing system are:

Eff icient Spot Trading System

A NOVEL AGRICULTURAL PLEDGE FINANCING MODEL


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Absence of a good qualit y assessment system: Thisoften result in lower price realization for the seller(farmer), while the buyer takes advantage of the stateof affairs to offer lower prices to the farmers.

Absence of a good grading system: This makesfarmers unaware of the quality requirement ofagricultural produce at the user end, making farmersneglect the quality aspect of their produce.

No post-harvest guidance system: Absence of anyextended system to guide farmers on post-harvest careresults in substantial losses of value of the agriculturalproduce.

Poor handling of agriculture produce: This practicein the market yard results in large losses of the farmproduce. Poor handling also results in substantial lossin quality during marketing of the produce, putt ing itfar below international standards.

Poor knowledge of packing and scient if ic storage: This leads to losses in the supply chain, which gets builtup at the consumer end.

Lack of price information: Price information aboutother markets is not available on right time, whichmakes farmers rely mainly on the prices quoted by localtraders.

No access to warehouse receipt financing: Thispushes farmers to distress sales and lower pricerealizations. Limitation of selling options: The systemof marketing through APMCs with only a few registeredtraders who often buy in collusion among themselves,farmers have restricted selling options.

Lack of effective information transmission: Thisleaves very high information arbitrage possibilitiesamong the markets.

Therefore, APMCs need to redefine their role in thecontext of present era of Information andCommunication Technology (ICT) and globalization. Inrecent years, certain policy changes have beenannounced to improve the agricultural marketingsystem and they are:

Encouraging procurement of agriculturalcommodit ies directly from farmers field

Removing all restrictions on production, supply,storage, and movement of produce

Permitt ing the establishment of private marketyards, direct purchase centres, farmers markets fordirect sales

Promoting PPP (public-private partnership) in themanagement and development of agriculturalmarkets in the country

Sett ing up special markets for perishablecommodities such as onions, fruits, vegetables, andflowers.

Encouraging alternative marketing systems such ascontract farming, direct marketing, and farmersmarkets

Promoting grading, standardization, and qualitycertification of agricultural produce, which would

While many of these initiatives are yet to beimplemented, a significant init iative that can be takenup immediately is the setting up of and enabling ofelectronic spot trading (e-spot trading) foragricultural produce.

The developments in ICT that have already taken placecan facilitate agricultural marketing functions andprocesses, including buying and selling, payment, andtransportation and logistics. This will connect localmarkets nationally and will effectively do away withinformation arbitrage that exists in todays APMCmarkets. ICT can also play a pivotal role indisseminating and using trade information. Adoptionof ICTs for agricultural trade, in the form of electronicspot trading, will benefit farmers enormously. Thus, thee-spot exchange is a marketplace where local farmersand traders can sell farm produce, while upcountry

buyers, processors, exporters, and end-users can buyelectronically through competitive bidding.

E-spot trading is an effective method which enablesfarmers to sell their produce to anybody, anywhere,anytime in a transparent way. This can not only reducetransaction costs and make intermediation incommodity markets cost-effective but can alsoeffectively mitigate problems of lengthy supply chainthrough the elimination of middlemen connectingfarmers through the shortest possible value chain,which in turn helps farmers realize a better share ofconsumers rupee. Price realization by sellers will alsobe faster. Further, the anonymous nature of the systemwill ensure pricing transparency and reducepossibilit ies of speculation.

This screen-based trading will help small and marginalfarmers participate as it will be possible to do trading insmall quantities, without any dependence onmiddlemen to sell their small marketable surpluses. Thee-trading will also remove the problem of informationasymmetry, as price information will be availableinstantaneously in any terminal and quality assessmentwill be done before the transaction. The trading will help

the producer get the best possible price for hiscommodity/produce. Potential participants/traders onthe exchange platform can be farmers, farmersassociations/co-operatives, corporate, wholesalers,exporters, importers, processors, the government, etc.

E-Spot Trading


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Requirements for successful implementation of e-spot t rading:

APMCs and spot trading the PPP model oftransformation

Synergy bet ween APMCs and NESEs

Amendment of the APMC Act that gives recognitionto these electronic spot exchanges.

Good warehousing facilities, coupled with gradingfacilities at market yards where farmers producecan be graded and stored, as well as be able topledge produce for warehouse receipts. This willenable farmers to get easy financing.

Setting up grading laboratories at market yards forestablishment of uniform grading/qualitystandards. APMCs stand guarantee to the qualityspecified in the auctioned lots.

Arrangement with transporters who can ensuredelivery of the goods sold.

Removal of restrictions on interstate movement ofagricultural produce.

Setting up of trader work stations, leased lines,internet facilities, power backups, etc

Establishment of contract specifications thatinclude particulars such as opening of contracts,unit of trade, base value, price quote, maximumorder quantity, delivery specifications (delivery unitand centre) and quality specifications (grades,standards, tolerance limit s, etc).

Though the e-spot trading is a good alternative totraditional marketing, the investment needed to set upnational-level electronic spot exchanges (NESE) byevery APMC is likely to be a deterrent. Theinfrastructure and quality of manpower needed arealso deterrents to sett ing up of an e-trading platform inagriculture. Therefore, a viable model is to have a PPPwith NESEs. This can be done at the state level byorganizations like State Marketing Boards, which willlink each APMC with the existing NESE.

Synergy in this PPP is feasible due to thecomplementary nature of the two entities APMCand NESE. APMCs have physical infrastructure,knowledge and catchment of commodities, whileelectronic spot exchanges have pan-India reach with arobust delivery and payment mechanism, which cancreate an effective combination to transformagriculture marketing. NESE is neither a buyer nor aseller nor a commission agent. It is a facilitator thatundertakes delivery and payment responsibility and,thus, functions like a national-level APMC facilitatingtrade between the buyer and the seller. While APMCsprovide a backward integration, linking farmers tomarket yards, NESEs provide a forward integrationlinking processors, export ers, end-users and upcountry

buyers to local delivery points. Hence, the synergybetween APMCs and NESEs will complete the chainand make it most efficient.

NESE is a new distribution channel with tradeguarantee that offers advantages to the overallmarketing system. It allows desktop monitoring oftrade, offers efficient warehousing and logisticssupport, guarantees quality, functions as acomplementary market to derivative traders, facilit atestimely disbursement of commodities and funds whileensuring transparency in transaction and settlement.More importantly, being online and accessible totraders located across the nation, it preventsinformation arbitrage from getting added toconsumers rupee. This model of marketing of producehas advantages for farmers, APMCs, traders and

exporters. Farmers will have better price realization,lower transaction cost, easy access to credit, clarity onquality requirements and quicker transaction. APMCswill have better realization of market fees, greaterout reach and timely t ransaction. Traders will have a bigand liquid market, where they can sell a large quantity,with the elimination of counterparty risk, credit risk,rejection at the buyers godown at the time of deliveryand easier access to bank finance against warehousereceipts. With the grading system in place, they caneffectively use the futures market for managing theirrisk. With operational ease, availability of finance and

absence of counterparty risk under the NESE system,they can expand their activities to multiplecommodities. Exporters can buy certified qualitymaterial through a secured platform. Hassles relatingto procurement of material in physical markets cancompletely be avoided. Exporters can save brokerageor commission payable to procurement agents. Usingthe price available at NESE, they can make exportcommitment and cover themselves immediately bybuying at NESE.

Formal grading of agricultural commodities is veryrarely done for internal transaction in India. This hascaused the lemon problem in agricultural marketswhere bad quality produce drive away good qualityproduce in the market as there is no price incentive forfarmers to supply better quality produce. This also hasled to a larger gap between the quality of domesticallytraded produce and internationally traded produce,making exports of agricultural produce difficult. Inaddition, imports of good quality produce are takingplace to meet the needs of the emerging quality-conscious section of Indian population. Reversing this

trend necessitates development of a value chain that isconscious of quality. This can be effectively facilitatedby introducing grading at the primary wholesalemarket level.

Eff icient Grading System


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Although Agmark standards and labelling has been inexistence for nearly half a century, its reputation hasnot helped produce quality crop in India. Also, forcommodities, grading is hardly practised in thecountry. But then the pressing need for a good systemof grading to bring in quality consciousness amongvarious participants in t he agricultural value chain canhardly be overstated.

A good grading system ought to have unquestionableintegrity and standards in line with the requirement oftrade, continuous upgrading of standards andharmonising with international standards. This couldbe achieved effectively with participation of both thepublic and private sectors. While the governmentshould set standards and continuously undertakeresearch to upgrade and harmonise, the private sector

can develop a system to implement it effectively. Whilesteps should be taken to update Agmark standards toreflect consumer preferences and technical needs ofprocessors, a few national-level companies can beaccredited for grading and certification of agriculturalproduce. These companies can have franchises so as tocreate enough facilities for grading and certification atall APMCs. This will help in facilitating e-spot trading,warehousing, financing and forward contracting. Thecommodit ies futures exchanges already have already agrading system in place, but a robust grading systemcan be set up only when the government too pays

adequate attention to the development of standardsand grading systems.

An efficient warehousing receipt system can go a longway in helping reduce transaction costs in the supplychain and facilitate financing of agriculturalcommodities. A scientific method of storage, whichprevents deterioration in quality and quantity duringstorage, will give financial institutions the confidenceto extend easy financing. The extent of finance that themarket participants can obtain through pledging willalso increase. This will also make transactions over longdistances easier. There are private sector companieswhich are already providing scientific warehousingfacilities including collateral management. Withappropriate backup of legislation, the warehousereceipt system will become easier to implement.

With the warehouse system available at the APMClevel, a farmer can either sell his qualitycertified/graded produce immediately through an e-spot exchange or defer the sale. In case of deferment hemay go for pledge financing to meet immediate

financial requirements. This protects farmers fromdistress sales.

Efficient Warehouse Receip t System

Eff icient Forward Market

Eff icient Insurance Market

Conclusions

With the futures market, grading and warehousingsystem in place, private companies can offer retailing ofcommodity futures contracts at the APMC level. Aformula can be established to retail futures contracts tofarmers in the form of forward contracts. Since there is aproblem of uncertainty about the amount of yield,forward price contract may require a yield insurance tobe obtained as a prerequisite. Once the decision onplanting certain acres of a particular crop is made, hecan obtain insurance and then forward sell at an APMC.In case there is a shortfall of yield, the insurance can beused to make up the losses. As more and more agenciescome up to retail forward contracts, a much neededhealthy competition to provide this service will becreated at the APMC yard. With yield insurance andforward contracting, farmers can effectively addressboth yield and price risk, which will enable the farmerto obtain credit easily.

Yield insurance has been existence in India for morethan three decades for crops such as rice and wheat.However, they are offered on an area basis, as there areno effective ways of dealing with moral hazard andadverse selection problems. Nevertheless, withincreasing sophistication in the data collection

methodology, individual assessment-based insurancewill become a reality. Such an insurance system willaddress the risk management needs of farmerseffectively. With a good insurance market, financing atthe farm level and, thus, credit access to farmersbecomes easier.

An integrated approach, in which efficient systems ofe-spot trading, grading and quality certification,scientific warehousing and collateral management,crop/weather insurance, and futures-benchmarkedOTC offered forward contracting could exploitcomplementarities between agricultural marketingand financing, will help address current problems inthese functions. The ultimate objective is to developmarketing and financing systems wherein pricediscovery takes place in an efficient manner, cost ofmarketing reduces, quality of produce improves,farmers are able to get their payment in time, farmersget both production and marketing credit in time,transaction costs are reduced and risks are minimised.

Prof. Gopal Naik is Professor, Indian Institute of Management Bangalore. Views expressed by the author are personal and not of the institution.


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Economic liberalisation took off in the early 1990s inIndia. Like in many countries, policymakers,practitioners and academics responded to the growthof financial markets worldwide, and a new-foundebullience surrounding emerging markets, byadvocating wide-ranging reforms. International tradeand investment were opened up, a process ofderegulation and privatisation init iated, the tax regimereviewed.

India's economy greatly benefitted. In 2007, thecountry clocked its highest ever GDP growth rate of 9%

the second-fastest in the world after China and a far cryfrom its annual GDP growth in the three decades post-Independence. However, the reform process is stillincomplete, and the financial sector has been laggingbehind many parts of the real economy. Stakeholdershave still not reaped the fruits of greater competition infinancial markets, unlike what has been seen in sectorssuch as telecom, banking, insurance, and aviation. Butnow, Indian financial markets are poised to scale to thenext growth orbit.

India increasingly integrates with markets around theworld. This opens a window of opportunity to Indiancompanies but also, exposes them to a whole newworld of risks. Among these risks, of key import ance to

many, is commodity price volatilit y. Companies need tobe able to manage these risks if they are to be globallycompetit ive, and this is where an efficient commodityfutures market plays a primordial role not only infacilitating price/volatility risk mitigation but alsocatalysing near-perfect price discovery.

After decades of decay, India's organised futuresindustry was revived in 2003. As it matures over time, itsbackward and forward linkages will strengthen,resulting in widening and deepening of the marketthrough increased part icipation by various ecosystem

players. This in turn is changing the ways producersmake their cropping decisions, traders trade theirproducts, and banks lend against commodities orthose with exposure to commodity price risk. Theult imate result s will be 'Financial Inclusion' and 'MarketInclusive' growth.

The price discovery process should not be left to just ahandful of traders in asymmetrically informed or ill-informed, segmented markets. Rather, the best pricediscovery comes when a large number of variouscategories of market players with a wide range of

The Enabler of Eff icient Price Risk Management andPri ce Discovery

C o m m o d i t y Fu t u r es

in In d i a A Pr o d u c t o f G l o ba l i s a t io n a n dLibe r a l i s at io n

A beginning has been made towards transforming the Indian commodities sector, from itscurrent status of being a price taker to a price setter, with the national online commodity

futures exchanges taking the lead. These exchanges are offering the benefits ofliberalisation and globalisation directly to the industry and consumers by empoweringthem to influence the global prices of commodities they deal in. It is time the markets weremade much more vibrant and efficient by allowing participation of a larger number of newcategories of economic stakeholders and introduction of innovative derivativeinstruments. This is to plug risks at the roots rather than when they finally sneak into theprices of end products. And this will make the Indian markets a force to reckon with on theglobal commodity map, turning them into a price setter indeed.

By Mr. Lamon Rutten


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EXPERTS VIEWS | 23

objectives and interests converge on an organizedfutures platform. Such a platform and the MultiCommodity Exchange of India Ltd. (MCX) is oneensures that all relevant information is absorbed in theprice formation process, and the right price isdiscovered. The more efficient the discovered prices ona futures platform is, the more effective are thebusiness and policy decisions that are taken based onthese prices.

The efficiency and transparency of price discoverydepends on the robustness of the trading platform; itsregulations; the right mix of its participants withrelevant price information; making participation cost-effective vis--vis alternatives available for riskmanagement and/or investment; effectivemanagement of the participants' varied risks and, lastbut not the least, a robust and transparent clearingpolicy.

In just about six years, the national commodity futuresexchanges in India performed better than thepolicymakers expected in terms of catching up withtheir age-old global counterparts on most of theaforesaid parameters. A lot of efforts delivered from abase of strong domain knowledge and technical skillswent behind this spectacular growth. Selection ofcommodities relevant to the stakeholders; rightcontract design; keeping ears and eyes to market

needs; taking them to appropriate participants;creating awareness; expanding infrastructure; andbringing in world-class technology and global bestpractices are some worth mentioning.

To make these markets more relevant and useful todifferent categories of stakeholders and thus theirparticipation more effective, it is necessary that variousrisks to the participants be effectively managed. Riskmanagement tools on a futures platform includemargining, limits on open positions, and effectivesurveillance (see table 1). Price volatility ofcommodit ies traded on an exchange is an indicator ofhow effectively these tools are used by the exchangemanagers to improve the efficiency of price discovery.That is to gauge the capabilit y of its futures contracts topredict its maturity prices more accurately (indicatedby the percentage deviation between the first tradedprice and the last traded price of a given contract). Theefficiency of price discovery is also indicated by thenearness of the spot and futures price movements. Inthe case of MCX, the correlation between its goldfutures contract and gold spot prices is around 99.8%(from January 2007 to August 2009), which indicates astrong inter-linkage between domestic spot andfutures markets. For the same period, MCX goldcontract's correlation with the global benchmark,COMEX gold futures contract, is around 99.9% (therupee adjusted). This reflects how efficient t he Indianfutures market is in capturing global cues.

Note: In t he case of price discovery, we considered August 2009 contracts MCX Gold cont ract, COMEX Gold and Nifty Futures.Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore sourced from NSE website on September 9, 2009.Impact cost for Nifty was calculated based on trading happened on a regular trading day. Impact cost of MCX gold calculated for a portfolio size of Rs.2 crore.Impact cost of COMEX Gold calculated for a portfolio of USD4 lakh (app. Rs.2 crore).

Position limit is significantly lower than thatof global benchmark exchanges indicatingthat t he domestic futures market cannot bedistort ed by single/a few players.

The lower price volatilit y on MCX comparedwith global exchanges reflects that pricediscovery on the domestic platform ishappening with more price stability.

The lower impact cost on MCX at par withglobal exchanges reflects bett er liquidity interms of market depth and width.

Particulars Domestic Exchanges

Commodityexchange (MCX)

Stockexchange (NSE)

COMEXand CBOT

Global Exchanges Remarks

Positi on limit tophysical marketsize (%)

Impact cost

Avg. daily volatilit yin January 2007to August 2009

Gold - 0.9%

COMEX Gold - 1.5%CBOT Soybean Oil- 2.1%

COMEX Gold - 18.7%

COMEX Gold - 0.019%

NIFTY - 1.60%

NIFTY - 0.16%

-

Gold - 1.3%,Ref. Soy Oil - 1.2%MCX Comdex- 1.4%.

Gold - 0.027%

Table 1: MCX vis--vis global paramet ers


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Again, as the same table shows, MCX gold contract ismore efficient than COMEX gold contract in terms ofprice discovery. The lower volatility on the Indiancommodity exchanges is due to the close monitoringand the robust margining system adopted by them.MCX follows strict vigilance with an automated systemin place. The system, for example, provides automatedalerts when a members margin utilization crossesvarious levels. If the margin utilization crosses 100%,the member in question is put automatically on asquare off mode. This innovative risk managementsystem has been adopted to prevent any spread offinancial contagion. Besides the functional efficiency oftrading, the technological robustness (both hardwareand software) also adds value to the MCX participantsby enabling cost reduction. It has a constant

collaboration with FTIL, the parent company, aimed atimproving the software through telecom technology,and this works towards cost-effectively connecting thestakeholders to the market.

The introduction of commodity derivatives hasremained one of t he most significant developments inthe Indian commodity market sector. The threenational online exchanges brought in revolutionarychanges in this sector by bringing in spatial integration

and temporal price discovery of commodities at thenational level. In the span of just six years, they haveperformed well, being successful in bringing variousecosystem participants such as producers, hedgers,arbit ragers, and speculators on to a single platform. Theannual turnover of domestic commodity exchangesincreased from Rs.5.7 lakh crore ($127.6 billion) during2004-05 to about Rs.52.48 lakh crore ($1,143.1 billion)in 2008-09 at 74.10% CAGR.

The exchanges clocked this robust growth despitecontinuance of various restrictions. For example, on

instruments such as options and indices; participationof commercial banks, mutual funds and FIIs; and so on.What helped these exchanges to leap forward andattain higher levels of efficiency and t rade volumes aretheir innovative products, functional transparencybased on sound regulation, innovative applications oftechnology, effective adoption of global best practices,etc. These exchanges effort s and performance helpedmake Indian companies and economy globallycompetitive. The robust growth numbers reflect thestakeholders strong faith in these exchangesfunctional efficiency and transparency, as well asindicate the commodity markets growing influence

Commodi ty Derivatives - the Road So Far

over the Indian economy. The prices efficiently andtransparently discovered on these exchanges aregradually being transmitted to the physical markets,and this will lead to increased competit iveness both in

the manufacturing and services sectors.Global commodities traded on these Indian exchanges,such as bullion, ferrous and non-ferrous metals(copper, aluminium, steel, etc) and energy (crude oiland natural gas), account for more than 80% of theiraverage daily turnover. These commodities are largelylinked to the global markets as their imports andexports are allowed subject to a marginal tariffincidence. Obviously, most of these commodities arelargely governed by their fundamentals (the supplyand demand condit ions) at the global level and part ly

by developments on the domestic front . Therefore, it isnecessary for the users of these commodities to takepositions on a futures platform with global linkages inorder to hedge their risk. Such users may participate inexchange-traded contracts with their underlyingphysicals being the same as their raw materials andwhose prices are linked to the prices discovered on theinternational benchmark exchanges. But in theabsence of such an arrangement, trading onexchanges having the right mix of arbitragers betweenthe domestic and global benchmark exchanges willalso serve the hedging purpose. However, the second

option may not be workable due to lack of clearparticipation norms for international exchanges, whilethe option of indirect participation will be costly formost of todays corporate hedgers.

For globally traded commodities, particularly metalsand crude oil, the prices discovered on MCX have veryhigh correlation (96%, on an average) with theinternational benchmarks (see table 2) despite the highvolatility in USDINR in the recent past. This also showsthat the prices of MCXs futures on globally tradedcommodity follow efficiently and in tandem the

combined forces of domestic and internationalfundamentals. And this makes the domestic onlineexchanges a cost-effective and superior alternative totheir international counterparts.

Gold 94.3Silver 94.8Copper 94.4Crude oil 97.6Average 96.0

Data Source: Exchanges' websites

Table 2: Price correlation MCX vs. global benchmarkexchanges in globally-linked commoditi es fromApr 05-Mar 09 (in %)


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The Way Forward

At this juncture when the Indian markets are on theirway to the heights achieved by the global benchmarkmarkets, it is essential t hat t hey are allowed to have theright mix of participants and products to have thenecessary liquidity depth and width. Corporates andphysical market players in India are gradually realisingthe importance and need to participate on commodityexchanges. An increased participation of such playerswill go a long way in streamlining commodity tradingin India by bringing in relevant information about thefundamentals into the markets and, thus, making theprice discovery process more efficient. Besides, this willalso help corporate best practices percolate into themarkets to fine-tune their functioning and efficiency.

Given the current trend of globalisation of economies,competitiveness remains one of the most definingfactors for developing economies. And this not onlymeans having competit ive manufacturing and servicessectors but also necessitates promotion of markets tomake them globally-competit ive.

To cite an example, in India, neither theautomobile/ancillary industries manage their inputcosts effectively nor do the suppliers of their rawmaterials. This is partly due to lack of policy guidelinesallowing and promoting them to effectively participate

in the market and partly because of lack of awarenesson their part. However, of late, the coming up of thenational commodity exchanges, armed with theirglobal alliances, has provided industrial users ofprimary commodities with easy access to an alternativeplatform to trade on. The domestic exchanges offeringsuch an opportunity to the industry ought to beeffectively harnessed to efficiently manage their profitmargins and safeguard their investor and consumerinterests by infusing efficiency and economy into theirprocurement operations. Effectiveness of participationin global exchanges can only be replicated if thedomestic exchanges meet the efficiency of t rading inthe global benchmark exchanges, especially in theglobally traded commodities (with least tradedistortions).

Although India has a long way to cover in harnessingthe potential in the major commodities, the story of it sbullion market is bright. The Indian bullion market hasdemonstrated its resilience to remain t he price setterfor gold and silver in the Euro-Asian time zone. Indian(MCX) bullion prices have strong correlation with thoseof the international benchmark markets.

Gone are those days when policymakers successfullyused MSP as an instrument to influence the croppingpattern and production of farmers. It is the functioningof the domestic commodity exchanges which will

strengthen the market-based trading system in Indiamaking it useful for Government procurement. Theexchanges will create an environment where farmershave multiple selling options (for their produce) suchas the spot market, the futures market, and the futuresmarket-referred over-the-counter forward market. Thefutures market in electronic format being executable atthe national level, integration of banks andinstitutional traders into the market will create severalinstitutional opt ions for farmers. Further, once allowedoptions will help farmers lock in their prices on thecommodity exchanges in a more efficient way than

they can currently do with the existing instruments.

Besides the price risk, which can be mitigated bytrading in relevant commodity derivatives, the weatherrisk has a profound impact on a farmers income underthe predominantly rainfed farming (about 70% of netcultivated area) conditions prevalent in India. And ifthere could be a single most positive and defining stepthat can be taken towards solutions to such problemsas mentioned above it shall be the passage of the long-pending amendment to Forward Contracts(Regulation) Act. The Act, once effective, will work

towards an efficient and vibrant commodit y market inIndia (both on the physical and futures fronts) andbring a world of good to the entire commodity marketecosystem. The multi-faceted benefits will includeintroduction of a number of innovative instruments,such as farmer-friendly weather derivatives.

India is a land of billions thatconsume a large portion of most

primary commodities produced inthe country. For the domesticexchanges to rise to the challengeof turning the country into a pricesetter it is necessary that India hasstrong and transparent marketswith robust infrastructure forefficient transactions.


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India is a land of billions that consume a large port ion ofmost primary commodities produced in the country.For the domestic exchanges to rise to the challenge ofturning the country into a price setter it is necessarythat India has strong and transparent markets withrobust infrastructure for efficient t ransactions. This inturn necessitates that Indian commodity exchangeshave an upright regulatory framework under a robustregulator. Therefore, strengthening FMC through theFCRA will be a momentous step towards strengtheningthe commodity futures market as a whole.

First, once amended, the FCRA will clear the deck forintroduction of long-awaited instruments such asoptions, intangibles like weather derivatives,commodity indices and freight indices, which through

value additions will attract risk-averse participants.And the deepening of the commodity market, thusachieved, will enhance the markets efficiency of pricediscovery and efficacy of risk management. And thiswill eventually result in fairer returns to farmers.

Second, the amended FCRA will pave the way forpart icipation of banks, MFs and FIIs in the commoditiesmarket. This will not only democratise the pricediscovery process on the exchange platform but willalso stabilise the market forces and, thus, the overalleconomy. Participation of financial institutions on

exchanges will also enable lending at market-linkedprices, which in turn will lead to the benefits of pricediscovery flowing down even to small farmers, as theirholding power will be enhanced.

Warehouses and the related institutions (quality testing,standardization, and marketing yards) form a vital clusterin the logistics sector linking the producers of agriculturalcommodities with their end-users ensuring effectivecarryover of the commodity from the farm gate to theconsumers table. Efficient warehousing creates efficientlinkages among the participants in a value chain resulting

in improved efficiency with which the produce is beingmarketed, enhanced income of the farmer, availability ofcredit through warehouse receipts (WR) etc. Besides therevenue earned from scientific stock management, thecoming into force of the Warehousing (Development andRegulation) Act, 2007 (WDRA) and setting up of theauthority will create an efficient warehousing ecosystemthat will include quality testing and certification,standardization, and marketing. Following this, issuanceof WRs and collateral management services will enableearning of higher revenues than the plain-vanilla storagecharges levied on their clients.

As the WR draws its power under the act, the value to it isadded by the linkages that the warehousing institutioncreates with the funding institutions and the strength ofthe collateral management services for the funding

agencies and their clients at a cost which would keepboth the financial institutions and clients happy.

The WDRA will also create efficient linkages betweenproducers and markets. Application of information,communication and technology (ICT); innovativesolutions to practical constraints; and effectivenurturing of t he linkages will go a long way in creatinga healthy warehousing system in the country.Development of the warehousing sector throughthe linkages to be created between the players and theinstitutions in the agricultural supply chain ecosystem

will help achieve the ultimate objective of creatingwin-win supply chains for producers, intermediaries,and consumers.

Since its inception in 2003 MCX has taken a number ofinitiatives to help the farming community to realize abetter value for their produce. It launched two majorinfrastructure projects - ?National Spot Exchange Ltd(NSEL) and National Bulk Handling Corporation Ltd.(NBHC). The combined strengths of MCX, NSEL and NBHC,

along with its strategic partners, is committed totransforming the Indian rural economy to internationalstandards by providing the last mile connectivity to ruralareas and developing the required infrastructure.

Availability of liquid futures contracts on various keycommodities on the MCX platform has dramaticallychanged the spot market scenario. The fact that theseprices are arrived through collective participation of thestakeholders from various parts of the ecosystem and thecountry makes it suitable to be benchmarked for thecommodities underlying the futures contracts for the spot

markets. This is despite the standardised nature ofcontracts and terms and conditions of futures trading. Thishas ensured emergence of benchmark prices of variouscommodities representing the most prevalent varieties inthe most active physical markets in India. Thus, thesebenchmark prices, discovered on the MCX platform,reflect the sentiments of the entire producing, trading andconsuming community representing a one-India market.The futures market is also increasingly acting as a guidinglight for the physical markets to assess the upcomingunderlying fundamentals and sentiments, and provideprice signals to the physical markets.

MCX Unrelent ing in Its Endeavour


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EXPERTS VIEWS | 27

Creating a silent revolut ion

Taking the market t o themasses

A pre-WDRA entity, NBHC, which was floated by MCXwith the felt need for delivering the underlying at the

maturity of contracts, is an end-to-end solutionsprovider in the entire gamut of collateral management;procurement; warehousing; bulk handling, grading andquality certification; commodity care and pestmanagement; audit; accreditation and commodityvaluation; trade consultancy and disposal ofcommodities. In just a few years, NBHC, with its robuststandardisation and quality-testing facilities, developedits own sustainable business model and came out ofMCXs shadow. One such business opportunity thatevolved was collateral management undertaken tofacilitate trading against collaterals (warehousereceipts). NBHC, with about 437 warehouses spread over18 states with a total capacity of 16.5 lakh million tonnesby the end of 2008-09, facilitated in its first year ofoperation (2006-07) collateral funding of Rs.1,500 crore,which rose to a cumulativefigure of over Rs.8,800crore in the current fiscal.NBHC also facilitatesgovernment procurement(cumulative of 5,34,007tonnes of rice and wheat by2008-09).

M C X h a s a c h i e v e dremarkable success inreaching out to a largen u m b e r o f a g r i -c o m m o d i t yproducers/farmers hitherto unreached through itsunique Gramin Suvidha Kendra (GSK) model. Theinnovative outreach network in tie-up with India Postto leverage the latters vast rural infrastructure in cost-effective, traditional modes of communications forprice dissemination and providing other services likeredressal of technical queries and supplies of farminputs such as seeds, pesticides/fungicides/weedicidesand fertilizers, has now spread over 768 villages servedby about 160 branch post offices, across five states,benefiting over 3,800 registered farmers more directly.Farmer registration with GSK shot up by 34% to 3,897 ason March 31, 2009 vis--vis 2,869 in 2007-08 testifying the growing popularity of the model.

Why Can India Not Be a Price Sett er?

Despite the fact that it is fast developing into a majoreconomic powerhouse in the global arena India

continues to look up at other markets to decide thelocal prices of commodities. With the country being thelargest producer and consumer of a large number ofcommodities, is it not just logical that the Indianmarkets upgrade to t he level of price setter from theircurrent tag of a price taker? And this assumes morerelevance and priority with the Indian marketsincreasingly opening up and integrating with marketsaround the world. As for commodity markets, in whichit is either one of the largest producers or consumers orboth, India has immense potential to have a domesticmarket that is strong enough to set global market

prices. In fact, given its share in global supply anddemand as a dominant player in the world market (seetable 3), the country has the potential to become theprice setter in 17-odd commodities.

To transform the country into a 'price setter' the firstlogical step would be to democratize its markets to

enable an efficient flow of information for effectivedetermination of commodity prices. And this has partlybeen taken care of by the modern national-levelcommodity exchanges, thanks to policy liberalizationof 2002-03. The rapid ICT developments helpedpenetration of the online electronic exchangesthrough reduced participation costs and increasingawareness. With the development of liquid futurescontracts in many of the aforesaid commodit ies, Indiahas started emitting price signals to the linked globalmarkets of those commodities. To a large extent , suchbenchmark futures prices of the standardisedcontracts, as discovered on the MCX platform, havestarted influencing the global counterparts. They have

CommoditiesShare (%) i ntotal global

output

Share (%) in totalglobal consumpt ion

Global r ank inproduction/consumption

Rice milled 19.4 20.5 2nd largest producer behind China

Wheat 12.1 12.0 3rd largest producer behind EU-27and China

Soybean Oil 3.8 6.1 6th largest producer and 5th largestconsumer

Gold - 22.7 Largest consumer

Coal 7.6 7

Aluminium 3.1 3.2 6th largest producer

Source: USDA, GFMS, BP Statistical review

Table 3: India's share in global production and consumpt ion


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started discounting the Indian fundamentals andsentiments in Indian time zone. For example, incommodities such as gold, of which it is the world'slargest importer and consumer, and chana, of which itis the largest producer and consumer, India, on thestrength of its futures market, is slowly gaining therightful place among the world markets, in terms ofinfluencing or setting the prices.

Although it is still a long way to go, a beginning hasbeen made towards transforming the country'scommodit ies sector from being a price taker to a pricesetter, with the national commodity futures exchangestaking a lead. They are offering the benefits ofliberalisation and globalisation directly to the Indianindustry and consumers by empowering them to

influence the global prices of the commodities theydeal in. With increased accuracy of the pricesdiscovered and more effective price risk management,the efficiency of the Indian industries and commoditymarkets will increase significantly. And this will result ina mult iplier effect on the national economy.

While proliferation of products and participants isevident from the phenomenal 110% annualcompounded growth rate at which the trade on thedomestic commodity futures exchanges grewbetween 2003-04 and 2008-09 (source: FMC and

Economic Survey data), in many global commodities

the participants tended to discount the global price-moving factors rather than domestic information.Indian markets have to enable cost-effectiveparticipation of all those with information to effectively

discover prices, and the national online commodityexchanges are already helping various categories ofparticipants get all such available information toconverge.

It is time these markets were made much more vibrantand efficient by allowing participation of a largernumber of new categories of economic stakeholdersand introduction of more innovative derivativeinstruments, besides carrying out other next-levelreforms. This is to plug risks at the roots rather thanwhen they finally sneak into the prices of end products.

And this will make the Indian markets a force to reckonwith on the global commodity map, turning them intoa 'price setter' indeed.

Mr. Laman Rutten is MD & CEO of Multi Commodit y Exchange of India Ltd. Views expressed in this article are personal.


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The Indian mutual funds industry is older than theIndian public sector banks (other than the SBI Group).The industry has made remarkable progress in terms ofsome parameters like opening up of the sector instages to all sorts of players, entry of new fund houses,growth of assets under management (AUM), expansionin the number of unitholders, introduction of newproducts, adoption of robust risk management systemcovering all operational aspects, relaxation ofinvestment restrictions, posting of consistent betterreturns, reduction of fees and other expenses, abolitionof entry load (initially for direct applications and now

for all) and investor awareness and distributioninit iatives. The Article describes the current state of thedomestic mutual fund industry, discusses theinvestment objectives and restrictions applicable to adomestic mutual fund and concludes with a briefoverview of the commodity funds.

An overview

As at end-August, 2009, there were 43 mutual funds

registered with SEBI, who offered a total of 852schemes (Open-ended: 608; Close-ended: 196 and

The Indian Mutual Fund Industry

Interval Funds: 48) to the investors. Of the open-endedschemes, six were Gold ETFs and 12 were other ETFs.The assets under the management of t he mutual fundsstood at Rs. 7,56,638.17 crore as on August 31, 2009.Equity oriented schemes, viz., Growth/Equity Schemes,Balanced Schemes and ELSS, accounted for only26.12% of the AUM. While debt oriented schemes, viz.,Income Schemes, Liquid/Money Market Schemes andGilt Schemes, made up for 73.26% of t he AUM, ETFshad 0.23% share in AUM and fund of funds investingoverseas 0.39% share in AUM. More than 56% of theAUM was contributed to by corporates and institutions.

As a percentage of GDP at market prices at currentprices, the AUM stood at 14.22% as at end-August, 2009.The AUM of mutual funds in developed markets rangebetween 20% and 70% of GDP. As on August 31, 2009,open-ended schemes accounted for 91.42% of the AUM,close-ended schemes 8.48% of the AUM and intervalfunds 0.10% of the AUM. The worldwide total net assetsunder management of mutual funds as at end-2008were $ 18.975 trillion. Hence, Indian mutual funds, with $85.32 billion AUM as at end-2008, accounted for 0.45%(down from 0.53% as at end-2007). As on August 31,

2009, the number of folios with the domestic mutualfunds totaled 4,83,51,487

commodity insights yearbook( part 1)

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