Agro Commodity Derivatives Market & Potato Futures

Ravishekhar Pandey

  1. The commodity futures market in India dates back to more than a century. The first organized futures market was established in 1875, under the name and style of 'Bombay Cotton Trade Association' to trade in cotton derivative contracts. This was followed by institutions for futures trading in oilseeds, foodgrains, etc. The futures market in India underwent rapid growth between the period of First and Second World Wars. As a result, before the outbreak of the Second World War, a large number of commodity exchanges trading futures contracts in several commodities like cotton, groundnut, groundnut oil, raw jute, jute goods, Castorseed, wheat, rice, sugar, precious metals like gold and silver were flourishing throughout the country. In view of the delicate supply situation of major commodities in the backdrop of war efforts mobilization, futures trading came to be prohibited during the Second World War under the Defence of India Act. After independence, especially in the second half of the 1950s and first half of 1960s, the commodity futures trading again picked up and there were thriving commodity markets. However, in mid 1960s, commodity futures trading in most of the commodities came to be banned and futures trading continued only in two minor commodities, viz, pepper and turmeric. In the 1980s, the futures trading in some commodities like potato, Castorseed, and gur (jaggery) was permitted. In 1992, futures trading in hessian was permitted; in April 1999 futures trading in various edible oilseed complexes was permitted and in May 2001 futures trading in Sugar was permitted. The National Agricultural Policy announced in July 2000 recognised the positive role of forward and futures market in price discovery and price risk management. In pursuance thereof, Government of India, by a notification dated 01.04.2003, permitted additional 54 commodities for futures trading. With the issue of this notification, prohibition on futures trading was completely withdrawn.

  2. A commodity is a product that has commercial value. A commodity is a physical good attributable to a natural resource that is tradable and supplied without substantial differentiation by general public. Commodities are usually the products of primary sector of economy. The primary sector of an economy comprises of the agricultural produce, the raw materials extracted from nature such as metals, energy resources like crude oil, natural gas etc. These primary commodities forms the basis of secondary sector of economy. These commodities include bullion (gold, silver), non-ferrous metals (copper, zinc, nickel, lead, aluminium, tin), (crude oil, natural gas) and agricultural commodities such as guar, soya, edible oil, palm oil, coffee, pepper, cotton, rice, wheat and cashew. About 70% of Indian population depends directly on agriculture. Agricultural produce accounts for almost 23% of the nation’s GDP. Several Indian cities are known for their agricultural produce and their respective agro commodity trading practices. For instance, Indore is well- known for its soya bean production and trading; likewise southern parts of India are globally known for rubber, coffee and spices production and trading. Uttar Pradesh and West Bengal are well known for production and trading of potatoes. A transparent and vibrant commodity derivative market is a significant characteristic of a developed economy.

  3. A commodity derivative is an investment tool that allows investors to profit from certain commodities without possessing them. In simpler words, a derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset or set of assets. In the case of commodity derivative, the underlying asset is the commodity. In a free market economy, Futures trading performs two important economic functions, viz., price discovery and price risk management. Such trading in commodities is useful to all sectors of the economy. The forward prices give advance signals of an imbalance between demand and supply. This helps the government and the private sector to make plans and arrangements in a shortage situation for timely imports, instead of having to rush in for such imports in a crisis-like situation when the prices are already high. This ensures availability of adequate supplies and averts spurt in prices. Similarly, in a situation of a bumper crop, the early price signals emitted by futures market help the importers to defer or stagger their imports and exporters to plan exports, which avoid glut situations and ensures remunerative prices to the producers. At the same time, it enables the importers to hedge their position against commitments made for import and exporters to hedge their export commitments. As a result, the export competitiveness of the country improves. These trades are carried out on an exchange. A commodity exchange is a place where various commodities and their derivatives (futures) are traded. Just like a stock exchange, a commodity exchange also has a buyers, sellers and intermediaries framework. At present, there are 6 commodity exchanges in India. In this article we shall be focusing on the regulatory framework governing commodity derivatives market and specifically deal with the regulations and industry development with respect to potato future.

  4. Indian commodity market was regulated by the Forward Markets Commission (FMC). FMC is a legal body set up under Forward Contracts (Regulation) Act 1952. The act provides that the commission should consist of minimum two and maximum four members appointed by the Central Government. The chairman of the FMC is nominated by the central government. FMC comes under the Ministry of Consumers Affairs, Food and Public Distribution because futures traded in India are traditionally in food commodities. However, under the FCR Act, 1952, FMC was not granted an autonomous status. Therefore, in the year 2015, the then Finance Minister announced the merger of FMC with the capital market regulator Securities and Exchange Board of India. Through the Finance Act, 2015, FCRA was repealed with effect from September 28, 2015. Consequently, all recognized commodity derivative exchanges under the FCRA were deemed to be recognized stock exchanges under the Securities Contracts (Regulation) Act, 1956. Ever since, SEBI has been regulating the commodity derivatives market with effect from the aforesaid date.

  5. Presently, around 80 agro commodity derivatives are traded across the commodity exchanges. Out of these, there are around 20-25 liquid and frequently traded commodities. In India, Guar Gum, Castor seed, Soya, Spices (turmeric, pepper) are some of the most traded commodities on the exchanges. Having said that, once upon a time, Potato Futures were once one of the most traded commodity derivative in India. However, the journey of the Potato Futures has been inconsistent.

  6. Tarkeshwar in West Bengal, Delhi and Agra in Uttar Pradesh have consistently been top potato trading hubs. In 2012, the prices of potato futures hiked due to increased cost of cold storage facility. However, soon the prices of potato futures shot down despite the increased cost of cold storage. This was due to widespread market participation by some major Collective Investment Scheme (CIS) companies based in West Bengal. These CIS companies floated a scheme called ‘potato bond’ where the investors were promised returns in excess of 20% to 100% within 15 months. The flexi potato scheme proposed a model to its investors where monies will be raised by public and used to buy potato when the market is offering low price and will be sold when the potato prices are high. Potato being an essential commodity, high returns were guaranteed by the CIS companies. However, SEBI addressed such companies that under Section 12(1B) of the SEBI Act and provisions of SEBI (Collective Investment Schemes) Regulations, 1999 no company can carry on or sponsor or launch a CIS without obtaining a certificate of registration from SEBI.

  7. As things turned out, the market was adversely affected and potato futures prices dropped drastically as people opted to invest in potato bonds and not in potato futures. There was a fall in demand which was further supplemented by the legal battles between SEBI and the CIS companies. The introduction of potato bonds and the legal battle between SEBI and CIS companies adversely affected the Potato Futures market.

  8. Thereafter in 2014, the FMC curbed trading in Potato Futures for July, August and September 2014 in order to check the prices by disallowing fresh positions and hiking deposit amount on buyers. This decision was in the backdrop of rising prices of potato between January2014 to June 2014. The government then suspected hoarding and black marketing of essential commodities. Despite there being an increase in the domestic production of potatoes in the respective financial year, there was a price rise. The potato prices in January 2014 contract trading at Multi Commodity Exchange at Rs.945 per quintal had arisen to Rs.1,270 per quintal in June 2014, despite surplus supply.

  9. Subsequently, in September 2014, Multi Commodity Exchange (MCX) sought approval of FMC to discontinue Potato Futures contracts. It was observed by the regulator that the said contracts are no longer serving the purpose of price discovery and hedging because of lack of liquidity, broad based participation and adequate stock of potato in the exchange’s accredited warehouses. The representation of MCX was allowed and MCX was allowed to discontinue Potato Futures trade on its platform.

  10. However, recently, after 6 years, MCX has sought approval of SEBI to re-launch Potato Futures contracts. In the present times of uncertainties, there is a need of hedging in sensitive commodities. During the lockdown, the commodities market has seen crude oil prices falling over 70%. Other essential commodities have also exhibited huge volatility hurting the consumers as well as FMCG Companies. Potato prices have also been fluctuating significantly over the last 5 months. In recent past, we have also witnessed SEBI circulars and proposals over warehousing norms and warehouse receipts for both agri and non-agri commodities to consolidate the ecosystem of the commodities market.

  11. Compared to global markets, Indian Commodity markets are yet to diversify and spread to its possible reach. India being an agro based country, the scope for commodity market in India is tremendous. With the probable re-entry of Potato Futures on MCX platform, the commodity market in India is going to increase its reach and liquidity.

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