Report Of The Expert Committee On Futures Trading: Some Observations

Prasenjit Bose

BACKGROUND

FUTURES trading in most commodities was prohibited in India under the provisions of the Forward Contract Regulation Act, 1952 since the early days of development planning. While the prohibition was progressively lifted for many commodities in the post-liberalization period, essential commodities like wheat, rice (non-basmati), pulses, edible oils and sugar continued to remain outside its purview. It was in 2003 that the BJP led NDA government lifted all prohibition on futures trading and even allowed online trading of essential commodities in newly established commodity exchanges.

However, opposition to futures trading in essential commodities gathered momentum in the backdrop of high inflation being experienced in the country since 2006, particularly the sharp rise in prices of essential commodities. Besides the Left parties, which have consistently opposed futures trading in essential commodities, other political parties had also started voicing similar demands. The Standing Committee on Food, Consumer Affairs and Public Distribution in its report on the Forward Contract Regulation (Amendment) Act submitted in December 2006 arrived at a unanimous conclusion: �agricultural commodity especially foodgrains including coarsegrains, pulses and sugar need not be permitted to be traded in the commodity markets including forward/future contract derivatives and options�. The political heat generated on this issue coupled with sustained pressure from the Left, forced the UPA government to ban futures trading in four commodities � wheat, rice, arhar and tur, in early 2007. Alongside, a five-member committee was also constituted by the government to study the impact of futures trading on wholesale and retail prices of agricultural commodities.

ECFT  REPORT

This Expert Committee to Study the Impact of Futures Trading on Agricultural Commodity Prices (ECFT), chaired by Planning Commission member Prof. Abhijit Sen, has recently submitted its report to the government. The main report, which has been agreed upon by all the committee members, states: �current evidence available does not provide any conclusive evidence about whether there is any causal relationship between futures trading and rise in prices of the agricultural commodities�. However, it needs to be noted that the evidence collated and analyzed by the ECFT report does not rule out the possibility of futures trading contributing to inflation. In Para 4.12 the report says: �Both monthly and weekly data show that the annual trend growth rate in prices was higher in the post-futures period in 14 commodities, viz. Chana, Pepper, Jeera, Urad, Chillies, Wheat, Sugar, Tur, Raw Cotton, Rubber, Cardamom, Maize, Raw Jute and Rice; and lower in seven commodities, viz. Soy oil, Soy bean, Rape-seed/Mustard seed, Potato, Turmeric, Castor seed, and Gur...The number of commodities in which inflation accelerated is double the number in which this decelerated, and their weights are also much higher in both futures trading and in the WPI. Also, significantly, all sensitive commodities (i.e. food grains and sugar) recorded some acceleration in inflation after the start of futures trading.� But the report goes on to say in Para 4.13: �there is the problem that the period during which futures markets have been in operation is much too short to discriminate adequately between the effect of opening up futures markets and what might simply be normal cyclical adjustments�. Thus, while the price rise of most agricultural commodities in the post-futures trading period is clearly established, whether or how much futures trading has caused or contributed to the price rise could not be conclusively ascertained.

The ECFT also studied the four commodities � wheat, rice, arhar and tur, in which futures trading was suspended from February 2007 (Para 4.25). In the case of wheat the report notes: �Wheat prices did behave unusually and annualized wheat WPI inflation at 9.8 per cent during the 30 months when futures trading was liquid (August 2004 to February 2007) stands in sharp contrast to inflation in either the previous 30 months (1.5 per cent) or in the year subsequent to de-listing (0.3 per cent, y-on-y February 2008)�. There was some evidence of futures trading flaring price rise in the case of arhar too, but no evidence in the case of rice and tur. On the basis of these findings the report concludes: �The Committee has been unable to determine any conclusive causal relationship in view of short time period during which futures markets have functioned and the complexities that arise because a large number of variables impact spot prices.� Therefore the main report has not made any specific recommendation vis-�-vis allowing/prohibiting futures trading in essential commodities.

SUPPLEMENTARY  NOTES

While the main report has remained silent on the question of allowing futures trading in essential commodities, the report also contains supplementary notes given by four committee members, including the chairperson of the ECFT, which make divergent recommendations on that crucial question. In his supplementary note, the chairperson of the ECFT has specifically recommended that the suspension of futures trading in the four commodities (wheat, rice, arhar and tur) should continue and the case for suspending trade in sugar and edible oils should also be considered. The other committee members have disagreed with this view and argued for unrestricted trade in all commodities.

The supplementary note of the ECFT chairperson makes the reason clear why the committee could not arrive at a conclusive answer to the basic question whether futures trading caused a rise in spot agricultural prices: �it was not possible to arrive at any conclusive answer to this question, particularly on the matter of causation, since the period of operation of futures trading was too short to provide statistically meaningful results�. However, he has made a number of important observations with regard to futures trading. Firstly, the findings of the Committee shows that the supposed benefits of futures trading in terms of providing better prices to the farmers and reducing price volatility have not materialised in the Indian context. Secondly, he has drawn attention to the recent meeting of the Commodities Futures Trading Commission (CFTC) in the United States (April 22, 2008) where farmers and trade associations in the US have also blamed excessive speculation in the futures market by the hedge funds for unprecedented price rise and volatility. He has also said that in the case of wheat trade in India there is some evidence that �futures trading may be associated with factors that can impede the operation of the public system of grain procurement, storage and distribution�.

The ECFT chairperson has stated: �Having found no conclusive evidence that futures� trading always caused inflation, the Report has followed the approach of giving such trading the benefit of doubt on the matter of less benign transmissions and to chart out some requirements that would strengthen positive aspects. However, while this may be the approach that should generally be taken for a range of agricultural commodities, those who have argued for a ban on futures trading in essential commodities have made the case that items of necessary consumption cannot be treated in this manner. Their argument essentially is that in these cases the benefit of doubt should be accorded not to the exchanges but to those who rely on the existing system of buffer stocks, minimum price support and public distribution involving the active role of government in physical trade�. Agreeing with that argument the chairperson notes: �it is clearly necessary in the immediate inflationary situation that there be a clear statement of the government�s intent to maintain and expand the current system of public procurement and PDS in order to ensure remunerative prices to farmers and affordable prices to consumers. In this context, combining prudence with benefit of doubt, the best course of action would be to identify those commodities where there is possibility of futures trading affecting expectations that may influence inflation in essential commodities and insulate these from futures. Therefore, the suspension of futures trading in the four sensitive commodities should continue and, in the case of sugar and edible oils, discussions with processors held on how much hedging benefits they currently derive from futures markets, and a decision taken accordingly�.

In their supplementary notes, the other committee members not only disagreed with the chairperson�s views, but also articulated their individual positions on a whole range of extraneous issues. For instance, one of the members (Sharad Joshi) states: ��a large number of political parties who had very little understanding of the functioning and the character of the futures markets were brought up, conditioned to believe that the futures markets was a den of speculators and gamblers interested in making profits at any cost�the tirade against the futures markets started taking socialistic overtones and supporting the demand that would mark the return to the days of low-cost economy and imposition of negative subsidy on farmers. Those who were by mindset all against free-market started advocating a dual policy of globalisation�. Another member (Prof. P.G. Apte) has stated: �It is argued that futures trading may interfere with government procurement of foodgrains and functioning of the Public Distribution System (PDS). It is time we initiate steps for government to gradually distance itself from the direct contact between suppliers and consumers in agricultural commodities. Availability of adequate essential commodities to low income groups can be handled in other ways such as food coupons. Universal subsidization in any case does not enhance overall economic welfare�. The final supplementary note (by Prof. Sidharth Sinha) states: �An efficient futures market requires government and markets working together in a synergistic manner�In the process markets will fail sometime. But so do governments�. The fifth member of the ECFT was also a member of the Forward Market Commission, who did not submit any supplementary note.

CONCLUDING OBSERVATIONS

With a majority of the members of the ECFT having such strong neoliberal convictions, the inconclusive nature of its report has perhaps come as a relief. The neoliberal spin-doctors, even before the submission of the report, went on an overdrive to claim that the report�s findings are a vindication of the argument that futures trading does not lead to price rise. And their gullible friends in the media lapped up such a distorted view with one daily newspaper cynically carrying the headline: �Experts junk Left theory on futures trading�. Such hubris, however, has been short-lived and dashed by the decision of the government announced on May 7, 2008, to further prohibit futures trading in four more commodities � potato, chana, soya oil and rubber.

While this step has been in the right direction, prohibition of futures trading in other commodities like edible oils and sugar also need to be considered seriously. The inconclusive ECFT report has in effect thrown the ball back into the UPA government�s court. In the context of high inflation and price rise of essential commodities, it has to now decide whom to give the �benefit of doubt�: the speculators in the commodity exchanges or the public procurement and distribution system?