Fixing Volatility
Why drought-hit India needs good commodities market more than ever
THE Prime Minister's speech on
Independence Day recognised that the drought will impact agricultural production.
He reiterated that nobody "should go hungry" because of this. But
also of concern is the terrible effect that volatility in food prices has on
some of the most vulnerable sections of our society.
The price of anything is determined
is by demand and supply. If demand is "elastic" it adjusts to the
level of supply, leading to rapid price stabilisation. But for agrcommodities,
especially food products, elasticity of demand is very low- people have to eat.
So relatively small changes in supply can lead to high volatility in food
prices.
Another uniqueness of agricommodities
in India supply can be artificially manipulated based on geographical area,
which can lead to a big price difference in the prices of food items, and thus
large arbitrage opportunities.
The classic example recently was the
recent fracas over rice. When rice prices started firming interna- tionally,
the government banned rice exports to prevent them from rising domestically.
Naturally, they fell within India but internationally, they firmed up further,
due to non supply of rice from a major source (India). This created an arti ficial,
large price difference an arbitrage opportunity.
You could accumulate cheap rice
domestically, and then tap contacts in Africa, which through diplomatic
channels persuade our gov ernment to issue orders allowing exports
to sub-Saharan countries on compassionate or diplomatic grounds. Then sales on
the high seas could be used to divert these consignments to various European
markets-thereby making huge profits for a selected few.
Similar mechanisms work in domestic
markets which are geographically or otherwise dispersed. Then there are
rampant, unorganised, and unregulated markets for "controlled" agro
commodities in India. "Dabba trading", or pit trading, also happens
in parts, creating a complete chain of intermediaries from top to bottom which
restricts when knowledge about prices and open interna- positions to a very few
operators manned who could then use it to manipulate from late market prices.
Finally, differential transaction charges levied by exchanges concentrate
volumes with a few major operators; so most market participants choose an arti-
to trade through them (or se dabba traders). This can also create insider
information about open positions. Put together, this helps explain why so many small investors lose money in the commodities
-gov-market-and why, in spite of negative inflation, a recessionary
economy, and drought that hasn't hit fully supply yet, food prices in the
country are unexpectedly high.
Price discovery for food products
should be very transparent across geographical areas, should be without too
many undisclosed intermediaries, and should be con- ducted in a well-regulated
market. All price-sensitive information should be available in the public
domain. Open positions in the market should also be generally known, as they
are in well-constructed markets. Position holders should ideally be market
intermediaries subject to some regulatory oversight.
The problem is that government times
create artificial arbitrage of supply across different areas. This causes
massive problems of the sort visible in the discussion about rice and adds to
volatility. Fix this: free and fair movability graphical regions. (Sales tax
dis- should be permissible across geo-parity should also to be removed. Different
sales tax rates on food items in different states will just hold up the
development of a healthy nationwide market
The Indian economy, as human
enterprise and not value added, is dominated by agriculture. Around seventy
percent of our population depends on this segment. A wholly transparent and
well-regulated chain must be established between these producers and their consumers.
What needs to be done for that? To start off with, well-developed
transportation and warehousing facilities are a must. But who is going to
invest in that? We are talking of massive infrastructure investment. Without a
well-developed commodities market, it will be difficult to find and mobilise
the required funds.
All the above objectives can be
achieved if the market is brought under a powerful and transparent
regulator-perhaps in the form of a Forward Market Commission (FMC). On lines
similar to SEBI. Political interference could then be minimal. The regulator
needs to be given real power, as well as a clear mandate to develop both the
future as well as spot commodities market. The unorganised market should be
encouraged to wither away; certainly, "dabba" trading should be
scrutinised very carefully indeed for wrongdoing.
India is ready for this. Consumers
and farmers are more than capable of taking advantage of a transparent,
regulated and liquid market.
Food prices are still unexpectedly high. To fix that, all price-sensitive information should be available in the public domain. Open positions in the market should also be generally known, as they are in well-constructed markets; position-holders should ideally be market intermediaries subject to some regulatory oversight.
The writer is Alternate President of
the Commodity Participants Association of India and associ- ated with the BJP's
Chartered Accountant cell.
