Commodities and Derivatives Markets in India
The genesis of commodity futures trading in India can be traced back to the 19th century, when in 1875 the Bombay Cotton TradingAssociation was established which offered derivatives trading in cotton. In the subsequent years trading in other commodities like, oilseeds, gold, silver, jute and spices began in different cities across the country. The commodity exchanges in the country were located in cities nearest to the regions that were major producers of the commodities traded. Commodity trading in India was in simple futures contracts, unlike that in developed economies which were trading in forwards contract.
India’s commodity derivatives markets has had a checkered past. Commodity trading in India had been often discontinued, especially during the period of wars and natural calamities in order to prevent speculations during the periods when the nation faced supply shortages. In 1939, during the time of World War II trading in cotton and oilseeds was prohibited. Thereafter, commodity future trading was restarted with formation of the Forwards Markets Commission (FMC) in 1952. Under the Commission’s watch, futures trading in certain commodities were not permitted (restrictive list) and eventually trading in futures nearly ceased around 1966. This was done to enable the government to keep a watch on the price trajectory of essential agricultural products, as it was perceived that future trading of commodities had implications on price stability and inflation. It was during this period i.e. from 1980 to 1966 that most of the regional exchanges became dysfunctional.
With the Indian economy undergoing structural changes post-liberalisation (1990’s), the importance of commodity derivatives in protecting the commodity markets from price volatility gained credence which led the government in 2003 to remove a number of commodities from the restrictive list. It also extended permission for trading in a number of commodities. The government also undertook measures to setup autonomous demutualised National Commodity Exchanges along with regional exchanges with the intent of harnessing the potential of futures trading in price discovery and price risk management. It was felt that these national commodity exchanges would allow the government and private players to have an effective supply timeline, which could avoid excessive priced volatility.
There were 22 regional exchanges in the country in 2003 when the national exchanges came into being. Currently there are five national commodity derivatives exchanges which trade in multiple commodities. They are the National Commodities and Derivatives Exchange Ltd (NCDEX), Multi Commodity Exchange of India Ltd (MCX), Indian Commodity Exchange India Ltd (ICEX), Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The trading in the national commodity exchanges were entirely online, since its inception. The regional commodity exchanges which engaged in commodity specific trading have ceased to exist over the years with the last regional exchange ending operations in June’18. Lack of funds, low volumes in trade, difference in the rules and regulations governing the regional exchanges and prohibition of trading of certain commodities from time to time were factors that eventually led to the closure of the various regional exchanges of the country. Along with trading in commodity futures the trading in options has been operationalised on the exchanges in 2017-18.
Regulation of Commodity Derivative Trading
The Securities and Exchange Board of India (SEBI) currently regulates the commodities as well as the financial markets of India (prior to 2015 the Forwards Market Commission (FMC) regulated the market). The regulation of commodity markets has come under the jurisprudence of the Department of Economic Affairs, Ministry of Finance. The Finance Act 2015 stipulated that all exchanges recognised under the FCRA 1952 (Forwards Contracts Regulation Act) would be governed by the SCRA (Securities Contracts Regulation Act).
According to the SEBI classification, national exchanges should have a minimum turnover of Rs. 1,000 crores per annum and the regional exchanges should have a minimum of 5 percent of the nation- wide turnover of the commodity that is principally traded on their respective exchange. A failure in compliance of the rules and regulations as mandated by SEBI, leads to a withdrawal of recognition of the exchange by SEBI.
In 2003, under the Agricultural Policy 54 commodities in addition to the ones already traded were permitted for commodities derivatives trading. The number of commodities traded has increased over the years. As of 2018, 91 commodities could be traded under the SCRA. These commodities can be broadly classified as agricultural and non-agricultural commodities.
Of the 91 commodities permitted for trade under the SCRA, only a quarter of them are currently offered for trade by the exchanges. Of the 17 Pulses and Cereals permitted for trade, only 6 are being offered for trade by the exchanges. 11 types of oilseeds are permitted for trade, of which only 5 i.e. castor seeds, coconut, cotton seed, groundnut and Mustards seeds are traded on the exchanges. In all 12 spices are permitted for trade of which only 5 are offered for trade at the exchanges and it is only pepper that is traded on the exchanges. Of the 12 permitted metal commodities, 4 metals (pig iron, sponge iron, steel and tin) are not offered for trade by exchange. In case of precious metals, of the 3 metals permitted for trade only platinum is not offered for trade. Crude and natural gas are the only two commodities out of 8 that are offered for trade under the energy head.
Even though more number of agricultural commodities (26) are offered for trade as compared to non-agriculture commodities (8), the traded volumes in non-agriculture commodities far surpasses the volumes in the agriculture commodities.
Performance of Indian commodity derivatives markets
The Indian commodity derivatives markets have been exponential growth in the last decade and half. The markets have deepened over these years in terms of total turnover and volume of commodities traded. The turnover of the 4 major national commodity exchanges has witnessed a growth of 41percent over the 15 year period 2003-04 to 2017-
18. The turnover of the Indian commodity exchanges as of 2017-18 was Rs.61 lakh crores. Globally, the combined Indian commodity exchanges turnover rank among the top 5 countries.
The total turnover of the Indian commodity exchanges saw a sustained increase from 2003-04 to 2011-12 and reached its peak to Rs. 177.76 lakh crore in 2011-12– a growth by 54percent over the previous year. Thereafter there has been a near consistent decline in the turnover of the four exchanges. The turnover in 2017-18 was 66percent less than the peak of 2011-12. The turnover has been prone to fluctuation on a year-on- year basis.
The moderation in the turnover of the Indian commodity exchanges since the last 6-7 years can in large part be attributed to the suspensions of trading in commodities viz. agri commodities from time to time and the introduction of taxation on the trading of commodity derivatives (2013) along with other regulatory measures. In terms of segment wise turnover, in 2017-18, metals accounted for the highest share of 39 percent in the aggregate turnover of the 3 major national commodity exchanges followed by energy (30percent), bullion (23percent) and agriculture (12percent). Over the years, the share of metals and energy in the aggregate turnover has increased, agriculture has remained stagnant while that of bullion has decreased. In the total traded volume, energy segment had the share of 70 percent while that of agriculture is 19percent and metals is 12percent. Over the years, the share of energy in terms of traded volume has increased from 57 percent in 2010-11 to 70percent in 2017-18, whereas, that of agriculture has declined from 32percent in 2010-11 to 19percent in 2017-18.
Measures undertaken by regulators to develop Indian commodity derivatives market
The regulators (earlier FMC and now SEBI) have initiated various measures for the development of the Indian commodity derivatives markets over a period of time including, regulatory changes and oversight, permitting new exchanges , conducting various awareness and capacity building programmes with an aim to benefit farmers and clients. Since the re-introduction of commodity futures trading in India in 2002- 03 regulators have been issuing guidelines/directives to ensure sound framework for
commodity exchanges and have also issued various guidelines/norms to strengthen the integrity of the markets, enhance investors’ participation, facilitate hedger’s participation, reduce excessive speculation, improve compliance in the market and develop market infrastructure, viz. warehousing facilities.
Issues faced by commodity derivatives markets in India
The commodity derivatives markets in India is yet to gain enough liquidity and depth. This is primarily due to challenging regulatory environment, limited number of products and instruments, shortfalls in infrastructure facilities and lack of awareness and education about the market which, in turn, restricts market participation.
The Indian commodity future market has been prone to government intervention from time to time which has been found to affect sentiments in the market and dent market confidence. While the primary objective of launching futures market is to enable price discovery and price risk management, interventions by the government sometimes beats this very objective. Some of these actions which have a bearing on the commodity derivatives market in the country include: frequent suspension of agri- contracts, hike in margins, imposition of commodities transaction tax (CTT), limitation on investor participation, lack of proper warehousing facilities, fewer number of products in commodity derivatives market, absence of broad-based market participants and lack of awareness and education about futures commodity markets.
India and International Commodity Derivatives Markets
India has been a price taker in case of a number of commodities traded in the domestic futures market, viz. non-agricultural commodities. The price discovery of the major traded commodities viz. energy, bullion and non-precious metals takes place in the overseas markets. Similarly, commodities such as soyabean, cotton, palm oil, sugar, etc. are strongly influenced by global futures price movements as these commodities are international in nature and are impacted by price changes in key overseas futures contracts.
The prices of future contract of metals and energy commodities are seen to move in line with movement in global markets since India is a major importer of precious metals, energy and base metals. In case of commodities which have lower presence outside India viz. cereals, spices, pulses, etc. are mainly driven by domestic supply and demand factors along with local market factors.
A key reason so as to why the international exchange groups like CME, LME, ICE is able to influence the price of commodities and be a price maker is because these bourses have been in existence much longer (CBOT, now a part of the CME group started its operations in 1864) whereas the Indian exchanges (MCX and NCDEX) started its operations from late 2003. Maintaining of inventory is essential which is instrumental in the price discovery of commodity markets. Another reason which acts in favour of these global exchanges is the reporting of the stock. Most of the global exchanges also store commodities of other countries other than their own commodities which is making them a price maker in the commodity derivative markets.
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