Orderly Development of Commodity Market Needed, says PHD Chamber

July 31, 2008.New Delhi .Indian commodity markets are bound to experience true growth. making great progress in trading activity, technology and transparency. The market forces are allowed a greater role and more supportive policy environment is being provided. The development of the markets has also witnessed newer, non-conventional products such as carbon credits being included.

It is not surprising that the commodities have emerged as an important constituent in the investment portfolio along with other more popular instruments in the basket. In fact, in some adverse economic situations, such as the currently prevalent high inflation, the commodities – with their positive correlation with prices – have gained greater popularity.

In case of agricultural commodities, farmers often face the problems of poor financial strength, growing local varieties which have to be then graded and where a lot of subjectivity is involved and lack of logistics support in terms of warehousing facilities etc. In this context, support by way of ‘collective hedging’ by the State procurement agencies or their representatives can perhaps show the way through for the agricultural segment.  These agencies can aggregate the smaller lots from farmers and help sell them in marketable lots.

Further, agricultural commodities have always been a sensitive issue and subject to many controls and regulations. For instance many commodities, in which future trading is allowed, are still protected under Essential Commodities Act, 1955. Gradually moving to a less controlled regime and allowing the market forces to determine the prices would aid in better price discovery.

At this stage a stable policy environment is required. Frequent changes in policy measures such as bans and other artificial restrictions - and the risks that these would pose - will only drive away the investors and hedgers and shake their confidence.

Another important aspect is infrastructure and logistics system. There is need to have sophisticated, reliable and convenient warehousing facilities and independent quality testing centres to certify the quality, grade and quantity of commodities. There is a strong probability that the Government is considering allowing 100% FDI in warehousing and cold storage. The move would certainly help strengthen the necessary infrastructure.

At present, the spot markets in commodities are very fragmented as they face restrictions on movement of goods, holding of stocks, duty variations etc. at the State level. While having a “common market”, as the PHD Chamber has been emphasizing, would help address such issues. Integration of spot markets with the future markets would also strengthen the commodity markets.

Similarly, consolidation of the regional commodity exchanges and their integration with the national exchanges would facilitate better price discovery and risk management as it also helps to achieve economies of scale. There is also a discussion about the demutualization of regional commodity exchanges which would provide a proper framework for such exchanges to trade and shift from open outcry method to online trading which would be backed by appropriate market surveillance, technology support and strong clearing and settlement system.

Government’s move to allow Foreign Direct Investment (FDI) in Commodity exchanges is a right step which would propel competitiveness of the exchanges and facilitate introduction of sophisticated trading instruments as well as give a push to contracts pertaining to spot prices, forwards and futures.

Granting adequate powers to the regulator and making it autonomous and independent,  would be important to ensure an orderly development of the commodities market, bring greater transparency and effectively check the manipulators causing unjustified volatility and instill greater confidence among the investors.

Gradually allowing institutional investors such as mutual funds and banks to participate in the commodities markets would provide greater depth and breadth to the commodities market. As the markets mature, introduction of new products such as options would encourage greater participation in commodities market. Options would facilitate the participants in terms of defining their risk exposure and combined with futures, would contribute to the overall health of the market.

In conclusion, commodities markets have grown in the last few years.  The long term fundamentals of most of the commodities are sound and the commodities markets in India offer tremendous potential for growth. What is only needed now is the right policy environment, supported by adequate monitoring and surveillance, to help achieve its true potential.