Futures Trading and Inflation : A Tragedy and a Farce

The recent high speed continuation of the longstanding upward creep of the general price level has put to test several beliefs of the neo-liberal economists. They believe that with the state off-the-back of the market forces, the economy would get its prices right, that is, would have distortion- free prices reflecting the interplay of the market demand and supply forces. With right prices and unregulated free markets, the entrepreneurial energies would become active to generate such demand–supply responses as to produce an economy characterised by high growth, stable prices and growing integration with the world economy to add to the welfare of everyone by taking advantage of the natural endowments and economic opportunities as reflected in the comparative advantage of each nation.

To expand the ambit of the market forces, the range of market transactions was expanded to futures contracts for a large number of commodities. With poor and limited participation by the farmers and mandi traders and overindulgence by the brokers, financial markets operators, brokers, speculators and large wholesalers, the futures markets in India expanded quickly to overtake in volume the longstanding stock exchanges. At the same time, the prices, both spot and futures, moved northwards. This movement was, of course, facilitated by bringing under the ambit of futures trade practically all the farm commodities, including minor ones, such as spices and chronic short supply goods such as dals and edible oils. As a result of the permission to big companies, both Indian and foreign, to buy the farm goods directly from the farmers and build up non-monitored stock-holdings, there came into existence a group of market players who would surely take advantage of the hedging facility afforded by the futures exchanges. To them, the futures trade was indeed a god-send means of price risk management—a risk that increases along with the magnitude of the stockpiling. Unless they hedge at prices covering in addition to their purchase price, the cost of warehousing, interest, movement and wear and tear and a profit margin, the futures markets would be of no use to them. In fact, they would add an element of possible high returns owing to their market power to their normally spot markets based returns in the form of the futures prices at which they would play in the futures exchanges. Since food and water face perennial and growing demand, the corporate sector considers these two to be like gold and pour in investments to control their supplies (the way they do in the energy sector) and thus secure a permanent unshakable foundation for their empires. The commodity futures come handy to them to securely obtain high and rising returns, as they increase their stakes in the food an farm sector both by way of trade and investment. They have the highly successful experience of futures in crude oil to go by as the futures trade in crude has propelled the petroleum prices to dizzy heights.

Thus in the Indian conjuncture, especially with colossal amounts of illegal funds yearning for profitable investment opportunities (see the massive advertising campaigns for selling foreign real estate in India even though full and legal capital account convertibility is still a far cry), the commodity futures became a means to strengthen the market processes by ensuring to the big players and stock-holders that the risk of adverse price movement is minimised, if not eliminated. In fact a lot of information about the current and future market trends about availabilities, prices, production, weather conditions, economic intelligence in general, is widely available at a low cost and is largely uniform. This reduces the possibilities of too much divergence about the future price expectations. Introduction of futures in such cases is largely an invitation to non-merchandising stakeholders to come and speculate for quick, large and easy gains. Its impact is surely to impart a bullish push to the spot markets as well. It meant they use the futures contracts to avoid the risk of getting lower prices and, on the contrary, become a conduit for high prices giving good returns on the investment in stockpiling, practically according to their expectations. This price expectation and the futures contracts reflecting these price expectations became an influence on the spot or current prices as well. After all, the futures are supposed to provide price signals to the market operators, including necessarily to the spot market players as well. When after three months of the standard contracts (with one per cent margi money as the initial investment), prices are going to be at a particular high level, why would a spot dealer sell at a price much below that price except for the cost of holding the stocks for a period of three months? Thus in the form of futures trade in farm commodities, there appeared an additional force to accentuate the upward spiral of the prices.

After a lot of persuasion and pressure, the government seems to have seen the role of the futures in accentuating the runaway increase of the farm goods entering the daily consumption of the masses. After a lot of feet dragging, some commodities , such as rice, wheat, some dals, etc. were taken off the list of goods in which futures trade was permitted. It is true that even then the prices of these goods did not come down. It is difficult, at least in the short run and without a great deal of complicated and even then highly controversial analysis, to be able to say that but for the ban on futures trade, these commodities would have seen far greater and sharper price increase. Hence the supporters of futures argue that the ban has turned out to be ineffective. Thus they want a return back to the free-for-all for all the commodities in the futures markets too. Surely those who were gaining from such trade are a losing constituency as a result of restraining free trade, whether spot or future.

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THE procrastination and dummy symbolic action on the question of commodity futures in essential farm goods has come under a lot of fire from the entrenched lobbies, while some Left parties were insistent on extending the coverage of the prohibition of futures for all the farm goods of mass consumption. With unrelenting inflation and mounting public and political pressure, futures contracts involving four commodities have been suspended for a pre-announced period of four months. What in effect it amounts to is that the outstanding contracts stand rolled over and the contracting parties may resume them, if they chose to, after these four months. True, no fresh contracts can be traded on the exchanges for four months, but, given the history of kerb, that is, illegal and informal, deals and the penchant for them among our speculators, it would be naïve to expect that such a diversionary step can produce any restraint on the spiraling prices.. Thus the government has sent a clear message that it stands by the 2003 decision of the NDA Government to extend futures trading to all the major farm commodities entering mass consumption. By taking an ostensible anti-inflationary step that is of no consequence, it seems to be preparing ground for undoing the ban on all the farm commodities that was enforced earlier. Thus the effects of this kind of totally unnecessary trade will have to remain an ongoing concern of any public policy, particularly owing to the conversion of marketisation into financialisation.

The supporters of commodity futures often ask: did a ban on futures trade in essential farm sector commodities, such as wheat, rice , some dals, and so on, help contain the prices of the banned commodities? Why is it not asked: were not prices of these commodities experiencing periodic sharp upward movements in the past, prior to 2003, when for a long time no futures contracts in these commodities were available to anyone? In fact, there was no demand for futures in these commodities from any of the merchandising interests at any point of time before the liberalisers sought to do so. What makes one believe that price behaviour is an exclusive function of the presence or absence of futures markets? Such a naïve belief by the advocates of the futures markets or reluctance to encounter reality regarding the multiplicity of factors bearing on the movement of prices implies as if, according to them, spot markets do not exist or cease to be operative the moment the futures enter the stage! Why is the elementary fact not recognised that the futures trade is often an exacerbating factor that permits the speculators (often backed by huge amounts of unclean finance) to enter into contracts involving mass consumption goods to worsen their endemic price and availability volatility? Have we run out of all the other instruments of price stabilisation that recourse to futures trade is considered a must for price risk management? It is on account of the penchant for entrustng everything to the market and for increasing financialistion of the economy that the farm sector goods too have been made a target of speculative deals. Otherwise, why not ask: what did the country gain by permitting such speculative trade in which over 90 per cent of our small and marginal farmers have no prospects of entering, a trade that our lakhs of local mandi traders are opposed to but in which massive amounts are invested, mostly by the speculators, and one suspects that both the parties to the deals are speculators only, as is indicated by the massive volumes of the trade in futures exchanges (as just 10 per cent margin money has to be paid while entering in to a contract)? Such amounts are unlikely to come from people other than the speculators and large traders, of course most of them being the tribe of day traders who are basically gamblers with no interest in actual commodities. It is owing to such players that the volume of futures trade has left the share markets behind. It has been observed that any down turn in the stock market gets reflected in increased trading in the commodity futures.

Moreover, why is it not asked: who are the players in these markets, after all? Are they the farmers reeling under the burden of accumulated debts who enter these casino-kind of markets on top of their primary occupation that is inherently a gamble in monsoon and now also the machinations of the input suppliers, final produce markets and public policies? It is common knowledge that if the holders of huge stocks of any commodity have an opportunity to hedge their stocks, they would do so at prices way above the spot prices (that is, the prices at which they have done their stockpiling) in order to guard against low prices when they have to de-hoard these goods with short shelf-life. Moreover, can anyone prevent pure speculators to enter into futures contracts with another set of speculators without an iota of interest in physical merchandising? Does this kind of variety of trades, for different purposes, not distort the market information content of prices as one is not able to distinguish between demand emanating from different sources, such as consumer demand, processors demand, exporters demand, local traders demand, long distance trades demand, public stock building demand, public distribution demand, hoarders and speculators demand, etc. in normal times? Why add to it the most fickle and largest element, the speculative demand that is a function of the amount of finance that is available and the avenues for easy and quick gains, of course with their attendant risks? What has often been suggested about the pro-inflation attitude of the marker-friendly policies gets further reinforced by the way the question of futures trade in essential commodities has been dealt with by the government. In fact, the committee that was appointed to examine the question of inflationary impact of futures trade in farm goods was also asked to suggest the ways and means of increasing the participation of the farmers in the futures markets. Obviously this item on the terms of reference presumed that the futures trade in these commodities is to be continued. This is also reflected in the composition of the Committee with the inclusion of some persons who seem to be keen on futures trade in everything. Even the textbook conditions for permitting futures do not suggest that every commodity can benefit from futures. The gimmick of banning a few commodities for a period of four months, a farce in effect, is a confirmation of the pre-determined commitment to no-holds-barred extension of the market mechanism as it creates enormous opportunities for quick speculative gains and with huge funds available with a few persons, such opportunities see the emergence of some powerful lobbies to back up. The anti-inflation constituency seems to be on a losing wicket compared to the constituencies that have the means, will and power of moulding public policies to serve their specific interests, over and above the general interest of all the market forces in an undifferentiated form. Little wonder, at the end of the four months of embargo on futures contracts, one would again hear the voices proclaiming that the ban on some of the newer commodities too turned out to be ineffective. Such crude faith in single-factor explanations and single- factor policies seems to remind one of the tactic to give the dog a bad name and then hang it.

A prominent economist, Dr Kabra is a former Professor (now retired), Indian Institute of Public Administration, New Delhi.