THE FUTURE OF COMMODITY MARKETS IN INDIA

The Indian commodity futures landscape has been evolving and the national commodity exchanges have made a big headway since their inception, with volumes surging with every passing year. The turnover on the Indian commodity bourses has increased 120 times after electronic trading was introduced in 2003, according to the Forward Markets Commission (FMC), the commodities market regulator.The MCX is the world's largest exchange in silver, the second largest in gold, copper and natural gas and the third largest in crude oil futures. However, as a whole, exchange-traded commodities account for only a fifth of the total volume of commodities traded in India. Globally, the futures market in commodities is 30-40 times the size of the underlying physical commodity trade. The higher the multiplier, the more thinly the commodity price risks can spread across the market. So, it is evident that there is a large scope for increase in the volume of commodity futures trading in India.Part of the reason for the rising trade volumes on the Indian commodity futures exchanges is that they provide an efficient platform for hedging against price uncertainty and global volatility. The exchanges provide transparent price discovery and hedging platform for trading futures contracts of different commodities. On these exchanges, the fair value prices are determined through active participation of a large number of stakeholders of the commodity value chain, who have access to information on the demand and supply conditions.In recent years, with the globalisation of the Indian economy and sensitivity of prices of commodities to global factors, commodities have witnessed heightened price volatility. This has exposed all stakeholders to price shocks, from primary producers, such as farmers, to end-users, such as the manufacturing sector. For instance, in 2010, the high volatility in international prices of most commodities was reflected in the Indian prices.Volatility in the MCX Comdex, the benchmark index of the MCX, was 17.7 per cent in 2009 and 11.37 per cent during 2010 (January-October), while that for its Agri Index stood at 13.35 per cent and 12.48 per cent, respectively, during the same period. This has prompted a growing demand for hedging among commodity users. The high correlation between domestic and international prices is reflected in the close intertwining of the Goldman Sachs Commodity Index and the MCX Comdex during the 21-month period between January 2009 and September 2010 (see graph).

With heightened volatility in commodity prices and increasing execution of price risk management through the exchange platform, the Indian commodity futures market grew by 38 per cent in 2008, 41 per cent in 2009, and by 51 per cent between January and October 2010, in comparison with the corresponding period of the previous year. The commodity futures trading volumes, taken as a whole, have risen at a compounded annual growth rate of 97.9 per cent between 2003-4 and 2009-10.

The MCX has developed different contract denominations to accommodate the needs of varied market participants, ranging from all types of traders such as hedgers (jewellers, importers, retailers, and others from the physical market), and speculators, to investors (HNIs and retail) and arbitrageurs.Crude, Eurozone Turbulence Drive Volatility; But India Remains Preferred MarketIn The Long-Term how do they affect India?

Not since the 2008 financial crisis have the global markets seen the level of volatility it is witnessingcurrently. Already, in the first few trading sessions of 2015, steep corrections have been seen in theglobal and domestic markets, with US, EU and Asian markets falling nearly 3% in last 5 sessions. TheEurozone economic slowdown, the impact of the ECBs expected decision (later this month) toannounce a QE-style monetary policy action, uncertainty over Greece elections that could potentiallythrow the EU-led bailout plan out of gear, US 10-year government bond yield falling below 2%, andperhaps most significantly for India, the crude oil price free-fall, are all factors that point to ananticipated increase in short-term volatility.The impact on Indian markets has been seen over the last few days with FIIs cutting down on risk andemerging as key sellers of Indian equities. According to stock exchange figures for Tuesday, FIIs werenet sellers having sold a net of Rs.1,570.76 crore, while domestic institutional investors were netbuyers at Rs.1,189.65 crore. The repercussions of global volatility could cause some turbulence in thedomestic market and it is prudent for short-term traders should remain cautious till this volatility inthe currency/credit markets reduces.That said, fundamentally, India is more stable and less vulnerable to external shocks than we were ayear ago. Therefore corrections led by international triggers may offer excellent entry levels indomestic markets. Historically, a fall in Indian markets owing to global pressures have proved to be anideal buying opportunities for buying into preferred themes and picks with a time horizon of morethan a year. Hedging long portfolios may help in countering the expected surge in volatility and sharpprice declines.So what is the outlook for these global conditions, are these falls sustainable, and The Fall Of Crude Oil Prices And Its ImplicationsBrent crude has dropped 53% percent since June to about ~$51 a barrel from a peak of about $110 abarrel just six months ago, while WTI has slumped from US$101 a barrel to US$54 a barrel over thesame time period. This is largest fall since the 2008 financial crisis. But the fundamentals stronglysuggest that US$55 a barrel for WTI crude is an unreasonable and unsustainable price as:Supply and demand are not significantly out of balance and does not justify a 50% price dropOverreaction to projections of future oversupply has caused fear. At a low crude oil price, theprojection is likely to be wrong.Cash-strapped oil-producing countries will become more unstable, leading to fears of supply

The main reasons for this slump have beenA strong US dollar: Crude oil is denominated in US dollars. The trade-weighted dollar has appreciated by~12% since the summer, which implies this factor alone accounts for a fifth of the decline in crude oil.Weakening global demand: Fears of falling demand expectations played a part to some extent inbringing down crude oil price, but when it comes to the actual consumption of oil, there is nothing in thedata that would justify the freefall. In fact, crude oil demand, in both OECD and non-OECD economieshas perked up in the past couple of months (which is partly a seasonal effect).Accelerating supply from US Shale Oil: The strongest component of supply growth is the US shale patch,and there is little that will alter that dynamic. In general terms, non-OPEC world crude oil output isleading the supply surge. But, OPEC is not yielding ground by maintaining its overall output level despitegeopolitical events that have in recent years kept significant portions of Libyan and Iranian crude off themarket. US shale oil supply has been augmented by new fracking and drilling techniques to extract oilfrom shale formations in North Dakota and Texas states. The US alone has added 4 million new barrels ofcrude oil per day to the global market since 2008. Global crude production is ~75mn barrels per day, sothis is significantImplications on Global MarketsGlobal energy producers and linked markets are witnessing tremendous pressure in terms of viability ofproduction and financial stability.US Shale Oil: Below US$60 a barrel, a significant number of Canadian oil sand & US Shale projectsbecome unviable. If low prices persist, many US shale projects will not be viable, which could impactlong-term supply. Reduced budgets will begin to rein in production growth over the next 12 months. Infact, some major companies are already pulling out of Texas' Permian Basin for now. The catch is that noone quite knows how much lower crude oil prices need to go to rein in the US shale oil boom. Analystsoften focus on a metric called the "breakeven price" for oil-drilling projects. But, other drillers may try tocut their costs, grit it out, and keep drilling. It really varies from company to company. That makes it veryhard to predict how this all shakes out or where global oil prices will bottom out. The US EnergyInformation Administration still expects that overall US oil production will grow by another 700,000barrels per day in 2015 though that's slightly lower than the prediction when prices were high.OPEC: Many OPEC countries will be unable to cut supply since their fiscal budget is highly dependent oncrude. Breakeven prices to balance budgets for Iran ($ 140), Venezuela($121), Nigeria($119), Iraq ($106)are much higher than the current oil prices. Markets are looking at a psychological support at around~$50 for brent crude oil, hence prices are unlikely to fall substantially below this level.Russia: Russian economy is largely dependent on crude export, with oil revenues making up 45% of thegovernment budget. Falling crude prices along with the sanctions imposed by the west on Russia, hascaused turbulence in the Russian currency & equity markets. The Russian Rouble has depreciated by~81% in the last six months. The steep fall witnessed in Russian Ruble is one of the steepest for anymajor currency in the last 15 years. The RTSI index is also depicting the pressure in Russia; it has fallen by44% since June. If such low levels of crude persist, Russia's economy is expected to shrink ~4.5% nextyear. The escalation of the Russian scenario has caused risk aversion across the globe.Venezuela: With oil accounting for roughly 96% of its export earnings and 48% of budget revenue, theslump in oil prices have taken a toll on the country's already dire finances. The nation's economy heavily dependent on oil revenue is set to shrink by ~3% this year and inflation remains rampant,leading to a growing concern that the crash in crude oil could cause Venezuela to default. Global Markets Volatility

Saudi Arabia: There is no question that Saudi Arabia, the world's largest crude oil producer, will sufferfinancially from cheap oil. If crude oil stays ~US$60 per barrel next year, the government will run a deficitequal to 14% of GDP.For now, however, the Saudis are trying to grit this out and show no sign of panic by propping up prices asthey have done in the past. The kingdom has built up a stockpile of foreign currency worth ~US$740bn,which it will use to finance its deficits. Still, if low oil prices persist, Saudi Arabia may have to cut back onsome of the social programs it had instituted after the Arab Spring.Implications on IndiaLower crude prices leads to higher savings and increased consumptionAn average Indian consumer spends ~9.5% of his income on Fuel & Light (energy). Lower crude oil priceshave helped ease inflationary pressures in the country. Other than the direct impact on fuel prices, lowercrude prices also have a spillover effect on food inflation.Low crude prices imply low CAD and high Forex ReserveIndia is a major importer of crude oil as it imports ~70% of its annual requirements which comes to~US$3.86mn barrels per day. India also exports back ~40% crude imports after value additions (RelianceIndustries Ltd is having the major share of that export). So, the significant fall in crude oil prices would helpthe country to not only reduce pressure on CAD, it would also help to create healthy forex reserve, whichwill provide stability to INR against USD in a scenario of appreciating USD against all major global currencies.A word of cautionThe overall impact of crude oil on India will be positive. Although India stands to gain from lower oil prices,such a steep fall increases the risk of contagion due to trouble energy credit markets and leads to riskaversion in the global markets. Specifically, risk lies in the form of a potential crisis in Emerging Markets likeRussia. If the situation there escalates, there could be panic like situation which would lead to risk aversionand FII capital outflows from other EMs like India.UNTAPPED POTENTIALAlthough India has to cover a long distance to be able to harness the potential in many commodities, it has substantial opportunities to develop consumer demand and uncover latent consumption. Despite having significant benefits, commodities trading has been mostly limited to large corporates, trading houses and high net worth individuals (HNIs). The key reason that discourages retail investors from actively participating in commodities trading is lack of familiarity.Moreover, the current tax regime is not favourable for investors. Finally, the institutional and policy-level issues associated with commodity exchanges have to be addressed by the government in coordination with the FMC. This will help take necessary measures to pave the way for a significant expansion and further development of the commodity futures markets.

REGULATED GROWTHThe FMC has initiated several measures to stimulate active trading interest in commodities. Steps such as lifting the ban on futures trading in commodities, approving new exchanges which offer modern infrastructure and systems, and removing legal hurdles to attract more participants have increased the scope of commodity derivatives trading in India. This has boosted both the spot market and the futures market in the country. The trading volumes are increasing while the list of commodities traded on the national commodity exchanges also continues to expand.

The FMC has continued its efforts to broadbase the market by undertaking various regulatory measures to facilitate hedgers' participation and promote delivery in agricultural commodities. These include introduction of Exchange of Futures for Physicals (EFP), Alternate Futures Settlement Mechanism and introduction of an early delivery system in select commodities. In addition, efforts have been made to develop an aggregation model in collaboration with the commodity exchanges to promote participation of farmers (these will become feasible once options are allowed, which requires amendments to the Forward Contracts (Regulation) Act, 1952).

GOING FORWARDThe commodity markets are at a juncture where investment in education and research is important to sustain their growth. The MCX has been taking various initiatives to systematically develop markets through continuous innovation, education and research focused on spreading awareness of the modern trading mechanisms facilitated by commodity exchanges. The MCX, in association with the FMC, conducted 95 joint awareness programmes during January-October 2010 for physical market participants, especially farmers, who are the primary beneficiaries of this market, for hedging against price risk or for future price discovery.

To widen and deepen our commodities market for the future, policymakers need to strengthen the institutional infrastructure through market-friendly policies on taxation, enabling of institutions, such as banks and mutual funds, to participate in the commodity futures market, and the provision to initiate trading in options and intangible commodities. These would fructify as and when the Forward Contracts (Regulation) Act, 1952, under which the commodity futures market operate, is amended by the Parliament. Besides, innovative application of ICT, increased awareness programmes and outreach initiatives, best-in-class technological advancements by bringing solutions that address our customers' top trading needs, product innovation in line with the changing market dynamics and emerging challenges, and domain knowledge would ensure that the Indian commodity futures market scales global heights.THANK YOU.