Is Government Justified in Banning Futures Trade in Essential

Commodities?

Alka ParikhDepartment of Economics, University of Mumbai

This paper has benefited from the comments by Dr. Abhay Pethe, Dr. Mala Lalvani and Dr. Romar Correa.

The key question

Are the futures in essential commodities really responsible for the price rise? Do the commodity exchanges indeed affect the prices in the spot markets?

Focus of the study: Wheat

VolumeTable 1: Production and Volumes traded of different commodities

Commodity year Trade vol Production(1) (2) (3) (4) (3)/(4)

Urad 2005-6 7,31,73,050 10,85,000 67.4Wheat 2006-7 2,30,84,520 7,50,00,000 0.31Sugar (S) 2006-7 60,570 1,80,00,000 0.003Chana 2005-6 11,95,26,380 55,00,000 21.7Pepper 2005-6 7,05,529 50,000 14.1

Source: FMC, India, www.indiastat.com

Implication:

The volumes traded are much higher for urad, chana and pepper.

Wheat: Volumes traded are low.

Little likelihood of impacting spot markets.

Wheat: mainly backwardation

-150

-100

-50

0

50

Jan,

06 feb

mar ap

r

may

june july

augu

st

sept oc

t

nov

dec

Jan,

07 feb

Mar

Apr

date

basi

s

Both contango and backwardation

-1000

-800

-600

-400

-200

0

200

400

600

dates

basi

s chana basis

pepper basis

Urad: mainly backwardation

-600

-400

-200

0

200

400

1-Ju

n

16-J

un

1-Ju

l

16-J

ul

1-A

ug

16-A

ug

1-S

ep

16-S

ep

1-O

ct

16-O

ct

1-N

ov

16-N

ov

1-D

ec

16-D

ec

1-Ja

n

dates

basi

s

Implications:

This could happen only in condition of excess supply.

Wheat production reasonably high in last two years

Hedgers seem to want to sell to cover their risks, but few speculators who want to buy

No obvious proof of excessive speculation

Price Fluctuations

Wheat: 10% around the mean both in spot and futures markets

Chana: 12-13% around the mean in both spot and futures markets

Pepper: 20% around the mean in both spot and futures markets

Urad: 5% around the mean in futures and 10% around the mean in the spot markets

Thus, no excessive volatility in wheat markets.

Statistical Tests

Based on results of Gurpreet Singh Sahi

Structural Test

Chow test: No structural change in spot prices by introduction of future trade. Also, the coefficient of dummy variable for post futures years is insignificant for the tested commodities.

Grange Causality Test

Unexpected trading volume and unexpected open interest Granger cause cash price volatility in wheat, turmeric, soy oil and raw jute.

Decomposition

Generalised forecast error variance decompositions: For all tested commodities, variation in cash price volatility is not explained by futures price volatility or unexpected trading volume or unexpected open interest.

In short, the causality is not strongly established. Although it is shown that the direction of influence is from futures to spots, the extent to which the futures influence spot markets seems to be statistically insignificant.

Conclusions

Banning wheat markets: Not justified by the data.

Further research questions:

Pulses: Volumes traded are much higher than production -> Speculation might prove harmful in shortage economies. “Price discovery” should not become price determination.

Spices: Need to examine whether too much price volatility discourages farmers as shown in the case of cardamom

Impact on farmers:

Information should be available physically and functionally

Studies show that direct participation of farmers is very low.

Reasons: Low awareness

Individual farmer does not have enough supplies to fulfill contract specifications

Thus farmers benefit only indirectly.

But is the purpose of the futures really to benefit the farmers?

The farmer participation low even in USA.

It is an upgradation of marketing system, let it happen.