Suspension of futures trading in agri products

ECONOMY/ GOVERNANCE

• GS-2: Statutory, regulatory and various quasi-judicial bodies. 
• GS-2: Government policies and interventions for development in various sectors and issues arising out of their design and implementation.
• GS-3: Indian Economy & its challenges

Suspension of futures trading in agri products

Context: The Securities & Exchange Board of India (SEBI) recently issued directions to stock exchanges in commodity derivatives segment for immediately suspending trading in derivative contracts in key farm commodities namely paddy (non-basmati), wheat, chana, mustard seeds and its derivatives, soya bean and its derivatives, crude palm oil & moong for a year.

• The derivative contracts in these commodities were already suspended, as per a SEBI press release dated August 16, 2021 and October 08, 2021, respectively.

What are derivative contracts?

• Derivative contracts are contracts between two or more parties where the derivative value is based upon an underlying asset, in this case agri commodities. 
• The price of the derivatives are established by the price fluctuations of the underlying assets. 
• Derivatives can be traded on an exchange or over the counter (OTC).

How does the system work and what are derivatives trading? 

• Derivatives trading takes place when traders speculate on the future price of an asset through buying or selling of derivative contracts to maximise profit as compared to buying the underlying asset outright. 
• Traders also use derivatives for hedging to minimise risk against an existing position. With derivatives, traders can go short and make profit from falling asset prices. 
• They also use derivatives to hedge against any existing long positions. 
• The ultimate objective is to profit. This is viewed as a deterrent to bring in price discipline in the market. 

What does the SEBI order mean?

• Now no new contract will be introduced till SEBI’s further orders. 
• In respect of running contracts, no new position will be allowed to be taken. Only squaring up of position has been allowed. 
• The imports of such commodities especially edible oils would reduce in the short term as traders will not have a hedging platform. 
• Hedging which is speculative in nature has been made difficult. This will lead to release of blocked local produce supplies into the market which should cool the prices, and imports of commodities for speculative gains will be discouraged.

Why suspension?

• Control Inflation: To reign in on the rising prices of these essential commodities which is fuelling inflation. It is believed that speculators have a role in jacking up of prices and this needs to be discouraged to curb inflation 
• Curb Imports: India is the world’s biggest importer of vegetable oils and this measure will make it difficult for edible oil importers and traders to transact business since they use Indian exchanges to hedge their risk. 
• Growth agenda of Government: The suspension of trading in these commodities follows a communication from the Department of Economic Affairs which is closely monitoring price movements. Such measure will also help in supporting growth as the economy is recovering from the COVID-19 impact. 

How alarming is inflation? 

• As per RBI governor’s recent monetary policy statement, CPI inflation ticked up in October 2021 to 4.5% from 4.3 in September, after falling sharply between June and September. 
• The persistence of high core inflation (i.e., CPI inflation excluding food and fuel) since June 2020 has been an area of policy concern as input cost pressures could rapidly be transmitted to retail inflation as demand strengthens.
• RBI governor’s assessment is that price pressures may persist in the immediate term. He observed that supply side interventions by the government have limited the fallout of continuing high international edible oil prices on domestic prices.
• While cost-push pressures continue to impinge on core inflation, the inflation prints are likely to be somewhat higher over the rest of the year as base effects turn adverse. 
• However, it is expected that headline inflation will peak in Q4:2021-22 and soften thereafter. RBI has projected CPI inflation at 5.3% for FY22.

What is being done to deal with it?

• Besides suspension of futures trading in key farm commodities by the SEBI, the government and the RBI are undertaking multiple interventions to curb the rising inflation.
• Recently as prices of edible oil hit near record highs, the Union Government substantially reduced taxes on imports of palm, soy and sunflower oil, but the move had limited impact on combating inflation. 
• The Union & State Governments had also recently reduced excise duty and VAT on petrol and diesel which was aimed at bring down inflation by way of direct effects as well as indirect effects operating through fuel and transportation costs.