Context: Recently, SEBI has extended the ban on futures trading in seven Agri commodities, including the derivatives of two produce which has been in force since December 20, 2021.
SEBI extended the ban on trading in non-basmati paddy, wheat, chana, mustard seeds and its derivatives, soyabean and its derivatives, crude palm oil and moong on concerns that lifting the curbs will lead to inflation.
About Commodity Trading:
A commodity market is a market that trades in primary rather than manufactured products.
Soft commodities are agricultural products such as wheat, coffee, cocoa and sugar.
Hard commodities are mined, such as gold and oil.
Commodity markets can include physical trading and derivatives trading using spot prices, forwards, futures, and options on futures.
Farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management.
There is a huge difference in the trading volume of commodities and the actual value of the commodities in physical form — this is because of hedging undertaken by several participants.
Commodity Market in India:
Commodity Market: Commodities market is either a physical or a virtual space, where interested parties can trade commodities (raw or primary products) at present or future date. The price is dictated by the economic principles of supply and demand.
Regulator: Till 2015, the market was regulated by the Forward Markets Commission which was finally merged with SEBI to create a unified regulatory environment for commercial investing.
Types of Commodity Market: Typically, commodity trading occurs either in derivatives markets or spot markets-
Spot markets are also known as “cash markets” or “physical markets” where traders exchange physical commodities, and that too for immediate delivery.
Derivatives markets in India involve two types of commodity derivatives: Futures and Forwards; these derivatives contracts use the spot market as the underlying asset and give the owner control of the same at a point in the future for a price that is agreed upon in the present.
When the contracts expire, the commodity or asset is delivered physically.
Reasons for the ban on these commodities:
The Centre, in particular, and SEBI have extended the ban on concerns over inflation.
While surging edible oil prices resulted in imposing the ban last year, this year high rice and wheat prices have forced the Centre to extend the same.
Rice prices have increased by 7.5 per cent and those of wheat by 15.5 per cent in the past year.
Though consumer inflation dropped to 5.9 per cent in November from the highs of over six per cent in the previous months, the RBI feels it is “down but not out”.
Impact of the ban in the market:
Prices of mustard seed and its derivatives, soyabean and its derivatives, and crude palm oil have dropped.
On the other hand, prices of moong and chana are ruling higher currently compared with the year-ago period as also those of rice and wheat.
Oilseed prices have declined mainly since edible oil supplies are no more a concern.
Benefits and need for Commodity Trading:
Protection against inflation, stock market crash etc.
Transparency and Fair Price Discovery
High leverage facility
No Insider Trading
Seasonality Patterns and diversification
No Counter party Risk (since there are Clearing Houses)
Decrease the risk of cartelization
Disadvantages of commodity trading:
Not necessarily immune to inflation: Price inelasticity means that while the price increases or decreases, the supply of the commodity remains unchanged.
High Volatility: The prices of commodities are highly volatile and depend on demand and supply factors. The supply and demand of commodities are price inelastic.
Not ideal for diversification: The common consensus is that there is a negative or low correlation between the prices of commodities and the prices of stocks.
Way Forward:
Therefore, sometimes these bans can be detrimental to the Indian commodity markets, severely denting the perception of ease of doing business in the country. There is need for detailed discussion and research should be carried out for such extension.
Commodity derivatives give important cues on price discovery and price risk management to the entire value chain participants across farmers, processors, millers, traders in physical markets and farmer producers’ organizations.
