Context
SEBI recently extended the ban on futures trading in seven agricultural commodities, including derivatives of two crops, which had been in effect since December 20, 2021.
Relevance:
GS Paper-3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment; Commodity Market in India.
Mains Question
What exactly is commodity trading? Also, what are the advantages and disadvantages of commodity trading? (250 Words)
Key Highlights
- Non-basmati paddy, wheat, chana (Bengal gramme), mustard seed and its derivatives, soyabean and its derivatives, crude palm oil, and moong are among the prohibited commodities (green gram).
- India imports more than 60% of its edible oil demand.
- The Securities and Exchange Board of India recently approved the FPI route for foreign investors to participate in Indian exchange-traded commodity derivatives (ETCDs).
- Foreign portfolio investors (FPIs) are permitted to participate in cash settled non-agricultural commodity derivative contracts and indices containing such non-agricultural commodities.
Why were they prohibited?
- They have been prohibited because spot market prices for these commodities have risen over the last year and a half.
- After edible oil prices doubled last year, the ban was initially imposed.
- The Centre received numerous complaints that excessive speculation, particularly in mustard seed and derivatives, had resulted in high open market prices.
What are the justifications for extending the ban?
- The Centre, in particular, and SEBI, have extended the ban on inflationary concerns.
- After imposing the ban due to rising edible oil prices last year, the Centre has been forced to extend it this year due to rising rice and wheat prices.
- Rice prices have risen 7.5% year on year, while wheat prices have risen 15.5%.
- 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”.
India’s Commodity Market
- Commodity Market: o A commodity market is a physical or virtual space where interested parties can trade commodities (raw or primary products) at a current or future date. The price is determined by supply and demand economic principles.
- Regulator: o The Forward Markets Commission regulated the market until 2015, when it was merged with SEBI to create a unified regulatory environment for commercial investing.
- Commodity Market Types: o Commodity trading typically occurs in derivatives markets or spot markets- Spot markets, also known as “cash markets” or “physical markets,” are where traders exchange physical commodities for immediate delivery.
- In India, there are 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 it at a point in the future for a price agreed upon in the present.
- When the contracts expire, the commodity or asset is physically delivered.
- Benefits of commodity trading include: o Protection against inflation, stock market crashes, and so on.
- High-leverage capability
- Diversification
- Transparency
- Disadvantages of commodity trading: o Not always resistant to inflation
- Extreme Volatility
What effect did the ban have?
- Prices for mustard seed and derivatives, soyabean and derivatives, and crude palm oil have fallen.
- On the other hand, prices for moong and chana, as well as rice and wheat, are currently higher than a year ago.
- Oilseed prices have fallen primarily because edible oil supplies are no longer a concern.
- Has the move had an impact on commodity exchanges?
- The ban has had an impact on commodity exchange turnover.
- The crude palm oil ban has had an impact on MCX.
- NCDEX, on the other hand, has suffered greatly as its monthly turnover has been cut in half to 10,053 crore in October from over 20,000 crore in January. It was trading in the remaining six commodities.
The Way Forward:
- These bans can sometimes be detrimental to Indian commodity markets, severely undermining the perception of ease of doing business in the country. As a result, such an extension requires extensive discussion and research.
- Commodity derivatives provide important price discovery and risk management cues to all value chain participants, including farmers, processors, millers, physical market traders, and farmer producers’ organisations.
