TABLE OF CONTENTS Topic no Executive summary by alicejenny

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									TABLE OF CONTENTS



  Topic                                       Page no.

1- Executive summary………………………………...5
2- Commodity markets in Iindia……………………...7
3- Hierarchy of Indian commodity market……….………8
4- Commodity futures……………………………..….9
5- Participation of bank on futures market.....…..…13
6- Role of banks…………………………………..…13
7- Bank as commodity pool operator…………..…...14
8- Lending against warehouse receipt……………...17
9- Current status of Indian commodity market…....21
10-Practical problems of banks…………………….26
11-Problems of farmers……………………………..27
12-Findings and recommendations………………...28
13-Aggregation models……………………………..29
14-Excerpts from RBI report……………………….31
15-Conclusion………………………………………33
16-Special thank……………………………………34
17-Webliography…………………………………....35
EXECUTIVE SUMMARY

Commodity is a product having commercial value, which can be produced,
brought, sold and consumed. Commodities are basically the product of primary
sector of an economy.


Commodity market is the oldest market, and it has evolved tremendously since
the civilization of mankind. To make this market more transparent and regulated
there has been introduction of many exchanges and governing bodies. In India in
the mid-60s, the Government imposed a ban on the futures trading of most of the
commodities on the assumption that this led to inflationary conditions. However,
with a view to improving the lot of the Indian farmer and to reverse the adverse
terms of trade that they have been suffering for their produce, the restrictions on
forward trading were lifted in April 2003.


As commodity market is the global market, it becomes necessary to understand
the global scenario. International Exchanges like London Metal Exchange, Chicago
Metal Exchange, Chicago Board of Trade, and Tokyo Commodity Exchange plays
important role in the price discovery of the commodities.


As Government lifted the ban on future trading on commodities in 2003, the
Indian investors and traders got new asset class for investment and
diversification. However there is huge potential still left unutilized in this market.


As compared to other market in last ten year commodities market has perform
relatively better than any other market like bonds market, equity market or
currency market.


However the participation in future trading in Indian commodity market is very
low as compared to other countries as there is lack of knowledge about this
market to the investors/ traders. Commodity market is not for mere trading
purpose; commodity trading is also used for hedge against inflation, price
discovery of the commodity, as a sound investment.
Exchange members play an important role in the development of commodity
market. They are not mere an intermediaries between the trader and exchange,
they also play an important role in educating and building confidence level in the
trades and investors.


Once the Government removes all the restriction on the commodity market and
permits the participation of Banks, Mutual Funds, and FIIs. The Indian
commodity market will touch new height resulting in better trade volumes and
liquidity in the market, as well building the confidence level in the investors and
traders.
             COMMODITY MARKETS IN INDIA
             The Forward Market Commission (FMC) headquarted at Mumbai is
      the regulatory authority for Commodity Derivatives Markets in India. It is a
      statutory body set up in 1953 under the Forward Contracts (Regulation) Act,
      1952. FMC is in turn supervised by the Ministry of Consumer Affairs, Food
      and Public Distribution, Govt. of India. The Act provides that the
      Commission shall consist of not less than two but not         exceeding four
      members appointed by the central government out of them being nominated
      by the central government to be Chairman thereof.

      The functions of the FMC are as follows:

(a)      To advise the Central Government in respect of the recognition or the
      withdrawal of recognition from any association or in respect of any other
      matter arising out of the administration of the Forward Contracts (Regulation)
      Act, 1952.

(b)      To keep forward markets under observation and to take such action in
      relation to them, as it may consider necessary, in exercise of the powers
      assigned to it by or under the act.

(c)      To collect and whenever the Commission feels it necessary, to publish
      information regarding the trading conditions in respect of goods to which any
      of the provisions of the act is made applicable, including information
      regarding supply, demand and prices, and to submit to the Central
      Government, periodical reports on the working of forward markets relating to
      such goods.

(d)      To make recommendations generally with a view to improving the
      organization and working of forward markets.

(e)      To undertake the inspection of the accounts and other documents of any
      recognized association or registered association or any member of such
      association whenever it considers it necessary.
HIERARCHY OF INDIAN COMMODITY MARKET




              Ministry of Consumer Affairs


           Forward market commission (FMC)


                Commodity Exchange


         National                             Regional
        Exchanges                            Exchanges



 MCX   NMCE         NCDEX       NBOT               20 Other
                                                   Regional
                                                  exchanges
                  COMMODITY FUTURES


Meaning and objectives of commodity futures

    “A commodity futures contract is an agreement between two parties to
buy or sell a specified and standardized quantity and quality of a commodity
at a certain time in future at a price agreed upon at the time of entering into the
contract on the commodity future exchange”

    The need for a futures market arises mainly due to the hedging function
that it can perform. Commodity markets, like any other financial instrument,
involve risks associated with frequent price volatility. The loss due to price
volatility can be attributed to the following two reasons:

1-Consumer Preference:

In the short term, their influence on price volatility is small since it is a slow
process permitting manufacturers, dealers & wholesalers to adjust their
inventory in advance.

2-Changes in Supply:

They are abrupt & unpredictable bringing about wild fluctuations in prices.
This can be especially noticed in agricultural commodities where the weather
plays a major role in affecting the fortunes of people involved in this industry.
The futures market has evolved to neutralize such risks through a mechanism;
namely hedging.

The Objectives of commodity futures are as follows:

        Hedging with the objective of transferring risk related to the
         possession of physical assets through any adverse movements in price.

        Liquidity and Price discovery to ensure base minimum volume in
         trading of a commodity through market information and demand-
            supply factors that facilitates a regular and authentic price discovery
            mechanism.

           Maintaining buffer stock and better allocation of resources as it
            augments reduction in inventory requirement and thus the exposure
            to risks related with price fluctuation declines. Resources can thus be
            diversified for investments.

           Price stabilization along with balancing demand and supply position.
            Futures trading leads to predictability in assessing the domestic prices,
            which maintains stability, thus safeguarding against any short term
            adverse price movements. Liquidity in the contracts of the
            commodities traded also ensures in maintaining the equilibrium
            between demand and supply.

           Flexibility, certainty and transparency in purchasing commodities
            facilitate bank financing. Predictability in the prices of commodity
            would lead to stability, which in turn would eliminate the risks
            associated with running the business of trading commodities. This
            would make funding easier and less stringent for banks to commodity
            market players.

In commodity futures, it is necessary to distinguish between investment
commodities and consumption commodities. An investment commodity is
generally held for investment purposes whereas consumption commodities are
held mainly for consumption purposes. Gold and Silver can be classified as
investment commodities whereas oil and steel can be classified as consumption
commodities.
 Why Commodity Futures?


     One answer that is heard in the financial sector is "we need commodity
futures markets so that we will have volumes, brokerage fees, and something to
trade''. I think that is missing the point. We have to look at futures market in a
bigger perspective -- what is the role for commodity futures in India's economy?


      In India agriculture has traditionally been an area with heavy government
intervention. Government intervenes by trying to maintain buffer stocks, they try
to fix prices, and they have import-export restrictions and a host of other
interventions. Many economists think that we could have major benefits from
liberalization of the agricultural sector.


      In this case, the question arises about who will maintain the buffer stock,
how will we smoothen the price fluctuations, how will farmers not be vulnerable
that tomorrow the price will crash when the crop comes out, how will farmers get
signals that in the future there will be a great need for wheat or rice. In all these
aspects the futures market has a very big role to play.


    If you think there will be a shortage of wheat tomorrow, the futures prices will
go up today, and it will carry signals back to the farmer making sowing decisions
today. In this fashion, a system of futures markets will improve cropping patterns.


      Next, if I am growing wheat and am worried that by the time the harvest
comes out prices will go down, then I can sell my wheat on the futures market. I
can sell my wheat at a price, which is fixed today, which eliminates my risk from
price fluctuations. These days, agriculture requires investments -- farmers spend
money on fertilizers, high yielding varieties, etc. They are worried when making
these investments that by the time the crop comes out prices might have dropped,
resulting in losses. Thus a farmer would like to lock in his future price and not be
exposed to fluctuations in prices.
The third is the role about storage. Today we have the Food Corporation of India,
which is doing a huge job of storage, and it is a system, which -- in my opinion --
does not work. Futures market will produce their own kind of smoothing between
the present and the future. If the future price is high and the present price is low,
an arbitrager will buy today and sell in the future. The converse is also true, thus
if the future price is low the arbitrageur will buy in the futures market. These
activities produce their own "optimal" buffer stocks, smooth prices. They also
work very effectively when there is trade in agricultural commodities;
arbitrageurs on the futures market will use imports and exports to smooth Indian
prices using foreign spot markets.


      In totality, commodity futures markets are a part and parcel of a program for
agricultural liberalization. Many agriculture economists understand the need of
liberalization in the sector. Futures markets are an instrument for achieving that
liberalization.
PARTICIPATION OF BANKS IN COMMODITY FUTURES

AMENDMENT IN BANKING REGULATIONS ACT
According to the Banking Regulations Act of 1949, banks are not allowed to trade
in the commodity derivatives. However a Proviso of the same section stipulates
that restrictions imposed in Section 8 shall not apply to any such business as is
specified by Central Government. But contradictorily, banks have a big role to
play in the development of the commodity market. As they have exposure to
agriculture, they would be better off in case they were able to hedge their
positions. Since banks have a strong rural reach and financial expertise, they can
become aggregators and take an aggregative position on behalf of farmers.


ROLE OF BANK
1 HEDGING CREDIT RISK
Banks run price risk on agricultural commodities on their portfolio of agricultural
advances. When commodity price falls, often the farmer is not able to recoup his
investment and the loan become non‐performing. It has been suggested that banks
may use futures to hedge the position. Futures can be used to hedge the price risk
in a portfolio. It is not possible to hedge credit risk by using futures.
At present, it is illegal to buy or sell options on goods. It needs to be examined
whether this prohibition will extend to option on futures. It is felt that the
Government may consider amending the Forward Contracts (Regulation) Act,
1952 to permit options on futures.




2 ROLE OF BANKS AS COMMODITY POOL OPERATORS
Farmers like to hedge their long positions in commodities by selling futures. In
developed countries, especially USA, farmers are large and capable of hedging
their own positions.
However, in Indian situation, it is likely that most of the farmers will not be able
to understand the dynamics of hedging by selling future contracts. Even if they do
so, it is unlikely that they will have the facility of approaching a member of
commodity exchange on their own. In such circumstances, commercial banks
should be able not only to offer advisory service but also run a commodity pool
for their agricultural borrowers. Commodity Futures Trade Commission (CFTC)
of the United States has mandated very detailed disclosure requirements for
Commodity Pool Operators. However, banks are exempt from such disclosure
requirements. Thus, it appears that it in the USA, it is common that banks offer
such pooling services to their customers. We may examine whether banks in India
can be allowed to offer such pooling services as well as advisory services in
respect of agricultural commodity futures to their
farmers.




3-VIEW OF ONE OF THE BANK ON “BANK AS A COMMODITY POOL
OPERATOR”
Commercial banks, with proper risk management system and with help of
commodity trading advisor (CTA), can offer advisory and pool services for their
borrowers.
Issues:
Keeping in mind the dynamics of the future market and complexity of
mechanism, following are the risks involved:
1-The small hedgers, especially farmers will not have understood the risks fully.
Hence, on
account of loss, it will be difficult to charge the pool participant for the loss, which
may lead to default.
2-Exposure in derivative markets of stocks more than the one’s in custody of the
commodity pool, will be in speculative in nature, and hence, result in higher risks
for pool participants
3-Over exposure of banks in this segment, given the fact that the supply of
commodities are dependent on various factors beyond human control, which can
be environmental, political,social, etc, can be detrimental to the shareholder value.
Way out:
CPO (commodity pool operator) should be treated as a hedging mechanism, i.e.,
the exposure on derivatives to be limited to stocks of commodity with custody of
the pool. The bank should not do speculation of commodities with the help of this
system.
The following procedure is suggested for setting up CPO by the bank:
Setting up Commodity Pool limits.
Derivative can be setup at two levels i.e. overall bank level and individual
commodity pool level.
These two levels can be decided on the basis of following criteria:
• Bank’s allocated capital for commodity and Commodity production
• Local commodity consumption and ‘mandi’ trading volumes Based on business
strategy, the bank has to set up commodity desks with a team of qualified
professionals in commodity markets. Appointment of Local Experts or Extension
officers.In order to get local information from farmers and commodity
aggregators, it is essential to
appoint local experts or extension officers by the bank. These people will be
responsible for
following activities:
• Furnishing information about various members of commodity pool
• Coordinating execution of necessary documents
• Communicating various details of commodity pool system to members on time
to time basis
Disclosure of risks
Disclosure of risks involved for the pool participants, as Indian farmers, are yet
not fully
conversant with the risks and mechanisms of the futures market, To cite an
example, a
declaration of understanding of the risks involved can be taken from the pool
participants in
their native language. This can be done through these appointed local agencies
Commodity Trading Positions & Infrastructure:
The Bank needs to set up infrastructure for online information transfer on
commodity trading positions. On request basis, the views on the markets can be
discussed with commodity pool members.




4-BANKS’     PARTICIPATION         IN    NONAGRICULTURAL            COMMODITY
FUTURES
Currently, commodity futures are generally understood to be futures on
agricultural commodities. Yet it is likely that non‐agriculture commodities such as
oil and natural gas, electricity may start trading in a large way. Banks would
profit from trading in such contracts.
They may also like to offer swaps in such products. It needs to be examined
whether banks may be permitted to deal in non‐agricultural commodities such as
oil, natural gas, electricity as and when these are introduced in the Indian market.
The above proposition needs to be examined in the context of the risks involved
when banks trade in Commodity Trades, viz;
a) A bank may get stuck with non‐financial non‐liquid assets
b) If banks are engaged in all kinds of non‐financial activities, the economy loses
its width as the number of effective players are reduced in the economy.




5-PHYSICAL DELIVERY
Banks generally deal in financial products and are ill‐equipped to take or give
physical delivery of the underlying commodities. It involves environmental and
other risks. Till recently, banks in the USA were not permitted to give or take
physical delivery of the underlying commodities. Not permitting banks to give or
take physical deliveries may prevent banks from participating in certain ‘types of
futures where it is necessary to give or take physical delivery, even if temporarily
as a pass‐through. It also takes away an important right from the banks of forcing
physical delivery of any contract where the bank has a reason to believe that the
counter party has acted with impropriety in the futures market. It needs to be
examined whether banks should be allowed to have unlimited freedom to give
and take physical delivery of the contracts. Permitting banks to give and take
physical delivery has to be examined in the light of possible risks, viz;
a) By force of circumstances, the banks may have to process, refine or otherwise
do operations on the commodities while taking physical delivery.
b) The banks may face environmental risk in the process of taking or giving
physical delivery.




6-BANK LENDING AGAINST THE SECURITY OF WAREHOUSE RECEIPTS
Retail lending against the security of agricultural commodities is difficult for
banks as enforcement of security interest is not easy. Banks can lend against the
security of Warehouse Receipts. This kind of lending is likely to find greater
acceptance if the Warehouse Receipts are not only freely transferable but also
negotiable. There are two enabling conditions
a) Warehouse receipts should be widely acceptable among farmers, commission
agents
(adatiyas) and the lending institutions.
b) There should be a statutory provision making the Warehouse Receipts
negotiable. This could perhaps be done by either amending the Negotiable
Instruments Act, 1881 or by incorporating such provisions in the Central! State
Warehousing Acts. Amending statutes can take considerable time and also wide
acceptability of an instrument is something which cannot be achieved either by
statutory or administrative action. It is felt that we could try something on the
lines of Dubai Commodity Receipts (DCRs), which have been introduced by
Dubai Metals & Commodity Centre (DMCC). In this model, a central authority
[for example, a Warehousing Authority (WA) which could be established by
chambers of commerce as a joint effort] issues and maintains electronic warehouse
receipts. Various warehousing organizations become a member of WA. The
depositors also have to be members before they can put their goods in a member
warehouse. In such circumstances, every player will be governed by the rules of
WA which can impart negotiability to the Warehouse Receipt. Negotiability will
be contractual rather than statutory. The matter can be examined from legal point
of view.
Now, with the advent of the Warehousing (Regulation and Development) Act
2007, measures have been taken towards this direction. It is a landmark act, if the
implementation of the same takes place efficiently then it will facilitate the
agricultural storage of goods and the strenthging of the futures market.
7-OWNERSHIP OF COMMODITY EXCHANGE AND WAREHOUSING
SYSTEM BY BANKS
Banks own a substantial share in the equity of the Commodity Exchanges. In the
Central Warehousing Corporation too, banks collectively own 37% of the equity.
In other areas too, such as Asset Reconstruction companies, banks own a
substantial equity. Concerns have been expressed that such an extensive
ownership of ancillary institutions by banks on one hand renders these
institutions susceptible to contagion from banking sector and on the other and
takes banks out of their area of core competence.
On the other hand, we are well aware that a law based efficient warehousing
system will take considerable time to evolve as it to touches central and state laws
in several areas. The best alternative before us is to create a warehouse system
which is owned and run by the major stakeholder such as commodity exchanges
and banks. The system will be electronic and open to membership by all
concerned, the public, the warehouses, commodity exchange clearing house and
the lenders. Membership is a contractual issue and all the participants are bound
by the rules of the group. It needs to be debated whether banks should contribute
towards setting up of such a central warehousing system.
BANK’S ROLE AS PROFESSIONAL CLEARING MEMBER AND TRADING
MEMBERS IN COMMODITY EXCHANGES — CONFLICT OF INTEREST
Banks may get involved in a range of activities involving commodity future
exchanges viz.
i. Own shares in the commodity exchange.
ii. Act as Professional Clearing Member.
iii. Act as trading member, clearing member or trading cum clearing member.
Banks already own shares and are established as Professional Clearing Members
in several commodity exchanges. If they are allowed to trade on their own behalf
or on behalf of their clients, it has to be examined whether any conflict of interest
will be involved. If yes, what can be the ways of dealing with the conflict of
interest?



CURRENT STATUS OF BANKS IN INDIAN COMMODITIES MARKET
After liberalization, trading in commodity futures has picked up volumes in
several commodities. However, the major users of the commodity futures
continue to be traders in commodities, exporters and food processing units. Banks
are not permitted to deal in commodities or commodity derivatives. By anecdotal
evidence, use of commodity futures by individual farmers is almost non‐existent.
In agricultural lending, banks are exposed to several risks. In case the commodity
prices fall drastically, the farmers are unable to repay their loans. Lending against
the stock in agricultural commodity is risky as the collateral of stock of
commodity is illiquid and difficult to ascertain as to quality and quantity.
By taking proprietary positions in futures, banks will not be able to mitigate their
credit risk.
To achieve this, they will have to buy options on futures. The restrictions imposed
on option trading in the Forward Contracts Regulation Act, 1952 could have been
relevant at the time the Act was passed. Since then, there have been several
developments in technology, risk mitigation and the overall regulatory
effectiveness. Further, option trading in equities has been permitted for several
years and no destabilizing effect has been noticed. In view of the above, the Group
reached a conclusion that the Forward Contracts (Regulation) Act, 1952 may be
suitably amended and Forward Markets Commission may frame suitable
framework for option trading in India.
It is examined whether banks could link their agricultural loans to the farmer
taking a corresponding short position in the futures market, thereby making sure
that the farmer is hedged against possible price fluctuations. Banks could act as
facilitator to the farmer in taking position in the futures market. In following such
an approach, the following difficulties were envisaged.
1. The farmer would find it difficult to pay the variation margin to the bank as he
is usually short of cash before harvesting;
2. Even if banks extend the variation margin as additional loan, in case of violent
movement of prices, the credit exposure of the banks could increase substantially;
3. It will be difficult to convince the farmer that he is losing money on his short
positions asthe price of the commodity is increasing.
In view of above, it would be difficult for banks to link their agricultural advances
to the futures position taken by the farmer. If the farmer takes the position
voluntarily, banks can act as facilitators.




Can banks act as Commodity Pool Operators (CPOs) on the line of CPOs
functioning in USA under the CFTC Regulation and help farmers in taking
position in the futures market?
CPOs are vehicles of financial investors who either want to leverage or diversify
their exposures. The model was unsuitable to help farmers. Banks’ exposure to a
particular commodity is a general exposure and cannot be linked to a particular
loan. Permitting banks to have independent proprietary positions is the best way
in which banks can cover their risks. It is to be however understood that assuming
such proprietary positions has its own risks and suitable risk control measures
must be adopted by the banks.
As the farmers are likely to find it difficult to assume positions in future market of
their own, it was deliberated whether banks can offer non standard contracts to
the farmers and cover themselves in the exchange traded futures. The position
was examined from the angle of Forward Contracts (Regulation) Act, 1952 and it
was concluded that it should be possible for banks to offer a nonstandard contract
to the farmers to suit their needs. The banks may, however, need to keep in mind
that positions taken by farmers are reasonable as compared to the risks that they
are exposed to. Simply on the back of exchange traded futures and bilateral
contracts of the kind allowed under the existing laws (ready forward, NTSD and
TSD contracts) banks could offer a very limited menu of customized products to
farmers. To effectively manage their commodity trading books or commodity
portfolios while offering tailor made products, the banks will require a combination of
exchange traded futures, options, options on futures, less restrictive bilateral contracts
and actively traded OTC markets.
Banks should ideally deal only in those commodity futures or forward contracts which are
cash settled as it would not be prudent for them to make or take physical delivery of
goods. This has also been a practice in advanced countries such as US where banks have
to take special permission if they intend to make or take delivery of physical goods.
Banks will have to abide by the bye‐laws of the exchanges or the features of the contracts
they trade in, which could require them to make or take delivery if they held the contract
till the delivery period for that contract started. The Group is of the view that under the
existing environment banks may have to devise a trading strategy to close the contracts
before the delivery period started to escape making or taking delivery of goods. However,
keeping in view that Warehouse Receipts in demat form are available in all national
exchanges, even if the bank had to take possession of the goods, it would be only through
credit to a demat account. This, the Group feels, should mitigate risks emanating from
having to actually hold and manage physical commodities. The bank will of course have to
incur carrying cost till it is able to sell the commodity through some other contract on the
exchange. In regard to OTC contracts the Group feels that it would be difficult to deal in
contracts which require physical delivery of goods. OTC contracts should also preferably
only be cash settled. Under Section 27 of FCRA, the Central Government has the power to
exempt under certain conditions any contract or class of contracts from the operation of
all or any of the provisions of FCRA. The Group is of the view that to make OTC contracts
a feasible proposition for banks, the Government should exempt transferable specific
delivery (TSD) contracts, where one of the parties to the contract is a bank authorised by
RBI, from the operation of all or any of the provisions of FCRA. This would enable banks
to provide bilateral contracts tailored to the requirements of their customers without
running the risk of taking or making delivery.
ISSUES ON WAREHOUSE RECEIPTS
Currently, WR is not an instrument, against which banks lend comfortably. There
are number of risks associated with it. Some of them are like fraud WR, credit risk
with the warehouse owner, and financial strength of the warehouse, quality of the
warehouse and of course the credibility of the goods valuation. Closely analyzing
the problem, NCDEX in particular has taken some initiatives to bring banks closer
to the farmer in the field of structured finance. Farmers can get finance through a
pledged dematerialized warehouse receipt of an accredited warehouse of the
Exchange. This instrument is pledged by borrowers against the loan. Since they
sell forward the underlying on the Exchange's platform, the value of the collateral
is fixed in a futuristic perspective, which mitigates the default risk for the banks.
This value addition can boost up agro‐lending, thereby strengthening the
agricultural development process. At the same time, it will mean a better business
for the banks too which are lending around Rs 9000 cr as lending against
commodities. The potential can be seen to be in the region of at least Rs 150,000 cr.
But there are certain issues which need to be resolved. If dematerialized WRs
issued by the commodity exchanges are recognized by the Depository Act, it will
give credibility to the receipt and will provide an ease for banks to lend against
WRs. At the same time, WR should be allowed to become negotiable under the
Negotiable Instrument Act
Practical problems of the banks:

1-Staff strength

One of the problems highlighted by the bank officials is that the business from the
rural branches is not that significant so the employee strength is already
maintained at a sub-optimal level. Also not many people are readily accepting
transfers to the rural branches as it gives them a psychological feeling of
demotion. In order to introduce the commodity futures there would be an
additional requirement of staff, which is trained and dedicated specially to this
activity, which will be hurdle for the bank.

2- Risk and Return equation.

The activity of the participation of the banks of on the futures market is risky and the
return is not in proportionate to it. This is the reason why banks will be hesitant to the
implementation of the proposed role as aggregators.

3- Physical delivery in commodities.

Few commodity contracts are settled by compulsory delivery, in such cases the banks
need to maintain the stock of the commodity which should be as per the specified
quality of the contract. It becomes difficult for the bank to do as it has to provide for
the warehousing facilities as well as the keep a check of the quality of the produce.
Problems of the farmers:

Issues for Indian Farmers
      Traditional cropping pattern
      Income variation due to price instability
      Asymmetric price information
      Dependency on monsoon
      Irregular flow of credit
      Reliance on money lender, arathiya
      Lack of warehousing infrastructure
      Absence of grading and assaying facilities
      Restrictive marketing environment
           APMC laws
         Absence of common economic market

       Low earnings due to a long intermediary chain as depicted in the diagram.




Agricultural futures trading volumes have grown at exponential rates (100 times
during the last five years with the figure at Rs37 trillion in 2006-07) and new
commodities are being introduced at a rapid pace, with the present number at
about 70. The most disquieting aspect, however, of this otherwise impressive story
is that the farmers—primary stakeholders in the speculator-dominated market —
are conspicuously absent.

Commodity exchanges have obviously not kept the promise under which these
markets were deregulated in 2003, to offer farmers a market-based mechanism for
hedging their price risk and facilitating transparent price discovery.
The minimum lot size requirement acts as a major “entry barrier” for farmers with
small landholdings. The transactions need the payment of an upfront margin and,
depending on subsequent price fluctuations, there are daily “mark to market”
margin requirements by exchanges till the settlement date.

Such conditions impose a financial burden on the farmer who may find it difficult
even to comprehend complexities related to additional margin calls.

Third, on the settlement date, if the farmer decides to use the physical delivery
route to settle the contract, he has to move the produce from his village to the
designated warehouse at his cost. This cost can be significant because the lack of
accredited warehousing facilities in and around villages imposes additional
burden while transporting produce to a designated warehouse




FINDINGS AND RECOMMENDATIONS

The answers to these problems lie in having “aggregators” who would aggregate
the produce of various farmers and provide the required logistical services
including transportation, testing and grading, and interaction with warehouses
and commodity exchanges. This mechanism is the surest way to bring the benefits
of futures trading to farmers. There is, therefore, a need to identify entities for
consolidating individual farmer requirements and allowing them to hedge in a
consolidated manner all their needs on the exchange platform.

A large proportion of Indian farmers have small and marginal holdings. Their
marketable surplus is small or negligible; their access to market is poor and costly;
their holding capacity is weak as they need cash for their consumption and other
needs immediately at harvest; and access to credit is poor. In order to ensure that
benefits of price discovery on Exchange platforms reaches them, it is of prime
importance to create infrastructure which enables dissemination of prices to the
remotest corners of the country.
The above model for aggregation can be used by banks to facilitate the
participation of farmers on the exchange. Before the harvest season begins the
farmers can approach the aggregators who will on their behalf take position on
the exchange to hedge the risk of price and quantity. Also the farmer will get a
clear signal looking at the commodity prices of the futures contract as regards
the expected movement in price and thus accordingly plan his activity.
Post harvest the small and marginal farmers can aggregate their farm produce
with the aggregators who can take a position on the exchange and sell the produce
forward if the prices are favourable in the forward market. Also they can deposit
their produce in the warehouse and on the warehouse receipt avail of bank
finance. This will enable the farmer not sale the produce in distress and bargain
for a fair price. He can decide to sell later if he thinks the price may improve over
as period of time. Option to sell the produce in futures or spot is open to him. As
produce will be graded and assessed, he will make sure he maintains the quality
of                                   the                                   produce.
EXCERPTS FROM RBI (RESERVE BANK OF INDIA)
Date : 11 May 2005
RBI Working Group on Warehouse Receipts and Commodity Futures submits
Report :
In accordance with the announcement made by the Governor, Reserve Bank of
India in the Mid-term Review of the Annual Policy Statement for the year 2004-05,
RBI had constituted a Working Group on Warehouse Receipts and Commodity
Futures with Shri Prashant Saran, Chief General Manager as Chairman. Other
members included representatives of Indian Banks' Association (IBA), Forward
Markets Commission (FMC), NABARD, SBI, Punjab National Bank, Bank of
Baroda and ICICI Bank Ltd. The Working Group was entrusted with the task of
evolving broad guidelines, criteria, limits, risk management system as also a legal
framework for facilitating participation of banks in commodity (derivative)
market. The Group was also asked to suggest enabling measures, including
necessary statutory amendments to impart negotiable status to Warehouse
Receipts, to encourage flow of institutional finance to farmers. The Working
Group has submitted its report, which examines the existing situation, furnishes
relevant international experience and suggests the possible course of action on
various issues. The Group has recommended that banks may be permitted to offer
futures based products to farmers in order to enable them to hedge their price
risk. To enable banks to offer such products, the Group has recommended that
banks may be permitted to have proprietary positions in agricultural commodities
within certain prudential limits. Therefore, it has recommended that the Central
Government may issue a Notification under clause (o) of sub-section (1) of Section
6 of the Banking Regulation Act, 1949 for permitting banks to deal in the business
of agricultural commodities including derivatives. It has also been recommended
that the Forward Contracts (Regulation) Act, 1952 should be amended and
Forward Markets Commission (FMC) should evolve a framework for introducing
Options trading in agricultural commodities in India. The Group has suggested
that banks may be permitted to offer non-standard contracts as well as derivative
based products to farmers so as to help them to hedge their commodity price risk.
The Group has referred to the efforts being made towards drafting suitable
legislation to make Warehouse Receipts negotiable. With a view to making
Warehouse Receipts freely transferable pending suitable legislation and to create a
physical infrastructure it has recommended creation of an umbrella structure to
act as a Closed User Group (CUG), the membership of which may be extended to
all players in the commodity market.
The report of the Group is available on the Reserve Bank of India’s website
(www.rbi.org.in).
Views may be faxed to 022-22660970 by May 31, 2005.
Alpana Killawala
Chief General Manager
Press Release: 2004-2005/1183
CONCLUSION
India is one of the top producers of a large number of commodities, and also has a
long history of trading in commodities and related derivatives. The commodities
derivatives market has seen ups and downs, but seems to have finally arrived
now. The market has made enormous progress in terms of Technology,
transparency and the trading activity. Interestingly, this has happened only after
the Government protection was removed from a number of commodities, and
market forces were allowed to play their role. This should act as a major lesson for
the policy makers in developing countries, that pricing and price risk
management should be left to the market forces rather than trying to achieve these
through administered price mechanisms. The management of price risk is going to
assume even greater importance in future with the promotion of free trade and
removal of trade barriers in the world. All this augurs well for the commodity
derivatives markets. All said about the commodity markets but unless the producers of
the commodity i.e. the farmers do not participate on the market the very purpose for the
futures market will not be served. Banks can play a vital role in uplifting the agricultural
community and thus lead to healthy growth of the country, bridging the gap between the
rural Bharat and urban India.
A special thanks to all the below mentioned people who have been of immense help to me
in the completion of the project. They have given me all the required guidance and
information whenever required. Without their support the project would not have seen
the light of the day.

Dr .SHUNMUGAM               CHIEF ECONOMIST                            MCX

Dr. RAOSAHEB MOHITE         AVP-AGRICULTURE RESEARCH                  MCX

Mr. RAJESH SINHA            HEAD-SPOT EXCHANGE                        NCDEX-SPOT

Mr. MAHESH TIWARI           HEAD-LOGISTICS                            NCDEX

Mr. PRABHAT RANJAN          VICE PRESIDENT                            NCDEX

Mr. DEEPAK KANNAN           DEPUTY MANAGER-RISK DEPT.                 NCDEX

Mr. KAUSHIK CHATURVEDI      RURAL PLANING AND CREDIT DEPARTMENT

                                                              RESERVE BANK OF INDIA

Mr. S. N. A. JINNAH         GENERAL MANAGER                          NABARD

Mr. R. A. S. KHANGAR        ASSISTANT GENERAL MANAGER                NABARD

Mr. SUNIL KUMAR             BANKERS INSTITUE OF RURAL DEVELOPMENT

Mr. A. L. PARAJAPE          CHIEF MANAGER-PRIORITY SECTOR           BANK OF INDIA

Mr. R. K. PATIL             SME & AGRI. FINANCE                     BANK OF BARODA
                         Webliography


Futures Exchange or Gov’t Agency Internet Site

Forward Market Commission                         www.fmc.gov.in
NABARD                                           www.nabard.org
NCDEX                                            www.ncdex.com
MCX                                              www.mcxindia.com
RBI                                              www.rbi.org.in
New York Mercantile Exchange                      www.nymex.com
Kansas City Board of Trade                        www.kcbt.com
Chicago Mercantile Exchange                       www.cme.com
Chicago Board of Trade                            www.cbot.com
Chicago Board Options Exchange                     www.cboe.com
Minneapolis Grain Exchange                        www.mgex.com
New York Cotton Exchange                          www.nyce.com
Coffee, Sugar & Cocoa Exchange                    www.csce.com
CFTC                                             www.cftc.gov




Other Useful Sites for Commodities:-
www.agriwatch.com
www.commoditiescontrol.com
www.commodityonline.com
www.kitco.com
www.bloomberg.com
www.silverstock.com
www.bulliondesk.com
www.mesteel.com

								
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