Commodities Markets in India
Finance Presentation
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized Contracts. This article focuses on the history and current debates regarding global commodity markets. It covers physical product (food, metals, electricity) markets but not the ways that services, including those of governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets and currency markets cover those concerns separately and in more depth. One focus of this article is the relationship between simple commodity money and the more complex instruments offered in the commodity markets. History The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States, other basic foodstuffs such as soybeans were only added quite recently in most markets. For a commodity market to be established, there must be very broad consensus on the variations in the product that make it acceptable for one purpose or another. The economic impact of the development of commodity markets is hard to overestimate. Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade." Early history of commodity markets Historically, dating from ancient Sumerian use of sheep or goats, or other peoples using pigs, rare seashells, or other items as commodity money, people have sought ways to standardize and trade contracts in the delivery of such items, to render trade itself more smooth and predictable. Commodity money and commodity markets in a crude early form are believed to have originated in Sumer where small baked clay tokens in the shape of sheep or goats were used in trade. Sealed in clay vessels with a certain number of such tokens, with that number written on the outside, they represented a promise to deliver that number. This made them a form of commodity money - more than an "I.O.U." but less than a guarantee by a nation-state or bank. However, they were also known to contain promises of time and date of delivery - this made them like a modern futures contract. Regardless of the details, it was only possible to verify the number of tokens inside by shaking the vessel or by breaking it, at which point the number or terms written on the outside became subject to doubt. Eventually the tokens disappeared, but the contracts remained on flat tablets. This represented the first system of commodity accounting.
However, the Commodity status of living things is always subject to doubt - it was hard to validate the health or existence of sheep or goats. Excuses for non-delivery were not unknown, and there are recovered Sumerian letters that complain of sickly goats, sheep that had already been fleeced, etc. If a seller's reputation was good, individual "backers" or "bankers" could decide to take the risk of "clearing" a trade. The observation that trust is always required between market participants later led to credit money. But until relatively modern times, communication and credit were primitive. Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness. Considering the many hazards of climate, piracy, theft and abuse of military fiat by rulers of kingdoms along the trade routes, it was a major focus of these civilizations to keep markets open and trading in these scarce commodities. Reputation and clearing became central concerns, and the states which could handle them most effectively became very powerful empires, trusted by many peoples to manage and mediate trade and commerce. Forward contracts Commodity and Futures contracts are based on what‟s termed "Forward" Contracts. Early on these "forward" contracts (agreements to buy now, pay and deliver later) were used as a way of getting products from producer to the consumer. These typically were only for food and agricultural Products. Forward contracts have evolved and have been standardized into what we know today as futures contracts. Although more complex today, early “Forward” contracts for example, were used for rice in seventeenth century Japan. Modern "forward", or futures agreements, began in Chicago in the 1840s, with the appearance of the railroads. Chicago, being centrally located, emerged as the hub between Midwestern farmers and producers and the east coast consumer population centers. Benefits: Price discovery for commodity players A farmer can plan his crop by looking at prices prevailing in the futures market Hedging against price risk A farmers can sell in futures to ensure remunerative prices A processor/ manufacturing firm can buy in futures to hedge against volatile raw material costs An exporter can commit to a price to his foreign clients A stockist can hedge his carrying risk to ensure smooth prices of the seasonal commodities round the year Easy availability of finance
Based on hedged positions commodity market players (farmers, processors, manufacturers, exporters) may get easy financing from the banks
Hedging "Hedging", a common (and sometimes mandatory) practice of farming cooperatives, insures against a poor harvest by purchasing futures contracts in the same commodity. If the cooperative has significantly less of its product to sell due to weather or insects, it makes up for that loss with a profit on the markets, since the overall supply of the crop is short everywhere that suffered the same conditions. Whole developing nations may be especially vulnerable, and even their currency tends to be tied to the price of those particular commodity items until it manages to be a fully developed nation. For example, one could see the nominally fiat money of Cuba as being tied to sugar prices, since a lack of hard currency paying for sugar means less foreign goods per peso in Cuba itself. In effect, Cuba needs a hedge against a drop in sugar prices, if it wishes to maintain a stable quality of life for its citizens. Community Exchange A commodities exchange is an exchange where various commodities and derivatives products are traded. Most commodity markets across the world trade in agricultural products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, oil, metals, etc.) and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures. Other sophisticated products may include interest rates, environmental instruments, swaps, or ocean freight contracts. Commodities Trading Commodities exchanges, usually trade futures contracts on commodities. Such as trading contracts to receive something, say corn, in a certain month. A farmer raising corn can sell a future contract on his corn, which will not be harvested for several months, and guarantee the price he will be paid when he delivers; a breakfast cereal producer buys the contract now and guarantees the price will not go up when it is delivered. This protects the farmer from price drops and the buyer from price rises. Speculators also buy and sell the futures contracts to make a profit and provide liquidity to the system.
Multi Commodity Exchange (MCX) is an independent commodity exchange based in India. It was established in 2003 and is based in Mumbai. It has an average daily turnover of around US$1.55 billion. MCX offers futures trading in Agricultural Commodities, Bullion, Ferrous & Non-ferrous metals, Pulses, Oils & Oilseeds, Energy, Plantations, Spices and other soft commodities.
MCX has also setup in joint venture the National Spot Exchange a purely agricultural commodity exchange and National Bulk Handling Corporation (NBHC) which provides bulk storage and handling of agricultural products. MCX in association with Welingkar Institute of Management has setup a course called "Diploma in Commodities Market" The commodities market in India is vast, with over 30 major markets in operation alongside 7,500 small localized markets (known as „Mandies'). As a result, the Indian Gross Domestic Product (GDP) is hugely dependent on agrarian commodities. Two years ago, the Government of India identified the agricultural sector as a thrust area for modernization and began an initiative to commission an effective nationwide commodity trading infrastructure. As a key element of this strategy, the Ministry of Consumer Affairs, Food and Public Distribution envisioned a state-of-the-art nationwide commodities exchange, that by adopting global „best practices' and technology standards, would ensure the efficiency of its members. Commodity futures market in India is one of the oldest in the world. We institutionalized futures trading at the Bombay Cotton Trade Association in 1875, with contracts. Futures trading in many other commodities like oilseeds, foodgrains and bullion were doing well during the pre-independent days and in the 50s led to banning of futures trading in most of the commodities. The revival started in the mid 90s with liberalization of the economy and agricultural sector in particular. Multi Commodity Exchange of India (MCX), an independent and demutualized multicommodity exchange, was amongst the first organizations to receive a mandate to commission a nationwide multi-commodity trading platform in February 2003. They faced a challenging deadline, wherein Exchange operations had to go live within 10 months. Headquartered in Mumbai, MCX is led by a team of senior industry professionals, with extensive business and operations expertise. MCX needed an infrastructure with an optimal Total Cost of Ownership (TCO) and the potential to scale up seamlessly, with growing transaction intensity. MCX was aware that its long term profitability depended on bringing the platform to market quickly and cost effectively. With Exchange operations being technology centric, the MCX Management Team had intensive discussions on the best alternative to fulfill its business objectives and at the same time successfully comply with the requirements of the Ministry. It was therefore decided to entrust the roll-out of the technology framework to the market leader in mission-critical Straight Through Processing (STP) technologies and Microsoft® partner, Financial Technologies (India) Ltd. (FTIL).
Our Government have taken several measures to revive and accelerate futures in the past few years.
Between August 2002 and April 2003 prohibition on futures trading in 81 commodities was removed. From April 1st 2003 therefore all commodities are permitted for futures trading. This was a major decision of the Government considering the fact that we had only 6 commodities, and that too low volume once, allowed for futures trading in 1997. In our endeavor to reach the benefits of commodity futures treading to all parts of the country trading facilities have been extended to the State of Jammu & Kashmir for the first time in September, 2003. In its efforts to remove restrictions on physical trade in commodities the Government removed party-to-party forward contracts in commodities ( NTSD contracts) from the purview of the Forward Contracts ( Regulation) Act. Following the announcement of the Hon‟ble Prime Minister on 15 th August, 2002 four nation wide multi commodity exchange have been approved by the Government during January-February 2003. One of them ( National MultiCommodity Exchange of India, Ahmedabad) is today commencing futures trading in wheat and rice, the most voluminous basic consumption goods of the masses. This event is specially significant as we enter a major phase in futures trading.
Participants in Futures Commodities Farmers/ Producers Merchandisers/ Traders Importers Exporters Consumers/ Industry Commodity Financers Agriculture Credit providing agencies Corporate having price risk exposure in commodities
India’s Place in World Market
COMMODITY RICE (PADDY) WHEAT PULSES GROUNDNUT RAPESEED SUGARCANE TEA COFFEE(GREEN) JUTE AND JUTE FIBERS COTTON (LINT) INDIA 240 74 13 6 6 315 0.75 0.28 1.74 2.06 WORLD 2049 599 55 35 40 1278 2.99 7.28 4.02 18.84 SHARE 11.71 12.35 23.64 17.14 15.00 24.65 25.08 3.85 43.30 10.09 RANK THIRD SECOND FIRST SECOND THIRD SECOND FIRST EIGTH SECOND THIRD
Nationwide Multi-Exchanges vs Regional Exchanges • • • • • • • Better Reach in all parts of the country Wider base for speculators from other markets including securities market Broad basing of the underlying commodity Industry diffused in several parts of the country may also directly participate Few commodities can be projected viable for an international futures Contract, with participation from global player Novation of all open positions in the market by the exchange Best management practices, end of day mark to market, online margining and surveillance, daily pay-in & pay-out are some of the features to woo the players
Future of the Commodity Market in India India is the largest consumer, producer, exporter and importer of raw materials. Lately, there have been large size intermediaries penetrating the commodities market. This helps in bringing in more finance to the market. The major banks are also financing commodities. This makes the futures a secured route for hedging investments and against risks. The RBI permits banks to hedge their bullion risk through Futures Exchanges. The other commodities will also soon follow. More and more international players are being attracted towards the Indian shores as the trade interest and BPO increases. India is fast becoming the hub for value added services and food processing.