Don't ban futures trading in commodities

It will impede price discovery Jignesh Shah MD & CEO MCX The Economic Times FRIDAY, JUNE 30, 2006

“No activity in the economic field is perhaps so little understood as futures trading on organised commodity exchanges”, wrote the Forwards Markets Review Committee, headed by the internationally acclaimed agricultural economist Prof M L Dantwala, in 1966.

The recent knee-jerk reaction of some in the central government and many in the media to the rise in the prices of wheat, sugar and pulses is reminiscent of the truth of this statement. Futures trading in these commodities is being blamed for price escalation in these essential commodities. Four decades ago, futures trading in most commodities was banned fearing that trading will fuel inflation. Is history repeating itself once again? Commodity futures trading was revived towards the end of the last century, after a lapse of nearly three-and-a-half decades, in the wake of economic reforms and liberalisation following India’s entry into WTO.

It was recognised that futures markets perform the economic functions of price discovery and price risk management. Futures markets do not actually determine prices. The basic forces of supply and demand set prices in both the physical and futures markets. Futures markets only discover prices, and disseminate these widely for the benefit of producers and consumers, as also the government authorities so that the latter can devise appropriate trade and fiscal policies to correct the supply-demand imbalances. When supply is short, prices are bound to rise, whether futures markets exist or not. The converse is true with surplus supplies.

Stoppage of futures trading is no solution to the rising or falling price trend. With such stoppage, not only do we lose the valuable price discovery mechanism, but, also the risk management tool — so vitally needed to avert price risks. Suspension of futures trading drives speculation to the physical markets, aggravating the rising or falling trends in prices. At a time when the last phase of Doha round of talks is about to end, and convertibility of rupee seems near, it is ironical that some are clamouring for the closure of futures markets in agricultural commodities.