Commodity derivatives market in India seems like old wine in new bottle. In reality, forward trading in commodities existed in India from ancient times (period of Kautilya’s Arthashastra) and the first modern futures market was established in 1875 for cotton contracts by the Bombay Cotton Trade Association, just a decade after CBOT entered the focus and traded its first future. The separate association Bombay Cotton Exchange Ltd was established over widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association. The movement continued by setting up “Gujarath Vyapar Mandali” in 1900 for futures trading in oil seeds, ground nut, castor seed and cotton seeds etc. The chamber of commerce at Harpur established the futures exchange for wheat trading in 1913, the first futures exchange for bullion futures in Mumbai in 1920 and similar exchanges come up in Rajkot, Jamnagar, Kanpur, Delhi and Calcutta. In Calcutta Hessain Exchange Ltd in 1919 and East Indian Jute Association Ltd in 1927 were established further and these two exchanges merged in 1945 as East India Jute and Hessin Ltd to conduct the organized trading of futures contracts in raw jute and related goods, meanwhile, many other exchanges started in country to trade in diversified commodities.
After independence, Government of India commissioned a committee headed by A D Shroff in 1950 to introduce Forward Contract bill in Parliament, under the regulation of Ministry of Consumer Affairs and Public Distribution. The FMC was powered to regulate, licensing and control of trading of forward and option contracts all over India. The smooth functioning of market continued till 1966, but due to various regulations, the market lost its vivacious and finally the forward trading was completely banned. The Government of India reintroduced forward trading in select commodities like Cotton, Jute, Potato, etc., as per the recommendation of Khusro committee in 1980. Subsequently, the liberalization of Indian economy in 1991 gave a new lease of life for commodity trading. The Government setup a new committee under the chairmanship of Prof. K. N. Kabra in 1993, the committee recommended to start the futures trading in agriculture commodities in basmati rice, cotton seed, oilseeds, etc. Further in 1996, the World Bank in association with United Nations Conference on Trade andDevelopment (UNTCAD) conducted a feasibility study and found that there is tremendous scope in revitalizing futures trading. In 2000, National Agricultural policy envisioned the reforms in agricultural commodities trading, that has brought a new wave in trading of commodity futures and paved the path for hedging and risk management by removal of control and regulation in agricultural market. In the aftermath of the second generation reforms, based on the recommendations of Kabra committee, World Bank Report and Guru Committee (2001) brought a dimension futures trading in Indian commodity market.
Indian commodity derivatives market has been rationalized in 2003 and futures contracts trading has seen upturn in terms of volume and value surge with very swift growth during that decade. It raised itself to compete in the global market with international giants, such as NYMEX, CBOT, LME, etc., and became the top fifth exchange in terms of number of contracts in gold, second in silver, copper and natural gas. It is found that the trading in commodity derivatives is about three times more than in physical market, whereas, it is more than ten times in advanced economies. In spite of reaching global standards, the market is facing the challenges due to lack of infrastructure, warehousing, inadequate risk mitigating instruments, etc. If the regulators take cognizance of these issues, Indian commodity derivatives market will become definitely an icon among the world commodity derivatives market.At present 21 commodity futures exchanges are working in the country, out of which, six are at national level and fifteen at regional level. All these exchanges are under the regulatory system of Forward Market Commission (FMC), Government of India but now merged under SEBI. By and large, the market has staged a spectacular growth of trading in terms of volume and value of commodity trading. It is very clear through the statistics that 53 commodities notified and permitted for futures trading in 2003 by forward market commission that moved to 113 in agricultural, and non-agricultural commodities futures contracts. On the other hand, the market has registered a significant growth in terms of value, which was Rs.12.9364 billion in 2003-04 and augmented to Rs. 1812.6104, 1704.6840 and 1014.4795 billion during the last three years, i.e., 2010-11, 2012-2013 and 2013-14 respectively.
Review of Literature
There is plethora of studies in the field since the existence of trading took place on commodities at India and the world. The important studies are reviewed and presented in a chronological order and examined the performance of trading, growth, role of price discovery, hedging, regulation future prospects to assess the performance of Indian commodity derivatives market specifically.
Shroff (1950) referred the Government of India draft bill on introduction of forward trading in India and recommended the introduction of forward trading helps in hedging, price stabilization, reducing the speculation. The study further advised to establish the trading rules and regulations, approved and managed byGovernment. Kamara (1982) analyzed the impact of introduction of commodity futures by comparing the spot market volatility before and after introduction of commodity futures and found no significant change. Kabra Committee Report (1993) advised to strengthen the Forward Market Commission (FMC) and Forward Contract Act, 1952 by means of improving infrastructure, telecommunication, functioning of the exchanges, adequate norms, automation of trading in exchanges, regulation to designing and trading of futures contracts, and establishing strong vigilance committee.
UNCTAD and World Bank Joint Mission Report (1996) highlighted the role of futures markets as market based instruments for managing risks and suggested the strengthening of institutional capacity of the regulator and the exchanges for efficient performance of these markets. Further noted that Government intervention was pervasive in some sensitive major commodities like wheat, rice and sugar and was of the view that future markets in these commodities were unlikely to be viable.The National Agricultural Policy , (2000) recommended to liberalize the agriculture and allied sector, enhance the infrastructure and information technology, the commodity exchanges has to launch futures contract on liquid commodities in the market. Singh (2000) analyzed efficiency of Indian commodity futures, advised optimizing the futures markets to discover the prices and minimise risk. According to him, exchanges should be self-regulated to curb speculation. The Government should minimize the intervention in pricing mechanism and should initiate private participation. Sahadevan (2002) surveyed the recognized exchanges and their organizational, trading and the regulatory set up for futures trading in commodities and revealed that many of the commodity futures exchanges fail to provide an efficient hedge against the risk emerging from volatile prices of many farm products in which they carry out futures trading. Habibullah Committee (2003) advised the Government of India that the development of commodity derivatives market must be upheld by removal of obstruction on convergence between securities and commodity derivatives market on account of policies relating to cash market, which will impact demand and supply forces. The Government follows common policy applicable to all over India. It further advised on removal of restrictions on participation of banking institutions at least for hedging purpose. The new policy framework should permit the introduction of the commodity futures indices contracts, spreads, weather, electricity and freight. It also recommended modifying the SEBI regulation to permit participation of mutual funds, Foreign Institutional Investor.Chen and Firth (2004) analyzed the relationship between return and trading volume of four commodity futures in China, by using correlation and Granger causality test. They found no correlation between return and volume, but signify the causality from trading volume and return, vice versa. They, however, found a correlation between absolute return and trading volume. Bir (2004) investigated hedging performance of agricultural commodity futures market in terms of price discovery and risk management. The factors responsible for inefficient hedging in commodities were found as low volume, low participation, inadequate warehouse facility and deficient information system of commodity exchanges. Wang and Ke (2005) analyzed the efficiency of the futures market for agricultural commodities in China found that long term equilibrium exists between futures and cash prices for Soybean. On the other hand, the comparison of wheat and soya bean futures reveals short term efficiency of Soybean futures market. Zapata (2005) analyzed the unidirectional Granger causality from futures prices for world sugar on the New York Exchange and world spot price of sugar and found the futures market helps in price discovery in spot, and the flow of information is from futures to spot market but not vice versa. Gorton and Rouwenhorst (2004, 2005) analyzed the long term characteristics of investment in collateralized commodity futures contracts by creating a commodity futures weighted index covering period of July 1959 to December 2004. The results showed that there was higher historical index and spot market return during the sample period. Further the study was found that the commodity futures risk premium was higher than debt market return and equal to equity market return. Ahuja (2006) analyzed the commodity derivatives market in India. And found that the commodity futures market in India has recorded spectacular growth to reach a one trillion mark in 2006. However, several challenges have to be overcome for further stability and persistent growth and development of the market. Karande (2007) studied the castor seed futures traded in with Mumbai and Ahmadabad and evaluated three features of commodity futures market in India, viz, basis risk, price discovery and spot price volatility. The result found that the price discovery was achieved and beneficial in spot price volatility market. Liu and Zhang (2006) analyzed the Price discovery of Spot and Futures price in Chinese Copper, Aluminium, Rubber, Soybean and Wheat markets and found that lead lags relationship between spot and futures market is quite limited. Abhijit Sen (2007) revealed that there is no significant proof for price acceleration of agricultural commodity prices in post futures period, the period of study being very short to discriminateenough between the futures trading and the cyclical adjustments. Lokare (2007) revealed significant co integration between futures and spot prices of selected commodities and had shown the slower operational efficiency. On the other hand, there was inefficient exploitation of available information to capture in the prices of futures contract.
Ram and Ashis (2007) concluded that agricultural commodity derivatives provide an efficient protection against the price volatility risk in terms of commodity prices, commodity exchanges offer a broad based platform for trading of agricultural and non-agricultural commodities over time and space so the commodity exchanges need to be developed at national level. IIM Bangalore (2008) study found post futures period volatility increased, in spite of negative results of futures market, suggested to integrate the geographical separated markets, remove the incompetence is arising among the futures prices and futures spot prices, which was due to immature nature of the market, there are many obstruction in nature of the institutional and policy level constraints.
Kedarnath and Mukharjee (2008) investigated the impact of futures trading on agricultural commodity market and found there is nosignificant change in spot prices post futures period in essential commodities, but a comparative advantage found through causality analysis proves that bidirectional relation exists between futures and spot market through flow of information. Bose (2008) found that information flow between the market helps in price determination. In spite of lesser degree of association in spot and futures indices, the agriculture commodity indices shows weak performance in price dissemination for predicting the futures prices than non-agriculture commodity futures indices. Nath and Lingareddy (2008) concluded that futures trading in the selected commodities escort to increase volatile in case of urad, in case of gram and wheat prices moderately rise in post futures period not proved statistically significant. Bhawna et al. (2009) found the removal ban on commodities achieved the spectacular growth achieved its objective as price risk management and price discovery and high untapped potential market growth in agriculture commodities. IIT Bombay (2009) conducted a research study on behalf of Forward Market Commission (FMC) of India and found that seventy percent of population depends on agriculture commodities, and there is a need to liberalize the to manage the price risk through commodity futures. Sabnavis and Gurbandani (2010) analyzed global commodity markets. These markets have proved to be efficient price discovery mechanism in India and worldwide. Further, Gurbandani (2010) found that both spot and future prices for selected agricultural commodities are efficient in weak form. Future prices are independent and past prices have no role in the contribution of future price prediction.
Basu and Gavin (2010) concluded that the investors are searching for the alternatives like high risky mortgage debt and financial derivatives market to mitigate the risk. The study also found that there is negative correlation between equity market to commodity futures return and it gives scope of bringing the arbitrage to exit hedging profits. Shanmugam and Dey (2011) showed that the commodity market have performed better for all the stakeholders. There is an urgent need for new instruments in the commodity markets. In addition, the regulator has to develop stringent policies that can allow financial intermediaries like institutional investors, banks and mutual funds to benefit at gross root level. Swati and Shukla (2011) concluded there is a need to convergence of all types of market like equity, commodity, forex and debt, which should be developed and regulated properly to provide wide-ranging risk management solutions to Indian stakeholders. Gupta and Ravi (2012) investigated the relationship in price discovery which proved that futures markets are more responsive in dissemination information and price discovery to correct spot market. Mahanta (2012) analyzed price trends in the international market and concluded that gold price movements in international market is positively correlated with Indian gold price movements, so proper considerations to international markets should be given while designing policies of derivatives market in India. Barua and Mahanta (2012) investigated the high inflationary pressure due to commodity derivatives. Few futures contracts like red gram, black gram, chickpeas, wheat, rice, potato, refined soybean oil and rubber have been canceled, but analysis proved that the ban on these commodity futures contract didn’t bring price stability Popli and Singh (2012) revealed that commodity futures market was volatile in USA, U.K. and India. The comparison between US, U.K and Indian futures markets reveals the policy makers have to follow the clue from U.S and U.K regulation to promote and encourage investments in commodity derivatives market. Kaur and Anjum (2013) carried out the study on agricultural commodity futures in India and found that in spite of development of commodity futures market, farmers could not gain leverage from the market, as there is no integration between spot and futures market. They further found that due to lack of infrastructure and warehousing, regional exchanges could not penetrate to rural India
Research Gap and Contribution of the StudyThe systematic review of literature revealed that the majority of studies covered the feasibility of futures trading, institutional and policy level constraints, strengthening of regulations, liberalizing the exchanges, institutional building, need for new instruments in the market and International market linkages. In the aftermath of reintroduction, most of the studies conducted by many researchers focused on impact of futures on volatility, risk management, price discovery, hedging, and market efficiency, relation between return and trading volume, lead-lag relationship between trading activity and cash price volatility before and after introduction of futures market, but no study was found with regard to assessing the growth, development and future prospects on long term performance of the market. Hence, the present paper is undertaken as a modest attempt to dwell on such untapped aspects.
References
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DR.N.K. ARORAM.Sc.,Ph.D.,PGDCS., Gold medalist 52nd All India Warehousing,Former Director,WDRA, Delhi& GM/Dy.MD,MSWC,/ SAM,CWC
