Context

The regulator (SEBI) has banned derivative contracts trade in chana, wheat, paddy (non-basmati), soybean and its derivatives, mustard seed and its derivatives, crude palm oil and moong on the future’s platform (NCDEX) for a year with immediate effect.

Background

The recent act of SEBI has been due to various reasons in domestic and global market. These reasons are-

• Domestic reasons-
  • It is done to control rising food prices in the country. The wholesale price inflation (WPI) for Nov’21 was at 14.23%.
  • The prices of oilseed and edible complex have witnessed all-time highs in the last few months. Retail edible oil inflation was 29.7 % in Nov’21.These commodities are consumed by households and value chain participants like processors and millers etc.
  • Higher projection- The Reserve Bank of India (RBI) has projected consumer inflation at 5.3% for the current fiscal year. In the first half of the next fiscal, it’s pegged at 5%, a percentage point above the target of 4%.
• Global reasons-
  • US Federal Reserve is planning to accelerate the tapering of bond purchases and raise interest rates. Therefore, central banks around the world are focused on inflation.

Analysis

What is derivative trading and how does it work?

• Derivative trading is when traders speculate on the future price action of an asset via the buying or selling of derivative contracts. The derivatives are of various types such as Forwards and futures, Options, and Swaps.
• It has two main purposes-
  • It is used to achieve enhanced gains when compared with buying the underlying asset outright.
  • It is also used for hedging purposes in order to alleviate risk against an existing position.
• In India, derivative trading is allowed on a number of stocks, currency, bonds and commodities. After the recent ban by SEBI, commodity trading is now allowed only in metal and energy contracts.

What is Securities and Exchange Board of India (SEBI) SEBI is a statutory body and a market regulator, which controls the securities market in India. It was established in 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992. The basic function of SEBI is to protect the interests of investors in securities and to promote and regulate the securities market.

Importance of derivative markets in agriculture-

In agricultural commodities, it is importance for various stakeholders like farmers, investors and Indian economy for the following reasons-

• Early price discovery-
  • It can result in better price discovery for farmers and investors. Farmers can plan how and when their produce. Investors can decide if they should invest in market or not.
• Hedging risk exposure-
  • It can also be used for hedging any possible risks for farmers in the event of any steep fall in prices due to overproduction of a particular commodity.
• Development of secondary market in agriculture-
  • It can not only benefit farmers, but also can lead to the growth of agriculture in the longer. With better agricultural marketing, competitive price discovery, India can better participation in global value chains.

Impact of recent ban on trading in agricultural commodities-

While the move is aimed at controlling food inflation in India, the recent move by the SEBI has been criticised for a number of reasons. Some of them are-

• Reduction in investor base-
  • Such abrupt measures will deter new participants such as alternative investment funds and mutual funds to invest in Indian commodity markets.
  • It could also lead to trades in these commodities shifting to the dabba or unofficial market
• Inappropriate timing- The suspension comes at a time when the Rabi crop would start coming to the market in a couple of months. Both traders and farmers are likely to be affected as there will be no reference price.
• Less impact on food inflation-
  • As per various studies, such bans do not impact commodity prices in long run. This has been seen in the case of Chana, wheat, etc. the prices of which continue to rise despite the ban on futures trading. In the short term, prices may fall, but over the longer term, other factors come into play.
• Food inflation has many other reasons- The surge in commodity prices, including those of agri-commodities, had also been fuelled by the easy money policy of central banks globally. With central banks now getting into tightening mode, prices of commodities, in general, are expected to cool down.
• Global impact - Oilseed and edible oils constitute a major chunk of the exchange volume. As, these commodities are internationally linked and have high liquidity, any policy action can have an impact on the business volume at the exchange.

Issues related to derivative trading in agriculture-

Despite certain benefits, there are several issues in derivative trading of agriculture commodities. The key reasons are-

• Speculative prices based on estimates-
  • Many times prices are derived more on speculation than on actual condition of agriculture production. Thus, it can turn inflation into hyperinflation even when the production is high.
• High volatility in markets –
  • As derivatives are volatile in nature, it can sometimes to huge losses for the investors especially in perishable products.
• Low awareness among farmers-
  • Farmers have low awareness about derivative markets and mechanism about price discovery. It results in underdevelopment of secondary market with low participation of farmers.

Way forward-

The recent step by SEBI is considered a knee jerk reaction to the food inflation. It is also considered a reflection of underdeveloped secondary market in agriculture commodities. However, following steps can be taken by the government-

• Developing secondary market in agriculture-
  • It will increase farmers participation in secondary market and thus, making it more remunerative and predictive.
• Adopting predictive policy stance-
  • Predictive policy formulation can result in better acceptance by the market and thus, ensuring wider entry of investors in the secondary market.
• Alternatives of control food inflation-
  • Food inflation can be controlled by a number of steps like banning exports, tax reduction on commodities and improving logistics and supply chain.

While the step is taken by SEBI for interest of the farmers and the consumers, its short term and long term ramification need to be measured and further steps should be taken.