Exchange-traded derivatives help multiple stakeholders – farmers, producers, processors, miners, value chain participants, smelters- in the economy.
Commodity futures and options help farmers and other producers to ‘lock in’ the prices of their future output or inputs, therefore, helping to hedge against the volatility in commodity prices.
Commodity derivatives help farmers take informed decisions on sowing, warehousing and timing of sales.
Stakeholders benefit from commodity derivatives by locking-in their cash-outflows for their raw-material/end product purchases. This enables them to protect their margins from the volatility in international commodity prices.
By providing a risk-mitigation mechanism to users, commodity derivatives provide a higher degree of comfort to their lenders, thus providing easier loans for capital investment. Commodities stored in exchange accredited warehouses can also be used as collateral for post-harvest credit.
A well-developed commodity derivatives market necessitates the existence of modern warehousing, grading and quality certification, etc. Creation of such infrastructure brings about cascading beneficial effects on the physical markets in the agricultural sector, helping farmers receive fair prices for their produce.
The operating ecosystem of physical market, financial and commodity derivatives should progressively remain well evolved.The following reforms can provide thrust to commodity ecosystem:
Easing post harvest distress sale woes: Support on assaying cost for quality parameter and storage for two weeks with public private partnership model
Often the problems faced by the farmers pertain to distress sale of produce by the farmers. The prospective buyers express a difference of opinion on the quality of the produce. Farmers have less leeway in spite of the higher quality that they may have. Assaying of the produce by a credible agency will be a great help in removing this ambiguity.
The farmers do not have recourse to the storage facility and have to sell the produce at as is where condition.
The presence in the warehouses with assaying facilities and free storage for 15 days in the warehouses near the point of mandis will help the farmers to get a better price for their produce.
Use of put option as tool for MSP management in exchange traded commodities
Crop insurance covers risks like loss of crop but does not cover the price risk that farmers are exposed to.
Farmers can be given the support to hedge their price risk in the options market before the growing season by paying a premium and buying a put option (an option to sell produce at a predefined price on a future date by paying a fixed premium now). This will ensure that the farmer gets a guaranteed minimum price for his produce.
Government can buy the put options by paying the premium for the strike price closer to MSP for the farmer. If the price is above the MSP the farmers can sell their produce in the market.
Opening of commodities market to NRIs
Indian commodity derivative markets need to become more broad-based, vibrant, deep and thereby more efficient. The participation of such segments who can add more depth to the markets is a fundamental requirement. Indian Diaspora is an important segment and has emotional attachment to the agriculture market in India. However they have thus far not been allowed to take exposure in the agriculture market.
Allowing commercial banks to trade commodities
The participation of banks in commodity derivatives will deepen and widen the derivatives market as well as encourage more scientific price discovery. Policymakers should take initiatives to remove any reservation or apprehension that the banking regulator RBI may have on allowing banks to trade in commodities.
Abolishing commodity transaction tax
Abolishing CTT on agri processed and non-agri commodities will encourage the participation of hedgers who have felt the pinch of increased impact cost and increased cost of transaction which is primarily due to commodity transaction tax. If it cannot be abolished for any revenue consideration, then CTT paid should be allowed to be treated as tax paid u/s 88E & not as an expense. The hedging interest shifted to overseas exchanges due to high cost of transactions.
For Atmanirbhar Bharat, the hedging interest should come back to Indian Exchanges. We would collectively aim for being Price Setter and unlock our huge potential as large consumer, producer and processor of commodities.
[The author is National President, Commodity Participants Association of India (CPAI)]
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