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ROLE OF COMMODITY EXCHANGES,FUTURES & OPTIONS

(A CASE STUDY ON SOYA OIL)

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AuthorNitesh Ranjan

Economist, Andhra Bank, Economic Intelligence Section,Head Office, 5-9-11, Saifabad, Hyderabad 500 004.ranjannitesh@yahoo.com, nranjan@india.com

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iii

TABLE OF CONTENTS

Page No.

Preface v

Executive Summary vii

List of Tables & Figures x

Abbrevations xi

Chapter 1 Introduction 1

Chapter 2 Objectives and Methodology of the Study 13

Chapter 3 Effects of Futures Trading on Seasonal Price Variations 23

Chapter 4 Long-term Relationship between Futures & Spot Prices 29

Chapter 5 Futures Trading & Short-term Price Fluctuations 35

Chapter 6 Options as an Efficient Tool for Hedging Price Risks 39

Chapter 7 Influence of Futures Trading on Sowing Decisions & 45Cropping Pattern

Chapter 8 Supply Responses of Futures Prices on Technology 49Adoption & Yield Augmentation

Chapter 9 Non-transparency in Prices & Product Standardisation 53in Indian Commodity Exchanges

Chapter 10 Nature & Volume of Commodity Trading Pattern 55

Chapter 11 Conclusions and Recommendations 59

Notes 65

Bibliography 66

v

PREFACE

One fine Saturday afternoon in 2004, I was glad to receive a letterfrom the NABARD. It was an invitation for writing an occasionalpaper on any of the listed topics, all of them related to variousfacets of agriculture in India. I did not have a second thought onthis and immediately decided to accept the offer and selected thedemanding subject of “Price Stabilisation in Agriculture Commodities– Role of Commodity Exchanges, Futures and Options”. After variousstages comprising NABARD accepting my ‘Brief Approach Note’,selection of commodity and collection of data, submission of draftpaper and its review by independent referee(s), the book in presentform is now in the hands of the readers.

A few words need to be said about the contents of the paper.Commodity derivatives market size today is roughly of Rs. 6000crore with large participation from the commodity traders (40-50%),brokers (20-30%) and remaining from the high net worth individuals(HNI) and corporate sector. By 2010, market size is estimated to beof more than Rs. 50000 crore with more than Rs. 10000 crore oftrade each in precious metals, energy, agriculture, oils & oilseeds,pulses etc. The relationship between spot and futures markets inprice discovery has been an important area of research. In thispaper, price discovery in soyabean oil market in India is discussed.Soyabean is the single largest grown oilseeds in the world exceedingaggregate global output of four important oilseeds – groundnut,rapeseed mustard, sunflower and cottonseed. Indian scientists havebeen able to develop soyabean seed varieties suitable for differentagro climatic conditions which has led to rapid expansion ofsoyabean cultivation in India. The paper analyses the effects offutures trading in soyabean oil on its spot prices. It seeks todelineate whether futures trading has been helpful in controlling thedaily, weekly and seasonal price variations in soyabean oil. Theeffects of futures trading on cropping pattern, production, technologyand yield are also part of the paper.

Commodity derivatives provide three economic functions – riskmanagement, price discovery and transactional efficiency. It isimperative to note that the primary purpose of risk management isto protect existing profits and not to create new profits. Similarlyprice discovery means ability to achieve and disseminate priceinformation. Derivatives also facilitate efficiency in transactions whichis the product of liquidity. Higher the liquidity lower is the transac-tion costs.

vi

However, commodity derivatives in general and futures trading insoyabean oil in particular require larger participation, liquidity andefficient trading platform. Depth of the Indian commodity marketsneed to be broadened by allowing participation of banks, mutualfunds, primary dealers etc. An efficient markets lead to higher volu-mes of trading, greater market liquidity and tighter bid-ask spread.In a liquid and efficient market, cost of capital is also reduced.

I wish to thank the NABARD for inviting me to write thisOccasional Paper with the grant assistance from R&D Fund of theNational Bank (NABARD). I am also grateful to CMIE, FMC and SOPAfor their valuable help on data. A part of this paper was presentedat “Conference on Exchange Traded Commodities Outlook 2005-06”held at Hyatt Regency, Mumbai. I am grateful to the distinguishedparticipants for their valuable comments on presentation. I wouldlike to extend my deep appreciation to many of my colleagues andfriends who helped me directly or indirectly in the preparation ofthis paper. My sincere thanks to all of them. The author is particu-larly grateful to the Andhra Bank Management for its continuousencouragement and support at different levels.

Last but not the least, I would like to express my profound andheartfelt respect to my beloved parents and family members whohave always been a source of inspiration and encouragement for me.Without their blessings and love, this work could not have beenpossible.

Hyderabad Nitesh Ranjan04 April 2005

vii

EXECUTIVE SUMMARY

1. The history of commodity futures in India is more than acentury old. The first organised exchange of the country, CottonExchange of Bombay, was established in 1921. Apart fromfutures these exchanges traded in options as well. However,options trade was banned in 1939. The public policy withrespect to commodity futures has undergone a sea change fromthe restricted (& banned) trading to Multi commodity exchangesof recent origin. The need of the hour is that a significantsector of the Indian economy-Agriculture-be strengthened byway of building the efficient price discovery and hedgingmechanisms, which are greatly facilitated by the futuresmarket. Move away from price uncertainty and resultantfinancial insecurity to some degree of financial stability by areliable and relevant price discovery and hedging mechanism issine qua non for development of agriculture and agri-commo-dities market in India.

2. Exposure of Indian entities to commodity price risks has beenhighlighted by the growing integration of the Indian economywith the rest of the world and increasing cross border trade.Economic agents associated with commodity trade are in greaterneed to hedge against price risks than their counterparts inother markets such as bond or currency markets. This is dueto inherently unstable price situations in the commoditymarkets.

3. The Kabra Committee appointed by the Government of Indiarecommended in September 1994 the introduction of futurescontracts in many commercial crops and products, including oilseeds, oils and oil cakes. The basic objective of an oil seedprocessor (or any producer) would be to gain long-term growthand not the volatile short-term profit and loss. Anotherimportant objective is to have the ability to accurately projectprofits and more reliable cash flow. Both these objectives areachieved through “commodities futures”. By reducing the riskelement and enhancing stability, the futures system providesthe oilseed processors the necessary confidence in making largeinvestments in oilseeds processing industry to reap economiesof scale, which eventually will benefit the edible oil consumer.

4. The objective of the paper is to test whether any relation existsbetween spot prices and futures prices of a commodity and

viii

whether futures trading lead to price stabilisation of anagricultural commodity. The study undertakes to delineate thevarious aspects of futures trading in a single commodity andthe chosen commodity is Refined Soyabean Oil or Soy Oil. It isthe second most consumed edible oil in India after groundnutoil.

5. The most important factor for a farmer’s inclination towardssoyabean cultivation has been the very good price realization forhis product, which is well above the Minimum Support Price.The soyabean cultivation has been increasing in India becauseit is short duration (90 days to 110 days), sturdy crop that cangrow even if there is moderate rainfall. Farmers also prefer togrow soyabean because it is a cash crop. Soyabean oil consum-ption started at Madhya Pradesh and now it is popular in UttarPradesh, West Bengal, North-eastern states and other parts ofnorth India.

6. The paper comprises eleven chapters on various aspects offutures trading in agricultural commodities. Data related toRefined Soya Oil has been used for empirical analysis. Chapter1 sketches the importance of agriculture in Indian economy andtherefore need for futures trading in agricultural commodities. Itdiscusses the shape of traditional commodity market as well asstructure of commodity exchanges along with characteristics offutures trading.

7. A brief review of literature on role of futures trading has beengiven in Chapter 2, after which broad objectives and scope ofthe study are outlined. Methodology used for the study andnature & source of data also find a mention in the samechapter. It further gives a brief about Soy oil, including itsproduction and consumption pattern.

8. In Chapter 3, effect of futures trading on seasonal pricevariations in Soy oil is assessed. It is observed that during theyears when futures trading took place in Soy oil, averagevariations in prices of Soy oil over various seasons narroweddown as compared to period when futures trading was notallowed. In long-term futures prices have a positive effect onspot prices, i.e. variations in spot prices is gentle in presence offutures trading than in its absence when steep upward anddownward trend in ready prices were observed. This is analysedin Chapter 4. It also throws light on price stabilisation issue.

ix

9. Like seasonal price variations, effect of futures trading on short-term (daily & weekly) price variations is discussed in Chapter 5.As we know that options trading is not allowed in Indiancommodity exchanges, significance of options as a hedgingdevice is outlined in a theoretical framework with example inChapter 6. Then, in Chapter 7 influence of futures trading onsowing decisions of the farmers and cropping pattern isexamined.

10. Though crop area, production and yield have shown positivemovements during futures trading years, it could not be fairlyestablished that the positive influence is because of futurestrading only.

11. Chapter 8 discusses supply responses of futures prices ontechnology adoption and yield augmentation. The problems ofnon-transparency of price and product standardisation in Indiancommodity exchanges are examined in Chapter 9 of the paper.Our exchanges still have to go a long way towards completeprice transparency among traders irrespective of factors likegeographical distance. In penultimate chapter of the booknature and volume of commodities trading pattern is discussed.Chapter 11 summarises the entire aspects of the study andraises some policy issues for strengthening the commodityfutures market in India.

12. The commodity derivatives market in India are currently a farway off from well-functioning international exchanges dealing incommodities. The fraction of commodities markets covered bycommodity futures is very small leave aside options tradingwhich is still prohibited in the country. The government of Indiahas been taking steps to improve the business potential forcommodity derivatives exchanges by permitting derivatives onmore commodities and liberalising policies. In the days to come,it would not be a surprise when volumes in commodityexchanges surpass those in equity markets.

x

LIST OF TABLES & FIGURES

PageNo.

Table 2.1 Area, Production & Yield of Soyabean 19

Table 2.2 An Example of Soya Oil Contract at Nmce, 20Ahmedabad

Table 3.1 Period of Futures Trading in Soy Oil 24

Table 3.2 Monthly Prices of Refined Soy Oil (Mumbai) 24

Table 3.3 Deflated Monthly Prices of Soy Oil 25

Table 4.1 Futures Basis During Contract Month 32

Table 5.1 Weekly Range as % of Avg Weekly Prices 36

Table 7.1 Major Soyabean Producing States 45

Table 8.1 Correlationn Factor – Influence of Futures 49Trading

Table 10.1 Turnover of Indian Commodity Exchanges 57

Figure 1.1 Foodgrains Production & Decling Share of 1Agriculture In GDP

Figure 1.2 Structure of Derivatives Market in India 6

Figure 3.1 Deflated Monthly Prices 25

Figure 3.2 Range of Monthly Price Variation 27

Figure 4.1 Daily Spot & Futures Prices 30

Figure 4.2 Futures Basis for Soy Oil 31

Figure 5.1 Daily Price Variation 36

Figure 5.2 Weekly Price Range 37

Figure 7.1 Area Under Soyabean In India 46

Figure 8.1 Production & Yield of Soyabean 50

Appendix I List of Commodity Exchanges & Commodities 67Traded

Appendix II Yearly Crushing, Production of Meal & 69Oil in India

Appendix III Share of States in Production of Soyabean 69

Appendix IV A Typical Contract Cycle for a Futures Contract 70

xi

Abbreviations

CBOT : Chicago Board of Trade

CMIE : Centre for Monitoring Indian Economy

FCRA : Forward Contracts (Regulation) Act, 1952

FMC : Forward Markets Commission (Mumbai)

HNI : High Net Worth Individuals

IGIDR : Indira Gandhi Institute of Development Research

IPSTA : Indian Pepper & Spice Trade Association (Kochi)

MCX : Multi-commodity Exchange of India (Mumbai)

MSP : Minimum Support Price

NBOT : National Board Of Trade (Indore)

NCDEX : National Commodities & Derivatives Exchange ofIndia (Mumbai)

NMCE : National Multi-commodity Exchange of India(Ahmedabad)

OLS : Ordinary Least Square Regression Anlysis

SAMB : State Agricultural Marketing Board

SEA : Solvent Extractors Association of India

SEBI : Securities & Exchange Board of India

SOPA : Soyabean Procesors Association of India (Indore)

SMS : Short Messaging Service

WPI : Wholesale Price Index

1

CHAPTER 1

INTRODUCTION

1.1 BACKGROUND

1.1.1 India is predominantly an agrarian economy with very highpopulation dependence on agriculture and allied activities.More than 90% of rural population and about 65% of totalpopulation derive their livelihood from agriculture, directly orindirectly. Hence, the price determination and stabilisation inprices of agriculture commodities become very significant forsustainable growth in agriculture. It was in this perspectivethat the Long-term grain policy of the Govt. of India1 emphasi-sed that the role of public intervention should primarily be tostabilise prices and that any system of price stabilisationmust be national in scope. The opening up of agriculturaltrade has forced farmers to cope with the vagaries andvolatility of international market prices.

1.1.2 Apart from the role of public intervention through MSPs (mini-mum support prices) and Procurement Price in price stabili-sation of agriculture commodities, commodity exchanges havebeen an effective tool in price determination and stabilisationof such commodities. While public intervention brings aboutdistortions in efficient price discovery, cropping pattern andmarket mechanism, the role of commodity exchanges is toevolve an efficient price discovery system along with ensuringhedging of price risks.

1.1.3 The High-level Committee on long-term grain policy noted:

2

“Price instability is not merely a matter of concern from thepoint of view of the welfare of producers and consumers andtheir incomes. There is very strong evidence from across theworld and from India’s own experience in the past thatagricultural investment and growth is adversely affected ifprice instability is high and, in particular, if farmers cannotbe reasonably sure that prices will remain above their costs ofproduction.”

1.2 AGRICULTURE PRICE POLICY

1.2.1 Although India’s past record in food price stabilisation is good,principally because of government’s intervention, instabilityhas increased very markedly in recent years. In real terms(i.e. in terms of the ratio of the wholesale price index (WPI) forcereals to the all-commodity WPI), cereals prices increased17.4 per cent between 1997-98 and 1999-00 followed by analmost equally sharp decline of 13.3 per cent between 1999-00 and 2001-02. High MSPs have distorted inter-crop priceparities, particularly in favour of wheat, leading to shift ofarea from oilseeds and pulses and to high import of thesecommodities.

1.2.2 Agricultural price policy, as it exists in India currently, wasconceived of on the premise of a closed economy wheredomestic production has to meet domestic demand in almostevery commodity. MSP serves the requirement of price stabilityby ensuring that years of glut are not followed by largeproduction declines leading to high prices in the subsequentyear. The procedure assumes that long-run domestic costs aregood indicators of long-run prices and that stocks accumulatedwhen production exceeds demand in the short-run, pushingprices below MSP, can in normal course be disposed offwithout undue downward pressure on market prices at othertimes when production falls below demand.

1.2.3 In an open economy, however, long-run domestic prices willincreasingly be affected by trends in international pricesalthough domestic production costs would still be the dominantdeterminant in a large economy such as India’s. Assessmentof how India’s costs of production are moving relative to worldprices will, therefore, become progressively more important notonly for the design of domestic price policy but also in areassuch as technology development and trade policy. More

3

importantly for price stability, since world prices fluctuateconsiderably around their long-run trends, it would also benecessary to ensure a mechanism to prevent internationalprice fluctuations from influencing domestic prices so much asto nullify the domestic price policy.

1.2.4 Traditional system of price stability through MSP mechanismhas increased Government’s food-subsidy burden and is,therefore, unviable. Hence, it is also necessary to considervery seriously alternative mechanisms of risk management.One of these is the idea of extending insurance to cover notonly the risks of crop failure and yield loss but also lossesstemming from unforeseen price fluctuations. Futures tradingin grains can significantly reduce the risks of price fluctua-tions. Futures trading lead to more efficient price discovery byallowing more agents with relevant information to participatein price formation than would be possible if all these agentshad to bear the fixed costs of physical trading. Secondly,since risks in physical trading can be reduced through hedgeoptions, existence of futures markets can reduce costs ofinsuring against price risks and encourage more trade in spotphysicals.

1.3 COMMODITY MARKETS

1.3.1 As a result, commodity markets, both futures and spot, areexpected to be better able to discount likely future develop-ments and cause prices to be less subject to unanticipatedshocks. Although it is very unlikely that many farmers wouldbe able to participate in futures markets themselves, theycould still benefit from signals regarding likely future prices.More importantly, there could be benefits of competition ifexisting traders took longer positions because of reduced riskand this also encouraged new entrants into physical markets.

1.3.2 The farmers would gain directly if this enabled better linkagebetween storage and credit and induced banks to offer morepledge loans. A number of factors have so far kept trading inexisting Indian exchanges extremely thin due to reluctance ofmany relevant and important players to participate because oftheir differences with promoters regarding trading andsettlement procedures. Some of these have, however, beenovercome with the adoption of on-line trading.

4

1.3.3 It should be realised from the actual functioning of existingfutures markets in the United States and elsewhere thatfutures prices are always highly correlated with the corres-ponding spot prices and do not display any significantly lowerdegree of volatility. Existence of such markets has allowedrisks to be hedged, induced more finance into storage, andmay also have reduced spot price volatility from what theywould otherwise have been. But fundamentals cause highuncertainty in world commodity markets, and futures marketshave not prevented price volatility from being so high that ifreflected in domestic prices would be unbearable for Indianfarmers with their limited financial resources.

1.3.4 The High level Committee on long-term grain policy viewedwhile insurance and futures trading are important for riskmanagement, these should not be viewed as alternatives toprice stabilisation through MSP and through policies regardingtariffs on imports and exports. These should not be publiclyfunded but allowed to develop through commercial initiative. Ifgovernment supports these at all, this should be limited tosubsidies on interest and insurance premium paid by farmers.

1.3.5 For both insurance and futures trading, the main pre-condition is credible information about physical spot tradingand the existence of a good market infrastructure, including areliable information system. Further, for farmers to use thesethere is need for storage facilities, which can be linked toboth credit and these risk instruments. For this, the mostimportant initiative would be a system of certified warehousereceipts so that the quantity and quality of produce storedcan become acceptable collateral, and eventually negotiable.

1.4 TRADITIONAL COMMODITY MARKETS IN INDIA

Spot trading takes place mostly in regional mandis & unorga-nised markets. Markets are fragmented and isolated. ReducedGovernment procurement activity, mostly in cereals throughMSP distorts markets in favour of food grains. Mandi tradingin India is done in 140 crops through over 7500 Mandisamongst trading Farmers, licensed Traders, Brokers andWholesale Dealers. Mandi Inspectors issue type & quantitycertificate by levying Transaction fee and Taxes that variesbetween 4% and 12%. State Agricultural Marketing Boards(SAMBs) and Mandi Board (Farmers, Traders, State) governMandis.

5

1.5 EVOLUTION OF COMMODITY TRADING IN INDIA

1.5.1 The first derivative in the world started with the commodities.Organised futures trading started in 1865 at the Board ofTrade of Chicago, followed by other trading centres such asKansas, Minneapolis, New York. Futures trading in commo-dities like rubber, soyabean, black pepper etc. was started inthe U.S.A after 1920. Apart from US and UK, India is theonly country that had active futures market over a long periodof time. A good deal of futures trading in cotton was done atBombay. Other markets soon developed for oilseeds (Gujarat &Punjab), wheat (Hapur, 1913), raw jute (Calcutta, 1912).During WW II, futures trading in many commodities werebanned under Defence of India Rules.

1.5.2 Turnaround came in 1952 with the passing of ForwardContracts (Regulation) Act (FCRA, 1952), which led to theestablishment of Forward Markets Commission (FMC) inSeptember 1953. FMC, headquartered at Mumbai, is a regula-tory authority which is overseen by the Ministry of ConsumerAffairs and Public Distribution, Govt. of India. There are 24commodity exchanges in the country including recentlyestablished 4 national-level multi-commodities exchanges.

1.5.3 Derivatives market can be divided into two broad segments:

1. Financial Derivative

2. Commodity Derivative

Two separate regulators, set up under different Acts ofParliament, govern financial and commodity derivative marketsin India. They are also under the control of differentministries. (See Figure 1.2)

Futures trading has been largely regionalized & based on pittrading. There is an overwhelming need to develop commodityfutures markets as a stabilizing influence. Trading is theprocess whereby a commodity is simultaneously bought andsold in two separate markets to take advantage of pricediscrepancy between the two markets.

6

FIGURE 1.2 :STRUCTURE OF DERIVATIVES MARKETS IN INDIA

Derivatives in India

Ministry of Finance Ministry of Consumer Affairs

Securities & Exchange Board of India Forward Markets Commission

Stock Exchanges Commodity Exchanges

Financial Derivatives Commodity Derivatives

Futures Options Futures

Precious Metals Other Metals

Agriculture Energy

A commodity exchange acts as a market place for personsinterested in trading. The factors driving trading are thedifferences and perception of differences of the equilibriumprice determined by supply and demand at various locations.For instance, suppose there is a shortage of guar in AndhraPradesh to feed livestock. If one believes that he can profitfrom buying guar in Rajasthan, paying transportation costs,and selling guar in Andhra Pradesh, he will continue to do sountil the supply and demand for guar are equal in AndhraPradesh, thus the Rajasthan guar price plus the freightcharges equal the guar price in Andhra Pradesh.

1.6 OBJECTIVES OF FUTURES TRADING

� Leads to price discovery

� Provides hedging option

� A smart investment choice

� Integrates players and markets

� Improves cropping pattern (in case of commodity futures)

1.7 HISTORY OF FUTURES TRADING IN COMMODITIES

1.7.1 Organized futures market evolved in India by the setting up of“Bombay Cotton Trade Association Ltd.” in 1875. In 1893,following widespread discontent amongst leading cotton mill

7

owners and merchants over the functioning of the BombayCotton Trade Association, a separate association by the name“Bombay Cotton Exchange Ltd.” was constituted. Futurestrading in oilseeds was organized in India for the first timewith the setting up of Gujarati Vyapari Mandali in 1900,which carried on futures trading in groundnut, castorseed andcotton. Before the Second World War broke out in 1939several futures markets in oilseeds were functioning in Gujaratand Punjab.

1.7.2 Futures trading in Raw Jute and Jute Goods began in Calcuttawith the establishment of the Calcutta Hessian Exchange Ltd.,in 1919. Later East Indian Jute Association Ltd., was set upin 1927 for organizing futures trading in Raw Jute. These twoassociations amalgamated in 1945 to form the present EastIndia Jute & Hessian Ltd., to conduct organized trading inboth Raw Jute and Jute goods. In case of wheat, futuresmarkets were in existence at several centres at Punjab andU.P. The most notable amongst them was the Chamber ofCommerce at Hapur, which was established in 1913. Othermarkets were located at Amritsar, Moga, Ludhiana, Jalandhar,Fazilka, Dhuri, Barnala and Bhatinda in Punjab andMuzaffarnagar, Chandausi, Meerut, Saharanpur, Hathras,Gaziabad, Sikenderabad and Barielly in U.P.

1.7.3 Futures market in Bullion began at Mumbai in 1920 and latersimilar markets came up at Rajkot, Jaipur, Jamnagar, Kanpur,Delhi and Calcutta. In due course several other exchangeswere also created in the country to trade in such diversecommodities as pepper, turmeric, potato, sugar and gur(jaggery).

1.7.4 After independence, the Constitution of India brought thesubject of “Stock Exchanges and futures markets” in theUnion list. As a result, the responsibility for regulation ofcommodity futures markets devolved on Govt. of India. A Billon forward contracts was referred to an expert committeeheaded by Prof. A.D. Shroff and Select Committees of twosuccessive Parliaments and finally in December 1952 ForwardContracts (Regulation) Act, 1952, was enacted. The Actprovided for 3-tier regulatory system;

(a) An association recognized by the Government of India onthe recommendation of Forward Markets Commission,

8

(b) The Forward Markets Commission (it was set up inSeptember 1953) and

(c) The Central Government.

1.7.5 Forward Contracts (Regulation) Rules were notified by theCentral Government in July 1954. The Act divides the commo-dities into 3 categories with reference to extent of regulation,viz:

A. The commodities in which futures trading can be organizedunder the auspices of recognized association.

B. The Commodities in which futures trading is prohibited.

C. Those commodities which have neither been regulated forbeing traded under the recognized association nor prohi-bited are referred as Free Commodities and the associationorganized in such free commodities is required to obtainthe Certificate of Registration from the Forward MarketsCommission.

1.7.6 In the seventies, most of the registered associations becameinactive, as futures as well as forward trading in the commo-dities for which they were registered came to be eithersuspended or prohibited altogether. The Khusro Committee(June 1980) had recommended reintroduction of futurestrading in most of the major commodities, including cotton,kapas, raw jute and jute goods and suggested that steps maybe taken for introducing futures trading in commodities, likepotatoes, onions, etc. at appropriate time. The government,accordingly initiated futures trading in Potato during the latterhalf of 1980 in quite a few markets in Punjab and UttarPradesh.

1.7.7 After the introduction of economic reforms since June 1991and the consequent gradual trade and industry liberalizationin both the domestic and external sectors, the Govt. of Indiaappointed in June 1993 one more committee on ForwardMarkets under Chairmanship of Prof. K.N. Kabra. TheCommittee submitted its report in September 1994. Themajority report of the Committee recommended that futurestrading be introduced in Basmati Rice, Cotton and Kapas,Raw Jute and Jute Goods, Groundnut, rapeseed/mustard

9

seed, cottonseed, sesame seed, sunflower seed, safflower seed,copra and soybean, and oils and oilcakes of all of them, Ricebran oil, Castor oil and its oilcake, Linseed, Silver andOnions. The committee also recommended that some of theexisting commodity exchanges particularly the ones in pepperand castorseed, may be upgraded to the level of internationalfutures markets.

1.7.8 The liberalised policy being followed by the Government ofIndia and the gradual withdrawal of the procurement anddistribution channel necessitated setting in place a marketmechanism to perform the economic functions of pricediscovery and risk management.

1.7.9 The National Agriculture Policy announced in July 2000 andthe announcements of Hon’ble Finance Minister in the BudgetSpeech for 2002-2003 were indicative of the Governmentsresolve to put in place a mechanism of futures trade/market.As a follow up the Government issued notifications on1.4.2003 permitting futures trading in the commodities. Withthe issue of these notifications futures trading is notprohibited in any commodity. Options trading in commodityis, however presently prohibited.

Four national multi-commodity exchanges have been set up,namely,

(1) National Commodity & Derivatives Exchange of India,Mumbai (December 2003)

(2) Multi-Commodity Exchange of India Ltd., Mumbai(October 2003)

(3) National Multi-Commodity Exchange of India Ltd.,Ahmedabad (November 2002)

(4) National Board of Trade (NBOT), Indore

1.8 CHARACTERISTICS OF FUTURES TRADING2

1.8.1 A “Futures Contract” is a highly standardized contract withcertain distinct features. Some of the important features are asunder :

10

a. Futures trading is necessarily organized under the auspicesof a market association so that such trading is confined toor conducted through members of the association in accor-dance with the procedure laid down in the Rules & Bye-laws of the association.

b. It is invariably entered into for a standard variety knownas the “basis variety” with permission to deliver otheridentified varieties known as “tenderable varieties”.

c. The units of price quotation and trading are fixed in thesecontracts, parties to the contracts not being capable ofaltering these units.

d. The delivery periods are specified.

e. The seller in a futures market has the choice to decidewhether to deliver goods against outstanding sale contracts.In case he decides to deliver goods, he can do so not onlyat the location of the Association through which trading isorganized but also at a number of other pre-specifieddelivery centres.

f. In futures market actual delivery of goods takes place onlyin a very few cases. Transactions are mostly squared upbefore the due date of the contract and contracts aresettled by payment of differences without any physicaldelivery of goods taking place.

g. The options market is sometimes referred to as insurance.By hedging through the options market an individual/trader locks in the costs of hedging and then can lose atmost only the cost of the option premium while havingunlimited profit potential. Alternatively, holding a futuresposition limits profits and losses by the hedged price.

1.8.2 Commodity futures exchange markets provide a mechanismfor price discovery on an aggregate level through arbitragebetween multiple buyers and sellers. However, price discoveryat a given location is not nearly as clearly defined becauselocal supply and demand relationships are not as well known.However, historical basis provides a linkage between these twomarkets. Therefore, a simple, low cost, and relatively goodpredictor of the local cash price is the futures contract price

11

of interest adjusted for a multiple year average basis for thattime. An expected price, where E denotes an expectation, canbe found using :

E [Cash Price] = [Futures Price] + E [Basis],

Commodity futures prices can serve as a mechanism for pricediscovery either for the present price or for determiningexpected future prices.

13

CHAPTER 2

OBJECTIVES AND METHODOLOGY OF THE STUDY

2.1 INTRODUCTION

2.1.1 A stable and efficient commodity market is the essential partof a developing economy like India. It draws its importancefrom the fact that large number of population is engaged inthe process right from sowing decisions level to marketing ofthe final produce. Farmers should get remunerative prices fortheir products so that they can continue to grow the cropwithout any apprehensions of losses. These losses may arisedue to uncertain nature of climatic conditions, excessiveproduction, changes in tastes, market imperfections et al. Itwas in this background that the system of MSP and Procure-ment prices were introduced in India, under whichgovernment assured remunerative prices to farmers for theircrops.

2.1.2 The underlying problem of the rural agriculture market waslack of trading platform where large number of farmers couldmeet and ascertain price discovery. Few big traders largelyinfluenced traditional markets like mandis and price wasdetermined in connivance with selected parties. Evolution ofCommodity exchanges in India has helped in development ofan efficient market for agriculture commodities where not onlyprice determination takes place under the umbrella of acommon trading platform but also farmers and traders canhedge their risks. It also helps farmers in sowing decisionsand cropping pattern.

2.1.3 It is necessary to find effects of futures trading on prices byan enquiry as to why futures trading influence prices. Untilsuch a causal relationship between the two is established apriori, it would be pointless to examine either the qualitativenature or the quantitative extent of the influences of futurestrading on prices.

2.1.4 The price of any commodity, for immediate or forward delivery,is always determined after deliberations and negotiationsbetween the buyer and the seller. In these negotiations, thebuyers and the sellers are generally influenced by their own

14

judgements of the current and anticipated demand and supplyof the commodity. If, therefore, futures trading is to have anyimpact on prices, it must affect the judgements of either thebuyer or seller or the both. It can influence their judgementsin two ways. Firstly, the knowledge of price currentlyprevailing in the futures market would inevitably influence,though indirectly, the price decisions of buyers and sellers ofthe actual commodity. Both in the organised and unorganisedmarkets, many buyers and sellers transact business forimmediate as well as deferred delivery. As a result, their ideasof prices are influenced considerably by the prices prevailingnot only in the spot markets but also in the markets fordeferred delivery transactions.

2.1.5 Though futures contracts are normally intended for hedge andspeculative purposes, they are also useful for making genuinepurchases or sales when the buyers and sellers receive or givedelivery during the delivery month. Thus, for a prospectivebuyer or seller of agricultural commodities, there is a choicewhether he should enter into a futures contract or a deferreddelivery contract. In this way, the transactions in the futuresand in the deferred delivery contracts can become substitutesfor each other. Since the futures contract is more active, thefutures prices substantially influence the decisions of thebuyers and the sellers in the deferred delivery contracts. Asimilar influence of futures trading on spot transactions cantake place towards the closing stages of the delivery month ofthe futures contract, when actual deliveries can happen andthus transactions in future can compete for actual businesswith the ready transaction, particularly if the ready prices areout of alignment with the futures prices. In this way futuresprices may directly influence the spot prices.

2.1.6 Both hedging and speculation on commodity exchanges reducethe total marketing margin, i.e. cost of marketing services andconsequently producers receive a higher price and consumerspay a lower price than what they would otherwise havereceived or paid. The traditional theory affirms that the futurestrading assists in reducing the price variations resulting fromthe changes in supply & demand conditions.

Before setting up objectives of the study, a brief survey onavailable literature on the subject becomes inevitable.

15

2.2 REVIEW OF LITERATURE

2.2.1 Commodity trading is prevailing in India since mid-19th

century. The shape and structure of trading has undergone asea change in terms of nature of commodities traded, volumeof trade, clearing, settlement & guarantee system, transparencyin trade, governance and regulation. The commodities tradingthrough exchanges have traditionally been limited to singlecommodity exchanges until the Union Government decided infavour of national-level multi-commodity exchanges. It hasbeen observed at global level that the commodities havewitnessed much more volatile price situations than the pricesin the market for financial instruments.

2.2.2 The relationship between spot and futures markets in pricediscovery has been an important area of research. Garbade &Silber in their article ‘Price movements and price discovery infutures and cash markets’ (1982) tested whether futuresprices lead spot prices. Correlation of basis (spot prices futuresprices) of the previous time period with spot or futures pricesof the current time period was empirically tested. If basisinnovations forecast futures returns, then the spot marketleads the futures market. If basis innovations forecast spotreturns, then the futures market leads the spot market.Susan Thomas and Kiran Karande used it for castorseedmarket in India.

2.2.3 M. Thiripalraju & T.P. Madhusoodanan in their paper“Commodity Futures prices in India: Evidence on ForecastPower, Price Formation and Inter-Market Feedback” found theefficiency of price formation in the Indian commodity futuresmarkets of Pepper and Castorseeds. Susan Thomas of IGIDR,Mumbai has in her paper “Agricultural Commodity Markets inIndia” shown some evidence of role played by futures marketin price stabilisation. Her study is based on Muaffarnagarjaggery futures market. In her paper with D Balasundaram on“cotton futures” it has been concluded that the futures marketbenefit the cotton economy by increasing the efficiency ofprice discovery, in addition to enabling the reduction of pricerisk.

2.2.4 Futures and options market lead to destabilising speculationand malpractice if not properly regulated. The Gupta Commit-tee (1997) on ‘Hedging through international commodityexchanges’ noted:

16

“The need for regulation of the markets arises when suchregulations increase the allocative efficiency of these marketsfrom what would prevail under no regulation at all. Allocativeefficiency of the futures and options market is reflected by theability of these markets to perform their price discovery andrisk shifting functions efficiently.”

2.3 OBJECTIVES & SCOPE OF THE STUDY

2.3.1 The main aim of this paper is to seek whether commodityexchanges and their twin tools of Futures and Options canbring about price stabilisation in agriculture commodities. It isgenerally argued that futures trading, among other things,reduces the seasonal price variations in agriculture commodi-ties and also helps in discovery of spot (ready) prices. Thecropping pattern and sowing decisions are also said to beinfluenced by futures trading in commodities.

2.3.2 With these objectives, the following hypotheses have beenframed to be tested:

i. Seasonal variation in prices of agricultural commodities arereduced by trading at the Commodity exchange

ii. Short-term (weekly or daily) price variations can bereduced by futures and options

iii. There exists a definite relationship between futures pricesand actual commodity prices (Spot or ready prices)

iv. Futures trading influence the long-term price trend (pricestabilisation) in any commodity

v. Options are efficient tool for hedging price risks

vi. Futures trading influence the sowing decisions andcropping pattern

2.3.3 Apart from testing of listed hypotheses, the study also tracesthe problems of Indian Commodity exchanges with respect tonon-transparency of prices, product standardization etc. Itfurther attempts to find the supply response of futures pricesin selected crops on technology adoption, yield augmentation,crop diversification and income gains. The nature and volumeof the commodity trading pattern in India is also assessed.

17

2.4 METHODOLOGY OF THE STUDY

2.4.1 The price determination of any commodity is a complexfunction of multiple factors like its domestic production (orsupply) vis-à-vis demand, international demand and supply,market for its substitutes, changes in individuals’ tastes andpreferences etc. Apart from this, information asymmetry andother market imperfections also play a key role in pricedetermination. In such a scenario, a particular method ofquantitative measurement does not fully explain the causalrelationship.

2.4.2 This paper seeks to establish short-term as well as long-termeffects of futures trading in Soy oil on its ready (spot) prices.By short-term we mean daily and weekly period while long-term denotes seasonal variations. Range is an important toolto assess price variations during short period of time likedaily prices within a week. But it is also fraught with somedeficiencies. Therefore, range as a percentage of average pricesof a particular period is a better measure.

2.4.3 To establish a long-term trend in spot prices and see whetherany relationship exists between future prices and spot prices,ordinary least squared (OLS) regression analysis is used.Statistical measure of Correlation helps in establishing supplyresponse of futures prices on cropping pattern, technologyadoption and yield augmentation.

2.5 SELECTION OF COMMODITY

2.5.1 The study has been done to establish role of commodityexchanges in price stabilisation of Refined Soyabean Oil.Hereinafter, any reference to Soy oil or Soyabean oil wouldmean Refined Soyabean oil.

2.5.2 Soyabean Oil is the derivative of Soyabean (Glycine soja) or“miracle bean”, the most economically important bean in theworld. From 100 kg of soybeans, the soybean-crushingprocess produces 18 kg of soybean oil and 80 kg of soybeanmeal. While the oil is mainly used for human consumption,meal serves as the main source of protein in animal feeds.Soyabean Oil is the leading vegetable oil traded in the inter-national markets, next only to Palm oil. Palm and Soya beanoil together constitute around 68% of global edible oil trade

18

volume, with soyabean oil constituting 22.85%. During thelast decade, volume of soyabean oil exported has grown at therate of 4.05%. It accounts for nearly 25% of the World’s totaloils and fats production.

2.5.3 Globally, production of soyabean oil has grown at the rate of5.8% during the last decade. Increasing price competitiveness,and aggressive cultivation and promotion from the majorproducing nations have given way to widespread soy oilgrowth – both in terms of production as well as consumption.Argentina, Brazil, China and India along with US are themajor contributors for the growth. While US has a strongdomestic consumption base and mostly exports soyabean inaddition to oil, Argentina and Brazil exports much of theirproduction, mostly in the form of crude oil. China and India,though being producers themselves, import soyabean/itsderivatives to cater to their expanding consumer base. WhileChina imports both bean and oil, India allows only imports ofoil.

2.5.4 India is the World’s largest importer of edible oils. Of the total5.0-5.5 million tons of vegetable oils imported, 1.3-1.5 milliontons is soyabean oil, imported mostly from Argentina, andfollowed by Brazil and US.

2.5.5 In addition to imports, domestic production of around 0.7-0.8million tons takes the annual soyabean oil consumption of thecountry to 2.0-2.2 million tons, with a market value of Rs8000 crore. Crude (degummed) and Refined soyabean oils arepermitted to be imported into India at an import duty of45.9% (additional excise duty waived off in Union Budget2005-06). Imports of soyabean oil into India have been on acontinuous rise since the past 6-7 years. It has witnessed asharp rise from a mere 84,000 tons during 1996-97 to 1.54million tons during 2001-02.

2.5.6 Indian edible oil market is highly price sensitive in nature.Hence, the quantity of soyabean oil imports mainly dependson the price competitiveness of soyabean oil vis-à-vis its solecompetitor, palm oil. This also implies that soyabean oil pricesare highly influenced by palm oil prices in Malaysia, themarket leader in palm oil production and exports.

19

Table 2.1 : Area, Production & Yield of Soyabean

SOYABEAN SOY OIL

Year Area Production Yield Production(‘000 hect) (‘000 tonnes) (kg/hect) (‘000 tonnes)

1970-71 30 10 426 NA

1980-81 608 4224 728 NA

1990-91 2564 2601 1015 230

1995-96 5035 5096 1012 459

2000-01 6418 5280 823 474

2003-04 6221 5857 940 685

2004-05E NA NA NA 720

2.5.7 Soyabean oil is among the most vibrant commodities in termsof ‘price volatility’. Its prominence in the international edibletrade scene (9-10 million tons), concentration of productionbase in limited countries as against its widespread consump-tion base, its close link with several of its substitutes and itsbase raw material (soyabean) in addition to its co-derivative(soya meal), the nature of the existing supply and value chain,etc throw tremendous opportunity for ‘trade’ in this commodity.The opportunity is further enhanced by the expected rise inconsumption base and the consequent increase in imports ofvegetable oils in the years to come.

2.5.8 In India, ready (spot) markets of Indore and Mumbai serve asthe ‘reference’ market for soyabean oil prices. While the Indoreprice reflects the domestically crushed soybean oil (refined andsolvent extracted), Mumbai price indicates the imported soy oilprice. Futures trading in soyabean oil is also prevalent in manyfutures exchanges in the country, the prices of which arelargely influenced by the international edible price movements(especially Malaysian palm oil and soyabean oil at CBOT),soyabean availability in domestic markets, demand for mealand other associated supply-demand factors of soyabean andits derivatives.

2.5.9 The average fluctuation in spot prices of refined soy oil tradedat Mumbai has been at over 6% during 2001-03, themaximum monthly fluctuation being as high as 17% duringthe period. Historically, soy oil prices in the major spotmarkets across the country have been fluctuating in the range

20

of 4.5-8.5%. This offers immense opportunity for the investorsto profitably deploy their funds in this sector.

2.5.10 In the main production areas, soybeans are planted usually inMay. The rate of growth of the soybean plant depends on theamount of sunlight per day and temperatures. By late Augustor early September harvesting is taken.

2.5.11 Soyabean oil is the world’s largest source of vegetable oil. It isgrown extensively in the U.S.A., as well as South America andChina. Soyabean is also extensively grown in India. MadhyaPradesh is known to be the ‘Soya bowl’ of the country.

Table 2.2 : An Example of Soy Oil Contract atNMCE, Ahmedabad

Asset Code SOYO

Product Code SOYOF

Series Code SYOMMMYYYY

Trading System NMCE’s Derivatives Trading and SettlementSystem

Trading Hours Monday to Friday 10:00 am to 4:00 pmSaturday 10:00 am to 2:00 pm

Unit of Trading 1 MT

Delivery Unit 1 MT

Quotation/Base Value 10 Kgs

Tick Size 10 paise

Price Band 5% above and below the last traded price.10% above and below the last closing price.

Quality Specification Moisture Insoluble impurities - 0.1% (Max)

Color on Lovibond Scale Expressed As - Y + 5R in¼” cell

Refractive Index @ 40oC - 1.4650 to 1.4710

Specific Gravity @ 30oC @25/25 - 0.917 to 0.921

Saponification Values - 189 to 195

Iodine Value - 120 to 141

Unsaponifiable Matter - 1.5% (Max)

FFA - 0.25% (Max)

Flash Point pensky Martin Method 0C - 250 min

Refracto meter reading @ 40oC - 58.5 to 68.0

21

No. of delivery Maximum 12 monthly or minimum 2 monthlyContracts in a year contracts running concurrently.

Delivery Centers Indore

Opening of Contracts Trading in any contract month will open on the16th day of the month, 12 months prior to thecontract month.

Due Date 15th day of the delivery months if 15th happensto be holiday then previous working day.

Closing of Contract Squaring up of positions will be permittedbetween 10th and 15th of delivery month. Nofresh positions building will be allowed. From10th to the 15th of delivery month, seller cantender Warehouse Receipt for settlement andWarehouse Receipt will be accepted forsettlement at closing price of the previous day.

2.5.12 Soy oil contains higher level of poly-unsaturates, which breakdown on being heated, than other such as Rapeseed Oil orPalm Oil. This gives the oil its special characteristic of healthyoil. It is particularly attractive as a food ingredient and in theproduction of margarines and spread. It provides a healthy,nutritious and delicious cooking medium. The oil has specialadvantage over other oils as it is low in calories due to higherlevel of poly unsaturates. It is also a rich source of VitaminE. Due its safe use for heart patients it is being used bymillions of housewives and cooks all over the world.

2.5.13 It is delightful, odourless, healthy oil which is a pleasure tothe health conscious consumer. Soybean oil is also used insuch industrial products as printing ink, cosmetics, linoleum,vinyl plastics, paints, pesticides, glue, protective coatings,soaps, shampoos and detergents.

2.6 NATURE & SOURCE OF DATA

2.6.1 The basic data used in the study is secondary data. It wascollected principally from Centre for Monitoring IndianEconomy (CMIE), Forward Markets Commission (FMC),Soyabean Processors Association of India (SOPA), NationalCommodities & Derivatives Exchange of India (NCDEX) Ltd.and National Multi-Commodity Exchange of India Ltd. etc.Trade data on various other commodities were also collectedfrom the website of Ministry of Consumer Affairs, Govt. ofIndia.

23

CHAPTER 3

EFFECTS OF FUTURES TRADING ONSEASONAL PRICE VARIATIONS

3.1 INTRODUCTION

3.1.1 Volatile trend in the price movement of oilseeds and theirderivatives often has a telling effect on the performance of theprocessors, growers and other intermediaries. FuturesExchange tends to achieve a rational for price discovery anddata dissemination on real-time basis which improves hedgingby minimizing speculative risk.

3.1.2 Futures trading reduces those major variations in priceswhich are noticed in any commodity from season to season,and particularly from month to month within a season. Inother words, the steady influence of futures market is mainlyin regard to the seasonal variations in prices, resulting fromthe pattern of production and marketing of agriculturalcommodities. The production of agricultural commodities isseasonal whereas the consumption is more evenly distributedthroughout the year. The prices of such agriculturalcommodities are subject to marked seasonal variations in viewof the seasonal nature of production. The bulk of theagricultural crop moves to the market immediately afterharvest, and, as a result, prices are then unduly depressed.

3.1.3 Futures Trading in Soy oil started in India for the first timeat National Board of Trade (NBoT), Indore. The first suchtrading took place on 10 February 2000. In initial months,trading was low in terms of volume and contracts. In thischapter objective is to analyse seasonal variations in price. Bythis we mean price variations in Soy oil over various months,lean season to peak season.

3.2 METHODOLOGY

3.2.1 As the futures trading in Soy oil was started only in February2000, hence up to this period spot prices are treated ashaving no impact of futures trading whereas March 2000onwards, spot prices were determined when futures trading in

24

Soy oil was very much active. For the sake of convenientcomparison we have divided the data set into two parts asshown in the table below.

Table 3.1: Period of Futures Trading in Soy Oil

No Futures Trading in Active futures trading inSOY OIL SOY OIL

Year Nov 1997 - February 2000 March 2000 onwards

3.2.2 Spot price of Soy oil has been arranged in Table fromNovember 1997 to September 2004. These are monthlyaverage prices and relate to spot price at Mumbai, a principalmarket where Soy oil is traded.

Table 3.2 : Monthly Prices of Refined Soy Oil :Mumbai (Rs./10 kg)

Months Years (November – October)

1997-98 1998-98 1999-00 2000-01 2001-02 2002-03 2003-04

Nov 272.06 363.22 235.64 235.86 292.19 412.44 417.47

Dec 290.10 346.38 240.07 243.00 299.57 417.95 438.38

Jan 310.37 329.79 242.22 236.33 305.50 405.61 433.52

Feb 317.24 305.81 223.00 237.27 292.00 409.94 455.89

Mar 340.33 292.50 232.44 268.15 292.82 410.76 456.86

Apr 382.25 306.38 238.25 259.62 303.59 415.72 435.17

May 395.41 282.81 230.17 254.24 325.65 406.81 441.24

June 397.80 255.29 230.00 259.08 363.17 395.29 436.68

July 399.00 234.00 230.00 301.82 349.44 396.41 434.33

Aug. 378.11 262.00 230.00 300.71 378.33 378.83 452.59

Sept 386.25 262.64 230.00 278.53 374.74 385.05 429.33

Oct 396.78 250.25 230.00 262.57 369.05 409.90

3.2.3 The price variations in any commodity may be due to intrinsicfactors of supply and demand as well as extrinsic factors likeimpact of monetary and fiscal measures. In order to minimizeeffects of external factors on prices of Soy oil, all monthlyprices have been deflated with corresponding monthly WPI(wholesale price index) for All Commodities.

25

TABLE 3.3 : Monthly Prices of Soyabean Oil :Mumbai (Rs./10 kg)

(Deflated with WPI for All Commodities of corresponding month)

Month Years (November – October)

1997-98 1998-98 1999-00 2000-01 2001-02 2002-03 2003-04

Nov 82.04 101.29 63.91 149.09 82.04 101.29 63.91

Dec 86.75 97.43 65.70 153.80 86.75 97.43 65.70

Jan 91.77 93.19 66.38 149.67 91.77 93.19 66.38

Feb 94.08 86.36 61.36 152.10 94.08 86.36 61.36

Mar 101.05 82.70 155.48 174.12 101.05 82.70 155.48

Apr 112.26 86.26 157.05 171.14 112.26 86.26 157.05

May 115.01 79.26 151.63 167.48 115.01 79.26 151.63

June 114.47 71.25 150.62 169.78 114.47 71.25 150.62

July 113.55 65.07 150.23 197.14 113.55 65.07 150.23

Aug 107.05 72.56 149.93 196.03 107.05 72.56 149.93

Sept 108.28 71.70 148.67 180.05 108.28 71.70 148.67

Oct 110.55 67.74 145.66 166.29 110.55 67.74 145.66

Annual 103.07 81.23 122.22 168.89 200.50 236.43 241.95Average

3.2.4 Here we have used two different series of WPI due to paucityof data. From November 1997 to February 2000, prices havebeen deflated with respect to WPI with old base year (1981-82=100) whereas new series of WPI (1993-94=100) is used forMarch 2000 onwards. It would not give any aberration to ourstudy, as February 2000, up to which old series has beenused, is the month when future trading started in Soy oil.

Figure 3.1 : Deflated Monthly Prices (as % of Average Annual Price)

26

3.3 INFERENCES

3.3.1 The Figure 3.1 is plotted with monthly-deflated ready prices ofSoyabean oil as percent of average annual price. It depicts byhow much prices vary during various months. If we look atthe first two sets of column bars (for 1997-98 & 1998-99),wide variations in monthly prices is discernible. It is checkedduring the very next year, i.e. 1999-2000, where after firstfour sub-bars, remaining 8 sub-bars do not show muchvariation. It should be remembered that the futures trading inRefined Soy oil started during this period only in February2000. First four sub-bars correspond to November 1999 toFebruary 2000, after which we find low volatility in prices.

3.3.2 The column bars for 2000-01, 2001-02, 2002-03 and 2003-04shows decline in price volatility. This is the period when activefutures trading in Soy oil are seen at commodity exchanges,mainly NBoT, Indore and NCDEX, Mumbai. Therefore, it isestablished that the futures trading reduces seasonal pricevariations in agriculture commodities.

3.3.3 Alternatively, range of monthly price variation has beencalculated and then range as per cent of average annual priceof the corresponding year has been shown in the Figure 3.2.

Range = Maximum monthly value – Minimum monthlyvalue

3.3.4 During 1999-2000, range is calculated excluding values ofNovember 1999 – February 2000 on two grounds. One,February 2000 is the dividing line as futures trading in Soyoil at NBOT, Indore started during this month. Second, realmonthly prices up to February 2000 have been deflated bymonthly WPI with base year 1981-82 due to paucity of dataand, hence bar for 1999-2000 is reflecting somewhat abnor-mal picture.

3.3.5 The column bars represent the range of monthly pricevariations during various years. It is giving a distorted picturebecause there may be general rise in prices during aparticular year due to factors like demand & supply. If weplot the range value of various year’s prices as percent ofcorresponding years average annual price, it would give abetter picture of price variations during the year. It is shown

27

as smooth dotted lines, which clearly depicts fall in monthlyprice variation during the years with futures trading ascompared to years with no futures trading in Soy oil.

Figure 3.2 : Range of Monthly Price Variation

3.3.6 Similarly, the dark undotted line represents the trend ofstandard deviation in monthly prices with respect to mean ofannual prices. It also shows that the ready (spot) prices variedless sharply during years with futures trading than during theyears when futures trading in Soy oil were not there. It has aclear downward slope indicating low variations in prices ofRefined Soyabean Oil with active futures trading in the samecommodity.

3.3.7 Statistical comparisons between years with futures tradingand those with no such trading show that amplitude ofseasonal price variations was smaller during the former groupthan in the latter group of years. When the statisticalcomparisons are checked with available market information, itis discovered that other possible price influences are by

28

themselves inadequate to explain the smaller seasonalvariations in Soy oil prices during years of futures trading.The hypothesis that futures trading reduces the seasonalrange of price fluctuations is favoured by the outcome of theanalysis.

3.3.8 Therefore, by logic, it seems that futures trading can haveinfluence on reducing the seasonal fluctuations of agriculturalcommodities’ prices. By how much change in futures prices iscontributing to variations in spot prices of the commodityshall be tested in the next chapter.

29

CHAPTER 4

LONG-TERM RELATIONSHIP BETWEENFUTURES AND SPOT PRICES

4.1 INTRODUCTION

4.1.1 In this Chapter we propose to test our hypothesis that thereexists a definite relationship between futures prices and readyprices of soyabean oil. In other words, futures prices leadready (spot) prices of Soy oil. We shall also try to find outwhether price stabilisation is possible by futures trading, i.e.general upward or downward trend in prices over a period oftime is also an outcome of futures trading.

4.1.2 When we plotted a chart for the daily spot (ready) prices andfutures prices of Soy oil it was observed that no definite lead/lag relationship exists between the futures and spot prices.Futures prices of near month contract are sometimes inbackwardation throughout the month, i.e. spot prices shown alead over the futures prices of refined soyabean oil.

4.1.3 As said earlier, the futures trading in refined Soy oil is arecent phenomenon, which started only in February 2000.National Board of Trade (NBoT), Indore is the most activederivatives market as far as refined soyabean oil is concerned.Hence, futures prices of NBoT has been taken from April 2000onwards. On some days, there has not been any futurestrading or very less trading in Soy oil futures at this exchange.Therefore, all such days have been deleted from the study forthe sake of unbiased analysis. Ready prices for this particularanalysis on long-term relationship between futures and spotprices have been taken that of Indore market. For seasonalvariations in prices, Mumbai spot prices were taken which aremore representative of imported Soy oil price.

4.2 METHODOLOGY

Here, both the prices are of Indore market. When two marketsare at same geographical place it is thought that developmentsin underlying market would affect its derivatives market moreeffectively than the markets which are at two different places,even if they are in the same time zone. This is perhaps

30

because of time lag in spread of market information from oneplace to another owing to factors like information asymmetryamong the markets.

Figure 4.1 : Daily Spot & Futures Prices

4.3 INFERENCES

4.3.1 Backwardation in futures prices was observed during beginningof several months. It appears to be because of low openinterest during initial months of futures trading on account oflower market participation (i.e. number of contracts) andvolume of trade.

4.3.2 During the period beginning from April 2000 to September2004, basis3 for Soy oil varied in the range of 0 to 30. It is

CHART: DAILY SPOT & FUTURES PRICES

200.00

250.00

300.00

350.00

400.00

450.00

500.00

PERIOD (Apr 2000 -Sep 2004)

Rs.

/10

kg

200.00

250.00

300.00

350.00

400.00

450.00

500.00

Ready Prices

Futures Prices

31

seen that as the date of expiration of futures contact comesnear, the basis reduces and on the day of expiration it tendsto zero. This means that there is convergence of the futuresprice to the ready price of Soy oil (underlying asset). Higherbasis near expiration is also observed in several monthsduring 2000-02 and some months in 2002-04, too.

It reflects an arbitrage opportunity. Arbitrage can arise whenthe basis or the spreads (difference between prices of twofutures contract during the life of a contact are incorrect. Insuch cases, the trader can short his futures contact, buy thecommodity from the spot market and make the delivery.

4.3.3 In Figure 4.2, dark lines represent basis as percent ofcorresponding ready (spot) price. Columns represent basis innumbers. When basis is positive (column bars above 0-line) itreflects lead of spot prices over futures prices, i.e. futuresprices in backwardation. On the contrary, a negative basisrepresents futures premium, i.e. contango or lead of futuresprices over spot prices. It is observed from the analysis that

FIGURE 4.2: FUTURES BASIS FOR SOYA OIL

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

PERIOD (APR 2000 - SEP 2004)

B A S I S IN RS.

B A S I S (%)

Basis % of Ready Prices

32

basis converges to zero near date of expiry of future contactin most of the cases. Some months begin with positive basisand then go to negative territory before converging to zero.

4.3.4 On the basis of observations in the study, the followingoutcomes arise :

1. The data for 53 contract months from April 2000 toSeptember 2004 for futures as well as ready prices wereanalysed to check the lead & lag relationship betweenfutures prices for Soy oil and its ready market price.

2. For sake of comparative analysis, each month was dividedinto three parts consisting of 7-8 trading days each, viz.Beginning, Middle and End of Month. In each part, basiswith maximum frequency has been taken as the represen-tative. For example, if basis was positive on 2 days,negative on 4 days and near zero on 2 days out of 8trading days, this part of the contract month is said tohave negative basis. In similar fashion, assessment wasmade for three parts of each contact month.

3. It was observed that during beginning of the month,negative basis prevailed in 29 observations while positivebasis was seen in 17 and near zero basis in 7 observations.

4. During middle of the contract month, too, negative basiswas higher than the other two.

5. At the end of the month basis shown the tendency ofreaching zero.

Table 4.1 : Futures Basis During Contract Month

Beginning Middle End

+ ve Basis 17 15 3

- ve Basis 29 28 4

Near Zero 7 10 46

6. Thus, in more than 50% of the observations, futures pricesof Soy oil lead its spot prices.

4.3.5 Though from the above observations it cannot be establishedthat the futures prices lead spot prices, it can definitely be

33

deduced that futures prices influence daily market prices to agreater level. It helps in daily spot price determination.

4.3.6 What is more important to note is that size of basis (absolutevalue of difference in spot & futures prices) has narroweddown progressively from 2000-01 onwards. That is to say,futures and spot prices of Soy oil move in tandem.

4.4 LONG-TERM PRICE TREND (PRICE STABILISATION)

4.4.1 We have seen in the previous chapter that trading incommodity exchanges reduces the seasonal price variations.However, it does not establish that the futures trading insoyabean oil has really given some long-term price trend. By‘trend’ we mean the basic tendency on the part of a variableeither to increase or to decrease over a sufficiently long periodof time. It is determined by forces which move slowly butgiving a definite direction to the changes in variable. Monetaryand short-term forces may cause changes in that direction,yet the basic direction is discernible.

4.4.2 When we ran regression analysis on the daily spot andfutures prices of Soy oil, it did not give a delineating trend soas to arrive at a definite long-term trend. However, the valueof R2 was 0.289, which suggests that about 29% variation inspot prices of Soy oil is explained by variation in futurestrading of the commodity. ‘t-stat’ was also a significant value(3.357) at 10 per cent level of significance. It was furtherinferred that the slope of the trend line of Soy oil prices wasreduced in the presence of futures trading. Average annualsteepness with which sloped upwards was checked during theyears when futures trading was active. In other words, duringfutures trading prices sloped upwards rather gently than inabsence of it.

4.4.3 We have already seen that over a period of time daily, weeklyand monthly price variation in Soy oil has been checkedremarkably after introduction of futures trading in this com-modity. “By how much” price stabilisation is affected remainsto be answered. The daily prices have displayed trend ofstability from September 2002 while monthly prices havestabilised later. What is common though is the fact thatprices have stabilised and wide fluctuations in prices could bechecked after futures trading.

35

CHAPTER 5

FUTURES TRADING ANDSHORT-TERM PRICE FLUCTUATION

5.1 INTRODUCTION

We have already seen that futures trading reduces seasonalprice variations. It was observed that the prices of soyabeanoil in ready market varied less sharply during the years withfutures trading than during the period when there was nofutures trading in Soy oil. The direction and steepness ofmonthly price variations was used to establish the result. Insimilar fashion, by using daily and weekly prices of soyabeanoil it shall be established whether futures trading has anysignificant impact on short-term price fluctuations and, if yes,then to what extent.

5.2 DAILY PRICE VARIATIONS

5.2.1 We have daily spot prices of soyabean oil since November1997 to September 2004, i.e. about 7 years. Futures pricesare available since April 2000 to September 2004. Daily pricevariation in the absence of futures trading was higher thanduring years in which futures trading existed. When dailyvariation in spot prices (pt-pt-1) was observed over a longperiod of time, it was observed that price variation has beengentle after 2001 than before. Alternatively, weekly average ofdaily price variation in Soy oil was shown as a ratio of weeklyaverage price for the corresponding week. It also shows arrestin daily price variation in terms of magnitude after futurestrading. During the period 1997-2000, daily average pricevariation was near ±1.0%. On many days it exceeded 1.5%,too. The magnitude of variation was checked to some extentduring 2000 to early 2002 when futures trading took placebut the volume & contract level was lower. As the marketparticipation in Soy oil futures increased after 2002 it couldalso help check fluctuation in daily prices. Magnitude ofvariation came down sharply and remained in the comfortablerange of +0.5% to -0.5% compared to +1.0% to -1.0% prior tothis period. In the previous period (1997-2002), there weresome unusual variations during some days (see long lines inFigure 5.1).

Figure 5.1 : Daily Price Variation

Hence it is observed that futures trading in soyabean oil havereduced variation in its daily ready prices. Now, lets see theimpact of futures trading on weekly price variations ofsoyabean oil.

5.3 WEEKLY PRICE VARIATION

5.3.1 For testing whether weekly prices are influenced by thefutures trading, we have calculated weekly price range from1997 to September 2004 (i.e. maximum minus minimum priceof the week). Then, range so calculated was represented aspercentage of average price of the corresponding week. This isshown below as a frequency table where it is discernible thatthe price variations during 1997-2002 is more in higherfrequency, i.e. more than 4, which has come down in lateryears. Price variation in 2000, 2001 & 2002 has been higherdespite existence of futures trading.

TABLE 5.1: Weekly Range as % of Average Weekly Price

YEAR 0-2 2-4 4-6 6-8 Above 8

1997 1 1 1 1 1

1998 8 11 3 3 3

1999 1 7 7 3 3

2000 13 4 1 1 2

2001 4 7 6 4 4

2002 5 7 9 5 3

2003 22 11 1 0 0

2004 9 13 3 3 0

37

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

1998

1999

2000

2001

2002

2003

2004

YEAR

(%)

Range as % of Avg Weekly Price

Linear (Range as % of Avg Weekly Price)

5.3.2 When represented by a graph range as percentage of weeklyaverage price appears to have fallen. Skyscrapers during1997-2000 speak of high price volatility in the absence offutures trading. The high intra-week price volatility continuedeven after futures trading were started in Soy oil. However,volatility in prices was checked more effectively 2003 onwardswhen activity in the Soy oil futures market was good in termsof number of contracts and open interest positions.

Figure 5.2 : Weekly Price Range

5.3.3 The trend line plotted in the graph falls steeply duringSeptember 2002 to September 2004 than before. Trend lineindicates fall in weekly range over the years, particularly aftercommencement of futures trading in Soy oil.

5.3.4 Soy oil, as stated earlier is next only to groundnut oil indomestic demand. It is influenced by variations in prices ofMalaysian Palm oil and also its import in the country. The

38

factors that impact the price of soy oil have increased innumber in recent years due to opening of the economy.Changes in production and demand in one country influencesprices in another. So, it can be easily deduced that the short-term price volatility will be more in such a condition. But theempirical evidence comes against this. It is proved empiricallythat the variations have been checked during the years offutures trading.

5.3.5 Therefore, it comes to light that the futures trading has apositive effect on short-term price fluctuations. By short-term,we mean here price variations during a week and within amonth, i.e. intra-week and intra-month. Attempts should bemade by the exchanges and the regulator to promotevoluminous trading in principal commodities where largenumbers of farmers and traders could participate and help inefficient price discovery system.

39

CHAPTER 6

OPTIONS AS AN EFFICIENT TOOLFOR HEDGING PRICE RISKS

6.1 INTRODUCTION

6.1.1 Options are prohibited in Indian commodity exchanges. Theregulator, Forward Markets Commission is still examining theissue of allowing trading of commodity options. We shall, inthis chapter, outline a theoretical framework about optionsand see how options can be useful in hedging price risks.

6.1.2 An option gives the purchaser the right to buy or sellsomething (e.g. a commodity) at some time in future. Whilefutures, forwards or swaps necessitate an obligation toperform, the holder of an option has right to exercise as wellas not to exercise his right. The option-buyer purchases thisright by paying a premium to the option-seller whereas itcosts nothing (except margin requirements) to enter a futurescontract. Option trading is fraught with high risk if properrisk management and internal control systems are not inplace. Due to its inherent risks option trading in commoditieswas banned in 1939.

6.1.3 Option as a hedging device is widely used in internationalcommodity exchanges. Chicago Board of Trade (CBoT), MidAmerica Commodity Exchange, London International Futures& Options Exchange, Kansas City Board of Trade are amongthe prominent international exchanges where options inagricultural commodities are widely traded. The primaryobjective of hedging is not to make money but to minimizerisks and this includes using hedging to minimize losses.

6.1.4 Producers of agricultural commodities are faced with price andproduction risk over time and within a marketing year.Further, increased global free trade and changes in domesticagricultural policy have increased the price and productionrisks of agricultural producers. As price and productionvolatility increase revenue variability, the importance of riskmanagement gets significance. One means of reducing theserisks is through the use of the commodity futures exchangemarkets. Like the use of vehicle insurance to hedge the

40

potential costs of an accident, agricultural producers can usethe commodity options markets to hedge the potential costs ofcommodity price volatility. However, like vehicle insurancepayments from a small insurance claim may not exceed thecost of the premiums paid, the gains from hedgingagricultural commodities may not cover the costs of hedging.

6.1.5 The options market is sometimes referred to as insurance.Because by hedging through the options market an individuallocks in the costs of hedging and then can lose at most onlythe cost of the option premium while having unlimited profitpotential. Alternatively, holding a futures position limits profitsand losses by the hedged price.

6.1.6 For the options market, the Trading activities are carried outthrough the exchange of paper promissory notes to sell or buya commodity at an agreed upon price at a later date. Thispromissory note gives the individual the right to either buy orsell at a later date and not the obligation to buy or sell aswith futures hedging. As new information enters the market(exchange), peoples perceptions change and the process ofarbitraging begins again. Options change in value due to theperception of traders of where the market will go in thefuture.

6.2 TYPES OF OPTION CONTRACTS

Option contacts are broadly of two kinds – Call option andPut option. A put option gives the individual the right but notthe obligation to sell a futures contract at a later date. A calloption gives the individual the right but not the obligation tobuy a futures contract at a later date. The price at which thefutures market can be entered at a later date is referred to asthe strike price. The premium paid is in relation to the strikeprice. The strike price is a predetermined range of values thatis different for each commodity. A put (call) option is said tobe in the money if the strike price is above (below) theunderlying futures price. A put (call) option is said to be atthe money if the strike price is equal to (equal to) theunderlying futures price. A put (call) option is said to out ofthe money if the strike price is below (above) the underlyingfutures price. At any given time, the range of strike pricesquoted will cover values in the money, at the money, and outof the money. Thus, a hedger or speculator has the option of

41

purchasing an option at any of these three levels. Typically,options in the money will have the highest premium, followedby options at the money, and options out of the money willhave the lowest premiums.

6.3 VALUE OF AN OPTION

6.3.1 There are two components which make up the value of theoption, intrinsic and time value. Both of these values areimplicit values not observed, but theoretically present.Intrinsic value is the value of the option relative to theunderlying futures price. That is, a Rs. 500 per ton Put optionfor soy oil has an intrinsic value of Rs. 20/tonne if theunderlying soy oil futures is priced at Rs. 480/tonne. This isdue to the fact that the Put option could be exercised (sell afutures contract at Rs. 500 and buy back at Rs. 480). Typically,the change in intrinsic value of the option is determined bythe change in futures price. However, the change in optionprice is typically not as large for out of the and at the moneyoptions.

6.3.2 Additionally, there is a time component to the value of anoption. The time value reflects the time between the optionpremium quote and contract expiration. Typically, the largerthe time period the greater the implicit time value of theoption. That is, the greater number of days until contractexpiration, the higher the probability of the futures marketchanging in value enough to improve the intrinsic value of theoption. Let us take an example.

6.4 AN EXAMPLE

6.4.1 Suppose Trader A believes the domestic production of soyabeanhas been under estimated and Trader B believes the domesticproduction has been over estimated. Using the commodityexchange as a market place, since Trader A believes soyabeanprices are destined to go lower, he purchases the right to sella futures contract (Put) at a predetermined price at a laterdate, and Trader B purchases the right to buy a futurescontract (Call) at a predetermined price at a later datebecause he believes the price is going to go higher. Unlike thecase of the futures, Trader A & Trader B will not off-set eachothers position. In the options market there are writers ofoptions. These people are like an insurance agency. A writer

42

of an option is willing to take a set premium per unit ofcommodity in exchange for the risk that the commodity pricemay move against them.

6.4.2 Suppose Trader B purchases the right to sell (put option) afuture contract for soyabean at a later date at a strike priceof Rs. 260 per 10 kg for a premium of Rs.15 and the futuresprice is at Rs. 270 per 10 kg that day, then Trader B wouldinitially pay the commodity broker Rs. 15000 (if trading is inunit of 1000) plus commissions. The Rs. 15000 would go tothe writer of the option. Anyone can write options. Because ifthe price does not decline or the price rises the premiumwould decline over time and the option writer would profitRs. 15000. However, the futures market price could havedecreased to Rs.240 and the premium increased to Rs. 35.

6.4.3 Generally there is not a one-to-one relationship between achange in the futures market price and option premiums dueto less risk in the options market. Thus, Trader B could noweither sell the option for Rs. 35 per 10 kg and profit Rs. 20per 10 kg (Rs. 2000) or exercise the option. Exercising anoption should only be done if there is concern as to theliquidity in filling an order to sell the option.

6.4.4 Take another example of an option which gives the seller rightto sell if he so chooses without being obliged to do so. Afarmer who gets into an options contract to sell rice at Rs. 10per kg at the time of harvest in October pays an optionpremium of say Re. 0.50 for the same. In October, if themarket price is say Rs. 12, then he does not sell on theexchange and does so in his local market and gets Rs. 12 perkg. He gets this benefit at the cost of the premium which isforfeited. His net gain would be Rs. 1.50. In case of futures,he would be perforce compelled to sell at Rs. 10, as that wasthe price it was contracted. There would be an implicit loss oran ‘opportunity loss’ of Rs. 1.50. This is the scenario whichthe farmer has in mind when confronted with the issue ofselling in the futures market. He would like to have the bestof both sides, which can be satisfied only by allowing optionstrading on the commodity exchanges.

6.4.5 Options are different from futures in several aspects. Both areexchange traded and exchange itself defines the product, i.e.product standardisation exists similar to futures market.

43

These two tools are different in respect of strike price. Whilethere is no price (premium amount) in futures market andstrike price moves according to movement in the price of theunderlying, strike price is fixed in case of options and price ofthe option (premium) moves. The option buyer pays in full atthe time of the purchase. So, there is no possibility of optionposition generating any further losses than the amount ofpremium already paid at the time of contract. Though futuresis free to enter into by paying a margin amount, it cangenerate huge losses with adverse movements in the price ofthe underlying. This characteristic makes option attractive tomany participants who cannot put in the time to closelymonitor their futures position.

45

CHAPTER 7

INFLUENCE OF FUTURES TRADING ONSOWING DECISIONS AND CROPPING PATTERN

7.1 INTRODUCTION

7.1.1 It is generally said that futures trading benefits speculatorsmore rather than those who use it for risk mitigation. In caseof futures trading in agricultural commodities like soybean oilit is generally argued that trading through commodityexchanges does not have a significant impact on factors thatdetermine sowing decisions and cropping pattern. Indianeconomy has historically been a subsistence economy whereproduction is mainly for self-consumption and a part of pro-duction (marketable surplus) is traded. However, this patternhas had a paradigm shift in last 9-10 years, particularly post-liberalisation and relaxation in trade of commodities both,inside and outside the boundary of the nation.

7.1.2 Madhya Pradesh is the “soya bowl” of the country contributingabout 2/3rd of the total production of miracle bean (soyabean)in the country. Next comes Maharashtra with another 1/4th

contribution. Other than these two states, except for Rajasthan,no other state has more than 1% share in total production ofsoyabean. Trading of soyabean has been prevailing in Indore(M.P.) market since long. So far as impact of trading onproduction, cropping pattern and use of technology is concer-ned, Madhya Pradesh demonstrates higher linkage than anyother soyabean producing state in the country.

Table 7.1 : Major Soyabean Producing States

Year 2003-04 Area Under Soybean Percent toCultivation total Area (%)

(Million Hectare)

Madhya Pradesh 4.091 63.38%

Maharashtra 1.559 24.15%

Rajasthan 0.563 8.73%

Chattisgarh 0.050 0.77%

Other States 0.192 2.97%

Total 6.455 100.00%

46

Figure 7.1 : Area Under Soyabean in India

7.1.3 In last 22-23 years the area under cultivation of Soyabeancrop has increased by 10 times from low of 0.62 millionhectare in 1981-82 to 6.5 million hectare in 2003-04. Therehas been continuous growth in the area under soyabean from

0

1

2

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-198

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-92

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A (%

)

Area under Soybean Cultivation (Million Hectare)Growth in AreaAnnual Average

47

1981-82 to 1993-94 before it fell by 0.34 million hectare in1994-95. From 1999-2000 onwards there has been increase incropped area except for 2002-03. If futures trading has anyimpact on this fall, then relationship that emerges is inverseone because during this period futures as well as spot pricesof soyabean has shown increasing trend. Even Soy oil prices(futures as well as spot) increased from about Rs. 300 per 10kg in the beginning of 2002-03 to near Rs. 400 per 10 kg atthe end of the year. During previous year, too, market forsoyabean & Soy oil was largely bullish which should haveideally induced farmers to increase the area under soyabeancrop. But this did not happen.

7.1.4 Similarly during sowing season of soyabean in 2003-04,market was bearish but area sown under soyabean cropincreased by whopping 14 per cent. Price of soyabean atIndore was Rs. 151 per 10 kg on April 2003, which decreasedto Rs. 125 during July 2003. Similarly price of refined Soy oildecreased to Rs. 420 per kg in June 2003 from a level ofRs. 440 in April. Futures trading in both these commoditiesdid not reflect any bullish sentiment that could have led to14% increase in cropped area. Hence, futures trading do nottruly reflect the sowing decisions. One important reasonbehind this may be that traders in commodity exchanges arenot the real growers of a particular agricultural commodity.Other than this, factors like rain, cost of inputs also playpredominant role in sowing decisions.

7.1.5 Refined Soy oil is one of the important and actively tradedderivative product of soyabean. When two sets of data wereused to find out the correlation between them, a moderatevalue was obtained. The two sets of data being prices of Soyoil and area sown under soyabean crop from 1991-92 to2003-04 yielded a correlation coefficient of 0.42. However if wesee the correlation between the same sets of data for twodifferent periods, i.e. pre and post futures trading years, itappears that relationship between them has become muchstronger during the years with futures trading than inabsence of it. Correlation between Soy oil prices and areacultivated under its parent crop was mere 0.23 in absence offutures trading, i.e. 1991-2000. It, however, increased to 0.37during 200-2004. It should again be noted that futurestrading in Soy oil is a recent phenomenon and its true impacton factors like production and technology would be felt onlyafter a few more years.

48

7.1.6 Farmers take their sowing decisions after considering anumber of factors and one of the important being likelihood ofgetting remunerative prices for their products. The ‘likelihood’can be built more emphatically if there is a mechanism forefficient price discovery.

7.1.7 Futures trading and its long-term and short-term influencesmake us believe that it is an effective method for suchefficient price discovery which leads to changes in sowingdecisions and cropping pattern, too.

49

CHAPTER 8

SUPPLY RESPONSES OF FUTURES PRICES ONTECHNOLOGY ADOPTION & YIELD

AUGMENTATION

8.1 INTRODUCTION

8.1.1 We have seen in the previous chapter that futures tradingdoes not have a significant impact on sowing decision. Areaunder soyabean crop increased even when futures marketdisplayed bearish sentiments. Similarly during a bullish periodarea sown declined. However, more important aspect is higherpositive correlation between the two in the presence of futuresmarket than during the period when there was no futurestrading in Soy oil.

8.1.2 Similarly, correlation between prices of Soy oil & production ofsoyabean and prices of soy oil and yield of soyabean make usbelieve that futures trading helps farmers in their croppingdecisions.

Table 8.1 : Correlation Factor –Influence Of Futures Trading

CORRELATION BETWEEN PRICE OFSOY OIL AND

CROP PRODUCTION YIELDAREA OF OF OF

SOYABEAN SOYABEAN SOYABEAN

PRE-FUTURES 0.19 0.23 0.81TRADING (1991-2000)

POST-FUTURES 0.60 0.37 0.98TRADING (2000-2004)

By how far cropping decisions are influenced by trading of thecommodity in commodity exchanges is not easy to establishbecause of several other factors mentioned earlier thatinfluence decisions of the farmers.

50

Figure 8.1 : Production & Yield of Soyabean

8.1.3 During years with futures trading in Soy oil, correlationbetween traded price of Soy oil and production of soyabeanhas increased to 0.37 from 0.23 when there was no futuresmarket for Soy oil. Similarly, with yield, too, correlation of Soyoil prices has been highly positive at 0.98 during 2000-2004,i.e. period when futures trading existed.

0

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mill

ion

met

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ne)

0

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LD

(kg

/hec

tare

)

Production (million metric tonne)

Yield (kg/hectare)

Linear (Yield (kg/hectare))

51

8.1.4 Increase in yield during the years when futures trading waspresent in Soy oil may be because of producers’ inclination forincreasing the productivity of soyabean by adopting newertechnology. However, it cannot be established statistically thatthe use of technology for yield augmentation is the outcome offutures trading. Similarly, if we go alone by statistical resultthen it would be difficult to find why production of soyabeanin 2002-03 fell to 4.52 million tons from 5.28 million tons in2000-01, though futures market was indicative of bullishoutlook. In fact, below normal rainfall for the last threeseasons in the major production tracts has been the mainreason for this fall in production.

53

CHAPTER 9

NON-TRANSPARENCY OF PRICES AND PRODUCTSTANDARDISATION IN INDIAN COMMODITY

EXCHANGES

9.1 Self-regulatory measures devised and adopted by the exchangesaim at inculcating orderliness in the functioning of theexchanges through the standardisation of the trade practiceswithin the exchange. Such standardisations are likely toreduce transaction cost, counter-party risks and risks inherentin the fluctuations in commodity prices.

9.2 Before setting up of national level multi-commodity exchanges,almost all commodity exchanges in India were singlecommodity exchanges. The major part of the total trade wasrestricted to a single commodity. There also exist exchanges atcloser distance trading in the same commodity. For example,Jaggery futures trade is a set of seven to eight exchanges inthe U.P./Delhi region within 100 km of each other. Thetransparency with regard to market information and pricemovements was poor as transfer of information from onemarket to another was slow and limited because of factorslike conflicting ownership interests, poor and unreliableinformation infrastructure etc.

9.3 Though multi-commodity exchanges brought multi-commodities at a common trading platform and therebybringing several players in one fold, the dissemination ofinformation from one market to another is still limited. Theweb-based common interface, however, makes daily prices andother information in one market accessible at another. Nowsome organisations like Agriwatch is making available realtime prices of commodities available via mobile SMS (shortmessaging service). This is limited to prices at only a fewexchanges, namely NBoT, NCDEX, MCX, NMCE and someother large exchanges. Accessing price data from otherexchanges, say for example Muzaffarnagar Jaggery Exchangeis still difficult. For such exchanges, the collection of priceinformation is done at the initiative of individual traders anddealers. Rest of the exchanges are able to access informationfrom national level multi-commodity exchanges but theirinformation is not readily accessible.

54

9.4 All the four national multi-commodity exchanges have theirwebsites displaying real time spot and ready prices with sometime lag, generally 5 minutes. But there is no commonplatform where live prices at different exchanges for aparticular commodity could be accessed. Secondly, the marketdata wherever available is mostly for that particular day andnot a historical one. The futures trading must be backed withproper research and analysis, for which time-series data is notreadily available with the exchanges.

9.5 Product standardisation is one of the prerequisite for futurestrading unlike forwards market where customised contractsprevail.

There are several constraints also in product standardisationprocess. Prominent among them are:

1. Warehouse receipts issued by various warehouses lackcredibility

2. There is lack of infrastructure for quality certification ofvarious agricultural products

3. Inadequate reliable warehousing/storage system

4. Banks and financial institutions are unwilling to lendagainst pledge receipt due to legal problems of transfer-ability of title

9.6 The Indian commodity exchanges have, of late, been able tomove towards process of product standardisation by settingup national-level multi-commodity exchanges and framing aptregulatory mechanisms.

55

CHAPTER 10

NATURE AND VOLUME OFCOMMODITY TRADING PATTERN

10.1 Despite futures trading being conducted in many commodities,most commodity exchanges in the country continue to recordvery low trading volumes in relation to the production of theconcerned commodities. The four national-level multicommodity exchanges have been established but the nature oftrade reveals that even these exchanges are characterised byactive trade in one or two commodities only. Rest of thecommodities do not witness high volume of trading. Forexample, NBoT (Indore) is restricted to soyabean and itsproducts while bullion (gold) trading is so significant at Multi-commodity exchange of India (MCX, Mumbai) that thisexchange is now popularly known as “Gold Exchange of India”.

10.2 Among the newly established exchange associations, the onlyprofitable one have been the National Board of Trade, Indore(NBoT) and the India Pepper and Spice Trade Association,Kochi, (IPSTA) with profit levels of Rs 72,000 and Rs 10.94lakh, respectively in 1999-2000. But even here, their record ingenerating volumes have been limited. NBoT managed toreport trading of 61,800 tonnes of soy oil in 1999-2000 andabout 30 lakh tonnes during 2000-01, but could not registersufficient volumes in soya seed or cake. Similarly, the IPSTA’sdomestic division recorded trading of 1.23 lakh tonnes in1999-2000 and about 1 lakh tonne during 2000-01, but thevolumes in its international contracts has been a minuscule1,000-3,500 tonnes annually. The absence of dollar-denominated contracts has been the main reason for lowvolumes in international pepper futures.

10.3 Futures trading in cotton is done at five exchanges — EastIndia Cotton Association Ltd (Mumbai), Central Gujarat CottonDealers Association (Vadodara), Southern Gujarat CottonDealers Association (Surat), Ahmedabad Cotton MerchantsAssociation and South India Cotton Association, Coimbatore.Of these, only the first exchange has reported any significanttrading. According to the data compiled by the Department ofConsumer Affairs, the East India exchange recorded a tradingvolume of 2,03,775 bales (of 170 kg each) during the whole of

56

1999-2000 and 1,12,695 bales in 2000-01. Compared to thecountry’s annual cotton output of 11.5-12 million bales, thisis very negligible. Low trading volumes has led to theexchange running a loss of Rs 15.87 lakh in 1999-2000.

10.4 The case is similar in the case of castor, where there arethree exchange associations — Bombay Oilseeds and OilExchange, Ahmedabad Commodity Exchange and Rajkot SeedsOil and Bullion Merchants Association. The first one has failedto create volume in either castorseed (9,000 tonnes in 1999-2000 and 6,900 tonnes in 2000-01 or castor oil (2,500 tonnesin 1999-2000 and 1,100 tonnes in 2000-01). The other twoexchanges have done relatively better, with their trading incastorseed for the above periods being 30.68 lakh tonnes and16.98 lakh tonnes for the Ahmedabad exchange and 16.35lakh tonnes and 15.63 lakh tonnes for the Rajkot exchange.But even here, the Department has observed that the volumein the Ahmedabad exchange has declined compared to earlieryears. The Ahmedabad exchange recorded a profit of Rs 3.72lakh in 1999-2000, with the Surat exchange reporting a figureof Rs 7.23 lakh.

10.5 The East India Jute & Hessian Exchange Ltd, Calcuttarecorded a loss of Rs 6.75 lakh in 1999-2000, with tradingamounting to 7.08 lakh tonnes in sacking and a mere 260tonnes for hessian. For 2000-01, the exchange had a sackingvolume of only 4.13 lakh tonnes till December 2000 and nilin the case of hessian. The Coffee Futures Exchange IndiaLtd, Bangalore recorded a trading volume of 32,600 in 1999-2000 and 37,500 in 2000-01. During 1999-2000, theexchange posted a loss of Rs 2.01 lakh.

10.6 It is interesting to note that the exchanges that have faredrelatively better in the country’s overall context are thosedealing with less significant commodity, namely gur (jaggery).There are five gur exchanges, all of which have witnessedactive trading. The 297-member Vijai Beopar Chamber Ltd,Muzaffarnagar recorded a profit of Rs 9.97 lakhs and tradingvolume of 47.48 lakh tonnes in 1999-2000 and 23.30 lakhtonne in April-December 2000, with the corresponding figuresbeing Rs 5.51 lakh, 23.66 lakh tonne and 15.06 lakh tonnefor the Bhatinda Om & Oil Exchange and Rs 18,400, 23.92lakh tonne and 22.63 lakh tonne for the Chamber ofCommerce, Hapur. Considering that the country annually

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produces 90-100 lakh tonnes of gur, the total futures tradingvolume of nearly the same level is rather significant.

10.7 The turnover of Indian commodity futures market mayovertake the capital market turn over in the near future. Thetotal turn over of commodity futures market in India hasalready reached the level of Rs 1.4 lakh crore by March 31,2004.

Table 10.1 : Turnover Of Indian Commodity Exchnages

Name of Commodity Exchange Products Approx.AnnualVolume

(Rs crore)

National Board of Trade Soya, mustard 80000

National Multi-commodity Exchange Multiple 40000

Ahmedabad commodity Exchange Castor, cotton 3500

Rajdhani oil & oilseeds Mustard 3500

Vijai Beopar Chamber Ltd. Gur 2500

Rajkot seeds, oil & bullion Castor, 2500Exchange groundnut

IPSTA Pepper 2500

Chamber of Commerce (Hapur) Gur, Mustard 2500

Bhatinda Om & oil Exchange Gur 1500

Others (mostly inactive) 1500

TOTAL 140000

As per the reports available in February 2005, the totalvolume is likely to touch around Rs.500000 crore for 2004-05.In dollar terms this will be around $112 billion. For improvingthe income of the farmers through commodity futures marketgovernment has abolished Essential Commodities Act for freemovement of agricultural goods across states. For fullyutilizing the potential of the commodity futures market thebasic infrastructure of the Indian commodities market need tobe improved further.

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CHAPTER 11

CONCLUSIONS AND RECOMMENDATIONS

11.1 CONCLUSIONS

11.1.1 In the midst of the growing integration of Indian economywith the rest of the world, importance of efficient pricediscovery mechanisms has increased. It is also required toprotect the interests of domestic farmers, traders and otherintermediaries. Theoretically, commodity exchanges play avital role in price discovery, its stabilisation and hedging ofrisks involved in commodity trading. While financialderivatives have established their role in risk hedging,commodity exchanges have a long way to go.

11.1.2 Worldwide volumes in commodity derivatives have beenincreasing in last decade, particularly in non-US exchanges.While volume at US exchanges has increased by about 90%between 1991 to 2001, increase in volume at non-USexchanges increased by about 600%. US volume was higherthan non-US exchanges in 1991, but the scenario changedin 2001 when volumes at non-US exchanges was about 3times that of US exchanges. This shows the need andpopularity of futures trading in commodities.

11.1.3 There has been apathy on the part of the governmenttowards futures trading in commodities. Though in India,trading in commodity futures has been in existence from the19th century with organised active trading in cotton.Regulatory constraints in 1960s resulted in virtualdismantling of commodities futures market in India. Of late,the national agriculture policy and budget of the year 2002-03 has put in place a mechanism of futures trade in India.The futures trading is now permitted in all the commoditieswhile options trading is still prohibited.

11.1.4 The futures trading in Refined Soyabean Oil started atNational Board of Trade (NBoT), Indore in February 2000.Soy oil is a derivative of Soyabean, popularly known asmiracle bean. On crushing, 100 kg of soyabean, we getabout 18 kg of soy oil. The Soy oil consumption in India interms of volume is next only to groundnut oil. It has edible

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uses like cooking oil, coffee creamers, margarine, sandwichspread and industrial uses as anti-corrosion agents, electricinsulation, diesel fuels, lubricant, paints etc. Entire soy oilproduced in the country is consumed and additionalquantity is imported. The share of soy oil import in totaledible oil imports increased from 19.99% in 1998-99 to33.42% in 2001-02. Presently, import volume is more thanvolume of production.

11.1.5 Soy oil prices over the years have displayed a volatile trend.This price uncertainty and unpredictable price movementcauses heavy losses to a large number of processors,growers and other intermediaries. Hence the futures tradingin soy oil gains importance. NBoT, Indore is the principalfutures market for soy oil and also for soyabean and soymeal. There are two prominent ready markets in soy oil –Indore & Mumbai. While former represents market fordomestically produced soy oil, the latter is indicative ofimported soy oil prices.

11.1.6 During 1991-2000 monthly variation in soy oil prices was inthe range of Rs. 50 - Rs. 150. It declined to Rs.30-Rs.70after start of futures trading, i.e. post- 2000, except in2001-02 when the difference in maximum and minimummonthly prices was Rs. 120. This was because of poorsoyabean crop during this period. The production of soyabeandecreased from 5.90 million tonnes in 1998-99 to 5.01million tonnes in 2000-01. Generally speaking, inter-monthvariation in soy oil prices declined during futures tradingyears.

11.1.7 The standard deviation of monthly prices, i.e. deviation ofmonthly prices from annual mean price also declinedsharply after 2000 as compared to pre-2000 period. It was33.58 in 1999-2000, which declined to 9.23 in 2000-01 and3.01 in 2003-04. It can be, therefore, interpreted that thefutures trading in soy oil is also effective in reducing theseasonal price volatility.

11.1.8 Price of any commodity is the function, though not simple,of its demand and supply. These two factors, ceterisparibus, can cause monthly, weekly, daily and even intra-day price fluctuations. But in a competitive market degree ofprice volatility should be reasonable. The study reveals that

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the daily price variations in soy oil was – 0.02% in theabsence of futures trading which changed to 0.07% duringthe years when futures trading took place. It shows thatfutures trading did not have any positive impact on dailyprice volatility. However, when we see average daily pricevariation as a ratio of weekly average price, effects of futurestrading appears to be positive. Magnitude of variation hasdecreased sharply after start of futures trading, particularlyfrom mid-2001.

11.1.9 In the long-term spot prices have positive correlation withfutures prices. Correlation coefficient comes to 0.42. Thevalue of R2 obtained through regression analysis suggeststhat about 25% variation in spot prices of soy oil isexplained by variations in futures prices. Over a long periodof time, the difference between two prices has also narroweddown, i.e. basis (difference between spot & futures prices)has declined, suggesting thereby that the spot prices movecloser to the futures prices of soy oil.

11.1.10 Whether futures trading helps in sowing decisions, cropdiversification and yield augmentation is not readilyestablished. There is erratic growth in area under soybeancrop since 2000, i.e. the year when futures trading in soy oilstarted. Though futures market was very bullish before thesowing season in 2002-03, the actual area cropped undersoyabean crop declined by more than 5%. In fact, sowingdecisions depend more on climatic conditions than onoutlook of futures market. It is proved here. The fall incropped area was basically due to below normal rainfall inmajor producing regions. Similarly, there is increase in yieldof soyabean, too. But this again has been the trend evenbefore futures trading. However, correlation between futuresprices and area sown, yield augmentation and productionhas strengthened after futures trading when compared tothe years when futures trading was not allowed.

11.1.11 The weakness of the commodity futures market in Indiaimpacts on the farmers’ income and interests. For instance,though India is the largest producer of castorseeds,accounting for 70% of the global production, the countryhas an insignificant role in determining prices, which aredecided in the futures market at Rotterdam. Similarly in thecase of gold, where India is the largest consumer, the ability

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to influence global prices of the product is very limitedbecause of the lack of efficient market mechanisms in thecountry. It is time to think why India should not take amore effective role in pricing of those commodity marketswhere it has a dominant role either in production orconsumption.

11.1.12 Futures market of the commodity sector can be an effectivetool for shaping emerging cropping patterns of the farmers,provide them with price hedges to improve their incomelevels and improve holding power. Apart from this,transparency in price information will benefit all participantsin the value chain. Robust warehousing facility reachingdown to rural areas is a key infrastructure requirement. Toachieve these goals, permitting options to farmers,negotiability of warehouse receipts (WR), enabling banks andother financial sector participants to enter commoditymarkets are some of the key legal and regulatory changeswhich are urgently required to be undertaken. Negotiabilitystatus to the WR issued by the government warehouses arelargely accepted by lending banks but is not ‘legallynegotiable’. At present dematerialised WR does not have anystatus similar to the Depositories Act 1996. In the mid-yearreview of the Annual Monetary & Credit Policy announcedon October 26, 2004 the Reserve Bank of India has decidedto set up an expert group to suggest on the above issuesincluding participation of commercial banks in thecommodity market not only as a clearing member but alsoas a trading member.

11.2 RECOMMENDATIONS

11.2.1 The first and foremost factor for a commodity exchange toachieve success is that trade should happen on a large scalethrough on-line trading. Here, there is need to learn fromthe equity market and they way concept of equity investmenthas penetrated across the income-groups as well as itsregional spread. The challenge is to read the mindset ofpeople in order to orient them to investment in commodityfutures market.

11.2.2 Secondly, spot markets in India are spread across less than30 organised major markets and more than 7500 mandis.Mandis are mostly unorganised and have, therefore, lagged

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behind in the process of price discovery. Added to this, theyhave little transparency in trading and unwanted middlemenactivities. Government controls in the form of minimumsupport price, movement restrictions (relaxed to an extentrecently), licensing requirements further lead to ineffectiveprice discovery.

11.2.3 Farmers’ interest also needs to be addressed by thecommodity exchanges. They form an important part of thecommodity value chain but perhaps, in most of the casesthey are exposed to maximum risk. The participants in theseexchanges are large traders who could hedge their risksthrough commodity futures trading but farmers’ risk hedgingopportunity is very limited. There is need to encourageparticipation of farmers and their cooperatives. For this,entry regulations of the commodity exchanges should beliberalised and entry fee should also be brought down to anaffordable level. Unless they become an important segmentof the trading community, role of futures trading in decisionprocesses of the farmers can not be enlarged. Futures pricesshould lead to business decisions like crop selection, timingof the sale of commodity, storage etc.

11.2.4 Further important factor for growth of futures market incommodities is its liquidity. Unless hedgers, arbitrageurs andspeculators all play significant role in the market, it is verydifficult for any derivatives market to have volumes. Theprocess and entry level restrictions should be simplified andremoved wherever possible to increase liquidity. Liquidity canbe increased by allowing financial intermediaries like mutualfunds, banks who have no underlying physical exposure tothe commodity to participate in futures trading as principalsas a business by itself and not for hedging. (Ministry ofFinance and RBI are learnt to have initiated the process inthis regard). This will lead to development of vibrant, liquidand efficient commodity exchanges.

11.2.5 Commodity exchanges should further ensure effective systemof warehousing and warehouse receipt. It becomes essentialthat commodity exchanges ensure a proper system of qualityassurance and certification procedure in place. Thestandards to be decided should match the commercialpractices and administration of certification should be takenup by reputed quality certification agencies.

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11.2.6 There is also a need for a super-regulator. Currently,financial markets are being regulated by the Reserve Bankof India (RBI), securities markets by the Securities andExchange Board of India (SEBI) and commodity markets bythe Forward Markets Commission (FMC). Further to this,first two are regulated by the Ministry of Finance whilecommodity exchanges are regulated by the Ministry ofConsumer Affairs, Government of India. As the marketsintegrate, the participants will have exposure in multiplemarkets, It is imperative, therefore, to have an effectivemonitoring system without any conflict of interests. In thiscontext, steps should be initiated to increase the coordinationbetween the regulatory authorities. Also, the possibility of asuper-regulatory body should be examined from a long-termperspective.

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NOTES

1. The Union Ministry of Consumer Affairs, Food & Public Distribution constitutedHigh Level Committee for formulating a Long-term Grain Policy for the countryon the 17th of November 2000 for examining the areas of concerns likeMinimum Support Prices (MSP) and Price Support Operations, the role of theFCI, functioning of the PDS etc.

The Committee viewed insurance and futures trading as an important riskmanagement tools, but not as alternatives to price stabilisation through MSPsand through policies regarding tariffs on imports and exports.

2. Characteristics of futures trading have been taken from the website of ForwardMarkets Commission. GOI’s High-level committee on Long-term grain policyopined, “Benefits of futures trading are that this can, first, lead to more efficientprice discovery by allowing more agents with relevant information to participatein price formation than would be possible if all these agents had to bear thefixed costs of physical trading. Secondly, since risks in physical trading can bereduced through hedge options, existence of futures markets can reduce costsof insuring against price risks and encourage more trade in spot physicals. Asa result, commodity markets, both futures and spot, are expected to be betterable to discount likely future developments and cause prices to be less subjectto unanticipated shocks. Although it is very unlikely that many farmers wouldbe able to participate in futures markets themselves, they could still benefitfrom signals regarding likely future prices. More importantly, there could bebenefits of competition if existing traders took longer positions because ofreduced risk and this also encouraged new entrants into physical markets. Mostimportantly, farmers would gain directly if this enabled better linkage betweenstorage and credit and induced banks to offer more pledge loans.”

Giving a note of caution, Committee further said, “… although futuresexchanges have potential in India, this is unlikely to be realised without the farmore difficult task of reforming procedures in physical commodity markets, andimproving the low current degree of integration between them throughdevelopment of essential infrastructure. Most importantly, it should be realisedfrom the actual functioning of existing futures markets in the United States andelsewhere that futures prices are always highly correlated with thecorresponding spot prices and do not display any significantly lower degree ofvolatility. Existence of such markets has allowed risks to be hedged, inducedmore finance into storage, and may also have reduced spot price volatility fromwhat they would otherwise have been. But fundamentals cause high uncertaintyin world commodity markets, and futures markets have not prevented pricevolatility from being so high that if reflected in domestic prices would beunbearable for Indian farmers with their limited financial resources.”

3. Commodity basis is the difference between a local cash price and the relevantfutures contract price for a specific time period. For a specific commodity basisis defined as:

Basis = Cash Price - Futures Price

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Bibliography

1. Balasundaram, D., Prospects for Cotton futures in India (1998), in Thomas, S.,editor, Derivatives markets in India, 1998, TMH

2. Chandrasekhar, C.P. and Ghosh, Jayati, Articles published in “The HinduBusiness Line”, Hyderabad

3. Government of India (July 31, 2002), Report of the High-level Committee onLong-term Grain Policy, Ministry of Consumer Affairs, Food & PublicDistribution, New Delhi

4. Joe, Parcell & Verne, Pierce, Using commodity futures as a price forecastingtool, University of Missouri, Columbia

5. Kolamkar, D.S. (2003), Regulation and policy issues for commodity derivativesin India, in Thomas, S., editor, Derivatives markets in India, 2003, OUP

6. Kumar, Sunil (2004), Linking commodity derivatives with farm credit: A win-winproposition, ICFAI Professional Banker, June 2004

7. Kumar, Sunil (2004), Role of commodity futures in boosting agricultural creditflow: A conceptual exposition, Bank Quest (IIBF), January-March 2004

8. Larson, Donald & Varangis, Panos (January, 1999), Using markets to deal withcommodity price volatility, World Bank Economic Policy Note

9. Oils & Oilseeds – Future Contracts, NCDEX, Mumbai

10. Reserve Bank of India (1997), Report of the Committee on Hedging throughInternational Commodity Exchanges

11. Sankhayan, P.L. (1988), Introduction to the economics of agriculturalproduction, PHI, New Delhi

12. Shenoy, P.V. (2003), Oilseeds Production, Processing and Trade: A PolicyFramework, Occasional Paper –26, NABARD, Mumbai

13. Thomas, Susan (May 2003), Agricultural commodity markets in India: Policyissues for growth

14. Thomas, Susan & Karande, Kiran (July 2001), Price discovery across multiplespot and futures markets, Technical Report, IGIDR, Mumbai

15. Commodity Exchanges – Future Beckons, www.CommodityIndia.com (August2003), Volume 3 Issue 8

16. About Miracle Bean, www.CommodityIndia.com (October 2003), Volume 3 Issue10

17. The Public Ledger, World Commodities Weekly, September 1-7, 2003

18. WEBSITES of:

A. Forward Market Commission (www.fmc.gov.in)

B. Soyabean Oil Producers Association of India (www.sopa.org)

C. National Commodity & Derivatives Exchange of India Limited(www.ncdex.com)

D. Solvent Extractors Association (www.seaofindia.org)

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Appendix I :List Of Commodity Exchanges & Commodities Traded

No. Name of Exchange & Location Principal Commodity Traded

1. India Pepper & Spice Trade Association, Pepper (both domestic andKochi (IPSTA) international contracts)

2. Vijai Beopar Chambers Ltd., Muzaffarnagar Gur

3. Rajdhani Oils & Oilseeds Exchange Ltd., Gur, Mustard seed its oil &Delhi oilcake

4. Bhatinda Om & Oil Exchange Ltd., Bhatinda Gur

5. The Chamber of Commerce, Hapur Gur, Potatoes and Mustardseed

6. The Meerut Agro Commodities Exchange GurLtd., Meerut

7. The Bombay Commodity Exchange Ltd., Oilseed ComplexMumbai Castor oil international

contracts

8. Rajkot Seeds, Oil & Bullion Merchants Castor seed, Groundnut, its oilAssociation, Rajkot & cake, cottonseed, its oil &

cake, cotton (kapas) and RBDpalmolein.

9. The Ahmedabad Commodity Exchange, Castorseed, cottonseed, its oilAhmedabad and oilcake

10. The East India Jute & Hessian Exchange Hessian & SackingLtd., Calcutta

11. The East India Cotton Association CottonLtd., Mumbai

12. The Spices & Oilseeds Exchange TurmericLtd., Sangli

13. Kanpur Commodity Exchange Ltd., Kanpur Rapeseed/Mustardseed, its Oiland cake

14. National Board of Trade, Indore Soya seed, Soyaoil and Soyameals. Rapeseed/Mustardseedits oil and oilcake and RBDPalmolien

15. The First Commodities Exchange of India Copra/coconut, its oil &Ltd., Kochi oilcake

16. Central India Commercial Exchange Ltd., Gwalior Gur and Mustard seed

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No. Name of Exchange & Location Principal Commodity Traded

17. E-sugar India Ltd., Mumbai Sugar

18. National Multi-Commodity Exchange Oilseed Complex and Rubber,of India Ltd., Ahmedabad Sugar, Aluminium, Nickel,

Zinc, Copper, Lead. Tin, Pepper,Gram and Sacking.

19. Coffee Futures Exchange India Ltd., CoffeeBangalore

20. Surendranagar Cotton Oil & Oilseeds, Cotton, Cottonseed, KapasSurendranagar

21. E-Commodities Ltd., New Delhi Sugar

22. Bullion Merchants Association, Bikaner Mustard seed its oil & oilcake

23. National Commodity & Derivatives Soy Bean, Refined Soy Oil,Exchange Ltd., Mumbai Expeller Mustard Oil, Rbd

Paloleine crude palm oil,Medium staple cotton, Longstaple cotton, Gold, Silver

24. Multi Commodity Exchange Ltd., Bullion trades, crude oil,Mumbai Castor, Rbd Palm oil, Gur

Note : Names in bold letters indicate status as “Nation-wide Multi CommodityExchange”

Source : Forward Markets Commission

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Appendix II : Yearly Crushing, Production Of Meal & Oil In India

Oil Year Soybean Extraction Oil(OCTOBER- Crushed Produced Produced

SEPTEMBER)

(In Million Metric Ton)

1992-1993 2.755 2.231 0.482

1993-1994 3.199 2.592 0.560

1994-1995 2.578 2.088 0.451

1995-1996 3.505 2.839 0.613

1996-1997 3.182 2.577 0.557

1997-1998 4.156 3.367 0.727

1998-1999 4.274 3.462 0.748

1999-2000 4.447 3.647 0.800

2000-2001 4.327 3.548 0.779

2001-2002 4.867 3.991 0.876

2002-2003 3.600 2.952 0.648

2003-2004 6.091 4.994 1.096

Point-to-Point Growth (%)

1992-93 to 1997-98 50.85 50.92 50.83

1998-99 to 2003-04 42.51 44.25 46.52

Source : Soyabean Oil Producers’ Association of India (SOPA)

Appendix III :Share of States in Production of Soyabean 2003-04

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Appendix IV : A Typical Contract Cycle for a Futures Contract

Jan Feb Mar Apr

TimeJan 20 contract

Date of Expiry is 20thof the expiry month &

Feb 20 contract the nex day a new far-month contract starts

March 20 contract

April 20 contract

May 20 contract

The figure shows contract cycle for a futures contract. At any given point oftime, three contracts are available for trading – a near-month, a middle-monthand a far-month. As the January contract expires on 20th of January, a newthree month contract starts trading from the following day, once more makingavailable for trading three futures contracts for the same commodity.

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