Futures Perfect- Always

The domestic futures markets are pricing in market fundamentals in an absolutely precise manner, contrary to a popular belief that futures spiral up the prices

The Refined soy oil futures for the month of November are trading to a discount to the spot prices as well as near month contract pricing in the set of fundamental factors in a precise manner- contrary to a popular belief that futures spiral up the prices. At the beginning of the year, Forward Markets Commission (FMC) imposed a ban on futures trading in urad and tur in an effort to control their soaring prices. The government believes that excessive speculation in these two pulses had led to a sharp rise in their prices.

The depressing run for the market continued further as the year progressed as the government axed two more commodities. Under pressure to cool inflation running near two-year highs, the government banned new wheat and rice futures contracts in February in a bid to check speculation and tame prices. On the other hand, market players believe that the price rise is more due to a demand - supply mismatch. The production of pulses has stagnated in last seven years, whereas the population has grown by 20% in the same period.

Prices of Tur and Urad moved in accordance with the poor supply conditions. Tur production was lower last year, slipping to 24.7 lakh tonnes as against 25.7 lakh tonnes previous year, leading to higher prices. In case of Urad, which is primarily a khariff crop, a large chuck of the production was affected due to the incessant rains in AP and Maharshatra, two of the largest producing states of the commodity.

However, these figures carried much more weight when analyzed from a historical perspective. Pulses and indeed, most of the important items of mass consumption have a lop-sided demand-supply equation in the country. The production of Tur was 17 lakh tonnes in 1950 –51 while the latest figures suggest that over the last five and half decades, its gone up by a mere 45%, which, compared to a 300% rise in the country’s population during the same period looks not only very poor but utterly disappointing in terms of assessing the performance of agricultural reforms in the country.

Thus, in case of the major food articles, what drove the prices relentlessly up was the hopelessly lop-sided demand-supply equation and costlier substantial imports. Demand side pressures also proved to be an important catalyst in keeping a shortage syndrome firmly entrenched in the economy. In economic survey 2006-07, the government stated that “Higher demand as a result of an accelerated growth in GDP, higher growth in reserve money because of a faster increase in foreign assets, the multiplier effect of increase in broad money, and credit growth have also exerted pressure on demand side”

The series of bans spooked the investors and made the commodity futures market witness its first pullback in terms of the trading volumes since its inception. In April-June 2007, the total turnover of the three exchanges – the Multi Commodity Exchange of India (MCX), the National Commodities and Derivatives Exchange (NCDX) and the National Multi Commodity Exchange (NMCE) - has fallen by 11.12 per cent compared with the first quarter of the previous year. The commodity futures market had recorded a stupendous growth rate of 96.05 per cent in the last financial year

In the context of these developments it is heartening to see the futures still pricing in the market dynamics in a flawless manner. The above cited price movement of refined soy oil defines the realities in the marketplace which stand testimony to the fact that the markets are serving one of the very basic purpose for which they were launched.

Domestic oilseeds acreage fell in the last year as farmers switched to more profitable crops such as pulses and wheat. While this lead to almost 17% fall in production of oilseeds, a sharp rise in international prices of palm oil and Soya oil led to a sweltering 14% rise in domestic prices of edible oils as a group. Such sweltering buoyancy in price prompted the farmers to increase their acreage of oilseeds in the current kharif season

Futures and options markets also provide the economy with price discovery. Futures prices are determined by supply and demand. An exchange itself does not set prices; it simply provides a place where buyers and sellers can negotiate. If there are more buyers than sellers, the price goes up. If there are more sellers than buyers, the price goes down. The prices discovered through futures markets offer valuable economic information about supply and demand in a competitive business environment.

Instability of commodity prices has always been a major concern of the producers as well as the consumers in an agriculture -dominated country like India. Farmers’ direct exposure to price fluctuations, for instance, makes it too risky for many farmers to invest in otherwise profitable activities. Agricultural products, unlike others, have an added risk. Many of them being typically seasonal would attract only lower price during the harvest season.

However, the current backwardation in the November futures contract- which has shown a constant tendency to drift lower since its launch and continue to trade below the spot prices as well as near month futures - embodying the scarcity premium which seems to be widening as the harvesting season approaches. The total coverage of oilseeds so far has been 149.38 lakh ha as compared to 141.83 lakh ha on August 2, last year. Soybean has been sown in 6% and groundnut in 10% higher area as compared to that in 2006. Thus, while the markets go on about their business in their usual self, justifying that " futures are perfect", the current price movement, when looked in the context of falling turnover on the bourses, makes one wonder – is the government solution to any problem is usually worse than the problem?