Allow business to hedge its future

Being a public sector organisation, IOC, however, hasn’t really felt the need to develop the skill to participate in futures markets and try to minimise cost fluctuation. The point is, however, a host of private sector firms who purchase petroleum products (and now the private developers like Reliance Industries and Videocon Ltd who are drilling oil in fields of their own) are keen on doing so. But wait a minute. Reliance cannot be allowed to export the oil from its Mukta-Panna fields since this has to be sold to the Government so what is it really asking for, and how can it buy futures if it is not free to sell the oil? Apparently all that Reliance is asking for is the right to buy futures and use this to help even out the impact of fluctuations on their oil operations — today, all private oil drillers are being paid on the basis of international crude prices. So what’s wrong with allowing it to do something like this?

Nothing really, but the Ministry of Finance — to whom Reliance had written since it involved forex transactions — doesn’t want to get into a tangle as it has had one bad experience earlier. Around a year ago, Coates Viyella, the textiles company, wanted to buy futures for the cotton it imported as this would help it even out sharp fluctuations in international cotton prices. Apparently the Ministry of Finance and the Ministry of Textiles agreed and the proposal was close to getting finalised when someone pointed out that the Ministry of Civil Supplies should be consulted since all commodity trading is governed by it. For some reason, the Ministry of Agriculture was also consulted since cotton falls under their purview as well. It is unclear as to what the stand the Ministry of Civil Supplies would have taken, but agriculture minister Chaturanan Mishra wrote to Finance Minister P. Chidambaram and talked of how the move would be disastrous, would hit small farmers, etc. The matter, naturally, died a natural death.

Even though futures would be very useful, futures trading is allowed only in six products raw jute and jute goods, black pepper, castor seed, gur, potatoes and turmeric.

The reason given for this is that futures drive up commodity prices as they give free reign to speculation. Actually, nothing can be further from the truth if exchanges are well-managed and certain other pre-conditions are met. Which is why the Dantwala Committee in 1966, the Khusro Committee in 1979 and the Kabra Committee in 1994 recommended the introduction of futures in items like basmati rice, cotton, oilcakes, gold and silver.

In fact, the experience of the Cochin pepper futures market shows how futures really help after sugar, pepper prices are the most volatile in the world. Such high risk, in turn, reduces the competitiveness of traders and processors as they cannot enter into long term contracts and even buy large quantities of goods just to cushion themselves against unfavourable price movements this is not specific to just pepper but applies to all commodities, which is why futures are an essential tool of business the world over. Most agriculture economists, for instance, feel that if FCI and private traders are allowed to buy futures for wheat, rice or sugar, we would be able to import them at cheaper prices. It has been found that Malaysian and Indonesian pepper exporters were unable to enter into contracts to sell for more than three months ahead — "forward" contracts, in jargon — as compared to Indian exporters who can sell forward for more than six months regularly since they can access the futures market for hedging purposes.

In fact, hedging also ensures that farmers don’t have to bear the brunt of sharp fluctuations in international prices. Indian pepper farmers, for instance, get a significantly higher share of export prices than their counterparts in South East Asia. It is ironic that countries that have had no past experience in futures — China, Brazil, Poland, Hungary, to name just a few, are now establishing such markets. India, by contrast, was one of the first developing countries to have commodity futures the Bombay Cotton Exchange was established in 1921.