Onions, without tears

When the prices of India8217;s most politically sensitive vegetable crash 8212; or rocket skywards 8212; there are consequences that go far beyond the onion fields of Nashik. The right solution to the problem is to have a futures market on onions. A host of forces come into operation once onion futures are available. First, there will be a greater push in favour of standardisation of grades, which will ease trade, and help in rapidly shifting onions from low-price regions to high-price regions.

Second, the process of speculative price discovery will yield early warnings about onion shortages well ahead of time. This will incentivise farmers to grow more onions, as well as induce onion import by the private sector. Greater storage facilities will help in carrying onions from low-price months to high-price months. This requires working capital for the firms which hold such inventory. But given the volatility of onion prices, banks are averse to giving loans against inventories of onions, since they can suffer losses if prices crash and the borrower defaults, leaving the bank holding a warehouse full of onions. Once again, onion futures are a key ingredient which could make bank financing possible. The bank which has given a loan, against a warehouse of onions as collateral, will sell onion futures, thus removing price risk. Onion futures would thus enable bank financing and a bigger onion storage industry.

However, once an onion futures market is in full play, it will exert a powerful force on the onion economy. That could induce new resentments. The benefits of onion futures trading can only be harnessed by society if politicians, bureaucrats, farmers and the media acquire a greater understanding of the role of futures trading. It is in the very nature of speculative price discovery that the futures market shows news about future events in prices visible today. This news is often unpleasant, and there is an instinct on the part of government to shoot the messenger. Instead, there needs to be a mature appreciation of the role that the futures market plays.