Opinion Fixing volatility
The Prime Ministers speech on Independence Day recognised that the drought will impact agricultural production. He reiterated that nobody...
The Prime Ministers speech on Independence Day recognised that the drought will impact agricultural production. He reiterated that nobody should go hungry because of this. But also of concern is the terrible effect that volatility in food prices has on some of the most vulnerable sections of our society.
The price of anything is determined is by demand and supply. If demand is elastic it adjusts to the level of supply,leading to rapid price stabilisation. But for agro-commodities,especially food products,elasticity of demand is very low people have to eat. So relatively small changes in supply can lead to high volatility in food prices.
Another uniqueness of agri-commodities in India: supply can be artificially manipulated based on geographical area,which can lead to a big price difference in the prices of food items,and thus large arbitrage opportunities.
The classic example recently was the recent fracas over rice. When rice prices started firming internationally,the government banned rice exports to prevent them from rising domestically. Naturally,they fell within India but internationally,they firmed up further,due to non-supply of rice from a major source (India). This created an artificial,large price difference an arbitrage opportunity.
You could accumulate cheap rice domestically; then tap contacts in Africa,which through diplomatic channels persuade our government to issue orders allowing exports to sub-Saharan countries on compassionate or diplomatic grounds. Then sales on the high seas could be used to divert these consignments to various European markets thereby making huge profits for a selected few.
Similar mechanisms work in domestic markets which are geographically or otherwise dispersed. Then there are rampant unorganised and unregulated markets for controlled agro commodities in India. Dabba trading,or pit trading,also happens in parts,creating a complete chain of intermediaries from top to bottom which restricts knowledge about prices and open positions to a very few operators who could then use it to manipulate market prices. Finally,differential transaction charges levied by exchanges concentrates volumes with a few major operators; so most market participants choose to trade through them (or se dabba traders). This can also create insider information about open positions. Put together,this helps explain why so many small investors lose money in the commodities market and why,in spite of negative inflation,a recessionary economy,and drought that hasnt hit fully supply yet,food prices in the country are unexpectedly high.
Price discovery for food products should be very transparent across geographical areas,should be without too many undisclosed intermediaries,and should be conducted in a well-regulated market. All price-sensitive information should be available in the public domain. Open positions in the market should also be generally known,as they are in well-constructed markets; position-holders should ideally be market intermediaries subject to some regulatory oversight.
The problem is that government policy announcements can sometimes create artificial arbitrages of supply across different areas. This causes massive problems of the sort visible in the discussion about rice and adds to volatility. Fix this: free and fair movability should be permissible across geographical regions. (Sales tax disparity should also to be removed. Different sales tax rates on food items in different states will just hold up the development of a healthy nationwide market.)
The Indian economy,as human enterprise and not value added,is dominated by agriculture. Around seventy percent of our population depends on this segment. A wholly transparent and well-regulated chain must be established between these producers and their consumers. What needs to be done for that? To start off with,well-developed transportation and warehousing facilities are a must. But who is going to invest in that? We are talking of massive infrastructure investment. Without a well-developed commodities market,it will be difficult to find and mobilise the required funds.
All the above objectives can be achieved if the market is brought under a powerful and transparent regulator perhaps in the form of a Forward Market Commission (FMC). on lines similar to SEBI. Political interference could then be minimal. The regulator needs to be given real power,as well as a clear mandate to develop both the future as well as spot commodities market. The unorganised market should be encouraged to wither away; certainly,dabba trading should be scrutinised very carefully indeed for wrongdoing.
India is ready for this. Consumers and farmers are more than capable of taking advantage of a transparent,regulated and liquid market.
The writer is Alternate President of the Commodity Participants Association of India and associated with the BJPs Chartered Accountant cell.
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