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Food Prices, Speculation and Futures' Trading Mon, 2010-01-25 12:42 |  <http://www.pragoti.org/taxonomy/term/1712 Sunanda Sen The role of future trading in commodity markets has often been a subject of controversies in India, between those who look at future markets as a guiding force for price discovery, risk sharing and market efficiency and others who contest such claims, maintaining that future trade has been responsible for speculation-led price increases, especially as at present. Prof. Sunanda Sen, formerly senior professor at the Centre for Economic Studies and Planning (CESP), Jawaharlal Nehru University, writes.    Rising food prices in the country have of late been subject to many disagreements, on factors behind these spurts and also on what would prove as a better policy measure to arrest the latter.  In this the role of future trading in commodity markets has often been a subject of controversies, between those who look at future markets as a guiding force for price discovery, risk sharing and market efficiency and others who contest such claims, maintaining that future trade has been responsible for speculation-led price increases. As it can be expected, the first is shared by those who are active participants in future markets for commodities and also by officials in the government who view future trading with favour. Positions as above are contested by others, who point at the failed performance of such trading in achieving its desired goals. In this view, future markets in commodities can be held responsible for speculation-led price increases. With steady increases in  food prices during the recent past, the official index of food prices as reported by the commerce ministry rose 19.83 percent in the week ending December 31, 2009, with food prices surging after the weakest monsoon in 37 years and floods in parts of the country. This was higher than an annual rise of 18.65 percent a week earlier, and just below an annual 19.95 percent rise on week ending Dec. 2. The hike has been a cause of concern and a lot of distress for consumers. The recent increases include the weekly hikes of a doubling of prices for potato, a 23% rise for onion, 42% for pulses, and 13% for wheat, 12% for rice, 13% for fruits and 11.3% for milk! Explanations offered for the rising food prices include those from the chief of the Forward Markets Commission B.M Khatua harping on the supply-demand aspects of food items that hold that it is the demand-supply mismatch, and not futures which are responsible for the rise in food prices. As held by him, this is reflected in the price rise for articles like vegetables, tur, rice and sugar which are not under future trading. Instead, future markets continue to provide price signals, both to farmers and to the government, the latter to provide suitable corrective measures. While shortfalls in supply as well as spurts in demand can explain part of the steady price rise in food items, these do not provide a complete story. As held by the international think tank IFPRI, for India rising expectations, hoarding and hysteria played a role in increasing the level and volatility of food prices, as did the flow of speculative capital from financial investors. A view close to above has been advanced by  Unctad in its 2009 Annual report, stating that .a major new element in commodity trading over the past few years is the greater presence on commodity future exchanges of financial investors that treat commodities as an asset class. The fact that these market participants do not trade on the basis of fundamental supply and demand relationships and that they hold, on average, very large positions in commodity markets, implies that they can exert considerable influence on commodity price developments The report points at the sharp rise in commodity prices   between 2002 and mid-2008 which has been followed by a reversal. Both of those, as pointed out by  Unctad, were related to the financial market boom which was recently followed by a crash. As pointed out, 'financialisation' also increases price volatility and .hedging becomes more expensive and perhaps unaffordable for developing country users, as they no longer be able to finance margin calls . The same argument probably also holds for intra-country future trade, where use of high margins can deter small traders. Back home, an Estimates Committee of the Parliament was presented at end of November with a recommendation that futures trade in essential commodities for consumption on the ground that such trade may spawn excessive speculation and cause artificial price increase. A slightly different explanation is offered by a researcher who claims that independent of futures, price rise can be explained by stocks held by the government which often fail to be distributed, thus leading to shortages and speculation in the market! Food items which in recent years have been traded in future markets include, among others, Coffee,barley,ground nuts,sugar, desi tur,urad and  rice(till January 2007),castor seed,guargum,gur,jeera, maize.masoor gram,musratd seed, pepper, oil cake and  soya oil (till January 2008)  sugar ( till January 2009) and finally, chilli, castor seed, coriander, potato, dhania and wheat (till now). Future trading in earlier months can still be a factor explaining the current spate of price increases, in the future/spot markets. Financialisation of commodity markets , as pointed out above, rests on the use of derivatives as well as  stock piling in physical terms in these markets. Speculation, which have been active in both the stock market and the commodity market in the country, calls for remedial measures, both in the interest of the consuming public and in the larger interests of avoiding a bubble which can affect the  macro-economy. One     such measure can be, short of a complete ban on entry of footloose FII inflows, a Tobin tax or a restraint on FII outflows unless such funds stay in the country for a minimum time period. To restrain the future transaction related price hikes in commodity markets, it may work to de-list commodities like chilli, castor seed, coriander, potato, dhania and wheat for the purpose of future trading. A stiff rate of tax on commodity trade transaction ( so far proposed at a very low rate and not even implemented) may also serve as a signal to discourage speculation in food via future trading.