India is a commodity powerhouse. It is the largest producer or consumer for commodities that range from milk, pulses and spices to gold, edible oils and industrial crops. It is second largest producer of sugar, rice and cotton. And yet, instead of dictating terms, we follow the prices set overseas for them. What stops us from taking our rightful place in the global order? The feebleness of our market.
The power of any market comes from its ability to set the benchmark price that acts as the reference for all other trades around the globe, whether it is London for physical gold or New York for cotton. India’s commodity markets have been illiquid, ill-equipped and ill-connected ever since their inception in 2003 due to a combination of outdated laws and ill-informed policymakers.
Now, 12 years later, this is set to change. SEBI has taken over as the new regulator and guardian of the commodity market, which will now be governed by the Securities Contracts (Regulation) Act, 1956, applicable to stock exchanges. India’s commodity markets have a fighting chance to emerge from the shadows.
Here are five steps SEBI can take to make it happen.
1. Create policy stability
Commodity exchanges need a conducive ground created by surrounding institutions such as the government, the banking framework and corporate law. Commodity trading has been frequently disrupted by bans and mid-air changes in trading rules. This destroys market confidence despite a strong regulator. As an independent regulator, SEBI should seek a commitment from Central and state governments to adopt transparent and predictable rules for direct interventions, such as changes in trade policies, procurement operations and trading rules. To prevent panicky reactions, it has to rapidly educate the media, politicians, bureaucrats and the public about the role and mechanics of commodity exchanges.
2.Consolidate volumes by expanding the network
Size begets power. Commodity exchanges benefit from strong “network effects”. These mean that more members are better–the more trades exchanges handle, the more liquidity they can provide and the more activity they attract. By connecting hedgers, government companies such as FCI, and farmer bodies, to generate trade volumes that are in multiples of crop production, SEBI can improve price discovery and make the market more efficient.
3. Build scale by allowing better quality of investors and speculators
A large market to which producers, dealers, manufacturers, and speculators converge makes a contract as liquid as a stock certificate or a coupon bond. Allowing banks, mutual funds and large foreign investors to enter the commodity market will improve its risk-insuring function.
4. Connect to overseas markets
Today, no market is an island. In a hyper-connected world, India will only gain if its commodity contracts are listed on overseas exchanges reciprocally so that they are quickly accepted as a reference price.
5. Create a cost advantage
Compared to overseas markets, it is expensive to trade in India. The commodities transaction tax, local state taxes, high brokerage fees and high cost of physical delivery due to poor logistics have made costs a deterrent. SEBI will have to scrutinise each one so that market participants are attracted by favourable terms and remain loyal due to the high cost of switching business away from India.
In 2014-15, 10 out of the top 20 agricultural contracts by volume were traded on exchanges based in China, according to data from the US’s Futures Industry Association. CME’s Chicago Board of Trade was the leading agricultural futures market outside China. Precious metals are dominated by the Comex gold and silver contracts traded at CME’s New York Mercantile Exchange. The Shanghai Futures Exchange is emerging as an important centre for gold and silver trading in Asia.
India has a natural competitive advantage in a wide swathe of this global commodity market. But it remains untapped because little attention has been paid on how to fight competition. SEBI has a historic opportunity to create a wide and enduring economic moat around our commodity markets through sophistication and scale. If it is successful, India–with its 52 million farmers and 1.2 billion consumers–can finally stand up to take its rightful place in the world of food and natural resources.