Is Government Justified in Banning Futures Trade in Essential Commodities?

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Is Government Justified in Banning Futures Trade
in Essential Commodities? Alka
Parikh Department of Economics, University of
Mumbai This paper has benefited from the
comments by Dr. Abhay Pethe, Dr. Mala Lalvani and
Dr. Romar Correa.
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The key question Are the futures in essential
commodities really responsible for the price
rise? Do the commodity exchanges indeed affect
the prices in the spot markets? Focus of the
study Wheat
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Volume Table 1 Production and Volumes traded of
different commodities Commodity year Trade
vol Production (1) (2) (3) (4) (3)/(4)
Urad 2005-6 7,31,73,050
10,85,000 67.4 Wheat 2006-7 2,30,84,520
7,50,00,000 0.31 Sugar (S) 2006-7 60,570
1,80,00,000 0.003 Chana 2005-6 11,95,26,380
55,00,000 21.7 Pepper 2005-6 7,05,529
50,000 14.1 Source FMC, India,
www.indiastat.com
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Implication The volumes traded are much higher
for urad, chana and pepper. Wheat Volumes
traded are low. Little likelihood of impacting
spot markets.
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Implications This could happen only in condition
of excess supply. Wheat production reasonably
high in last two years Hedgers seem to want to
sell to cover their risks, but few speculators
who want to buy No obvious proof of excessive
speculation
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Price Fluctuations Wheat 10 around the mean
both in spot and futures markets Chana 12-13
around the mean in both spot and futures markets
Pepper 20 around the mean in both spot and
futures markets Urad 5 around the mean in
futures and 10 around the mean in the spot
markets Thus, no excessive volatility in wheat
markets.
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Statistical Tests Based on results of Gurpreet
Singh Sahi Structural Test Chow test No
structural change in spot prices by introduction
of future trade. Also, the coefficient of dummy
variable for post futures years is insignificant
for the tested commodities.
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Grange Causality Test Unexpected trading volume
and unexpected open interest Granger cause cash
price volatility in wheat, turmeric, soy oil and
raw jute. Decomposition Generalised forecast
error variance decompositions For all tested
commodities, variation in cash price volatility
is not explained by futures price volatility or
unexpected trading volume or unexpected open
interest.
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In short, the causality is not strongly
established. Although it is shown that the
direction of influence is from futures to spots,
the extent to which the futures influence spot
markets seems to be statistically insignificant.
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Conclusions Banning wheat markets Not justified
by the data. Further research
questions Pulses Volumes traded are much higher
than production -gt Speculation might prove
harmful in shortage economies. Price discovery
should not become price determination. Spices
Need to examine whether too much price volatility
discourages farmers as shown in the case of
cardamom
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Impact on farmers Information should be
available physically and functionally Studies
show that direct participation of farmers is very
low. Reasons Low awareness Individual farmer
does not have enough supplies to fulfill contract
specifications Thus farmers benefit only
indirectly. But is the purpose of the futures
really to benefit the farmers? The farmer
participation low even in USA. It is an
upgradation of marketing system, let it happen.