THE MINISTER OF STATE IN THE MINISTRY OF AGRICULTURE AND THE
MINISTER OF STATE IN THE MINISTRY OF CONSUMER AFFAIRS, FOOD AND PUBLIC DISTRIBUTION
(PROF. K. V. THOMAS)
(a) & (b): Yes Madam, the Food and Agriculture Organisation (FAO) in its Policy
Brief of June, 2010 on the topic ‘Price surges in food markets – How should organised
futures market be regulated?’ has advocated adequate regulation of futures market to foster
market performance, given the fact that the futures markets have become an integral part of
the Food Market and perform an important role for many market participants.
The policy brief analyzes the global price surges in food market between 2006 &
2008. While attributing the rise in food prices to macro economic factors, such as high crude
oil prices, strong demand for crops from the bio-fuel sector, falling stockpiles of food and
lower cereal production, it stated that the upward swing may also have been amplified in the
short term by speculation in organised futures market. However, it clarified that longer term
equilibrium prices are ultimately determined in cash markets where buying and selling of
physical commodities reflects the fundamental supply and demand forces that ultimately
determine the prices. The policy brief stressed the benefits of futures contracts by stating that
these contracts provided an important instrument to hedge against price risk in commodity
markets and were basically used by all traders of physical commodities as part of their normal
trading behavior. While commodity futures had become increasingly appealing to non-
commercial investors (speculators), these speculators provided important liquidity to the
market.
While debating on whether speculation in commodity futures increased price volatility
on food markets, the policy brief puts forth the viewpoint that futures markets have
stabilizing effect as traders merely react to price signals that eventually depend on market
fundamentals. In this way, speculation could even accelerate the process of finding an
equilibrium price. On the other hand, there is a possibility that, in the short term, powerful
investors such as index funds might be attracted by the opportunities offered by the upward
trend of a commodity price, thereby strengthening the trend and pushing the futures price
further from its true equilibrium. The policy brief, however, could not find sufficient
empirical evidence for both the hypotheses and felt that there were a number of reasons to
believe that speculation might not have been the main driver of the food price surge. For one,
price volatility had also been high for commodities that did not have futures markets or
where these markets were not important (e.g. steel & rice). Furthermore, as excess demand in
well functioning futures markets could easily be met by sufficient supply (i.e., by issuing
futures contracts), the effect of speculation on the equilibrium price is relatively small and
short compared to price swings of a physical asset where supply is less elastic or even fixed.
It must be noted that these observations are in the context of global market and not
specifically premised on any particular country. The government is in agreement with the
policy brief of the FAO. The futures market has become an integral part of the global food
market and serves as an effective mechanism for price discovery and price risk management.
The long term equilibrium price of food commodities is determined by fundamental supply
and demand forces as reflected in the buying and selling of physical commodities in the cash
market. As the futures markets plays a very important role of mitigating price risk in the
commodity markets and emitting price signals for not only its users but also for the non-user
stakeholders, effective regulation of the market becomes paramount. In India, the commodity
futures market is closely regulated by the Forward Markets Commission by using stringent
regulatory measures, such as margins, position limits, price circuit limits etc. that limit
unrealistic movement of futures prices in the market. Also, unlike in developed markets, large
investors such as hedge and index funds having the ability to invest large amounts of money
in the futures market and thereby swing the futures prices away from its true equilibrium are
Not Permitted to participate in the Indian market. The conservative regulatory framework in
the Indian commodity futures market and absence of big fund investors ensures that the
market performs its economic functions efficiently.
(c): The policy brief of the FAO does not recommend banning of futures trading
of food items. The report recognizes the need for and economic utility of the futures market
and recommends adequate regulation of the commodity futures market for improvement in
market performance. The government and the market regulator are already effectively
regulating the commodity futures market in India through the use of appropriate policy
framework by the former and stringent regulatory tools and close supervision of the market
on a daily basis by the later. The government does not contemplate banning of futures trading
in food items nor does the FAO suggest any such thing.
The futures market, by serving as a platform for price discovery and price risk
management helps various stakeholders in the food market such as farmers, producers,
processors and exporters to plan their production or purchase / sale, get better value for their
produce and mitigate the price risk. In addition to its aforesaid utility for the market players,
price information emanating from the futures market is useful for policy makers to take timely
corrective policy interventions on the supply or demand side, as the case may be, to redress
the supply – demand gap (which is responsible for price rise in food items). For example, if a
future shortage trend is indicated by the futures market, policy action to incentives the
farmers for higher acreage and / or to liberalise the import regime etc. can be taken to ease the
supply constraints in order to control the prices. Similarly, in an over supply situation,
encouragement of exports, increased consumption by the consumers / processors etc. will ease
the downward pressure on prices (to the detriment of producers). Thus, the futures market
also acts as an indicator or enabler of potential policy changes to manage prices of food items
in future. In view of the above, the government does not contemplate to ban futures trading
of food items.
(d): No Sir, the government has not received any suggestion from any social
organization in this regard.
(e): In view of answer (d) above, the question does not arise.
