29 Pages Posted: 5 Aug 2008
Date Written: July 12, 2008
On 7 May, 2008, the Indian Government announced the ban futures trading in four agricultural commodities - chickpea, potato, rubber and soy oil. The purpose of this paper is to examine the rationale behind the ban and study how logical the decision to impose it is. The stated purpose of the ban was to control inflation. However, of the four banned commodities, only the price of potato declined after the ban due to the bumper crop.
The rising inflation rate, pegged at 11.42% for the week ended 14 June, 2008, has been attributed to a number of factors, including the 56% increase in global food prices over the past year, record crude oil prices (over $140 a barrel), the diversion of land for bio-fuel production, loose monetary policy in emerging economies, and the adoption of an expansionary fiscal policy by the Government.
An analysis of spot and futures prices of the four banned commodities shows a high degree of positive correlation in the prices of the two markets. The prices are interdependent: the futures markets give signals to the spot markets on the direction in which prices will move in the future and the futures prices are determined on the basis of the conditions in the spot markets. Speculation may drive prices further up, but a speculator expects prices to rise due to the market conditions, and doesn't arbitrarily bet on a price rise. The extent to which two markets influence each other depends on the level of integration of the two markets. Developing the spot markets along with the futures markets and ensuring higher participation from the farmers is essential to integrate the futures and spot markets. When the participation by consumers and producers of agricultural commodities in the futures market is low, the debate over the futures ban becomes irrelevant.
Keywords: Derivatives, Futures Trading, Commodities, Agriculture, Policy
JEL Classification: E31, G18, G28, M20, 013, 016, Q18
Suggested Citation: Suggested Citation
By Alok Mishra