The Hindu Business Line : Fuel futures cautiously

WITH NATION-WIDE MULTI-COMMODITY exchanges proliferating — four at last count — and futures trading started in a number of commodities, there is an air of expectancy in the marketplace. The so-called feel-good factor is fuelling interest in commodity futures even as the physical market for quite a few is booming because of a fortuitous combination of factors. Speculative interest in commodities is heightened by the all-round hype, including in the media. Stock market players are diversifying into commodity futures as they are in a position to leverage their hands-on experience in equities trading.

Speculators — integral to the success of futures trading — are also entering the market to profit from it though they also provide liquidity. However, trading volumes in most exchanges are nothing much to talk about. A major reason is the lack of interest of hedgers or those with genuine underlying interest/exposure in the traded commodity. Hedgers, including many corporates, are still wary of the futures market mainly because of lack of awareness, fear of the unknown, and general inertia. Their perception that futures exchanges are nothing but dens of speculators is not unreal. Their comfort level with the physical market and its characteristic volatility seems to be high, possibly for historical reasons; forward trading and futures trading were prohibited until recently.

Although it is somewhat early to judge the performance of the new futures exchanges based on total number of contracts traded — volumes take time to build — weak participation of hedgers is a matter policy-makers and exchange managers should be concerned about. It is in this context that the proposed entry of foreign institutional investors in the Indian commodity futures market should be viewed. In Kochi recently, the Consumer Affairs Secretary referred to the serious interest shown by foreign bodies to enter commodity futures market. There is little doubt that if mutual funds, financial institutions and foreign institutional investors are allowed a play, the commodity futures market will get a boost. For this, the extant restrictions need to be reviewed. These entities operate in stock futures, so there is no reason why they should not be allowed into commodity futures.

But there is a flip side. While large inflow of funds into commodity futures would increase liquidity and trade volumes, there is nothing to suggest that such a performance would per se deliver benefits to the intended beneficiaries, especially primary producers, processors and exporters. The theoretical basis for allowing large funds to flow into futures trading is sound; but whether the market conditions justify it is debatable. After all, futures trading is nothing but a two-person-zero-sum game; for every gainer, there has to be a loser. Futures trading cannot thrive if it chokes the physical market — for instance, through excessive speculation — and hurts such genuine hedgers as processors and exporters. The futures market is evolving and has some way to go before reaching maturity. Instead of undue haste in introducing speculative elements, a cautious approach is desirable.

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