The Hindu Business Line : Allowing FCI to trade surplus grains on the futures exchange not desirable

THE Food Corporation of India (FCI) is reportedly toying with the idea of trading its so-called surplus grains (wheat and rice) on the futures exchanges.

The purpose obviously is to cut down losses and manage price risks arising out of its procurement and storage operations.

There is absolutely no doubt that as the country's single largest fine cereals handling agency, the FCI runs the risk of adverse price changes, quality deterioration and cost escalation. These risks have to be minimised so as to reduce the massive burden of food subsidy.

Ironically, over 40 per cent of the so-called food subsidy bill comprises storage and interests costs incurred by the procurement agency for handling wheat and rice.

In 2004-05 fiscal, this amounted to well over Rs 10,000 crore.

Much as the country's grains trade and commodity futures exchanges would be keen to have the FCI on board to hedge its grain stocks, the proposal is not as simple as it looks ex-facie, and is fraught with danger.

First of all, the functions of the FCI have to be understood in the correct perspective. The objective of wheat and rice procurement that the FCI undertakes is to create buffer stocks to ensure food security, supply to welfare programmes including public distribution system and for market intervention when necessary.

These are sovereign functions discharged by the FCI as the arm of the Government of India, Ministry of Food and Public Distribution. Almost all decisions of the FCI are dictated by the Government in its wisdom. The FCI has very little autonomy in matters relating to foodgrains management.

In the discharge of these sovereign functions, losses if any, that the FCI may incur are on Government account and borne by the latter.

In sum, because the FCI operates as per Government directive and has little independent decision making authority (that will have huge cost implication), it enjoys sovereign immunity in the discharge of its sovereign functions.

Once the FCI starts trading grains on commodity futures exchanges, that activity would be a commercial activity, as the FCI would behave like any trader and would be subject to all the duties, liabilities and obligations of a private trader.

The FCI cannot and will not be able to invoke sovereign immunity in case of its commercial activities.

It would, therefore, be necessary to draw a clear distinction between sovereign and commercial functions of the agency. Risks arising out of the commercial functions will have to be borne by the agency itself like any player in the private sector.

This fundamental issue needs to be clearly understood by policymakers before any decision is taken to allow the FCI to trade on futures exchanges. But this is not all ; there are other issues to be examined.

The very structure of the FCI, as at present, is unsuitable for engaging in futures trading. It is common knowledge that the monolithic Government parastatals such as the FCI are bureaucratic in their working. They are ill-equipped to take quick decisions as demanded by dynamic market conditions. Trading on a commodity futures platform requires special skills which the FCI presumably does not posses at present. Bureaucracy within the organisation will prevent the agency from drawing any real benefit from futures trading.

Worse, there is danger of insider-trading. With huge clout gained from holding massive stocks on Government account, the FCI can actually rig the futures market before it takes a decision to sell. Nothing can prevent the agency from manipulating the price to its advantage.

In addition, even if the agency itself does not manipulate prices, those who are privy to FCI's sales decision can take advantage and indulge in undesirable practices, by themselves or through willing accomplices.

Look at it another way. If players in the private sector come know of FCI's decision to sell a large quantity of say wheat at a particular price, the players can cartelise and push prices down, and defeat the price or profit objective of the FCI. These are real possibilities in the present Indian context.

In the current dispensation, allowing FCI to trade its so-called surplus grains on the futures exchange is neither desirable nor necessary. The agency should concentrate on improving efficiency and reducing operational costs. Even the present `tender system' for sale of grains is not transparent and needs to be improved.

Indeed, the FCI should have no surplus in the first place. The country has paid a heavy price in the past for various omissions and commissions that resulted in inventory build-up of 60 million tonne at one point of time, not long ago. The procurement policy itself — open-ended or unlimited procurement — at a fixed price deserves to be reviewed and the role of the FCI in foodgrains handling and distribution reduced.

Allowing futures trading in commodities that are subject to Government intervention — wheat, rice and sugar — is fraught with danger. The price discovery function of the market will not be faultless. Hopefully, policymakers in the Food Ministry will take note.

NCDEX perspective: Confirming that the National Commodity and Derivatives Exchange (NCDEX) was in talks with the FCI, the Chief Executive Officer of the exchange Mr P.H. Ravikumar, shared his views on the subject with Business Line.

Asserting that the proposal is confined to physical sale of FCI's surplus stocks on the exchange platform and not paper contracts on the futures counter, Mr Ravikumar said the tender system to sell surplus grains currently in vogue at the FCI had inherent weaknesses (participants are regional and can potentially cartelise) and that NCDEX's proposal would help address some of them.

The agency is known to obtain relatively low prices in the tender system because of suspect quality (grains are not graded, traders complain) and absence of wider participation of traders from across the country. NCDEX believes that sale through its e-platform would attract wider participation and lead to better price realisation for FCI.

The exchange also believes it would be able to guarantee sale of all the material FCI places with it for disposal. In order to address the problem of sub-standard or non-uniform quality, NCDEX has proposed that it is in a position to grade the grain stocks the FCI intends to market as a result of which pricing would be quality-related.

Mr Ravikumar asserted that many of the problems associated with fine cereal procurement and disposal would be sorted out when `options' trading is introduced.

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