The Hindu Business Line : Too much money, too little control

Three apparently unconnected news stories in the media on the same day (June 6) from three different sources; yet, the underlying message is clear. That too much money is chasing commodities; that it is adversely affecting those dealing in real goods; and there is urgent need to curb excessive speculation in the market.

"Nod soon for banks' participation in futures: FMC Chairman" — Business Line; "Copper users urge LME to curb speculation" — Reuters newswires in Business Line; "Over 75% of net foreign capital inflows are hot money: RBI" — Economic Times, Mumbai edition. Each one of these news stories is about flow of funds and its effect on commodity prices or stock prices. Notwithstanding the recent correction, the so-called commodity boom is actually hurting users and consuming industries.

In India, whether wheat, sugar, pulses or soyabean oil, the domestic market prices are surely far from being consumer-friendly. The government's action to contain inflation is at best half-hearted and largely futile.

Worse, at a time when the commodity markets are already distorted and prices of essential goods are artificially high — bearing no real relation to demand-supply fundamentals — there are attempts to further open up the flow of funds into this sector.

New Delhi may be deeply concerned about inflation, but has failed to identify and look into the root causes of the current artificial prices for a large number of essential goods. Currently, high food prices have been caused by a combination of factors — lower production, tightening supplies, too much money flowing into the commodity sector and unchecked speculative tendencies. Instead of taking quick and firm action to curb unnatural price hikes , there are attempts to further distort the market by allowing more money to flow in.

If all this is in the name of liberalisation, then the question is: for whose benefit? Unfortunately, Indian policymakers do not seem to learn from experience.

There is now a move to allow banks, mutual funds and foreign institutional investors to trade in commodities. These cash-rich entities will be allowed to trade bullion and crude to start with, according to the Chairman of the commodity futures regulatory agency, Forward Markets Commission (FMC).

For the fragile commodity sector nothing is more avoidable at the moment and potentially more damaging than allowing excessive flow of funds into it and encouraging concomitant speculative activity. In last two years, despite several actions, FMC has not been able to contain speculative activity in a number of commodities.

In an economy where shortages are becoming endemic, large flow of funds and unchecked role of speculators without a genuine underlying exposure to any commodity can have a disproportionately large impact on prices. The recent unusually sharp rise price of two essential commodities — wheat and pulses — is a case in point.

Unfortunately, futures trading is allowed to be launched in commodities without adequate research. There is little stakeholder consultation, not is any impact analysis done. In the developed economies, it takes up to six months for exchanges to come up with new proposals for launch of new derivative products, while here everyone seems to be in hurry to launch product futures in less than six weeks.

Although the FMC Chairman has said that banks and financial institutions may not be allowed to trade in agricultural commodities, the situation could change sooner than anyone can imagine. Unfortunately, FMC will not be able to prevent banks and financial institutions from extending their business opportunities.