Introduction

Commodity markets have existed in India for over a century now, however, the official exchange-traded mechanism we see today only began in 2003. While there have been hurdles in the form of regulatory jurisdictions or liquidity issues, we still have a platform for commodity trading and a forum for debate regarding the same. Let us take a look at the role of commodity markets in India and the role they fulfil:

Commodity markets can help achieve food security

Achieving food security is a considerable challenge faced by the Government of India. Destruction of crops or stored grains due to warehousing issues, climate change, unpredictable weather, and other reasons is, unfortunately, a common phenomenon.

With futures markets, farmers can sell futures on their grains and lock in a price to avoid losses, thereby safeguarding themselves against potential fluctuations in the price. Presently, we can see farmers in India suffering the effects of weaker prices for pulses due to an oversupply in the market in India. This can be dealt with by selling futures on pulses at a price that can provide remuneration to the farmers. As we have seen in Western countries, farmers can trade in the futures markets to hedge the price fluctuations when it comes to agricultural products.

Commodity markets can increase investment in the agricultural ecosystem

Another significant roadblock in the agricultural sector is the lack of adequate post-harvest infrastructure. Due to this issue, a sizable amount of food grains are often lost during transmission or while being transported. This impacts the price situation for the customers adversely and does not benefit the farmers either. Here’s where a commodity market mechanism that is viable for farmers, middlemen, brokers and customers can help generate more investments in the agricultural ecosystems, leading to the development of efficient transport and warehousing facilities.

Commodity markets can create better mechanisms for aggregation and financing

For example, the size and sparseness of the distribution of the farmer population in India calls for better mechanisms of aggregation. While middlemen are currently playing that role, there needs to be greater transparency. Organized commodity markets can help with the efficient and effective aggregation and sale of agricultural products, which farmers can use to their advantage. Financing, which is another important aspect of commodity markets, can also be upgraded. For instance, commodity markets have an institutional mechanism for raising financing against warehouse receipts, creating an organized option for the financing required to deal with such issues.

Commodity markets can enable retail investors to diversify their portfolio

Investors in India have found themselves limited to traditional investment classes such as real estate, gold, bonds, equities and FDs for several years. While the equity market mechanism entails indirect participation in commodities, most investors have not participated in commodities as an asset class directly. Commodity exchange in India is a golden opportunity for investors, small and medium, to explore a new asset class. This portfolio diversification will also help them in diluting the concentration risk that comes with the pre-existing asset classes. The commodity markets widen the scope for investment by presenting an extensive range of options for investors and traders including agricultural products, gold, silver, crude oil, base metals and so on.

Commodity markets can help deal with speculative excesses of the spot market

To illustrate this point, let us consider gold as an example. The demand for gold is driven by speculative purposes to a considerable extent. India relies heavily on gold imports to meet additional demand which national supplies cannot satisfy, however, there are certain pitfalls associated with the imports. There is a lack of productivity benefits that accompany the use of precious foreign exchange goods since speculators and traders prefer holding on to spot gold. A strong gold futures market can help resolve this issue since it can act as a buffer to absorb most of the speculative demand for this precious metal. By doing so, the commodity exchange in India can help save valuable forex resources in the country’s economy.

Commodity markets drive  price discovery, hedging prices and distribution of risk

In commodity markets, traders utilize the inputs they receive about specific market information while participating in futures exchanges. As a result, there’s a continuous price discovery mechanism in effect.

Another important function that commodity markets play is the distribution of risk and the protection it provides to the investor or trader. For example, if a jewellery manufacturer is aiming to hedge against the price volatility of gold, they can do so by locking in the price with the sale of gold futures. This can be applied to other commodity sectors too. As the risk is shared by a greater number of traders and is effectively diluted, more investors can be drawn to the commodity markets.

Conclusion:

India has a long history of commodity trading as well as the exchange of related derivatives. Today it is one of the major producers of a variety of commodities, but the potential of commodity markets in India is still relatively unexplored and underdeveloped. As the production and distribution of several commodities, especially in the agricultural sector, is still controlled by the government, the futures market is subject to strict regulations and trading in futures has only been introduced in a selective manner. In order to allow commodity exchange in India to thrive the market forces must be given enough freedom to play their roles, rather than being limited due to the control over prices. Although commodity markets in India are still in their infancy, they are emerging and developing quickly. Commodity markets have a lot of scope for evolution and will likely play a crucial role in India’s economy in the near future.