INDIA: Agricultural Commodity Derivatives (PART 1 of 2)

The Indian Parliament recently enacted fresh laws relating to marketing of agricultural commodities (especially food commodities). As I understand, this has largely had the effect of undoing some of the older laws, in an effort to create an efficient market.

Agriculture has been a state subject and almost all state governments enacted APMC acts, circa 1950s, to bring transparency and bring to end, the overarching discretion that traders could exercise. The objectives were of food security, remunerative prices to farmers and fair prices to consumers. These perhaps served their purpose well during an earlier era. Over time, several areas needing improvement were noted, viz. how to deter cartelization, how to bring down entry barriers, how to better market information for farmers, how to avoid the multiple layers of taxes and fees which was ultimately having the impact of chipping away at farm producers and consumers both.

India is a large country. Unlike most of the other large-population countries such as China and Russia, all of India’s geographies are habitable and arable. The erstwhile naturally-parched strips of lands have been made arable, by stretching water through systems of long canals in arid regions. (A corollary therefore is, that contrary to popular imagination, much of India is not as densely populated as thought of from outside of the subcontinent.)

Since the green revolution brought in mid-seventies has made India a very large agricultural producer (India does not import food in any significant measure, except for edible oils), and also one of the largest consumers of these commodities. Though our agricultural production has gone up, there is lot to be done in terms of having efficient supply chains to reduce the wastages and increasing marketable surplus. Moving and selling commodities from farms to plates and factories, therefore should be such a country’s top priority. That needs good transportation, state-of-the-art-warehousing facilities, and efficient markets. The transportation has improved continually over the last 40 years. Agricultural logistics and Warehousing have improved only in the last two decades, one could say (derivatives exchanges like NCDEX have a remarkable contribution to this). The improvement however has been least in the agricultural market. The only development that had taken place so far was restricted to catchment areas of national-level derivatives exchange delivery centres , but without a corresponding national-level agricultural market. The last point has long been the choke point.

India had national long-distance telephone call rates of $3 per minute in 1980s. Lot has changed since then. The sector was opened-up to competition from private players and national-level integration was completed by giving out pan-India operability to tele-communication firms. Today, the same 1-minute of long-distance domestic telephone call can be purchased for 0.01 US cent. Even the cash-strapped and struggling telecom firms of today provide call qualities that well exceed that of the 1980s.

India’s large food production at national level does not automatically translate into food sufficiency and availability for the whole national landmass as such. Food grains may physically lie at one corner of country, while demand may be burning in another part of country, leading to erratic local price movements. Movement of goods has been made easy after India built nation-connecting roads, starting with its “Golden Quadrilateral” project two decades back. This has changed the way goods are transported and business is done. It has propelled consumerism. Road based tourism has taken off and so also sale of personal vehicles at large scale, apart from building factories, outlets etc. along these roads. Further, likes of Amazons and Flipkarts will usher access to sellers and consumers crisscrossing the nation at a previously unimaginable scale and invest in strengthening supply chain infrastructure for agricultural produce. Ubers and Olas have done that for taxis, further propelling the vehicle market and public convenience. And India’s national payment systems has done it too. Payments can be made and received in real-time, at any of the given 31.5 million seconds that make up a year. Generating trust and dealing with another business at any other part of the country had never been easier.

The larger point is that of the immense benefits that a Very Large Country can create, by integrating itself. Its size is its biggest asset. Not using it to its benefit would be a pity. Yet India was stuck in that pity for a long time in several sector, including in agriculture. India’s agricultural markets acted more in pockets for a long time. One needed multiple licenses to act in agricultural markets across geographies within the country and there coexisted several applicable tax structures. These created inefficiencies. Creating an additional system that allow room for extra-mandi sales, should in paper help efficiencies by eliminating supply chain layers, i.e. farmers get higher prices and consumers buy at lower costs. This should pave way for intra-state trade, enabling farmers to directly engage with agri-business companies, exporters and retailers for services and sale of produce while giving the farmer access to modern technology and infrastructure. Without these set of things happening, the reforms could end up blunted.

What does it mean for the Derivatives Exchanges like NCDEX and MCX that trade agricultural commodities? So far, the derivatives were traded here without a strong underlying spot market that it could rely upon. With the current changes, underlying markets in food commodities may soon find a transparent price discovery and settlement mechanism. India already has a national level trading platform for agricultural commodities (ENAM), and it may grow rapidly now. With a strong spot market, the agricultural commodities derivatives market would grow phenomenally. Hopefully, new reforms in agricultural markets will accelerate much needed growth for the sector and also help in creation of infrastructure and supply chains to help in tapping the true potential for India. We are probably standing at the take-off point.

Things to ponder over:

Can by 2030, agricultural commodities derivatives in India reach US$ 100 billion of outstanding notional value?

Will this create new benchmark international prices in certain commodities?

Will it propel the economic well-being of farm producers and their entire supply chain, by creating economic and stable structures with use of derivatives risk management products such as the commodity options and futures?