The institution of formal commodity futures market in India is almost as old as in the USA and UK. The Indian experience, however, is much older as references to such markets in India appear in Kautialya’s Arthasastra. The first organized futures market was established in 1875 under the aegis of the Bombay Cotton Trade Association to trade in cotton contracts which was followed by oilseeds and food grains. Before the Second World War, a large number of commodity exchanges trading futures contracts in several commodities like cotton, groundnut, groundnut oil, raw jute, jute goods, castor seed, wheat, rice, sugar, precious metals like gold and silver were flourishing throughout the country. During the Second World War futures trading was prohibited. After Independence, especially in the second half of the 1950s and first half of 1960s, commodity futures trading again picked up. However, due to shortage during the early and mid-sixties futures trading in most of the commodities was prohibited.

The Forward Contract (Regulation) Act, 1952 a Central Act, governs commodity derivatives trading in India. The Act defines various forms of contract.

Ready delivery contracts are contracts for supply of goods and payment thereof where both the delivery and payment is completed within 11 days from the date of the contract. Such contracts are outside the purview of the Act.

Forwards contracts are contracts for supply of goods and payment where supply of goods or payment or both take place after 11 days from the date of contract or where delivery of goods is totally dispensed with.

The forward contracts are categorized as specific delivery contracts and other than specific delivery contracts. The specific delivery contracts are those where delivery of goods is mandatory though the delivery takes place after a period longer than 11 days. Specific delivery contracts are essentially merchandising contracts entered into by the parties for actual transactions in the commodity and the terms of contract may be drawn to meet specific needs to parties as against standardized terms in future contracts.

The specific delivery contracts are again of two sub types, namely, the transferable variety where rights and obligations under the contracts are capable of being transferred and non-transferable variety where rights and obligations are not transferable.

Forward contracts other than specific delivery contracts are what generally known as ‘futures contracts’ though the Act does not specifically define the future contracts. Futures contracts are standardized contracts where the quantity, quality, date of maturity and place of delivery are all standardized and the parties to the contract only decide on the price and the number of units to be traced. Futures contracts are entered into through the Commodity Exchanges and are regulated by the provisions of the FC® Act. Options in goods means an agreement for the purchase or sale of a right to buy or sell, or a right to buy and sell goods in future and includes a put, a call, or a put and call in goods. Options in goods are currently prohibited under the Act. An Option Contract is the right (but not the obligation) to purchase or sell a certain commodity at a pre-arranged price (the “strike price”) on or before a specified date. For this contract, the buyer or seller of the option has to pay a price to his counterpart at the time of contracting. It is called the premium. If the option is not used, the premium is the maximum cost involved.

There are two broad categories of operators in the futures markets, namely hedgers and speculators. Hedgers are those who have an underlying interest in the specific delivery or ready delivery contracts and are using futures market to insure themselves against adverse price fluctuations. The examples could be stockist, exporters and producers. They require some people who are prepared to accept the counter party position. Speculations are those who may not have an interest in the ready contracts, etc. but see an opportunity of price movement favorable to them. They are prepared to assume the risk which the hedgers are trying in the futures market. They provide depth and liquidity to the market.

REGULATION

Since futures trading has the risk of being misused by unscrupulous elements, various regulatory measures are prescribed by the Forward Markets Commission. It prevents an individual operator from over trading limit on price fluctuation to prevent an abrupt upswing or downswing in prices, special margin deposits to be collected on outstanding purchases or sales to curb excessive speculative activity through financial restrains. Minimum and maximum prices prescribed to prevent futures prices from the failing below the levels that are unremunerative and from rising above the levels not warranted by genuine supply and demand factors. During times of shortages the Commission even takes extreme steps like skipping trading in certain deliveries of the contract, closing the markets for a specified period and even closing out the contract to overcome emergency situations.

Considering the importance of agriculture in India’s GDP and the genuine requirements of promoting sound commodity futures markets in the country, a number of major reforms have been undertaken since the early 1990s.

These include setting up a separate Department of consumer Affairs (1995) which has been in the forefront for major initiatives in the invigorating commodity futures trading. Major efforts at reforming and strengthening the Commodity Exchanges (1996) such as broadbasing the Board, computerization, professionalisation and onlinetrading are at different stages of implementation in various exchanges. The introduction of futures trading in edible oils, oilseeds and their cakes (1998) was a mojaor landmark in the development of commodity futures contracts in India. Exchanges started in some of these oils and cakes in 2000. Introduction of a major reform package for FMC and the Exchanges by means of a World Bank funded IDF Grant (1998) removing prohibition on all minor oilseed, oil and cake.

National Multi-Commodity Exchange are being promoted. Two exchanges-Online Commodity Exchange of India Ltd., Ahmedabad and National Broad of Trade, Indore- have since started working.

Evidently, the Government has taken a number of major reform initiative for implementation. It is expected that the rest of the package will be in place in the next couple of years. Further, a number of measures have been taken in the real commodity sector for removing hindrances to free the movement of goods, rationalizing tax structure, enhancing warehousing facilities and developing markets.

Together, these reforms put in place the essential ingredients for the development of the commodity markets and futures transactions on modern lines. However, because of various lags between policies, implementation and fruition the full impact of these reforms is still not visible but should be clear in the next one to two years which will result in substantial changes in the area.

The author is Director, Department of Consumer Affairs.