SEBI Suspended Futures Trading in Agri Products : Daily Current Affairs

Relevance: GS-3: Transport and marketing of agricultural produce and issues and related constraints; e-technology in the aid of farmers; food processing and supply chain management.

Key phrases: Food Inflation, SEBI, future contracts, Agri-futures, derivative contracts, price discovery, NCDEX, essential commodities, Core Inflation, hedging platform,

Why in News?

To reign in rising food inflation, the Securities and Exchange Board of India (SEBI) has barred exchanges from launching new futures contracts in seven food items for one year with immediate effect.

Keypoints:

SEBI issued directions to stock exchanges in the commodity derivatives segment for immediately suspending trading in derivative contracts in key farm commodities, namely paddy (non-basmati), wheat, chana, mustard seeds and its derivatives, soya bean and its derivatives, crude palm oil and moong for a year.
The derivative contracts in these commodities were already suspended, as per a SEBI statement on August 16 and October 8, respectively.
No new contract will be introduced until further orders. In respect of running contracts, no new position will be allowed to be taken. Only squaring up of position has been allowed.

Derivative contracts are between two or more parties where the derivative value is based upon an underlying asset, in this case agri commodities.

The prices of the derivatives are established by the price fluctuations of the underlying assets.
Derivatives can be traded on an exchange or over the counter (OTC).

Derivatives trading takes place when traders speculate on the future price of an asset through buying or selling of derivative contracts to maximise profit, as compared to buying the underlying asset outright.

Traders also use derivatives for hedging to minimise risk against an existing position.
With derivatives, traders can go short and make profit from falling asset prices. They also use derivatives to hedge against any existing long positions. The ultimate objective is to profit.
This is viewed as a deterrent to bring in price discipline in the market.

Agri-Futures: Like equity, currency or interest rate futures, they allows to buy or sell an underlier at a preset price on a future date. All agri contracts end in compulsory delivery.

Agri products available for trade include Wheat, sugar, chana, soyabean, castor, chilli , jeera futures, etc. Edible oil seeds and oils, spices and items like guar are among the more liquid contracts.
An objective of futures trading is gains reaching farmers, by establishing an efficient price-discovery platform.
This has been achieved to a large extent on NCDEX, in products such as castor, chana, soy complex, mustard, guar, cumin, etc.

National Commodity & Derivatives Exchange Limited (NCDEX) is an Indian online commodity and derivative exchange. It is under the ownership of Ministry of Finance.

Need:

The step is taken to rein in rising prices of essential commodities, which are fuelling inflation.
- India’s retail inflation rate rose to a three-month high of 4.91 per cent in November from 4.48 per cent in the previous month, driven largely by the rise in food inflation to 1.87 per cent from 0.85 per cent
The persistence of high core inflation (i.e., CPI inflation excluding food and fuel) since June 2020 has been an area of policy concern as input cost pressures could rapidly be transmitted to retail inflation as demand strengthens.
- The RBI governor’s assessment is that price pressures may persist in the immediate term.
- The inflation prints are likely to be somewhat higher over the rest of the year as base effects turn adverse.
- However, it is expected that headline inflation will peak in Q4 of 2021-22 and soften thereafter. RBI has projected CPI inflation at 5.3% for FY22.
Moreover, The poultry industry has been demanding a curb on futures trading in soy seed, along with an extension of the import deadline for soymeal, as it was hurting its margins.
- Soymeal is a key constituent of poultry feed meal and its rates are directly connected to soybean prices

Impact:

The imports in such commodities, especially edible oils, would reduce in the short term as traders will not have a hedging platform.
- Hedging, which is speculative in nature, has been made difficult.
- This will lead to release of blocked local produce supplies into the market, which should cool the prices.
- Imports of commodities for speculative gains will be discouraged.
It is believed that speculators have a role in jacking up prices and this needed to be discouraged to curb inflation and support growth as the economy is recovering from COVID-19 impact.
India is the world’s biggest importer of vegetable oil and this measure will make it difficult for edible oil importers and traders to transact business since they use Indian exchanges to hedge their risk.
Agri-futures, driven mainly by NCDEX, have a checkered history with bans often pushing NCDEX back.
- Such frequent bans are not a good development for the market as it affects confidence levels.
- Often, a contract that is banned may not return to the table, which were very effective in price-discovery.
- Even when the contracts are restored, traders hesitate because of the fear of bans.
- As it involves losses for market participants with open positions as they must square off contracts before maturity.

Other Steps taken:

Supply side interventions by the Government had limited the fallout of continuing high international edible oil prices on domestic prices.
The Union Government substantially reduced taxes on imports of palm, soy and sunflower oil.
Union and State Governments had also recently reduced excise duty and VAT on petrol and diesel, aimed at bringing down inflation
- It has both direct effects as well as indirect effects operating through fuel and transportation costs.

Way Forward:

The ban is expected to be lifted by March when the next mustard crop starts hitting the market and prices cool down.
- If the weather remains benign in the coming weeks, India is on course to harvest a bumper 11 million tonnes of mustard in 2021-22, up from 8.5 million tonnes in 2020-21.
The way out is not to ban any contract, but make sure to correct any serious aberration through a combination of higher margins so that if at all the price is getting distorted due to market manipulation, the correction takes place immediately.
Further, talking to potential wrongdoers is another way out, provided trading patterns noticed by the exchange reveals such tendencies.
- Position limits can be changed to ensure undue influence is not exerted by any set of traders.

Conclusion:

We need to keep in mind that bans on trading come in the way of functioning of the market as price-discovery process gets affected because liquidity is withdrawn. The farmers too don’t get clear signals and may start suspecting the market in general. Hence, its to be used as a measure of last-resort.

Source: The Hindu

Mains Question:

Q. Bans on trading come in the way of functioning of the market as price-discovery process gets affected. Discuss.