A long way ahead for commodity futures

V Shunmugam

The Financial Express, Oct 2, 2008
(http://www.financialexpress.com/news/a-long-way-ahead-for-commodity-futures/368467/)

Any two-player or team- game in this real world ends up either in a win for one and a loss for the other or in the rarest of the situations both might end up in a tie. It holds true except in the game of discovering the futures prices of the underlying instruments as played on the derivative exchanges, which gives both the players a win-win situation.
At the end of the game, this not only ends up with both the sets of players leaving happy, but also lets their supporters live serenely. In this game of commodity futures all the stakeholders of the economy would also benefit by stable, social, economic and political conditions. So, what do the commodity derivatives exchanges around the world do to keep both the parties happy about it?
It matches the interests of risk takers with that of risk providers, thereby reducing the impact of risks that might affect the entire spectrum of people connected to the commodities due to the price uncertainty. While the interests are being matched, they discover a price that better reflects the fundamentals among the ecosystem due to the transparency it creates. As the prices are being discovered, it helps the market participants manage their risks. Those, who are out of these markets, are helped by transparency in efficient decision making in production, consumption, inventory management and marketing.
Theoretically, as the participants make efficient choices in markets whose functioning resembles the theoretical setting of perfect spot market places (anonymity of the buyers and sellers, universal participation etc.), it collectively leads to an improvement in the economic efficiency of a nation, helping it develop global competency.
As the government’s role declines in a liberal economy, individual and business choices are left to the market forces and hence it is vital that these markets remain efficient to lead the individual and collective choices to keep the economy more efficient in terms of equity with growth, which is better than its past avatar of being regulated.
The degree of success of the decisions taken up based on the market information is dependent on the strength of the price signals. To make the markets more efficient, it is necessary to make them widely participatory. Efficient markets in turn make sure that the goods and thereby the services are produced and marketed at globally competitive prices in the economy.
Penetration of markets into the economy is more of a qualitative phenomenon that would fail to meet the eye of the common man unless that is quantitatively proven. Attaching numbers would help value this utility that is comparable with either the ideal or the best.
Here is an attempt to measure it. The size of the economy is measured in terms of GDP and the size of the market is either the number of lots traded or the value of the lots. So, either the number of contracts traded per million dollar worth of GDP or the value share of futures in every million dollar worth of GDP would be a better measure that makes it comparable with the industries in both the developing and developed parts of the world. The only flaw in this measure could be that the differences in the share of primary sector GDP (whose commodities are traded on exchanges) in total GDP would not be captured and hence this can only be a crude measure of the penetration of the markets into the economy. A better measure would be to compare the lots or their value with the value of the primary sector GDP – a number which is hard to get in most countries of comparison.
Despite the fast growth in the Indian commodity futures industry, the economic penetration of the commodity futures industry is lower than that of the developed economies and few other developing economies as well. If we look at China and put it on a common scale of number of commodity futures contracts traded per million dollar worth of GDP, we rank slightly lower (101.36) than the Chinese markets (110.6).
Attaching the total value of commodities traded as said above and comparing it with the GDP of a given economy would make our markets yearn for those scales to achieve. Given the size of our primary sector and the global benchmark physical markets multiplier for commodities and the current value of the trade happening in them, the commodity futures markets in India have greater heights to scale. Yet, within the short period of four years compared with the short history (10 years) of the Chinese exchanges and the basket of products and participants in their markets, the current level of growth in the Indian markets is no less appreciable.
Comparing the contracts in terms of their value and the value of GDP of the economies, the ranking of our markets would further slip. Given the right policy measures and institutional support to their growth, these markets would not only permeate the Indian economy in a seamless manner, but would also help scale up this multiple player win-win game taking its benefits to the bottom of the pyramid rather than to face the hostile policy environment.