Farming Reforms – Budgetary Efforts
Agriculture Today July 2009
V. Shunmugam[1]
Unlike his western brethren, no Indian farmer, however large his holding may be, has ever been keen on budgetary announcements to assess the future prospects for his farming business, nor have there been any obvious attempts to lobby for what he needs from this onerous effort made by our FM every year to utilise the country’s financial resources to put the economy on a sustainable higher growth path. The fact that in the past neither the agriculture sector had been taxed nor had there been attempts to infuse capital directly into farmers’ households substantiates their lack of attention. Few learned among them would know this budgetary process transfers enormous amounts of financial resources from other sectors to the agriculture sector in the form of subsidies, funding for research, technology development and dissemination, capital formation, price support through procurement, etc. Of course, the last announced mass loan waiver was also an effort to transfer revenues collected from other sectors to agriculture. Why do we need such large resource transfers? Are they efficient enough for achieving the goals? Despite all these resource transfers, why does the farming sector remain eternally indebted? What did this budget do to break the path trodden by its predecessors? Can this be sustainable? Here is an attempt to resolve all these riddles.
Agricultural commodities are much more essential to the mankind than other commodities, and farmers, unlike other participants in any other organized economic activity, are least equipped to bear the brunt of business cycles that operate in the economy. Also, we cannot afford to keep them away from farming with an output that barely meets the consumption need of our 1 billion-plus population and yet keep the livelihoods of about two-thirds of our population secure. Despite the agri-production shortage, growing population and their incomes, in general, prices of agri-commodities have never kept pace with the prices of other goods and services. That in general needs resource transfer from these sectors to agriculture not only for the sake of sectoral balance but also for its developmental needs. Given that the 28% of our population still lives in poverty, the prices had always been kept lower than their potential through various policy measures. Hence, to sustain farming activity it becomes necessary to subsidize its costs e.g. fertilizer subsidy. However, defeating its purpose, fertilizer subsidy over a time became a payment for inefficiency in both the fertilizer industry and agricultural production as it made farmers turn blind to nutritional requirements. In this regard, the FM announced a nutrition requirement-based subsidy to improve efficiency in its application. This is an innovative deployment of resources to correct inefficiency, but its success will depend on implementation.
Also, a rise in food prices has always evoked strong consumer reaction and a fall is not in the welfare of producers. Hence policymakers adopted a two-pronged approach to managing the same over a long period: price support for crops of economic importance and food subsidy to agricultural products of food importance — one is a direct transfer to farmers and the other indirect — continuing to support availability and affordability of food. This continued support since independence helped us attain self-sufficiency and reduce the incidence of hunger, but inefficiency in its delivery model continues to keep it hurting for the exchequer. With inadequate risk management and stiffness of price expectations, this cost continued to increase. The need of the hour is an innovative, cost-effective mechanism that adds value to both producers and consumers till such time they are equipped to face the market.
Despite large investments irrigational capacities continue to dwindle due to lack of maintenance needing focused attention. In this scenario, plans to effectively tap rainwater to augment groundwater will save our farmers from the declining groundwater tables. Effective plans to recycle wastewater from industrial and household usages will also increase water availability for sustainable agriculture growth. Focused research and targeted delivery of technology of the public sector will help maintain equity among farmers and make farming a sustainable activity. Strengthening of policies and providing incentives to promote private investment in technology development, market infrastructure, alternative marketing platforms and information dissemination for effective decision-making will go a long way in helping our farmers face the markets rather than look to the government or public sector spending for support.
While the resource transfer remains unduly high compared with the lost value (of total agri-commodities transacted in the markets) due to government policy restrictions, canalisation of these resources remains the key issue due to which farmers continue to remain indebted despite being free of any tax burden and a colossal Rs. 16,500 crore (2009-10 Budget estimates) proposed to be invested in the agriculture sector. Fertilizer subsidy canalisation as per nutrient requirement is innovative in terms of bringing in use efficiency, and only more such innovation in delivering the rest of the resources targeting the problem areas to provide the best possible solutions can make our farming sector more vibrant.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
Wednesday, 12 August 2009
V. Shunmugam[1]
Dalal Street Investment Journal July 2009
It was a bold attempt on the part of the finance minister to state the government’s objective to put the country on a long-term growth path, taking a chance at the deteriorating fiscal situation especially at a time when the human memory is getting shorter. It should have sent to the markets the signal that they can have a higher P/E ratio and, thus, invest in the economy to reap the demand created for the organized sector-offered goods and services. However, the markets (at least the cumulative index indicator) went swirling down keeping everyone — except those who pulled them down — baffled about who seemed to know or better analyzed the impact of the announcements being made by the FM on the floor of Parliament before reacting to it in the markets and as to is it so market-unfriendly a budget to talk about. It leaves one wonder: why did the markets react so strongly (almost the steepest decline in the past decade – see table), making a large portion of the investors run for cover in apprehensions that lower-than-expected returns were already built into their investments?
Worth to note that both electronic and print media debated the episode widely, putting the reasons on the expectations of the markets and the disappointments. What came out clearly was that the government had failed to detail the fine lines of the reform measures that it was expected to carry on, thus making investors lose faith in the expected growth story and reform measures that would carry the economy and, hence, the markets higher ups. Besides, the central fiscal deficit was also an area of concern for the large number of institutional (domestic and foreign) investors.
Even two months ago when the UPA government, largely consisting of reformists, won the second term at the Centre, the markets reacted strongly, surging ahead by almost 17% in expectations that the new government would carry out various reform measures during its next 5-year tenure. People who thought this budget did not propose any reform measures should not miss that it did touch the tip of large reform measures that the FM would want to bring in terms of rationalizing revenues and expenditure. For example, it trod upon an area almost none of the previous budgets had touched: reforming the fertilizer subsidy and more innovatively so based on nutrient need assessment and targeting the farmer directly. Also, the FM announced a committee to reform petroleum derivative pricing apart from various other minor reform measures, which will be a big stride towards economic liberalisation. However, the strength of the intent was overtly missing in the announcements (including disinvestment) read out on the floor, and the markets probably missed reading the fine line. Those who could read the fine print of the budget can be sure: those who sold on the day in the market would envy and those who bought would be envied in another month or so. Of course, the proof of the pudding will be in its making.
Also, on the other hand, fiscal deficit at this point of time should not be a concern for a country flush with resources to be able to repay conveniently in future. Of course, a para from the FM on his mid-term policy on deficit management could have done a world of good to the markets. One who looks at deficit should also look at other hard and soft infrastructure investment that the government is intent on making. While, on the one hand, it would generate enormous demand in the immediate term, it would also streamline economic efficiency over a long period in time making the economy more competitive in a globalized scenario — what we strive to achieve. For example, I fail to understand why the markets failed to look at the rural sector spending which will convert cent percent into consumption on the one side and the commodity demand and employment generation — a natural corollary of hard infrastructure investment as proposed in the budget. After all, the markets just lost a part of the flesh that they had put on during the day of election results announcement. The lesson to take home: Rome is not built in a day — a measured reaction is always good for the markets than unwieldy expectations.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
Agriculture Today June 2009
V. Shunmugam[1]
The fact that the economic performance of Indian agriculture still affects more than half of our population, whose economic fortunes are directly/indirectly linked to it, makes it necessary to look at the factors that affect this performance. In fact, all the years that recorded higher national GDP had strong agriculture output following a good monsoon (see table). It is clear that howsoever small the contribution of agriculture GDP to the overall GDP may be; it plays a critical role in deciding the performance of the country’s economy.
While a host of factors affect the performance of agriculture with almost two-thirds of India’s cultivated area dependent on monsoon and monsoon-led recharging of ground and land water systems, the performance of monsoon is very crucial in deciding the fate of those dependent millions. In fact, it takes at least two years of good monsoon for growers to recover from the impact of one bad monsoon year and invest more in their cultivation process. This is clear from the bad monsoon year of 2004-05 that the credit flow continued to increase during the next two years.
Credit flow determines farmers’ ability to make most of a good monsoon and is, in turn, determined by interest rates. Lower interest rates boost demand for credit, while higher credit demand does not necessarily affect interest rates. Here, the relative or real price change, i.e. inflation or deflation, plays an important role. Easing or tightening of interest rates determines farmers’ access to credit from formal and informal sources. This macroeconomic cycle persists in the economy and affects the real GDP. Therefore, though monsoon plays a critical role, credit flow into agriculture is also vital to boost agriculture economy. In good production years too, prices of commodities may fall and hence the agricultural GDP. In contrast, GDP of the services and industrial sectors may rise as the prices of their inputs may have increased or there may have been a perceived rise in the value added by them. Also, the terms of trade between agriculture and other sectors as determined by existence or non-existence of certain policies and institutions play an important role in the same.
Increase in agriculture production and productivity also significantly depends on capital formation both in the public and private sectors as it largely determines the existence of efficient infrastructure for production and marketing of crops. Though the fact that GCF in agriculture as a proportion to total capital formation had continuously declined at the start of this century, relative to the agriculture GDP it had shown a growth to 12.5 percent in 2006-07 from 9.6 percent in 2000-01. Implementation of expected policy changes, including that of Warehousing Development and Regulation Act, would go a long way in improving investments if an enabling environment also develops along. Besides monsoon, credit flow, interest rates, input availability, and infrastructural availability, a major factor that affects farmers’ decision-making towards growing a crop or investing in it is assured returns and the availability of a market. The statutory support prices (by the government) from time to time also determine farmers’ sowing decision. The availability of market for whatever a farmer can grow given his risk/return perception would still be a limiting factor considering the lack of physical and information connectivity between producers and end-users. Reforms in agricultural marketing policies, market infrastructure development, and growth of initiatives such as the National Spot Exchange would only determine the ultimate freedom of choice of growing a crop that a farmer would like to have.
Given the current economic slowdown, the performance of agricultural GDP would play an effective role in regaining the growth momentum we aspire for. It is, therefore, essential that policymakers ensure that necessary investments are made and healthy returns are derived thereof, besides enabling a policy and institutional environment that is conducive to a higher growth path for agriculture.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
Landmines to clear on the 9 percent growth path
V. Shunmugam[1]
Dalal Street Investment Journal June 2009
Economic growth as revealed by the recently released GDP numbers for 2008-09 came as a surprise to economic pundits and financial analysts alike. While important international organizations such as the International Monetary Fund and the World Bank that are monitoring the health of the economy on all its parameters predicted a grim growth rate of 4-5 percent, between them, for the Indian economy during 2008-09, the economy seemed to have come out unscathed with an estimated growth of 6.7 percent, according to the recent economic data release. It is, therefore, critical to look at what made this difference. To top it all, much to our joy, the prime minister recently assured that the economy would take the 9 percent growth path with a call for greater public spending in infrastructure. Accordingly, the markets reacted too.
What made most of the difference in the last year’s balance sheet of the economy is that the government spending alone increased by 20 percent during 2008-09 compared with the previous estimates. While a major chunk of it would have gone into offsetting the high global energy prices, the rest is estimated to have gone into formation of capital assets, as reflected in strong growth in capital formation. While one would have insulated the individuals and businesses from the oil market volatility that existed during 2008-09, the other is essential for long-term sustainability of the growth momentum in the economy. However, the fact that increased government spending came on the back of a higher estimated fiscal deficit (6.2 percent) would make the individuals and businesses a worried lot, as it would be collected from them along with interest costs in future. The moot question: will there be enough collective ability among the stakeholders to pay it back when it is due?
The past experience of deficit-driven growth suggests that the current level of deficit in percentage terms to GDP is not abnormal in our economic growth path. International examples also suggest that this level is much prevalent in a moderately aggressive growth-oriented economy. Also, our systematic repayment of the historically high external and internal debts while managing the cyclical movement of the economy in the past indicates that it is not something to be seriously worried about given the positive side it generates for investor sentiment; the need of the hour for keeping alive the growth momentum. The situation of the government in this case is much the same as that of an individual who yearns to own a home for his physical and financial security by leveraging 20 years of his future income. Of course, bankers know that not in all cases such loans go bad, given the strong risk management principles they adopt.
With the economy expected to pick up the growth momentum, not many jobs lost in the past during the meltdown years would be created in the near future, income of private individuals would remain flat in most cases, and the role of increased government spending vis-à-vis private spending assumes greater prominence. However, it is also critical to see the source of such expenditure that the government can make: as in this case, the revenue from perpetual source of taxes would in all probability shrink slightly or remain the same despite the buoyancy reported in the first two months of this fiscal year. Hence, it would become obligatory on the part of the government to reduce unproductive expenditure (including subsidies) and administration costs; seek additional sources of revenue such as sales of assets and stakes in the public sector; increase the cost of public services, and so on. While it is important to augment the sources of revenue, it is equally important that increased expenditure is parked prudently on such avenues that would strike a balance between short-term and long-term gains. The physical and social infrastructure typically stands for short-term and long-term gains to the economy. A neglect of one can only happen at the long-term cost to the other.
Although these appear to be logical economic solutions to help the new government in achieving its target growth rate of 9 percent for the current fiscal year, it would be interesting to see how the political cost of it unfolds.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
Improved Logistics to Boost Agricultural Economy
Times Shipping Journal April 2009
V. Shunmugam[1]
Despite spending about 15-40 per cent in logistics for transportation and storage of our grains, fruits and vegetables, it has been widely estimated that we stand to lose about 20 per cent of our grains and 30 per cent of fruits and perishables annually due to the poor quality of available logistics or the lack of logistics in some cases. As urban infrastructure developed over a period in time, the nearby urban markets remained the main assembling centres for traders to cater to the demand spread across the nation for a given commodity value chain. Additionally, these also remained the major centres for value addition leading to loss of value addition opportunities and the associated investment and employment benefits at the rural marketing centres. Over a period of time, this led to increasing pressure on the available urban resources not only making marketing and value addition costlier but also leading to a higher cost of available transportation capacity and poor quality of handling and storage.
What ails the Indian agricultural economy? Things have changed over the last decade or so. Technology has played a key role in spreading information across the rural canvass and empowered producers to take decisions based on their need and convenience. Also, increased investment in rural infrastructure (markets, roads, storage facilities, etc) and the expected entry of mechanisms such as warehouse receipts are likely to prop up the balance sheets of agricultural producers. However, nothing may actually change in terms of efficiently and cost-effectively reaching the produce to the consumer. This is mainly because of the fact that due to better the availability of connectivity and transparency, ‘assembling markets’ would continue to play a significant role in accumulating the produce at one place and send it to satellite consumption centres. Despite the current improvement in rural infrastructure, producers would continue to depend upon the major marketing centres due to lack of transparency within and among the rural producing centres compared with urban marketing centres which are more organized and well connected in terms of supply chain participants. The result: assembling as a function continues to add pressure on the transportation and storage logistics infrastructure, eventually reflecting upon the consumer rupee.
There are two ways in which the burden of excessive dependence on the urban assembling markets and the associated logistics can be reduced. One, by way of setting up agricultural logistics parks and connecting them to the info highway; this can reduce the concentration of produce in a particular centre and lessen the burden on the existing logistics thereby cutting on the wastage and costs. The other way in which this can be achieved would be through slow penetration of the national online electronic spot exchanges such as the National Spot Exchange Limited (NSEL) that would facilitate market access and transparency which otherwise was not available at the producing centre level and even if available, open access to make purchases was either restricted due to regulatory reasons or lack of means by which these can be accessed by buyers across the country.
Instead of competing between them these two new initiatives would actually compliment each other to coexist for their mutual benefits. While providing the spot exchanges and their buyers with a one-stop solution to getting agricultural commodities delivered, the logistics parks would also certify their quality and enable transportation to buyers located in satellite consumption centres. The national online electronic spot exchanges would enable buying and selling in these logistics parks, connecting the interests of buyers and sellers across the nation. Added to this, the two entities existing side by side would bring in transactional efficiency in trading of agricultural commodities close to other goods enjoying the benefits of organised logistics.
As far as perishables are concerned, a large part of their wastage can be prevented by putting up cold storages nearer to the production centres rather than the assembling centres. Agricultural logistics parks can house cold storage facilities near the production centres preventing potential losses due to longer-duration transportation. Development of consumption habits among the consumers of perishables in terms of the processed products starting from highly seasonal/high-value products would go a long way in curbing wastages. An agricultural logistics park housing such processing facilities would reduce time and costs besides creating employment opportunities and boosting investment potential in the rural economy.
As these entities develop and advance on to the national agri-horti landscape, necessary policy and institutional changes would have to be brought in to boost their growth and reach. Given the public and commercial interests that exist in coming up of these entities, a slew of fiscal measures, along with public-private partnership mode of operation of this model with stricter guidelines, would go a long way in creating a win-win situation for both producers and consumers. Hence, improving access to the markets and improved logistics would go a long way in boosting the rural economy.
[1] Author is Chief Economist, Multi Commodity Exchange of India Limited, Mumbai. Views are personal.
Prioritizing the Pending Bills
Dalal Street Investment Journal May 2009
V. Shunmugam[1]
Being mandated to be at the helm for the second consecutive term, the UPA government is faced with the daunting task of discussing a few critical finance bills if it intends to take the reforms to the next level, for higher economic growth. Selection and rejection of these bills would be challenging as each of them would have its own merits for an early clearance. While clearing these bills it may not only be useful to heed the issues raised by the respective ministries and departments in deciding the priority but it would also be in the fitness of situation to take the call keeping in view the broader need of the economy.
Having clocked around 9 percent growth every year over the last five years, the economy is set to slow down during the current financial year. The situation is predicted to deteriorate further during 2009-10, with many international and domestic agencies pegging the growth at less than 5 percent. The direct impact of this slowdown is being felt in terms of losses in jobs, as many facilities have either closed down or scaled down their operations in light of plummeting demand. According to the labour ministry, about half a million Indians lost their jobs in a matter of just three months between October and December 2008. The situation is not likely to reverse any time soon given the longer reversal time. While an increasing number of unemployed labours would, understandably, become a social threat, the government, on its part, has been making earnest efforts through stimulus packages.
With such clouds of uncertainty, arising from the ongoing financial crisis, casting their shadow over the domestic economy, it may be just apt for the government to supplement its monetary and fiscal measures with the passage of reform-oriented bills to fight the slowdown. And it may not be much difficult to identify such bills if the importance of strengthening regulation to avoid any major misadventures of firms that could risk the economic growth and employment, and the need to propel the economy are kept in mind. In other words, the bills seeking to strengthen regulation and boost economic growth should be given priority.
Coming to the pending bills, the most striking in the current context is the Banking Regulation (Amendment) Bill that seeks to provide the RBI with more flexibility in tinkering with its monetary policy, providing, among others, more operational flexibility to the central bank to fix the Statutory Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR) so as to make more funds available for stirring growth taking into consideration the inflation target. The amendment also provides the banking regulator with the larger regulatory power to order special audits of cooperative banks for increased effective supervision in public interest that could help in inclusive growth by strengthening the cooperative sector and improving their performance.
The bill that assumes urgency, next, for clearance is the amendment to the Forward Contracts (Regulation) Act, 1952 bill. This aims mainly to restructure and strengthen the regulator of the Indian commodity futures market, the Forward Markets Commission (FMC), on the lines of other key regulators such as SEBI, TRAI, and IRDA. FMC currently enjoys limited power yet regulates a large portion of the country’s commodity derivatives market. For an important and sensitive sector like commodities in India where a large segment of population still lives below poverty line, the need for proper monitoring and, hence, a powerful regulator become all the more critical. A well developed and regulated commodity market would, no doubt, create more direct and indirect investment and employment in the real sector.
Prominent among other bills are the Companies Bill (2008) and the Insurance Laws (Amendment) Bill (2008). By replacing the existing Companies Act, 1956, the Companies Bill does away with the criterion of minimum paid-up capital to start a company, provides for appointment of minimum 33 percent independent directors on board, and allows a single person to set up a company to encourage entrepreneurialism. The domestic insurance sector holds huge potential of new investment since the penetration of insurance is currently abysmally low with insurance premium collection estimated at 3 percent of GDP against the global average of 8 percent. Microfinance Bill which was expecting clearance for long could be another catalyst for inclusive growth. The passage of these two bills would impart a much-needed stimulus to investment and employment besides ‘inclusive growth’. Keeping in focus the broader objective of essentially catapulting the Indian economy to a higher growth trajectory, taking effective care of systemic risks would help the new government serve its mandate.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
Agriculture Today May 2009
Often farmers are thought of as producers whose production process involves a minimal and stable cost, and hence any rise in the prices of agricultural commodities is looked at by many to be in favor of the farming community without any consideration for the cost increase that the farmer would have faced in the light of increasing cost of other goods and services that he would consume either in his production process or for own wellbeing. Only a few, especially those from the policy making domain and academics close to economics of agriculture, would know that there is a strong input-output relationship (either directly or indirectly) that exists between agricultural and other commodities. More directly, these goods and services refer to those starting from production and marketing of agricultural inputs to those involved in marketing of these agricultural commodities. For example, a rise in crude oil prices, as was witnessed worldwide during the first half of 2008, would have made a small contribution to the farmer’s production cost due to the use of diesel in his tractor or pump. However, a larger contribution to the cost increase would be constituted by the rise in his marketing costs (directly – transportation).
Long supply chain is another deficit in our agricultural marketing system that rubs salt on the already bruised farming community, eating a lot into their margins – requiring a series of institutional and policy reforms in agriculture to tune the marketing efficiency in agricultural commodities. Ignoring that, an attempt has been made here to look at the simple terms of trade (TOT) between agricultural commodities and metals (as shown in the table below) i.e. proportionate amount of agricultural commodities that would be needed to produce a given amount of metal. Though our farmers are not constant consumers of metals in their daily life or production processes, this does affect the transportation cost of other agricultural commodities and inputs that they consume to be in the production process. Hence, it is a litmus test to see how the markets for agricultural commodities move unconnected with prices of metals.
A look at the numbers compiled from 2005 reveals that TOT had slightly been favorable to agriculture. As the financial boom progressed during the next two years, it is the metal commodities which have reaped gains and, thus, left the agricultural commodities way back in comparison – as is evident in the deteriorating TOT numbers during 2006 and 2007. However, with the financial meltdown and dwindling stock levels, increased industrial use of agricultural commodities (such as biofuel) during these years led to a turnaround in TOT in favor of agriculture during 2008. Globally also, TOT between agricultural and metal commodities did improve during 2008, passing on its partial effect into the Indian markets as well. The turnaround in TOT at the global level has not been as pronounced as in India, though many agricultural commodities are financially traded globally contrary to what critics might believe. More so, this interconnectedness between metals and agriculture commodities in India has deteriorated during both the burst years and the boom years unlike the normal years and the global experience where both the commodities are financially traded.
The remarkable turnaround in TOT during 2008 could largely be attributed to the longer lag-effect of the metal prices on agricultural commodities and the continued increase in the administered prices of several agricultural commodities, besides a marked decline in the stock levels of several agricultural commodities. Key lessons from TOT movements during the last five years indicate that:
- there is a strong need for closer integration among the markets for agricultural and other commodities
- there has to be increased integration with the global markets through improved trade liberalization to get the pass-on effect into the food economy
- there has to be a market-oriented, transparent food stocking policy to insulate producers and consumers effectively from violent fluctuations in TOT, and
- more importantly, a series of policy and institutional reforms would have to be introduced to improve agricultural marketing efficiency in favor of producers and consumers.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
Dalal Street Investment Journal May 2009
V. Shunmugam[1]
With India being the largest producer and consumer of numerous commodities and its markets increasingly opening up amid rapid globalization, it has been a top priority of our policymakers to transform our markets into a ‘price setter’ from their current status of a ‘price taker’. It is time the markets of the world’s fourth-largest economy (in PPP terms) get liberalized from outside forces and start discovering prices driven by their own fundamentals.
For this the first logical step would be to democratize our markets to enable an efficient flow of information for effective determination of commodity prices. In fact, the online electronic commodity exchanges of India have already taken up this responsibility, thanks to policy liberalization of 2002-03 which coincided with ICT developments that helped penetration of these exchanges through reduced participation costs and growing awareness. While proliferation of products and participants is evident from the phenomenal 159% CAGR at which these bourses’ trade grew between 2002-03 and 2007-08 (FMC and Economic Survey data), in many global commodities the participants tended to discount global price-moving factors rather than domestic information. Again, in many domestic commodities, particularly essential agricultural products, lack of an audit trail left the policymakers doubting the integrity of market participants in the eventuality of a sudden uptrend in the prices sustained by a set of information not clearly available to them, as passed on by the derivative market participants.
Next, it is necessary to have a strong information database for the markets to leverage. Information flowing into a market can be broadly classified into two sets: one that affects overall price levels and the other that represents a particular commodity ecosystem. The first set includes broad economic parameters such as GDP growth, WPI, Interest Rate, Unemployment, etc and, hence, largely affects equity indices and equities with broad economic exposure, besides commodities that are pervasive in all economic activities or are used to hedge against broad economic parameters such as gold, crude oil and electricity.
An analysis of general past trends shows that COMEX gold prices moved in line with the differences between the expected and actual CPI based on US data releases. In the equity markets, the two major barometers of the US economy — Non-Farm Pay Rolls (released by the US Bureau of Labor Statistics) and Personal Consumer Expenditure Index (Core) — took the Dow-Jones Industrial Index of NYSE to levels in line with the difference between the expected and actual data. Similarly, our own BSE Sensex reacted more sharply to the forecast error in inflation compared with the expected levels. But in the case of gold, domestic prices seem to be less driven by the domestic demand for gold as a hedge against inflation than global price signals and traditional demand. This is unfortunate as, with India sharing about 22% of world gold consumption, it is expected that our markets not only discover own prices but also transmit their price signals to other major markets to incorporate them seamlessly.
The second information set consists of data on global and domestic fundamentals of commodities and financial instruments, price information emerging from other markets, investment in marketing infrastructure, weather, rainfall, etc, affecting the respective financial instrument and commodity or its ecosystem. The analysis shows that data on advance retail sales affected Wal-Mart equity prices on NYSE in line with the momentum in the actual data compared with the market expectations, as also was the case with the GM equity price movement based on the vehicle sales data.
The crux: information plays a key role in price determination in any market. Our markets should, therefore, enable cost-effective participation of all those with information to effectively discover prices.
While the participatory strength would be determined by the policy and institutional environment, the amount and accuracy of information available to the participants would need intensive private and public efforts in identifying data sources, cost-effective collection and, wherever possible, attaching a suitable commercial value and innovative ways to publicize and market it. Accuracy can be improved by proactively recognizing the user and market needs. Over a period of time, market participants would drive the accuracy based on the returns to it. Private efforts in strengthening information databases would need incentives and innovation for information to be more coherent and, hence, meaningful to be adequately leveraged. This along with participants’ efforts to leverage the information in a cost-effective way would ultimately drive Indian markets to become a ‘price setter’.
[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.
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