The phrase “governance deficit” may lately have become a staple of coffee house conversation but the fact is that the Indian public has been suffering this administrative lapse in silence well before this term was coined. Though the aam aadmi has to grin and bear the deficit in governance in every single sphere of his life, he is most affected by the poor management of food supply and by inflation. And this deficit manifests itself most pitifully in pangs of hunger if he is at or below the poverty line.
The governance deficit in the food sector in particular and agriculture in general has many facets. Agriculture is perennially plagued by the Constitutional governance deficit – the Centre and States operate at different marketing wavelengths. The Centre’s policy discord between the administered price mechanism and futures/forward trading aggravates the governance problem. (See box).
Grain leakage through the Public Distribution System (PDS) is as common and widespread as littering. Periodic bursts of food inflation occur like seasonal viral fever. The gulf between the price realized by farmers, especially for perishables, and the price charged from the consumer continues to yawn. Yet, the government has not considered designing a food inflation index for the poor.
However, there are indices for agricultural futures in the country. Recently, the Finance Ministry’s Chief Economic Adviser, Dr Kaushik Basu, rationalized food inflation as: “There are certain natural rises and falls of price which are the market’s way of signalling information to consumers. It is not a good idea to flatten out these natural price movements.” Chairing a meeting of the Inter-Ministerial Group (IMG) on inflation, Basu stated the IMG aim was to move from reacting to each and every crisis to making structural improvements in the system of food production and delivery.
The fact is, the physical delivery of foodgrain and other commodities is not mandatory under futures contracts that are struck at the commodity exchanges. Futures contracts are often paper transactions that create illusions of bullish and bearish sentiments, depending on the positions taken by the market operators.
The lame-duck commodities futures regulator, the Forward Markets Commission (FMC), puts it this way: “In the futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any physical delivery of goods taking place.”
The UN Food and Agriculture Organization (FAO) agrees: “Only 2% of futures contracts end in the delivery of the physical commodity.” In a policy brief issued in June 2010, the FAO contends: “Commodity futures are generally traded before their expiration date. As a result, futures also attract investors who are not interested in the commodity as such, but in making a speculative gain. In fact, commodity futures have become increasingly appealing to non-commercial investors as their returns seem to be negatively correlated with returns to equities and bonds. They thus constitute an attractive vehicle for portfolio diversification. This process has provided important liquidity to the market since speculators are assuming risks related to the price of the commodity.”
The Centre has dismissed the charge that forward or futures trading in food items stokes food inflation. It has also skirted political parties’ demand for a ban on forward trading in food commodities. The CPI(M) and eight other Opposition parties noted this January that “the government has not stopped the speculation through forward trading in food items and essential commodities.” While calling for an anti-price rise agitation, they reiterated their demand for a ban on forward trading in food items and essential commodities.
The government has also veered away or at times acted contrary to the recommendations of the Parliamentary Standing Committee for the Ministry of Consumer Affairs, Food and Public Distribution that has repeatedly sought a ban on forward trading in food items. On March 1, for instance, the Minister of State for Agriculture, KV Thomas, defended food futures in the Lok Sabha: “According to information available with the government, no study has identified forward trading as one of the reasons for spurt in agri commodity prices.”
Similarly, he defended telecast of food future prices by the multi-commodity exchange (MCX) in December 2010. Answering a question in the Rajya Sabha, he reportedly said a daily telecast does not have any impact on the spot market.
As put by an Expert Committee that studied the Impact of Futures Trading on Agricultural Commodity Prices (ECFT) in April 2008: “Indian data analysed in this report does not show any clear evidence of either reduced or increased volatility of spot prices due to futures trading.”
It is true that there is no authoritative Indian study that can prove that futures prices influence retail prices. This might be due to the fragmented nature of wholesale and primary markets that lack the requisite infrastructure. Once the futures and spot markets integrate, the movement of price signals from the commodity exchanges and spot markets would be discernible and a cause for concern. Such price linkages have already been established outside the country.
A discussion paper by the US-based International Food Policy Research Institute (IFPRI) issued in June 2010 concluded: “Price changes in futures markets lead price changes in spot markets more often than the reverse, especially when examining returns.” The IFPRI paper added: “The identified causal link also appears to be stronger and more persistent. This finding suggests that the information flow from futures to spot markets has intensified in the past 15 years, probably due to the increase in the relative importance of electronic trading of futures contracts over open auction trading, which results in more transparent and widely accessible prices.”
The FAO Policy Brief believes the issue of inherently speculative futures prices impacting spot prices is wide open. “For each study that finds a positive impact there is at least one that claims the contrary. Indeed, there are a number of reasons to believe that speculation might not have been the main driver of the food price surge,” it adds.
There is, however, unanimity among different entities and studies that investors who have nothing to do with commodities trading are increasingly taking speculative positions on the futures markets. A World Bank Brief prepared for the G8 Summit held in July 2008 quoted the US Commodity Futures Trading Commission (CFTC) as reporting that “around 19% of outstanding rice contracts are held by non-commercial investors (eg companies that might be speculating as opposed to actually hedging against price moves).”
The FAO Policy Brief notes speculative investments could strengthen the trend and push the futures price further from its true equilibrium, especially if many investors jump onto the bandwagon (“herd behaviour”) or those who invest have sufficient funds to influence the market. Index funds are an example of such powerful investors. They have become key players in the market, holding about 25-35% of all agricultural futures contracts. Besides investing large amounts of money, they also hold futures contracts for a long time.
In July 2010, The Hindu Business Line contended: “India needs delivery-based forward trading in sensitive commodities, rather than mere paper-trading by a band of speculators.” But such sage advice as well as political outcry against speculative food futures is falling on deaf ears at the Centre. It is set to open up new opportunities for speculators. The Forward Contracts (Regulation) Amendment Bill, 2010, currently pending in Parliament, has provisions on this count, apart from empowering the FMC.
The Bill provides for introduction of options in goods, including foodgrain and commodities derivatives. It also provides for registration of intermediaries, a provision that can be used by speculators in the garb of assisting small and marginal farmers to participate in the commodities exchanges.
The Centre’s obsession for liberalizing and popularizing futures trading in agriculture raises a fundamental issue: Is forward trading the first and only option to help farmers and consumers realize better prices? The answer is no. Futures trading is just one of several options for mitigating agricultural price and marketing risks.
One important means to mitigating risks is expansion of the scope of minimum support prices (MSP) from major staple grain to all major food crops. This should be simultaneously backed up by timely and effective implementation of crop procurement when spot prices fall below MSPs. Announcement of MSPs six months in advance would send timely signals to farmers to choose and plan their next crop sowing.
The second and equally important means is to expand and implement in a timely manner market intervention schemes for crops such as onions that are not covered by MSPs. The third means is a carrot and stick scheme to prod States to undertake sweeping agricultural market reforms to free farmers from the clutches of traditional market intermediaries and also facilitate free flow of farm produce across the country. The States should be asked to embrace the concept of apna mandis (practised in Punjab and Rajasthan) and its variants such as rythu bazaars (in Andhra Pradesh). The common objective of such markets is to encourage farmers to directly sell their produce to consumers and thus create a win-win situation for both groups. The key lies in ushering in empowerment through farmer self-help groups and cooperatives to manage such market places.
Yet another crucial element of agri risk mitigation strategy should be launching innovative insurance schemes that compensate farmers for any decline in crop prices below the agreed mark.
In such a scheme of priorities, the futures trading should figure last and should for the time being be limited to all commercial crops. Neither the Indian farmer nor the consumer is as yet ready to see through the nitty gritty of futures trading.
The government must give up its strategy of putting the cart before the horse and instead fulfill the pre-requisites for creation of transparent and efficient futures markets.
One such prerequisite is improving the collection, dissemination and reliability of crop cultivation and production statistics. When such crucial data is deficient and unreliable, the futures prices cannot be taken as reliable signals on the pricing horizon.
As noted by the Committee of Experts on agricultural statistics that submitted its report this February, “That the existing system for generating land use and crop area statistics does not provide reliable, complete and timely data is an indisputable fact. This is primarily due to its dependence on tens of thousands of overworked, poorly supervised village officials to compile the data; because of this it is prone to a high risk of errors of omission and commission, and subjective judgments.” The Committee has rightly called for a radical restructuring of the system to ensure objective, reliable and timely estimates of cropwise area and yields.
The government also has to create conditions to enable farmers to participate individually or in groups in the forward markets. As noted by the Working Group on Risk Management in Agriculture for the Eleventh Five Year Plan, there is a negligible participation of farmers in the commodity futures market due to the predominance of small and marginal farmers, lack of awareness and other factors. A great majority of farmers just do not understand the ABC of futures trading or its alternative, the options trading that is proposed under the FCRA Bill.
Even if futures markets are kept free of speculation, the genuine price signals emanating from farmers cannot per se benefit growers. They have to be first empowered through adequate and timely supply of credit and all inputs to seize higher price earning opportunities in the future. In any case, forward marketing of farm produce should be delivery-driven and bereft of pure investors. Let investors play on the stock markets. Let the government open casinos to help stinking rich speculators whet their lust for a quick buck.
As the Food & Water Watch (FWW), a Washington-based non-profit organization, says, the food crisis of 2008 was exacerbated by deregulation of commodities markets that encouraged “a tidal wave of Wall Street speculation — leading to further increases in already rising food and energy prices.” In a report titled “Casino of Hunger: How Wall Street Speculators Fuelled the Global Food Crisis”, the FWW concludes: “Curbing excess speculation in agricultural commodity markets can protect consumers and farmers in the United States and worldwide.”
Under the Indian Constitution, stock exchanges and futures markets figure in the Union list. The Centre has availed of this provision to regulate forward markets in agricultural commodities across the country, even though agriculture, including agricultural marketing, comes under the States. This has led to a Constitutional governance deficit with both the Centre and States regulating the agricultural market in their own ways.
The Centre regulates the forward or futures markets in agriculture through six corporatized national commodity exchanges and 19 regional commodity exchanges. As the name suggests, the Centre regulates future prices of agricultural produce whereas the States regulate the spot prices at wholesale and primary agricultural markets through their respective laws.
According to a presentation by an official of the Union Agriculture Ministry in 2009, there are 7,566 regulated wholesale markets and 20,887 rural primary markets. The average area served by a rural market is116 sq km whereas the average area served by a regulated market is 435 sq km. The National Farmers Commission recommended availability of markets to farmers within a 5-km radius (approximately 80 sq km). This developmental deficit shows the basic challenge in helping farmers market their produce in time. But the Centre is obsessed with creating illusions before the growers through the medium of futures. The States have reluctantly and partially implemented the model Agricultural Produce Marketing Committee (APMC) Act that was circulated by the Centre in September 2003.
To break the near regional monopoly of existing APMCs that are packed with multiple and exploitative intermediaries, the Act provides for setting up of private, cooperative, farmer-consumer and direct marketing platforms. Apart from banning commission agents, it envisages single point levy and payment of market fee. Other features include provisions for contract farming and professionalization of management of markets. Only seven States have effectively implemented the Act by putting in place rules amended under their respective APMC law.
As the Commission on Centre-State Relations said last year, the wholesale trade in agricultural produce is governed by the APMC Acts enacted by States. These old laws empower the States to notify commodities and designate markets and market areas where the regulated trade should take place. These laws do not allow direct buying of agricultural produce by processing industries or exporters – thus preventing farmers from realizing better prices for their produce which was the main purpose of such legislation. In some States, restrictions on agricultural marketing even went beyond the APMC Act. One such example is the monopoly procurement of cotton in Maharashtra. This harsh ground reality shows the irrelevance and wrong prioritization of forward marketing by the Centre.
At the Centre, the subject of agricultural markets is split between two Ministries. The Ministry of Consumer Affairs, Food and Public Distribution oversees the regulation and development of forward markets and warehouses. The Agriculture Ministry focuses on modernization and expansion of spot agricultural markets regulated by the States through Central finances. The latter also operates a Central scheme for developing and maintaining the Agricultural Marketing Information System. Its website – agmarknet.nic.in – uploads daily data on crop arrivals and prices in several hundred markets across the country. The website does not carry speculative futures prices that are available on the websites of commodity exchanges. The disconnect between futures and spot markets is obvious.
The third aspect of governance deficit is the simultaneous existence of price and marketing controls for some sectors such as sugar and futures. When the States fix cane prices and the Centre fixes the monthly quantity of non-levy sugar to be released by each sugar mill, how and to what extent are sugar futures relevant?
It is also a moot point as to whether the farmer decides his foodgrain plan on the basis of minimum support prices announced by the Centre or the speculative futures prices flashed by commodity exchanges.
