India's farm sector may never be the same again. While close to two million farmers are already exposed to the wonders of an online market thanks to ITC's e-choupal project, others in places like Tamil Nadu are beginning to discover prices of their products through futures/options -- the National Commodities & Derivatives Exchange is currently working on some pilot projects in various parts of the country, and is trying to rope in bankers to fund the farmers.
And while farmers who are selling part of their produce to NCDEX (based on the current futures-price) at the sowing stage itself will not be able to gain in case spot prices go up, this is expected to change once the new government comes in.
An amendment to the Forward Contracts Regulation Act of 1952 is expected, and this will allow the use of 'options' in agricultural produce as well -- since the Rajya Sabha has passed the Bill, it has not lapsed.
Once this is done, and NCDEX chief P H Ravikumar expects it to be done soon, farmers will be able to take a two-way view of price movements in their commodities.
For now, of course, the biggest users of exchanges such as Ravikumar's, or the MultiCommodity Exchange among others, are going to be corporates and not farmers.
The reason is simple, in exactly the manner in which interest rates and exchange rates affect their bottomlines, companies lose/gain a lot of money in price swings of both inputs they buy as well as the products they sell.
So far, however, few companies have been able to do anything about it since hedging in commodities was banned, and when this was allowed, it took a while for multi-commodity exchanges like NCDEX and MCX to come up.
In fact, according to data from ICICI Bank, for several 'old economy' companies, the expenditure on raw materials accounts for over 70 per cent of their turnover.
NCDEX has done some analysis of the operations of three top corporates, to show the impact of commodity trading -- one is a leading player in the textiles field, another is a large producer of aluminium and the third is a top copper producer.
While NCDEX's study doesn't reveal the names of the companies, it's not too difficult to figure out their names, considering the textiles firm has a turnover of Rs 1,326 crore (Rs 13.26 billion), the aluminium firm Rs 2,639 crore 26.39 (Rs billion) and the copper one Rs 3,406 crore (Rs 34.06 billion).
Not surprisingly, given the importance of commodity pricing to the fortunes of these companies, their share prices have moved almost in tandem with commodity prices.
NCDEX then does an analysis of the impact of commodity price movements on the financials of these companies, and finds that in the case of the textiles firm, in the year 2002-03, its profits could have been hit by as much as 5.7 per cent due to even moderate price fluctuations.
The figure was broadly the same for the aluminium firm, but as much as 46 per cent for the copper firm. Clearly then, commodity trading by corporates is going to be a big thing, especially once the FCRA is changed to allow options trading as well.
Another area where commodity trading makes sense, but is not yet allowed by law, is the mutual funds business. NCDEX has looked at the returns of various portfolios over the last seven years, and done some scenario building by adding bullion to them.
The NSE Nifty Index has been taken as the index for equity and the NSE G-Sec Index is taken as representative of bond portfolios. Since prices of gold and silver are a lot less volatile, in principle, investment in bullion is a useful tool to reduce volatility -- while a pure stocks portfolio had a 24 per cent risk in the seven year period analysed, a half-stock-half-gold portfolio had a 14 per cent risk.
Once the risk is adjusted for, a pure stock portfolio comes out worse than a half-stock-half-gold one. While the risk adjusted returns on pure stock was 3.017, that on a half-stock-half-gold portfolio was 3.327 and that on a half-stock-half-silver portfolio was 3.636.
Risk-adjusted returns of a pure-bonds portfolio was 3.179 as compared to a much lower 2.671 for a half-bond-half-gold one and 3.655 for a half-bond-half-silver one.
The problem, however, is that under the Securities Contracts Regulation Act, 1956 (SCRA), commodities and their derivatives do not fall under the definition of 'securities'. So, mutual funds cannot invest in either commodities like bullion or their derivatives.
If the government is serious about giving a boost to the commodities trade, several other changes will also be required. While individual farmers are unlikely to get into commodities trading, it makes sense for banks to be getting into the business, especially if they are lending to farmers.
Yet, banks are forbidden from dealing in commodities. The issue of stamp duties is also a serious one and needs to be tackled immediately.
If a farmer sells his goods and these are then bought and sold in a demat form (NCDEX is working with the NSDL to create demat options for commodities), does a stamp duty have to be paid?
Going by the current duties on commodities like bullion or even edible oil, it's clear no major transactions can take place -- it's no surprise that most trading in edible oil takes place in Madhya Pradesh, for instance, given that there is no duty on transactions in the state.
Stamp duties have been, well, stamped out for demat shares, it's time to do the same for demat commodities. Given that, globally, commodity trades are far higher than those for stock markets, the impact on the economy can only be profound.
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