The dilemma of what a government can do when faced with soaring inflation and particularly, food prices, was well illustrated in a recent inter-ministerial dispute in Russia: the Finance Minister wants to cut state spending to curb demand and inflation, while the Economic Development and Trade Minister wants to stimulate the economy by increasing state spending, for helping the poor. (There are of course silver linings to Russia's inflation problem: the rising oil price helps GDP growth, government revenues and exports - and inflation has overtaken alcoholism as the policymaker's main worry!).
For us in India, the best illustration of confusing the messenger for the message, of correlation for cause and effect, of the anxiety to be seen to be doing something, is the actions taken in the commodity derivatives market. Not that our policy makers are unaware of the futility, sometimes counter-productiveness, of such measures. The PM has voiced his reservations against administrative measures to curb inflation, arguing that they send wrong signals about our commitment to economic liberalisation and reforms.
The Finance Minister has acknowledged that the ban on futures trading was a political, not economic, decision. The Financial Times (May 19th) has quoted him as saying, "If, rightly or wrongly, people perceive that commodities futures trading is contributing to a speculation-driven rise in prices, then in a democracy you will have to heed that voice".
Interestingly, while the Minister for Agriculture has said that the futures ban was a decision taken by the regulator (Mint May 13), the Chairman of the Forward Markets Commission has said in the same newspaper (May 22) that he does not agree that futures trading has fuelled speculation, adding that the farmers will suffer most from the ban as the big "corporates will go to the overseas bourses and the traders will go to the 'dabba' (unofficial) market". In fact, rubber prices jumped up after futures trading was banned.
Compulsions of politics apart, is there concrete evidence that derivatives trading is at the heart, or even the main cause, of the recent rise in commodity prices? Globally, a lot of money has been invested in commodity funds; but is speculation the real reason for the sharp rise in oil prices for example? Economist Paul Krugman, no market fundamentalist by any means, recently argued in the New York Times, that the only way speculation can have a persistent upward effect on oil prices, is "if it leads to physical hoarding".
This has not happened in the recent run up in oil prices! He argues that oil prices have shot up because of a genuine gap in demand and supply, and that energy conservation has become very important: the French and the Japanese consume much less oil on a per capita basis than the US - but their standard of living is hardly any less.
Coming back to India, the Abhijit Sen Committee was appointed to report on whether there is a linkage between futures trading and rising commodity prices after futures trading in rice, wheat and pulses was banned 16 months back, clearly a case of implementing a cure even before diagnosis begins. The Committee took 14 months to come out with its report, but found no empirical evidence connecting futures trading and price rises.
Nevertheless, Dr. Sen personally, not the Committee, opined that the ban should continue - and so it has, with the addition of four more commodities to the banned list. (Even Dr.Sen termed the latter as an over-reaction.) It almost seems as if the government wants to make it more difficult for the farmer to sell his produce - to keep prices lower! The anxiety to be "seen to be doing something" often overlooks the long term impact of such bans.
As the Chairman of FMC said in an interview "
two years ago
. the jute contract was deactivated because of price controls
. The price ceiling was unfair to the farmers and the jute contract has not taken off since." The issue of empirical evidence apart, before blaming speculators in commodities futures for the price rise, we need to keep a few points in mind, following from first principles: For every buyer hoping for a price rise, there is a seller with an opposite expectation : else a trade will not take place; Speculators are not merely parasitic: they play a very important role in the creating and functioning of a liquid and efficient market.
Hedgers (and arbitragers) alone cannot do it. One example: when RBI regulated that interest futures market can be used by banks only for hedging, the contract was still-born(June 2003); and the less liquid a market, greater the transaction costs and volatility.
In any case, the longer the ban on trading stays, the more the vested interests in its continuation, and greater the difficulty in lifting it, given our great faith in the benign nature of the status quo.
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