Dawn of a New Era for Price Discovery and Risk Management in New Commodities

In a significant development with the potential to reshape the Indian economy, the government has broadened the scope of the Securities Contracts (Regulation) Act (SCRA) to incorporate 13 additional commodities to be permitted for the launch of trading in derivative contracts on Indian stock exchanges. This move, hailed as a “game-changer” by industry experts, is expected to:

• Enhance Transparency and Efficiency: This move will foster the development of a more dynamic and transparent market ecosystem through the potential transformative effect of the process of these commodities being traded on derivative platforms. Derivatives play a crucial role in price discovery, a process where market forces determine the future price of an asset based on supply, demand, and other factors. This information empowers value-chain participants to make informed decisions, improving efficiency throughout the ecosystem of the respective commodities with vibrant derivatives trading behind them.
• Minimize risk at both ends of the value chain: Consider the Indian turmeric market, valued at over ₹70,000 crores annually. Price fluctuations are common, denying farmers a better price even though consumers may be paying far higher prices. Derivatives trading can provide much-needed stability by allowing farmers to lock in future prices beforehand, mitigating the risk of sudden price drops. This, in turn, can lead to more stable consumer prices, benefiting the entire market.

Strategic Diversification Across Key Sectors

Including these diverse commodities marks a strategic move, encompassing crucial sectors of the Indian economy.  Let’s have a quick look into the economies of the respective commodities to understand its significance :

• Agriculture: Garlic (valued at ₹14 lakh crore annually), apples (₹8 lakh crore), and cashew (₹7 lakh crore) are essential contributors to farmers’ income and the overall agricultural sector. Enhanced market stability through derivatives trading can incentivize increased production and improved quality, ultimately leading to greater food security for the nation.
• Metals: Manganese (₹3.5 lakh crore), a vital component in steel production, plays a crucial role in infrastructure development besides the battery economy. Palladium (₹1 lakh crore), though not directly used in manufacturing, acts as a catalyst in automobile catalytic converters, contributing to pollution control Derivatives trading can help ensure a stable supply of these essential metals and the competitiveness of sectors such as automobiles, infrastructure, oil refining, etc.
• Construction Materials: Bitumen (₹4 lakh crore) and cement (₹32 lakh crore) are directly linked to the government’s focus on infrastructure growth. Derivatives trading can encourage efficient price discovery and risk management for these commodities, facilitating cost-effective completion of critical infrastructure projects.
• Food Processing: Including skimmed milk powder (₹2.5 lakh crore) and white butter (₹1.2 lakh crore) can bring much-needed stability to the dairy industry. These ingredients are crucial for producing various dairy products like cheese, yogurt, and confectionery. Stable and predictable prices through derivatives trading can encourage investments in the food processing sector, leading to increased production of nutritious and protein-rich dairy products, contributing to improved dietary intake for the population.
• Intangibles: Freight services, a ₹12 lakh crore industry, can benefit from derivatives trading by enabling businesses to hedge against price fluctuations in transportation costs. This can lead to more efficient logistics and competitive pricing for businesses across various sectors. Weather derivatives, a nascent market, can also empower agricultural stakeholders to manage weather risks, a significant concern for Indian farmers.

Unlocking Potential and Driving Sustainable Growth

Launching these commodities on derivative platforms will attract more domestic and international participants who are stakeholders in the ecosystem. This, in turn, will lead to increased market liquidity, increased robustness of the market and its price discovery process, and boost its ability to provide a cost-effective risk management platform. A deeper market signifies a larger pool of participants, leading to more stable prices and a reduced risk of sudden price shocks for the entire value chain.

For instance, India’s per capita income is expected to reach ₹2.5 lakh by 2025. With rising disposable incomes, consumers are expected to demand more processed and value-added food products. This increased demand highlights the need for a robust food processing sector valued at approximately ₹20 lakh crore. Increased market liquidity through derivatives on multiple relevant raw materials can lead to stable and predictable prices. This stability can encourage investments into the food processing sector, driving technological upgrades, and fostering overall growth. As the sector expands, it is poised to create numerous employment opportunities, contributing to economic prosperity and sustainable development.

Further Considerations:

• Market Development: Indian commodity exchanges can develop new derivative products tailored to the specific needs of the stakeholders of the newly included commodities. This will attract a wider range of participants and increase market depth.
• Investor Education and Awareness: Creating educational initiatives to inform potential participants, especially farmers and small businesses, about the benefits and risks of derivatives trading is crucial. This will foster responsible participation and build trust in the market.
• Technology Adoption: Embracing cutting-edge technology solutions like online trading platforms and mobile apps will enhance accessibility and convenience for participants, particularly those in remote locations.  Leveraging technology for price dissemination will help the ecosystem be empowered to add value to all the commodities cost-effectively.
• Risk Management Framework: Developing a robust risk management framework with strong margining requirements and clearing mechanisms will be essential to ensure market integrity and stability.

Conclusion: A Catalyst for Transformation

Including these 13 commodities in derivatives trading marks a significant step forward for India’s financial markets. By fostering transparency, efficiency, and risk management, this move has the potential to:

• Empower stakeholders across various sectors, from farmers and producers to consumers and businesses.
• Drive sustainable growth by encouraging investments, technological advancements, and increased production in key sectors.
• Enhance India’s global trade competitiveness by facilitating efficient price discovery and risk management for crucial commodities.

As India navigates this transformative shift, a collaborative effort among policymakers, regulators, exchanges, and market participants will be crucial to ensure this key initiative of including commodities relevant to the modern economy and its growth aspirations,  successful implementation and long-term benefits. By leveraging the potential of derivatives trading, India can unlock new opportunities for economic growth, stability, and prosperity.  What can be a better guide than the Chinese derivative markets, whose vibrancy contributed to its commodity consumption and export of manufactured products based economy remain competent in a volatile word.