Commodity Markets

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COMMODITY MARKETS Organized markets for agricultural commodities, which drive price discovery and enable risk management, are of great importance in the modernization of Indian agriculture. India's government plays a major role in the operation and regulation of the "spot markets," called mandis. Each state has a state mandi board, which in turn governs district-level boards. These district boards authorize the creation of new markets. A market, or mandi, is typically a yard with concrete platforms where farmers collect to sell their produce to wholesale dealers at harvest time. Transactions are intermediated by designated brokers. The brokers act as competing market makers who can offer a price to the farmers and take possession of the commodity before selling it to wholesale traders. Farmers generally do not sell directly to retailers and instead sell their products only through mandis.

Price discovery at mandis takes place by open outcry. Since there is little standardization of the commodity, there is an open-outcry auction for practically every grade of the commodity brought in by farmers. Each mandi employs commodity inspectors, in addition to clerical staff. Inspectors, experts on the commodities traded at a mandi, certify the standard of a commodity when it is brought to market. If a dispute arises between parties, mandi inspectors play the role of arbitrators. Trades generally take place on the same day that a farmer comes to the mandi, and settlement is made immediately. There is no strong link between a mandi and an organized warehousing facility.

Price discovery across the mandis is fragmented, particularly owing to the distances between mandis, the lack of grade standardization, and the lack of price transparency. Farmers are price takers at mandis and have traditionally been unaware of prices prevailing elsewhere in the country. A government-run system named Agmarknet tries to capture prices from mandis and disseminate the information using computer networks. However, there are serious difficulties in the mechanism of recording prices, and dissemination takes place with a lag of one day, which reduces its importance to farmers selling goods.

Two recent developments have helped alleviate the difficulties of price transparency. First, the dramatic growth of mobile phones in recent years has helped farmers acquire better information. In addition, in 2003, the Center for Monitoring Indian Economy and the National Commodities Derivatives Exchange (NCDEX) have embarked on a process of polling dealers across the country, using the "adaptive trimmed mean" methodology to compute reference prices for standardized grades of many commodities. This polling is done three times a day, and price dissemination takes place within the same day.


Commodity futures markets have been present in India since 1875. These markets traded forward contracts on spot commodities such as cotton, spices, oilseeds, and food grains. In 1952 the Forward Contracts (Regulation) Act was put into place, giving the government powers over commodity futures trading. It banned cash settlement and options trading. In addition, extensive trading by the government on many markets—such as wheat and rice through the minimum support price (MSP) policy—stifled price flexibility. MSPs came to exist on rice, wheat, pulses (legumes), oilseeds, cotton, and sugarcane. Large-scale public sector procurement and storage led to a shriveling of the private sector in trading, storage, and transportation of commodities. These restrictive policies were accompanied by numerous other interventionist policies, including barriers upon movement of agricultural goods, and an extensive system of state intervention for agricultural inputs. These factors created a situation in which the agricultural sector became one of the most repressed sectors of the Indian economy.

As a part of this philosophy, and using the powers obtained under the Forward Contracts (Regulation) Act, commodity futures trading was banned on most commodities in the 1960s. In the 1970s trading was permitted on only six commodities: peppers, potatoes, jute, jaggery (unrefined sugar), castor oil, and turmeric. These commodities traded at futures exchanges, which were open-outcry markets that traded a single commodity and that were governed by the brokerage community.

The Forward Markets Commission (FMC) under the Department of Consumer Affairs (DCA) regulated these markets. The exchanges had to obtain prior approvals before they could trade any new contract, including those in which the old contract had matured and the exchange wished to create a new contract for the next period.

When this restrictive framework was imposed upon the futures market, the liquidity for these contracts went underground. A vibrant set of "illegal" futures markets sprang up, which catered to users in the economy while violating laws that banned commodity futures or imposed stringent restrictions upon them. Illegal markets had the additional advantage of avoiding direct tax and indirect tax provisions, which were often designed in a ways that were incompatible with a modern agricultural sector. At centers like Bhabar in Gujarat, active commodity futures and forward trading took place while violating laws requiring registration and regulation by the FMC.

Recent Initiatives

In 1999 government restrictions that prevented futures trading on commodities were removed. From 2000 onward, the FMC worked on the liberalization of existing rules in an effort to foster new kinds of institutional development. The major focus has been upon "national multi-commodity exchanges," which would trade in multiple products, for a community of brokers and market participants from all over the country. By December 2003, there were three exchanges—the NCDEX, the Multi-Commodity Exchange, and the National Multi-Commodity Exchange (NMCE)—trading futures on multiple commodities using order flows from across the entire country. The traded products include futures on twenty-two agricultural commodities, as well as on gold and silver. The trading is done using an anonymous, electronic limit order book, with orders being matched using price-time priority. The contracts are cash-settled on the prevailing spot commodity price.

In cases of commodities that were not legally traded earlier, such as gold and silver, the newer exchanges have escalating growth in volumes. When there are local markets with large volumes on a commodity, the liquidity on the electronic exchanges is much lower. Some exceptions are futures on guar seed trading, in which the liquidity has moved to NCDEX from local exchanges, or pepper, in which NMCE now has a significant share. Overall, futures volumes on the electronic exchanges grew from 1.5 billion rupees in January 2004 to 8 billion rupees in August 2004. This growth in business is likely to continue with new commodities and new products such as options.

Regulatory Architecture

Regulation of spot markets in each state is done by the state mandi board, which also acts as a record keeper of the number of mandis, commodities traded, and so on. The governance of each mandi rests with representatives from the local community of farmers. At the central government, the DCA tracks traded prices and volumes of commodities from the regional markets. The FMC regulates commodities futures exchanges.

Since Indian commodity derivatives share the same contract characteristics of Indian equity derivatives, their regulation and supervision requirements are also similar to those for equity derivatives markets. Due to the over-lap in the regulatory requirement, there was a proposal in 2003 to merge the FMC and the securities market regulator, the Securities and Exchange Board of India.

Susan Thomas

See alsoDebt Markets


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Kolamkar, D. S. "Regulation and Policy Issues for Commodity Derivatives in India." In Derivatives Markets in India, 2003, edited by S. Thomas. New Delhi: Tata McGraw Hill, 2003.

Shah, A. "Improved Methods for Obtaining Information from Dealer Markets." Technical report, IGIDR, 2000.

Thomas, S. "Agricultural Commodity Markets in India: Policy Issues for Growth." Technical report, IGIDR, 2003.

——. "The Jaggery Futures Market at Muzaffarnagar: Status and Policy Recommendations." In Derivatives Markets in India, 2003, edited by S. Thomas. New Delhi: Tata McGraw Hill, 2003.

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Commodity Markets

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