A

Joint Endeavour

COMMODITY INSIGHTS
A BaNK OF EXCLUSIVE KNOWLEDGE aND INFORMaTION ON COMMODITIES ECOSYSTEM

YEARBOOK 2011

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Commodity Economy During Recession and Recovery

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MARKET COMMENTRY PROLOGUE INTRODUCTION

EXPERTS' VIEWS

INDIAN ECONOMY

About Commodity Insights

The idea behind Commodity Insights, a bank of exclusive knowledge and information on the commodities ecosystem, jointly published by the Multi Commodity Exchange of India Ltd and PricewaterhouseCoopers, is to provide economic stakeholders like traders, processors, consumers, financial institutions, policymakers, analysts, industry observers, academicians, and students with rare insights into the commodities ecosystem. This is our third consecutive humble step in making the Yearbook a benchmark resource by spreading market intelligence through easy-to-access useful data and a rich repertoire of analytical articles to portray an all-inclusive, up-to-date and lucid exposition of a range of issues and concerns that are of paramount importance to a healthy development of the entire ecosystem. The focal point of Commodity Insights Yearbook 2011 is Commodity Economy during Recession and Recovery. To achieve this goal, we have sought to achieve keen and intense engagement of internationally acclaimed experts who are prolific authors in their own domain, especially when it comes to ideation and providing leads for informed decision-making on the policy front. In this edition, our value-adds include rare granular-level data on the Indian economy, time series data giving a broad span temporal perspective to the commodity economy, etc. The Yearbook, we believe, will prove to be truly useful and a fascinating read for the stakeholders as a one-stop, ready-reference material for the years ahead.

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About PwC
PwC (www.pwc.com) firms help organisations and individuals create the value they are looking for. PwC has a network of firms in 158 countries with close to 169,000 people committed to delivering quality in assurance, tax and advisory services. In India, PwC (www.pwc.com/India) offers a comprehensive portfolio of advisory and tax & regulatory services, each of which presents a basket of finely defined deliverables. Indian network of PwC firms also provide services in Assurance, as per the relevant rules and regulations in India. Providing organisations with the advice they need, wherever they may be located, PwCs highly qualified, experienced professionals, who have sound knowledge of the Indian business environment, listen to different points of view to help organisations solve their business issues and identify and maximise the opportunities they seek. PwCs industry specialisation allows help its clients co-create solutions for their sector of interest. In India, PwC is located in Ahmedabad, Bangalore, Bhubaneshwar, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai and Pune.

About MCX
Multi Commodity Exchange of India Ltd. (MCX) is Indias leading commodity exchange based on the value of commodity futures contracts traded. The demutualised Exchange has permanent recognition from the Government of India to facilitate online trading, and clearing and settlement operations for commodity futures across the country. It offers trading in over 40 commodity futures based on contract specifications, from a diverse range of classes including bullion, ferrous and non-ferrous metals, energy and agriculture. The same underlying physical asset traded under different contract specifications is regarded as a separate commodity future. A majority of these commodities are significant in the Indian and global context, and are also traded on international exchanges. MCX (www.mcxindia.com) was the 5th largest* commodity futures exchange globally in terms of the number of contracts traded. The Exchange was also the worlds largest* exchange in silver, the second largest* in gold, copper and natural gas, and the third largest* in crude oil, with respect to the number of futures contracts traded.

* Source: Data published for the period between January 1 and June 30, 2011 on the websites of the exchanges, use of Market Data and FIA volume survey, September2011. Disclaimer: Multi Commodity Exchange of India Limited is proposing, subject to market conditions and other considerations, a public offer of equity shares by way of an offer for sale and has filed a Draft Red Herring Prospectus (DRHP) with the SEBI. The DRHP is available on the websites of SEBI at www.sebi.gov.in and the book running lead managers at www.edelweissfin.com, http://www.online.citibank.co.in/ rhtm/citigroupglobalscreen1.htm and www.morganstanley.com/indiaofferdocuments. Investors should note that investment in equity shares involves a high degree of risk and for details in relation to risk factors, please see the section titled Risk Factors in the DRHP . This advertisement may not be published or distributed in the U.S., Canada or Japan and is not an offer or solicitation of an offer for sale of securities in the U.S. These securities have not been and will not be registered under the U.S. Securities Act of 1933, as amended, and may not be offered or sold in the U.S. absent registration or an exemption from registration under such act.

www.mcxindia.com / www.pwc.com/in/en

A PwC & MCX Joint Endeavour

EXPERTS' VIEWS

INDIAN ECONOMY

Contents
Message......................................................................................................................05 Foreword ...................................................................................................................07 Prologue.....................................................................................................................08 Experts' Views:
Commodity price movements: Understanding causes and consequences John Baffes, Senior Economist, World Bank .............................................................................14 Business cycles and their relationship with the commodity economy Stephan Pfaffenzeller, Lecturer Economics, University of Liverpool ...................................18 Can the commodity economy be decoupled from the financial sector? Adam Gross, Director of Strategy Bourse Africa........................................................................ 22 Recent trends in global commodity prices and regulatory responses: Which way now? Partha Ray, Professor of Economics, Indian Institute of Management - Calcutta ..................28 Commodity cycles : Follow or cause economic cycles Robin Roy, Associate Director, and Sanjoy Majumder, Senior Consultant, Financial Services, PwC ..... 36 Chinas pre-eminence in the global gold market Jeffrey M. Christian, Managing Director, CPM Group .........................................................................40 Re-writing the rules of the game: evolving contours of global regulatory regimes to govern derivatives Michael Greenberger, Law School Professor, and Michael Vesely, JD, University of Maryland ....44 Market as a bail-out institution: Commodity exchanges in liberalised trade regime Nilanjan Ghosh, Head Research & Strategy, MCX............................................................................ 50

Market Data for Ready Reference:

Indian Economy An Overview....................................................................................................... 54 Non-Agricultural Commodities........................................................................................................74 Agricultural Commodities ...............................................................................................................178
Every effort has been made to ensure high quality and accuracy of contents in the Yearbook. Under no circumstances, MCX and/or PwC shall be liable to any user for unintended/accidental errors. The opinions/views expressed and shared by domain experts/authors in all documented materials are their own and do not necessarily reect those of the organisations/companies/institutions they bear allegiance to, MCX, or PwC. Sources of information/statements in Experts Views may be found in the references, as indicated by the authors. Users/ readers may carry out due diligence before using any data/information herein; neither MCX nor PwC will be responsible for any discrepancies/ disputes arising out of such use. All rights reserved. No part of this publication may be reproduced, or transmitted in any form, or by any means electronic, mechanical, photocopying, recording, scanning, or otherwise without explicit prior permission of MCX or PwC.

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PROLOGUE

EXPERTS' VIEWS

INDIAN ECONOMY

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EXPERTS' VIEWS

INDIAN ECONOMY

Has commodity economy

really decoupled?

While the jury is out on the linkages between the commodity economy and the financial sector, what has emerged as a clear message from the recent turmoil is the strength of well-regulated exchange-traded derivatives as a safe risk-mitigating tool one that ensures rather than disturbs economic stability.

he clouds of a prolonged recession that first gathered on the global economic horizon with the sub-prime crisis in the American housing market in 2007, and thickened after the collapse of the Lehman Brothers in 2008, stubbornly refuses to dissipate. The weak spots in economic systems have been exposed, while whole societies are witnessing unprecedented turmoil owing to vulnerabilities created as a result. Thus, near-total freeze of trade credit shook the otherwise

solid foundation of Asian economies at the height of the economic downturn in 2009, while an overtly liberal fiscal agenda followed by European nations for years has made them pile unsustainable levels of debt, leading to a potential crisis. Consequently, large sections of the world economy are staring at a seemingly unending period of economic stagnation with apprehensions of deep social unrest. While commenters and scholars have been analyzing threadbare all relevant strands during the

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www.mcxindia.com / www.pwc.com/in/en

A PwC & MCX Joint Endeavour

PROLOGUE

EXPERTS' VIEWS

INDIAN ECONOMY

Hedging against commodity price gyrations has become a sine-quanon for healthy corporate bottomlines, as much for farmers profitability.
current instability in global financial markets, an aspect that has been left less examined and, as such, deserves an inquisition is the impact that the recent economic downturn has had on commodity markets. The interrelations among the real sector, the financial sector and the commodity economy have grown both in depth and in complexity over the past decade so that the developments in one have immediate impact on other sectors. More importantly, the manners in which these interrelations play out and manifest have undergone some visible changes themselves, thanks to the rising complexity just mentioned. For instance, some observers have commented that for a few commodities that have an unambiguously positive and strong correlation with economic cycles, the decline in prices during the recent downturn has been muted compared to previous cycles. For some commodities, there has been no discernible impact at all. These stylized facts raise the important question: To what extent has the oft-talked-about decoupling of the commodity sector actually taken place? On the other hand, it is also possible that as against earlier downturns, the timing and force of counter-cyclical policy interventions have been of higher order during the present downturn. Such expansionist policies, aimed at arresting economic contractions, could have worked their way into asset markets lifting prices across asset classes, including commodities. Proliferation of financial instruments that have commodities as the underlying could also have contributed to this linkage between counter-cyclical policies and commodity prices. However, it is still far from being clear as to what extent this factor would have been at play and what reasons can be attributed to the differential impact on different commodities. The other significant development in the last decade has been the unprecedented growth of a number of large economies, generally referred to as the emerging economies, whose growth has been 10 Commodity Insights Yearbook 2011

associated with concomitant huge demands placed on natural resources. During the financial crisis of 2008 and after, these emerging economies remained largely unscathed and experienced only a slowdown while most developed economies were reeling under recession. It is, therefore, possible that the forces of demand and supply of multiple commodities have appeared to act during the recent downturn in manners different from those in the earlier recessions. The macro changes observed in the commodity economy during the recent global economic downturn have had several and severe effects at the micro level too. Corporate bottomlines, especially of firms majorly exposed to commodities and those involved in international trade, have been affected significantly by commodity price volatility. These developments have made firms look out for hedging devices and practices to protect their bottomlines. While many of them found commodity futures as a safe platform to hedge their risks, it was time they needed to cast a relook at their existing hedging strategies in light of the changing paradigm of downturn in all markets they have stakes in and the interconnectedness among them. For instance, the prices of most commodities attached to global markets are found to be impacted thrice by economic events such as the recent one. First, by the economic event itself; second, by the demand-supply fundamentals, which are affected by the event; and third, by the movements in the markets of those currencies in which global commodities are mostly denominated in. Thus, hedging against commodity price gyrations has become a sine-qua-non for healthy corporate bottomlines, as much for farmers profitability. In this context, the role of exchange-traded commodity derivatives, vis--vis over-the-counter (OTC) derivatives, has been receiving renewed attention in recent years. This attention is a direct offshoot of the failure of loosely regulated off-exchange derivative products in the US and other developed markets that led to the crisis in world financial markets in 2008-2009. Indeed, the global crisis was, in many ways, a crisis of market regulation. It is for this reason that the US, the EU and many other countries are currently going about tightening the regulatory frameworks that govern their financial and commodity markets. The crisis was also one of trust, which myriad OTC products that proliferated before the crisis bred but eventually killed in the developed markets. The noticeable growth of the transparent exchange-traded commodity deriva-

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tives market, even as the OTC market is shrinking, is the result of both these factors. According to Bank of International Settlements (BIS) data, the gross market value of OTC commodity contracts crashed by 80 percent in just two years, from US $2,213 billion in June 2008 to $457 billion in June 2010. Yet, the number of exchange-traded contracts increased by 38 percent to 2,830 million in 2010 from 2,042 million in 2009. The benefits of transparent and wellregulated exchange-traded commodity derivatives are indeed becoming visible to market players and, no doubt, more so in the wake of the recent downturn. In view of all the above factors, it is pertinent that research agenda either in the commodity sector or in economic cycles include various facets of inter-relationships between them, especially during periods of turbulence in either. This is important for at least two objectives: one, to explore the possibility of using commodity price behaviour as a useful tool for predicting economic cycles. Two, and more importantly, to investigate the degree to which current efforts directed at global economic recovery can be influenced by commodity price movements. The latter is a particularly critical objective to keep in view when formulating effective anti-cyclical policies. Indeed, the exploratory journey to test the inter-linkages among commodity and other financial www.mcxindia.com / www.pwc.com/in/en

markets will throw its biggest benefits to public policy and enable policymakers to tread the careful path in avoiding policies aimed at buoying some markets that often have unintended ramifications for others. As observed above, what has emerged as a clear message from the recent turmoil is the strength of well-regulated exchange-traded derivatives as a safe risk-mitigating tool one that ensures rather than disturbs economic stability. Keeping in tune with these issues of high contemporary relevance, the 2011 edition of Commodity Insights very aptly focuses on the theme Commodity Economy during Recession and Recovery. Accordingly, the Yearbook attempts to scrutinize some of these critical issues and ask questions on the interconnectedness of markets designing appropriate ahead-of-the-curve policy actions, and whether commodity cycles will follow or cause business cycles, going forward. The Experts Opinions, substantiated by Data for Ready Reference, are an endeavour to investigate and flag these critical issues and seek to delve deep into them. Indeed, the mission of the Insights will be achieved if readers are sufficiently invigorated and triggered by the commentaries inside to embark upon a deeper probe, on their own, into the dynamics of inter-linkages among markets and their policy implications. A PwC & MCX Joint Endeavour 11