Dissertation Report on Study the impact of Monetary Policy on Commodity Price

Submitted in Partial Fulfilment of the Requirement of the Dissertation in the Master of Business Administration Programme (Full Time) 2009-11

Author: Ashish Sarkhel (091309) Faculty Guide: Prof Kshamanidhi Adabar Date of Submission: Jan 11th 2011 Institute Name: Institute of Management, Nirma University ,Ahmedabad

Table of Contents
Table of Contents........................................................................................................ 2 List of Figures..............................................................................................................5 List of Tables............................................................................................................... 6 Abbreviation................................................................................................................ 6 Letter of Approval .......................................................................................................7 Acknowledgment.........................................................................................................8 EXECUTIVE SUMMARY..................................................................................................9 Chapter 1.................................................................................................................. 10 Introduction...........................................................................................................10 Background............................................................................................................ 12 Literature Review...................................................................................................13 Objectives:............................................................................................................. 18 Chapter 2.................................................................................................................. 19 Research Plan....................................................................................................... 19 Selection of Monetary Indicator.............................................................................19 Selection of Statistical Method...............................................................................22 Methodology......................................................................................................... 22 Hypothesis - Filtering random parameter .............................................................22 Develop the Model for Individual parameter .........................................................22 Develop the Model with all parameters..................................................................23 Data Source (Secondary Data)..............................................................................23 Monetary Indicator:................................................................................................23 Commodity Indices.................................................................................................24 NCDEX (National Commodity and Derivative Exchange Ltd.)..................................24 1.1.1.1.MCX (Multi Commodity Exchange)..............................................................24 Tools.....................................................................................................................25 Pre Regression Data Analysis................................................................................25 2|Page

Post Regression Analysis.......................................................................................25 Hypothesis:............................................................................................................ 25 Establishment of the Model....................................................................................26 Assumption........................................................................................................... 26 Methodological Issues...........................................................................................26 Limitation of Model................................................................................................27 Data Analysis:........................................................................................................ 27 Identification of Trend Data...................................................................................27 Exchange Rate Analysis.........................................................................................27 Consumer Price Index Analysis...............................................................................28 Money Supply Analysis...........................................................................................29 Index of industrial Production Analysis...................................................................30 Interest rate Analysis............................................................................................. 31 Regression Analysis...............................................................................................32 MCX....................................................................................................................... 33 Regression of MCXCOMDEX along with Exchange rate .........................................34 Regression of MCXCOMDEX along with CPI ............................................................35 Regression of MCXCOMDEX along with Money Supply ...........................................36 Regression of MCXCOMDEX along with IIP .............................................................37 Regression of MCXCOMDEX along with IIP .............................................................38 Multiple Regression of Commodity Price with all Monetary Factors.........................39 MCX Sub indices Metal, Energy, Agri....................................................................40 Correlations: MCXCODMEX, SUB INDICES...............................................................40 Multiple Regression of MCX Agri with all Monetary Factors.....................................41 NCDEX................................................................................................................... 42 Correlation between Dhanya (NCDEX) and MCX Agri .............................................42 Chapter 3.................................................................................................................. 43 Interpretation......................................................................................................... 43 Exchange Rate...................................................................................................... 43 Consumer Price Index (CPI)....................................................................................43 Money Supply (M)...................................................................................................43 Production Index (IIP).............................................................................................44 Interest Rate.......................................................................................................... 44 3|Page

Recommendation...................................................................................................44 Conclusion..............................................................................................................45 Bibliography........................................................................................................... 47 Appendix................................................................................................................ 50 Analysis of NCDX (Ganya)...................................................................................50 TRENDS IN INDEX OF INDUSTRIAL PRODUCTION....................................................53 Monthly Average Data for All Monetary Indicators..................................................53

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List of Figures
Figure 2-1: Movement of Exchange Rate Along with Time.........................................27 Figure 2-2 Autocorrelation Graph for Exchange Rate ...............................................28 Figure 2-3 Movement of Consumer Price Index Along with Time................................28 Figure 2-4 Autocorrelation Graph for Consumer Price Index......................................29 Figure 2-5 Movement of Money Supply Along with Time...........................................29 Figure 2-6 Autocorrelation Graph for Money Supply...................................................30 Figure 2-7 Movement of Index of Industrial Production Along with Time...................30 Figure 2-8 Autocorrelation Graph for IIP....................................................................31 Figure 2-9 Movement of Prime Lending Rate (Interest rate) Along with Time............31 Figure 2-10 Autocorrelation Graph for Prime Lending Rate.......................................32 Figure 2-11 Movement of MCX Index (MCXCODMEX) Along with Time.......................33 Figure 2-12 Residual for Regression between MCXCODMEX and Exchange Rate........34 Figure 2-13 Residual for Regression between MCXCODMEX and Consumer Price Index .................................................................................................................................35 Figure 2-14 Residual for Regression between MCXCODMEX and Money Supply.........36 Figure 2-15 Residual for Regression between MCXCODMEX and Index of industrial Production.................................................................................................................37 Figure 2-16 Residual for Regression between MCXCODMEX and Prime Lending Rate.38 Figure 2-17 Residual for regression of MCXCODMEX with CPI, Money Supply, IIP, Interest rate, Ex Rate................................................................................................39 Figure 2-18 Movement of Sub-indices of MCX along with Time..................................40 Figure 2-19 Residual for regression of MCX Agri with CPI, Money Supply, IIP, Interest rate, Ex Rate.............................................................................................................41 Figure 2-20 Movement of Dhanya (NCDEX) index along with time.............................42

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List of Tables
Table 2-1 Calculation of Consumer Price Index..........................................................20 Table 2-2 Weightage various Sector in Index of Industrial Production.......................20 Table 2-3 A sample of exchange rate arious currency against Indian Rupee.............21 Table 2-4 Component of various MCX sun indices and Main Index MCXCODMEX........25

Abbreviation
RBI Reserve Bank of India IMF International Monetary Fund CPI Consumer Price Index IIP Index of Industrial Production Interest Rate Prime Lending Rate M Money Supply (M1 Level) MCX Multi Commodity Exchange Ltd NCDEX National Commodity Exchange Ltd.

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Letter of Approval
Institute of Management, Nirma University

MBA (Full-Time)II (2009-11 Batch)

Dissertation Report Approval Form

Roll No.

: 091309

Students Name

: Ashish Sarkhel

Faculty Guide

: Prof Kshamanidhi Adabar

Topic

: Study the impact of Monetary Policy on Commodity Price

Signature of Student

Approval of the Faculty Guide

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Acknowledgment

I would like to thank my research guide Prof Kshamanidhi Adabar, who has guided me through my project despite his busy schedule. He was always there to listen and to give advice. He is responsible for involving me in this interesting project in the first place. He showed me different ways to approach a research problem and the need to be persistent to achieve results. I would also like to thank to Prof P.K. Chugan and Prof Rajesh Jain who provided insightful comment and feedback during proposal presentation, as these comment comes very useful to keep the research resourceful. I would also like to thank other faculty member and my peer group, who always support and guide me in my dissertation report.

Place: Ahmedabad Date: 11th Jan 2011

Ashish Sarkhel

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EXECUTIVE SUMMARY
Commodities play an important role in the economies of most of the developing Countries, which derive the majority of its merchandise export revenues from one single commodity or several commodities. Against the background of rising commodity prices, most Asian economies developed favourably between 1999 and 2005, although differences between net oil-exporting and importing countries were apparent. Net agri commodity exporters recorded the highest growth rates, mainly supported by rising investment and exports on the back of record production and an expanding demand in some countries. Monetary policy helping to fight inflationary. In India exchanged based commodity price system has been newly developed and exchange like MCX and NCDEX now making an important role in commodity market system. Now the policy maker needs to consider the Commodity price also as due to various Monetary Indicator Commodity Price change significantly. In this dissertation report two phases are there. First, an analysis based on a system of five variables (commodity price index, money supply, interest rates, consumer price index and industrial production index) to Indian economical Data, emulating the study performed earlier by various authors using data from the RBI. Our second step in this paper is to develop the complete model with all-variable system by multiple regressions, in order to check the robustness of the empirical results obtained under the five-variable system. Most of the empirical literature devoted to the assessment of the relationship between monetary policy and commodity prices has focused on the interest rate as an indicator of monetary policy stance. However, interest rates may not fully represent the impact of a monetary policy shock and, more importantly, their movements can repeat the endogenous response of monetary policy to the general developments of the economy. So there is a need of a Mathematical Model which can show the significance of Monetary Indicators in Commodity Pricing.

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Chapter 1
Introduction
Many studies have debated whether the commodity price index serves as a leading indicator of future economic conditions. Many authors have applied time series analysis to investigate how this index relates to macroeconomic variables. Specifically, they applied statistical tests to analyse the validity of the commodity price index as a leading indicator of prices in general. If the commodity price index is valid as a leading indicator of prices or other macroeconomic variables, policymakers need to recognize the importance of the index as a policymaking variable. A rise in the index, for example, could be seen as a portent of future inflation. As such, trends in the index would come to have a certain influence in the management of monetary policy. Commodity prices are important as macroeconomic discussions were dominated by the oil price shocks and other rises in agricultural and mineral products that were thought to play a big role in the stagflation of that decade. Any discussion of alternative monetary regimes was not complete without a consideration of the gold standard and proposals for other commodity-based standards. Yet the topic of commodity prices fell out of favour in the late 1980s and the 1990s. Commodity prices generally declined during that period; perhaps declining commodity prices are not considered as interesting as rising prices. Nobody seemed to notice how many of the victims of emerging market crises in the 1990s were oil producers that were suffering, among other things, from low oil prices or others suffering from low agricultural prices. The crisis that began with turmoil in the US subprime mortgage market in 2008 has morphed into a crisis of two halves. In the first, rising inflation was a major concern, the economic outlook, while weaker, was expected to remain robust, especially for emerging East Asia. In the second-half, the opposite has happened. Amid falling world commodity prices driven by a severely weakened global economy, policymakers have aggressively eased policies to forestall further economic and financial deteriorations. This report focuses on the first-half of the crisis. In the firsthalf, central banks in the region faced a major dilemma in rising consumer prices and slower output growth. Higher interest rates would restrain rising inflation by lowering domestic demand, but also hurt output growth. Many central banks were uncertain how to respond. The challenge was rather a new experience: for a long time, monetary policy played a supportive role to economic growth with inflation never too menacing given rising productivity, plenty of spare capacity, and a
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generally disciplined fiscal disposition. The effect is not only specific to few countries, India also need to look as commodity market a major indicator for Monetary Policy. The establishment of commodity exchange like MCX and NCDEX shows commodity shows a lot of indicator for future monetary action. The report tries to establish a relationship between major Monetary Policy tools along with Commodity Indices. It would be foolish to think that the model captures everything. In reality, a lot of other things beyond real interest rates influence commodity prices. There are bound to be fluctuations both in the long-run equilibrium real price, the convenience yield, storage costs and risk premium. These fluctuations are not readily measurable. Such factors as weather, political vicissitudes in producing countries, and so forth, are likely to be very important when looking at individual commodities. Indeed analysts of oil or coffee or copper pay rather little attention to macroeconomic influences, and instead spend their time looking at microeconomic determinants. Oil prices were high in 2004-06 in large part due to booming demand from China and feared supply disruptions in the Middle East, Russia, Nigeria and Venezuela. There may now also be a premium built in to the convenience yield arising from the possibilities of supply disruption to terrorism, uncertainty in the Persian Gulf, and related risks. Yet another factor concerns the proposition that the world supply of oil may be peaking in this decade as new discoveries lag behind consumption, that such predictions have in the past been proven wrong. This would imply that the long-run equilibrium real price of oil has shifted upward. Other factors apply to other commodities. In coffee, the large-scale entry of Vietnam into the market lowered prices sharply a few years ago. Corn, sugar, and cotton are heavily influenced by protectionist measures and subsidies in many countries. And so on. If we look at aggregate indices of commodity prices, many of the idiosyncratic factors in individual markets wash out. Commodity price developments have been one of the major sources of concern for policymakers during the recent years. After having surged with increasing momentum to unprecedented levels in the course of 2008, prices of commodities fell abruptly in the wake of the financial crisis and the global economic downturn. Since the beginning of 2009, however, commodity prices first stabilised, and then resumed an upward path, characterized by relatively high volatility. As commodity prices in general .and the oil price in particular .are an important component of Consumer Price Indexes, the evolution of these prices and the driving forces behind them are clearly crucial for the conduct of monetary policy
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Background
Commodity price developments have been one of the major sources of concern for policymakers during the recent years. A wide strand of literature has examined the impact of commodity prices on macroeconomic variables and the stance of monetary policy. Fewer attention has however been devoted to the other direction of causality, i.e. the impact of monetary conditions on oil and other commodity prices. During the commodity price surge of 2008 some commentators indicated that loose monetary policy and persistently low interest rates could have at least in part fuelled the price hike. If this is so, it is then relevant to understand whether and to what extent the massive monetary policy easing which is nowadays taking place may sow the seeds for another surge in commodity prices. The aim of this study is indeed to analyze to what extent an expansionary monetary policy change may drive up commodity prices and through which channel. Monetary conditions and interest rates have attracted attention as possible driving factors of commodity prices. Most of the empirical literature devoted to the assessment of the relationship between monetary policy and commodity prices has focused on the US interest rate as an indicator of monetary policy stance. However, interest rates may not fully represent the impact of a monetary policy shock and, more importantly, their movements can reflect the endogenous response of monetary policy to the general developments of the economy. Our strategy is to identify a monetary policy change for other factor in the Indian economy, and then assess its impact on commodity prices. This allows us not only to examine the impact of monetary policy net of other interaction channels, but also to avoid employing indicators of global monetary conditions which are inherently difficult to measure. The main finding is that there is empirical evidence of a significant impact of monetary policy on commodity prices; in particular, an expansionary monetary policy change drives up the broad commodity price index and all of its major components. Taking a cue from Japanese Economy, there the causal relationship from the BOJ index to the consumer price index changed sharply when the Bank of Japan introduced its zero interest rate policy in February 1999. The BOJ index was valid as a leading indicator of the consumer price index before the policy was introduced, whereas the relationship ceased to exist thereafter. We found no causal relationship from the BOJ index to the industrial production index. Note that this relationship is unrelated to BOJs introduction of the zero interest rate policy. We

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can therefore argue that the commodity price index has functioned less effectively as an information variable for monetary policy since the adoption of the zero interest rate policy. Commodity prices and the general price level tend to be closely related, with movements in commodity prices leading movements in the general price level. Commodity prices are determined in auction markets, hence they reflect demand and supply shocks more rapidly than do the prices of manufactured goods. The change in commodity prices resulting from speculative purchases or sales of commodities can therefore be a leading indicator of change in the general price level. The price mechanism of financial markets was presumably no longer working when the zero interest rate policy was introduced. This would make it impossible to consider the future movements of monetary policy, and thus the CPI, when commodity prices are determined in auction markets. Secondly, the Japanese economy was in a serious depression when the zero interest rate policy was introduced The variance decomposition suggests however that the impact of monetary policy on commodity prices is rather limited, though statistically significant. Still, attempt is to throw some light on the channel through which monetary policy change affect commodity prices, focusing on the all major commodity. In particular, study investigate whether the positive impact on commodity prices of a monetary policy loosening can be ascribed to incentives to stock accumulation, disincentives to immediate production or to financial results.

Literature Review
Since the late 1990s, commodity prices have followed an upward trend, with the prices of Metals and crude oil showing the most pronounced increases. Although booms in commodity prices could be observed previously, the magnitude of the increase, its duration and its breadth are unparalleled compared with other upswings in the past 25 years. Notably, prices for all commodity groups have risen simultaneously since 2002, a pattern which cannot be detected for such a prolonged period any time since 1980. Now oil prices and many broader indices of
commodity prices are again at or near all-time highs in nominal terms, and are very high in real terms as well. Copper, platinum, nickel and zinc, for example, all hit record highs in 2006, in addition to crude oil. As a result, commodities are once again hot. It turns out that mankind has to live in the physical world after all! Still, the initial reaction in 2003-04 was relaxed, on several grounds:
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1. Oil was no longer a large share of the economy, it was said; 2. Futures markets showed that the spike in prices was expected to be only temporary; and 3. Monetary policy need focus only on the core CPI inflation rate and can safely ignore the volatile food and energy component, unless or until it starts to get passed through into the core rate. With regard to point (3), it is time to examine more carefully the claim that if an increase in energy or agricultural prices does not appear in the core CPI, then monetary policy can ignore it. The central argument of our research, reported in the NBER working paper The Effect of Monetary Policy on Real Commodity Prices, is that high real commodity prices can be a signal that monetary policy is loose. Thus they can be a useful monetary indicator (among many others). The analysis is both theoretical and empirical. The empirical work includes the determination of real commodity prices in the United States, the determination of prices in other smaller countries, and the determination of inventories. But by 2005-2006, the increase in prices had gone far enough to receive much more serious attention. This was especially true with regard to the perceived permanence of oil prices, largely because the futures price had gone from implying that the rise in the spot price was mostly temporary to implying that it is mostly permanent.Instability of commodity prices has always been a major concern of the producers, processors, merchandisers as well as the consumers in an agriculture-dominated country like India. Farmers direct exposure to price fluctuations, for instance, makes it too risky for them to invest in otherwise profitable activities. There are various ways to cope with this problem. Apart from increasing the stability of the market by direct government intervention, various actors in the farm sector can better manage their activities in an environment of unstable prices through derivatives markets mainly futures and options on futures. These markets serve a risk-shifting function, and can be used to lock-in prices in advance instead of relying on uncertain price developments in future. Apart from being a vehicle for risk transfer among hedgers and from hedgers to speculators, these markets also play a major role in price discovery.
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Svensson in his paper(2005) mention that commodity price developments have been one of the major sources of concern for policymakers during the recent years. After having surged with increasing momentum to unprecedented levels in the course of 2008, prices of commodities fell abruptly in the wake of the financial crisis and the global economic downturn. Since the beginning of 2009, however, commodity prices first stabilized, and then resumed an upward path, characterized by relatively high volatility. As commodity prices in general and the oil price in particular are an important component of Consumer Price Indexes, the evolution of these prices and the driving forces behind them are clearly crucial for the conduct of monetary policy A wide strand of literature has examined the impact of commodity prices oil in particular on macroeconomic variables (e.g. Kilian, 2008), but fewer attention has been devoted to the other direction of causality, i.e. the impact of monetary conditions on oil and other commodity prices. In this study focus on the latter, to analyse to what extent an expansionary monetary policy change may drive up commodity prices and through which channel. Hamilton (2009) explained, while supply and demand factors can in general explain the bulk of the fluctuations in commodity prices, other forces may at times play a role. Kilian (2009) and Alquist and Kilian (2010) highlight the relevance of precautionary demand shocks, which increase current demand for oil due to an increase in uncertainty about future oil supply shortfalls, in the behaviour of oil prices. Since the seminal contribution by Frankel (1984), monetary conditions and interest rates have attracted attention as possible driving factors of commodity prices. Frankel (1986) extends statistical theory of exchange rate overshooting to the case of commodities and, using no-arbitrage conditions, derives a theoretical link between oil prices and interest rates. Barsky and Kilian (2002, 2004) show that monetary policy stance is a good predictor of commodity prices. In particular, Barsky and Kilian (2002) also suggest that the oil price increases of the 1970s could have been caused, at least in part, by monetary conditions. Most of the empirical literature devoted to the assessment of the relationship between monetary policy and commodity prices has focused on the US interest rate as an indicator of monetary policy stance (Frankel, 2007, Frankel and Rose, 2009). However, interest rates may not fully represent the impact of a monetary policy shock and, more importantly, their movements can react the endogenous response of monetary policy to the general developments of the economy. For instance, Bernanke, Gertler and Watson (1997), using a regression framework, suggest that
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positive shocks to the oil price induce a monetary policy response which can amplify the contractionary effects of the oil price shock itself; Kilian and Lewis (2009), however, report no evidence of systematic Fed reaction to oil shocks after 1987. During the commodity price surge of 2008 some commentators indicated that loose monetary policy and persistently low interest rates could have at least in part fuelled the price hike (Hamilton, 2009). If this is so, it is then relevant to understand whether and to what extent the massive monetary policy easing which is nowadays taking place may sow the seeds for another surge in commodity prices. In this paper, study will not work with a plain analysis of co movements between commodity prices and interest rates, but rather identify a monetary policy change in a regression system for the Indian economy, and then assess its impact on commodity prices. This allows us not only to examine the impact of monetary policy net of other interaction channels, but also to avoid employing indicators of global monetary conditions which are inherently difficult to measure. More specifically, study will use a standard identification scheme for the monetary policy shock (Kim, 1999) and study will then project each of the commodity prices on this shock in order to single out the responses of the different prices to the same monetary policy shock. Study finds empirical evidence of a significant impact of monetary policy on commodity prices; in particular, an expansionary monetary policy shock drives up the broad commodity price index and all of its major components. Although the methodology is very different, our approach is similar in spirit to that of Frankel and Hardouvelis (1985), which investigated the impact of money supply announcements on commodity prices; the main methodological difference lies in the fact that in our case study work with an identified monetary policy shock in a regression system. In addition, study assesses the robustness of the results by repeating the exercise using several different identification strategies of the monetary policy shock, which are commonly used in the literature. In particular, remaining in a regression context, study used also the Choleski identification strategy proposed by Boivin and Giannoni (2006) and that based on sign restrictions in the spirit of Uhlig (2005) and Canova and De Nicol (2002). The actual implementation of the sign restrictions is obtained through the algorithm developed in Rubio-Ramrez et al. (2010). Study also analysed the effect on commodity prices of the monetary policy shocks identi.ed according to Kuttner (2001) and Romer and Romer (2004). Overall, all these different strategies lead to similar conclusions.

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The variance decomposition suggests that the impact of monetary policy on commodity prices is rather limited, though statistically significant. Still, study try to shed some light on the channel through which monetary policy shocks affect commodity prices, focusing on the case of oil. In particular, study investigate whether the positive impact on oil prices of a monetary policy loosening can be ascribed to incentives to stock accumulation, disincentives to immediate production or to financial results. Results show that all these direct channels display the expected sign, but the bulk of the impact of monetary policy on commodity prices seems to transit through the indirect channel of expected growth and inflation, as also reported by Barsky and Kilian (2004). The impact of monetary policy on commodity prices has been studied by Barsky and Kilian (2002, 2004), who argue that the channel through which monetary policy exerts its impact on commodity prices is via (expectations of) stronger inflation and economic growth. There are however a number of other channels, related to the opportunity cost of investing in real assets, according to which an expansionary monetary policy can cause an increase in commodity prices. Frankel (2007) summarizes them as:
1.

Low interest rates tend to reduce the opportunity cost of carrying inventories, increasing their demand for commodities; On the supply side, lower rates create an incentive not to extract today exhaustible commodities, as the cost of holding inventories in the ground also decreases;

2.

3.

For a given expected price path, a decrease in interest rates reduces the carrying Cost of speculative positions, making it easier to bet on assets such as commodities; under certain conditions, this will put upward pressure on futures price and, by arbitrage, also on spot prices.

The plan of the paper is the following. In section 2 paper evaluate the impact of monetary policy shocks on the commodity price index and on its major components. In particular, study first describes the theoretical arguments according to which commodity prices should react to monetary policy changes. Next, study present the data and the econometric framework, which includes the identification scheme, and then study provide regression evidence and robustness analysis. Paper also evaluates the transmission channels through which monetary policy may affect commodity prices.
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Objectives:
1. To Identify relationship between various Monetary Indicators and Commodity Prices 1. Verify that the Indicator have a trend and useful for analysis 2. Establish the Model between the Indicator and Commodity Price 3. Interpret the result for All sub Commodity indices with Monetary Indicators 4. Establish a model between all indicators and Commodity Price 2. Forecast future action for Monetary Policy on the basis of Commodity Prices 1. Interpret the Effect of adverse condition of Monetary policy on Commodity Price 2. Generate preventive measure for fluctuation

The objective of paper is to develop a model which shows the relationship between change in Monetary Policy and effect on Commodity Prices. In actual terms exact relationship is difficult to establish and Commodity price is based on various parameters including Monetary Policy, but in this report the trend has been analysed. It gives an insight how important is the commodity sectors is for Indian Economy and Policy formulation. Application of Granger causality tests to analyses the validity of the commodity price index as a leading indicator of prices in general. If the commodity price index is valid as a leading indicator of prices or other macroeconomic variables, policymakers need to recognize the importance of the index as a policymaking variable. A rise in the index, for example, could be seen as a portent of future inflation. As such, trends in the index would come to have a certain influence in the management of monetary policy.

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Chapter 2
Research Plan
Selection of Monetary Indicator In order to develop the relationship between monetary policy Indicator and Commodity Index Following Data has been collected for Monetary Indicator 1. Consumer Price Index (CPI) Consumer Price Index (CPI) in India comprises multiple series classified based on different economic groups. There are four series, viz the CPI UNME (Urban Non-Manual Employee), CPI AL (Agricultural Labourer), CPI RL (Rural Labourer) and CPI IW (Industrial Worker). While the CPI UNME series is published by the Central Statistical Organisation, the others are published by the Department of Labour The most common formula used in calculating consumer price indexes is a weighted arithmetic mean of price relatives. The price relatives described earlier are weighted according to the amounts consumers spend on each product; the resulting figures are summed for all commodities and divided by the sum of the base year expenditures for the same collection of commodities.

Major Group/Group
Primary Article Food Article Non-food Article Mineral

Weights
32.295 17.386 10.081 4.828 10.663

Fuel, Power, Light & Lubricant Manufacture 19 | P a g e

d Product

Food Product Beverages, Tobacco & Tobacco Product Textile Leather & Leather Product Other TOTAL

57.042 10.143 2.149 11.545 1.01 32.18 100

Table 2-1 Calculation of Consumer Price Index

2. Industrial Index of Production (IIP)

In India, the Central Statistical Organisation (CSO) is responsible for compilation and release of the Index of Industrial Production (IIP). This is a monthly index and is intended to measure changes over time in the volume of industrial production. The base year of the current series of IIP in India is 1993-94 which is being revised to 1999-2000. The current series of IIP with base 1993-94 is based on 538 individual items clubbed into 283 groups of items. The distribution of these items (item groups) and weights (100) among the three sectors covered by the index is as under:

Sector
Mining Manufacturi ng Electricity Total

No. of Items (item groups)

64 (1) 473 (281) 1 (1) 538 (283)

Weigh t
10.47 79.36 10.17 100

Table 2-2 Weightage various Sector in Index of Industrial Production

3. Interest Rate Here interest rate has been consider as Prime lending rate define by RBI The interest rate that commercial banks charge their best, most credit-worthy customers. Generally a bank's best customers consist of large corporations. The rate is determined by the Federal Reserve's decision to raise or lower prevailing interest rates for short-term
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borrowing. Though some banks charge their best customers more and some less than the official prime rate, the rate tends to become standard across the banking industry when a major bank moves its prime up or down. The rate is a key interest rate, since loans to lesscreditworthy customers are often tied to the prime rate. For example, a Blue Chip company may borrow at a prime rate of 5%, but a less-well-established small business may borrow from the same bank at prime plus 2, or 7%. Many consumer loans, such as home equity, automobile, mortgage, and credit card loans, are tied to the prime rate. Although the major bank prime rate is the definitive "best rate" reference point, many banks, particularly those in outlying regions, have a two-tier system, whereby smaller companies of top credit standing may borrow at an even lower rate. 4. Exchange Rate Here we have considered Rs/USD exchange rate. Few example of exchange rate are as follows Currency
American Dollar Argentine Peso Australian Dollar Brazilian Real British Pound Canadian Dollar Chilean Peso Chinese Yuan Colombian Peso Croatian Kuna Danish Krone Euro Hong Kong Dollar

1 INR
0.0220353 0.090559 0.0221714 0.0372953 0.0141407 0.02187 10.99 0.146288 41.1863 0.126052 0.126783 0.0170234 0.171388

in INR
45.3818 11.0425 45.1031 26.813 70.7179 45.7247 0.0909922 6.83584 0.0242799 7.93324 7.88752 58.7426 5.8347

Table 2-3 A sample of exchange rate arious currency against Indian Rupee

5. Money Supply The four measures of money supply for annual compilation developed in India by the SWG (1977) are as follows:
M1 = currency with public + demand deposits with the banking system + other deposits with RBI M2 = M1 + saving deposits with post office savings banks M3 = M1 + time deposits with the banking system M4 = M1 + all deposits with post office savings banks excluding National Saving Certificates

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Here we consider only M1 as money supply as that part is major money supplier entity among all. Considering all entity will be too tedious task. The following data has been collected as these are the major factor and quantifiable in nature. So a mathematical relationship is feasible. Selection of Statistical Method Various Researchers applied the Multiple Vector regression model to analyze the relationship between the commodity price index and macroeconomic variables in the United States. They found a causal relationship from the commodity price index to the consumer price index and the industrial production index. This study empirically analyses the role of commodity prices in India as a leading indicator of macroeconomic variables, especially the CPI (consumer price index), post the period of year 2000. For study Vector Regression model has been used to empirically analyse the relationship between the Commodity Price Index and macroeconomic variables.

Methodology
In order to established a model for relationship appropriate need to be recognize, so all available data for Monetary Indicator need to be auto regress ,so that only those indicator will be chosen those are not random in nature Hypothesis - Filtering random parameter Establish Auto Correlation of all the Monetary Indicator and Verify following hypothesis Monetary Indicator is not based on its past value(Random in nature)
H0: r =0 v/s Ha: r # 0 Where r is Auto Correlation Coefficient

If the Hypothesis turns fail, only in that case the parameter will be used for relationship Model

Develop the Model for Individual parameter Once Indicators are filtered out, relationship establishment can be done initially each individual parameter need to be regress with various commodity indices Here Regression implies, both data will generate following Eqn
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Yt = e + K1CPI(t)

where t = 1, 2,3..T

Yt : Forecasted Value of Commodity Index e: Error Term(intercept) K1: Slope of Eqn (Coefficient for CPI to be related with Commodity Index) CPI (t): Value of CPI at t

Various Monetary Indicator need to be regress along all available indices to analysis individual sector effect. Time Series Regression can be accomplished by either Unit Root Test or (Vector) Regression. Here Vector Auto regression will be used, where Time Series data will be consider as a vector Develop the Model with all parameters Finally a complete eqn established will all monetary indicators for predicating Commodity Index value
Yt = e + K1CPI(t) + K2 IR(t) + K3IIP(t) + k4EX(t) + k5M(t) where t = 1,2,3..T Yt : Forecasted Value of Commodity Index e : Error Term(intercept) K1: Slope of Eq (Coffcient for CPI to be related with Commodity Index) CPI(t) : Value of CPI at t IR(t) : Value of Interest rate at time t IIP(t) : Value of Index of Industrial Production at time t EX(t) : Value of Exchange rate at time t M(t) : Money Supply at time t

Data Source (Secondary Data)

Monetary Indicator:
1. Consumer Price Index (CPI) www.rbi.org /Data warehouse

CPI data are directly available in Monthly basis

2. Industrial Production Index - www.rbi.org /Data warehouse

IIP data are directly available on monthly basis

3. Interest Rate- www.rbi.org /Data warehouse

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Here Prime Lending rate has been Consider as Interest rate and the data is based on Daily basis, so monthly average has been taken for the given period. The interest rate is not changing with a cycle manner, so even monthly data doesnt show a particular trend. Quarterly data can be useful, but as all other Monetary Indicators are in Monthly format so Prime lending rate(Interest Rate) is also taken as Monthly one.
4. Exchange Rate - www.rbi.org /Data warehouse

Here Rs. /USD exchange rate has been consider as Exchange rate.These data is available on daily basis ,so it need to average out for monthly basis.

Commodity Indices
For Commodity Price various Indices have been chosen from Commodity Exchange. NCDEX (National Commodity and Derivative Exchange Ltd.) Indices Name: Dhanya Weightage:
Components Chana Cotton Seed Oilcake Guar Seed Gur Jeera Pepper Mustard Seed Soy bean Turmeric Wheat Weight (%) 0.1135 0.0203 0.1711 0.0337 0.0406 0.052 0.1156 0.1522 0.0275 0.2735

1.1.1.1. MCX (Multi Commodity Exchange) Indices Name: MCX COMDEX Sub-Indices: MCX METAL, MCX ENERGY,MCX AGRI Weightage:
MCX COMDEX 2009 Weights
MCX COMDEX Commodity Weight (New) Group Adjusted Wts.

MCX METAL INDEX

Gold Silver Copper Zinc Aluminum Nickel

15.21 % 9.66% 7.13% 2.00% 2.00% 2.00%

40.00%

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Lead MCX ENERGY INDEX Crude Oil Natural Gas Ref. Soy Oil MCX AGRI INDEX Potato Chana Crude Palm Oil Kapaskhalli Mentha Oil

2.00% 35.41 % 4.59% 3.91% 4.76% 4.14% 3.19% 2.00% 2.00%

40.00%

20.00%

Table 2-4 Component of various MCX sun indices and Main Index MCXCODMEX

Here we have taken commodity spot price and it is closing day value for all the Indices.

Tools
In order to gather the data in Structure Form MS-Excel 2010 has been used. All Statistics Analysis e.g. Auto Correlation, Regression, Unit Root Test has been done in Minitab Ver. 15

Pre Regression Data Analysis

Data has been Analysis in following steps
1. Use Auto Correlation Analysis to see that all Monetary Indicators have a trend and they are

not random in nature. If any variable do not satisfy auto regression criteria then it will not be used
2. Before Implementing the regression all-time series data are adjusted for common time

period and time space. For e.g. Commodity Index value is Weekly and CPI is monthly, then an average for Commodity Index on Monthly basis need to be calculated.

Post Regression Analysis

Quantitative: On the basis of Regression Coefficient we can determine that whether there is a relationship between monetary indicator and Commodity Price Hypothesis: We need to test two hypotheses here 1. Monetary Indicator is not Related with Commodity Price
H0 : R2 = 0 v/s Ha : R2 # 0

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2. If the test fail to accept the above hypothesis then check Monetary Indicator is loosely associate with Commodity Price
H0 : R2 low (< 50%) v/s Ha : R2 High (>50 %)

Establishment of the Model The theoretical model is based on exchange rate overshooting and can be summarized as follows. A monetary contraction temporarily raises the real interest rate, whether via a rise in the nominal interest rate, a fall in expected inflation, or both. Real commodity prices fall. In the long run, the general price level adjusts to the change in the money supply. As a result, the real money supply, real interest rate, and real commodity price eventually return to where they were. In this study we will use the hypothesis to justify that overshooting model is applicable for how many Monetary Indicators

Assumption
Aggregate demand is determined by the standard open economy IS-LM mechanism Financial Markets are able to adjust to shocks instantaneously, and investors are risk neutral. In the short run, goods prices are 'sticky'. That is, aggregate supply is horizontal in the short run, though it is positively sloped in the long run.

Methodological Issues
The key issue in during the research is the appropriate statistical Model and relevant data. Various tools for time series analysis demand and appropriate de seasonal and de trend data for regression, while in order to achieve true effect of Monetary Indicator, data should be used without any adjustment as Commodity price can be effected by factors which affect Monetary Indicators e.g. political, Climatic etc.

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Limitation of Model
The Model can only explain the partial effect on Commodity price as Commodity Price is also majorly derive by demand supply of particular product For ease of calculation Vector Analysis has been simplified for same time period and all data are average out for this , so very precise calculation may generate some errors In this model error lagging part has been removed for easy interpretation, which indicate that if residual are increasing in nature then model can produce wrong results, unlike ARIMA which consider the error part also.

Data Analysis:
Identification of Trend Data
Exchange Rate Analysis

Figure 2-1: Movement of Exchange Rate Along with Time

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Auto Cor r el ati on for Ex change R ate

1.0 0.8 0.6 A ut ocorrelat ion 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 2 4 6 8 10 12 14 16 Lag 18 20 22 24 26 28

Figure 2-2 Autocorrelation Graph for Exchange Rate

As we can see that Autocorrelation Coefficient r # 0, so we can reject the hypothesis and it implies that Exchange rate data have a trend and it depend on its previous value ,So we can use it as regression for Commodity Index.

Consumer Price Index Analysis

Figure 2-3 Movement of Consumer Price Index Along with Time

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Auto Cor r el ati on for CP I

1.0 0.8 0.6 A ut ocorr elat ion 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 1 5 10 15 20 Lag
Figure 2-4 Autocorrelation Graph for Consumer Price Index

25

30

35

40

45

As we can see that Autocorrelation Coefficient r # 0, so we can reject the hypothesis and it implies that Consumer Price Index data have a trend and it depend on its previous value, so we can use it as regression for Commodity Index.

Money Supply Analysis

Figure 2-5 Movement of Money Supply Along with Time

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Auto Cor r el ati on for M one S uppl y

1.0 0.8 0.6 A ut ocorr elat ion 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 2 4 6 8 10 Lag 12 14 16 18

Figure 2-6 Autocorrelation Graph for Money Supply

As we can see that Autocorrelation Coefficient r # 0, so we can reject the hypothesis and it implies that Money Supply data have a trend and it depend on its previous value, so we can use it as regression for Commodity Index.

Index of industrial Production Analysis

Figure 2-7 Movement of Index of Industrial Production Along with Time

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Auto Cor r el ati on for IIP

1.0 0.8 0.6 A ut ocorr elat ion 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 1 5 10 15 20 25 Lag 30 35 40 45 50

Figure 2-8 Autocorrelation Graph for IIP

As we can see that Autocorrelation Coefficient r # 0, so we can reject the hypothesis and it implies that Money Supply data have a trend and it depend on its previous value, so we can use it as regression for Commodity Index.

Interest rate Analysis

Figure 2-9 Movement of Prime Lending Rate (Interest rate) Along with Time

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Auto Cor r el ati on for Inter est R ate(P r i me L endi ng R ate)

1.0 0.8 0.6 A ut ocorr elat ion 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 1 5 10 15 20 25 30 35 40 Lag 45 50 55 60 65 70

Figure 2-10 Autocorrelation Graph for Prime Lending Rate

As we can see that Autocorrelation Coefficient r # 0, so we can reject the hypothesis and it implies that Prime Lending rate data have a trend and it depend on its previous value, so we can use it as regression for Commodity Index. After analysis the pre regression data we can conclude that all five parameter are fit for regression with Commodity Exchange Indices Data

Regression Analysis
In order to see the effect on commodity market we choose two commodity Indices

MCX NCDEX

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MCX

Figure 2-11 Movement of MCX Index (MCXCODMEX) Along with Time

The MCX has following Indices MCXCOMDEX MCXENERGY MCXMETAL MCXAGRI The initial regression start with MCXCOMDEX, in this index data comes daily, so it has been average out for Month basis. Now all Monetary Indicator Need to regress against this Index values on Monthly Basis

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Regression of MCXCOMDEX along with Exchange rate

Ver sus Fi ts
(response is MCX) 1000

500 Residual

-500

-1000 2150 2200 2250 2300 2350 2400 Fit t ed V alue 2450 2500 2550

Figure 2-12 Residual for Regression between MCXCODMEX and Exchange Rate

Result

The regression equation is

MCX = - 701 + 66.1 EX R2 = 7.7%

Hypothesis test

Testing first Hypothesis

H0 : R2 = 0

As R2 = 7.7 # 0 so the test fail to accept the hypothesis, so Testing second hypothesis
H0 : R2 < 50%

As R2 = 7.7 % < 50 % so the test fail to reject the Hypothesises Exchange rate is loosely associated with Commodity Price Now from the Equation it appears that value of Commodity Price is positive related with Exchange rate (EX),but as R2 value is quite low (<50 %) ,so the relationship is not very strong.

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Regression of MCXCOMDEX along with CPI

Ver sus Fi ts
(response is MCX) 1000

500 Residual

-500

-1000 2000 2200 2400 2600 Fit t ed V alue 2800 3000

Figure 2-13 Residual for Regression between MCXCODMEX and Consumer Price Index

Result

The regression equation is

MCX = 552 + 4.07 CPI R2 = 44.0%

Hypothesis test

Testing first hypothesis

H0 : R2 = 0

As R2 = 44 # 0 so the test fail to accept the hypothesis, so Testing second hypothesis

H0 : R2 < 50%

As R2 = 44 % < 50 % so the test fail to reject the Hypothesises CPI is loosely associated with Commodity Price Now from the Equation it appears that value of Commodity Price is positive related with Consumer Price Index (CPI),but as R2 value is quite low (<50 %) ,so the relationship is not very strong, but it has a larger impact than exchange rate.
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Regression of MCXCOMDEX along with Money Supply

Ver sus Fi ts
(response is MCX) 1000

500 Residual

-500

2000

2200

2400 Fit t ed V alue

2600

2800

3000

Figure 2-14 Residual for Regression between MCXCODMEX and Money Supply

Result

The regression equation is

MCX = 1171 + 0.00200 Money Supply R2 = 48.8%

Hypothesis test

Testing first hypothesis

H0 : R2 = 0

As R2 = 48.8 # 0 so the test fail to accept the hypothesis, so Testing second hypothesis
H0 : R2 < 50%

As R2 = 48.8 % < 50 % so the test fail to reject the Hypothesises, Money Supply is loosely associated with Commodity Price Now from the Equation it appears that value of Commodity Price is positive related with Money Supply, but as R2 value is just low (<50 %) ,so the relationship is not very strong, but it has a larger impact than exchange rate.
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Regression of MCXCOMDEX along with IIP

Ver sus Fi ts
(response is MCX) 800 600 400 Residua l 200 0 -200 -400 -600 -800 1800 2000 2200 2400 2600 Fit t ed V alue 2800 3000 3200

Figure 2-15 Residual for Regression between MCXCODMEX and Index of industrial Production

Result

The regression equation is

MCX = 96 + 8.26 IIP R2 = 53.3%

Hypothesis test

Testing first hypothesis

H0 : R2 = 0

As R2 = 53.3 # 0 so the test fail to accept the hypothesis, so Testing second hypothesis
H0 : R2 < 50%

As R2 = 53.3 % > 50 % so the test fail to accept the Hypothesises, IIP is strongly associated with Commodity Price Now from the Equation it appears that value of Commodity Price is positive related with Money Supply, but as R2 value is just low (>50 %) ,so the relationship is strong, but it is almost at par to Money Supply.
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Regression of MCXCOMDEX along with IIP

Ver sus Fi ts
(response is MCX) 1000

500 Residual

-500

-1000 2200 2300 2400 Fit t ed V alue 2500 2600

Figure 2-16 Residual for Regression between MCXCODMEX and Prime Lending Rate

Result

The regression equation is

MCX = 3041 59.1 Prime lending rate R2 = 4.2%

Hypothesis test

Testing first hypothesis

H0 : R2 = 0

As R2 = 4.2 # 0 so the test fail to accept the hypothesis, so Testing second hypothesis
H0 : R2 < 50%

As R2 = 4.2 % < 50 % so the test fail to reject the Hypothesises, interest rate is loosely associated with Commodity Price Now from the Equation it appears that value of Commodity Price is negatively related with Interest rate, but as R2 value is just low (<50 %) ,so the relationship is not very strong and it is almost close to zero.
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Multiple Regression of Commodity Price with all Monetary Factors

In order to develop the Complete Model, all Monetary Indicators have been included and a Multiple Regression has been done

Ver sus Fi ts
(response is MCX) 750

500

Residual

250

-250

-500 1600 1800 2000 2200 2400 2600 Fit t ed V alue 2800 3000 3200

Figure 2-17 Residual for regression of MCXCODMEX with CPI, Money Supply, IIP, Interest rate, Ex Rate

Result

The regression equation is

MCX = 4906 - 5.21 CPI + 0.00457 Money Supply + 0.79 IIP - 30.9 Prime Lending Rate - 62.3 Ex R = 69.6%
2

Hypothesis test

Testing first hypothesis

H0 : R2 = 0

As R2 = 69.6 # 0 so the test fail to accept the hypothesis, so Testing second hypothesis
H0 : R2 < 50%

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As R2 = 69.6 % > 50 % so the test fail to accept the Hypothesises, all five monetary indicator are not loosely associated with Commodity Price Now from the Equation it appears that value of Commodity Price is strongly related with all monetary indicators. This is the final complete Model and R2 justify that model is robust enough to predict commodity price with fluctuation in any of the given 5 monetary indicator MCX Sub indices Metal, Energy, Agri

Figure 2-18 Movement of Sub-indices of MCX along with Time

In order to see the effect of monetary indicator on sub-indices, we first evaluate that whether sub index is highly related MCXCODMEX. If they are highly correlated than Monetary Indicator has same results. So Correlation of Individual Sub index with MCXCODMEX has been deduced Correlations: MCXCODMEX, SUB INDICES Pearson correlation of MCX and METAL = 0.895 Pearson correlation of MCX and ENERGY = 0.762 Pearson correlation of MCX and AGRI = 0.609

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Now only MCX AGRI is not strongly correlated compare to others, so a separate Multiple regression has been done MCX Agri data Multiple Regression of MCX Agri with all Monetary Factors

Ver sus Fi ts
(response is MCX) 300 200 100 Residual 0 -100 -200 -300 -400 1500 1750 2000 Fit t ed V alue 2250 2500

Figure 2-19 Residual for regression of MCX Agri with CPI, Money Supply, IIP, Interest rate, Ex Rate

Result

The regression equation is

MCX = 2326 + 3.25 CPI + 0.000789 Money Supply - 0.80 IIP - 58.9 Prime Lending Rate - 33.9 Ex R = 84.8%
2

R2 has been jumped from 69% to 84% it shows , that in case of choosing only agri commodity , all monetary indicator show better association. It implies that in case of Metal and Energy there are others factors who determine the price also e.g. demand-supply with effective weight.

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NCDEX

Figure 2-20 Movement of Dhanya (NCDEX) index along with time

NCDEX has only one index Dhnya and that is only based on agri product .So first it need to be check whether the Dhanya Index and MCX are correlated or not ,only in that case effect of Monetary Indicator can be drawn for Dhanya Index Correlation between Dhanya (NCDEX) and MCX Agri
Results

Pearson correlation of Dhanya and MCX AGRI = -0.624 The correlation coefficient of -.624 shows that both indices are negatively correlated, it means in spite of the fact that both are agri index, they contain such product whose price very oppositely with Monetary indicator fluctuation. It can be also proved by looking at both indices component, while NCDEX Index is based on pulses while MCX Agri is based on perishable product which creates the difference. Also even both of them move oppositely but they have a significant relation

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Chapter 3
Interpretation
Exchange Rate The exchange rate shows very minimal effect on commodity price, it may be possible that the commodity price is based on domestic market, so impact of exchange rate is quite low. Exchange rate may have significant effect, if international market will be involve in terms of import and export. Even in overall multiple regression exchange rates doesnt show a significant effect .But there is unique observation while looking the equation as stand-alone it provide positive effect while for complete model it shows a negative impact. So we can infer that as a stand-alone factor Exchange rate increase the commodity price with increasing value ,but for a complete model it reduce the commodity price. It also implies that Exchange rate have some association with other monetary indicators. Consumer Price Index (CPI) In case of Consumer Price Index the effect is positive as like exchange rate , but its significance is quite good. Consumer Price Index is a major indicator for inflation measures, so we can deduce that increasing inflation as stand-alone factor the Commodity price will increase ,but in all practical purpose it is impossible to do, So in complete model it show a negative effect just like exchange rate. In overall monetary policy development inflation is a major indicator and if government failed to curb it, it will lead to a very high commodity price. Money Supply (M) Money Supply justify policys liquidity aspect ,it can be observe from equation that increase in money supply will lead high inflation and that lead to high commodity price, but in complete model it behaves differently compare to CPI. It act as a positive agent and increase Commodity price as it itself grow. It might possible that other Monetary factor dominate CPI ,so as it behaves oppositely in complete model, but Money Supply contain larger effect ,so it cannot be dominated by other indicators.

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Production Index (IIP) The most unexpected impact is of Production Index, it not only impact positively ,it also have a significant influence with regression coefficient value above 50%.Just like the case of Money Supply it is also a dominating factor ,which affect the Commodity Price even in the presence of other Monetary Indicators. Interest Rate This the most important and difficult factor to analyse. First of all it is very difficult to calculate the real interest rate in the absence of exact inflation value. Still forms stand-alone model it can infer that interest rate negatively affect the commodity price ,which has been proved several time earlier. The important part is to judge the effect with other indicators and we can see that interest rate prove to be a dominating factor even in complete model and act as a negative factor for commodity price. Recommendation From all the above statistical analyse it can be infer that the model for commodity price is more accurate as more & more indicator incorporated for regression. It happens because commodity price is driven by a number of qualitative and quantitative factors. All possible quantitate factor need to be incorporated in the model and once the model is developed it need to support the qualitative aspect also.

Determination of any monetary policy cannot be based on single commodity index. Ideally statistical analysis need to be perform on sector specific indices e.g. Metal, Energy, Agri, Oil etc.in Appendix the same statistical treatment has been given for NCDEX index Dhanya.

The current model gives equal weightage to all the factors, but for all practical purpose these factor need to be weighted as per their characteristics. Analyst Need to perform a separate an analysis for short term and long term interest rate because they depicts different policy requirement.

The current analysis is only based on Commodity spot price, commodity exchange contain a large database on future market, So any implementation of policy is more useful if it cover both spot and future price fluctuation and their driving factors.

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The price discovery process should not be left to just a handful of traders in asymmetrically informed or ill informed, segmented markets. Rather, the best price discovery comes when a large number of various categories of market players with a wide range of objectives and interests converge on an organized futures platform. Such a platform and the Multi Commodity Exchange of India Ltd. (MCX) is one ensures that all relevant information is absorbed in the price formation process, and the right price is discovered. The more efficient the discovered prices on a futures platform is, the more effective are the business and policy decisions that are taken based on these prices.

At this juncture when the Indian markets are on their way to the heights achieved by the global benchmark markets, it is essential that they are allowed to have the right mix of participants and products to have the necessary liquidity depth and width. Corporates and physical market players in India are gradually realising the importance and need to participate on commodity exchanges. An increased participation of such players will go a long way in streamlining commodity trading in India by bringing in relevant information about the fundamentals into the markets and, thus, making the price discovery process more efficient. Besides, this will also help corporate best practices percolate into the markets to fine-tune their functioning and efficiency. Given the current trend of globalisation of economies, competitiveness remains one of the most defining factors for developing economies. And this not only means having competitive manufacturing and services sectors but also necessitates promotion of markets to make them globally-competitive.

Conclusion
Theoretical explanation that monetary policy makers need to consider commodity price as an indicator is easy task but actual implementation is quite hard. But not everyone would consider it obvious that an index of agricultural and mineral commodity prices belongs on a useful list of variables to reveal current monetary conditions, alongside interest rates, the exchange rate, money
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supply and Production rate. The conventional practice is to throw the volatile food and energy sector out of the price indices, concentrating instead on the core CPI if one wants a good indicator of likely future inflation. It is certainly true that if one is looking for the single standard statistic that best predicts future inflation, the core CPI will do better than the adjusted CPI. But true monetary control comes by a free to look at lots of information. For example considering are agricultural and mineral prices on the list of variables have significant impact. Our perspective places commodity prices on a plane with central banks paying attention to housing prices or the stock market. The theory and empirical results reported in dissertation report suggest that the commodity prices belong on the list of monetary condition indicators. Real commodity prices reflect monetary ease, more specifically real interest rates, among other factors. We can never be sure what the real interest rate is, because we do not directly observe expected inflation. Thus it is useful to have additional data that can be expected to reflect real interest rates. The main empirical results of dissertation report are quite insightful. At a global level, several literature support the conjecture that monetary aggregates may convey some useful information on variables such as commodity prices which matter for aggregate demand and hence inflation. Moreover, report identifies a negative relation between the world interest rate and commodity prices as proposed by various other researchers. Thus, we conclude that even in India liquidity, Production Development and the interest rate are useful indicators of commodity price inflation and of a more generally defined inflationary pressure at a global level. Given that the interest rate is inversely reacting to output and commodity prices, but it might be not showing exact picture as the interest rate doesnt seem to have been adjusted enough in the long-run to account for commodity price inflation and output growth on a global scale. Therefore we would like to argue that Indian economic liquidity merits some attention in the same way as the worldwide level of interest rates received in the recent hot debate about the world savings and liquidity glut as the main drivers of the current financial crisis, if not possibly more. Expressed on a more technical level, this paper has analyzed the relationship among money, interest rates and commodity prices for Indian economy in theoretical nature. At the OECD level, report gather further support of the conjecture that monetary aggregates may convey some useful information about the future development of commodity prices which matter for aggregate demand and hence consumer price
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inflation. Dissertations empirical results appear to be overall robust since they pass most of the hypothesis for strong relationship. One further advantage might be the more timely availability of commodity price data relative to those on overall monetary indicator. Exchange like MCX and NCDEX are new to Indian economy, so data is available for year 2005 only, but still the statistical result show effective model has been established. A holistic study of the monetary policy is must to understand the formulation of Commodity Price. The interesting Part is that, not only Monetary Indicator affect the Commodity Price, commodity price also influence the monetary policy. Several studs i.e. have been done to analyses these and by digging more & more economist will be able to develop a policy system which will be robust in nature and included all aspect of economic growth driver.

Bibliography
1. Hanke and Wichern(2009). Busines Forecasting ,8th Edition ,PHI publication house,New

Delhi.
2. Pindyank(2009). Macroeconomic Theroy, 5th Edition ,TATA Mcgraw Hill

Publication,New Delhi.
3. Awokuse, T.O. and Yang, J.(2003). The Information Role of Commodity Prices in 47 | P a g e

Formulating Monetary Policy: A Reexamination. Economics Letters.

4. Cody, B.J. and Mills, L.O.(1991). The Role of Commodity Prices in Formulating

Monetary Policy. Review of Economics and Statistics.

5. Garner, A.C.(1989). Commodity Prices: Policy Target or Information Variables?

Journal of Money, Credit and Banking.

6. Hua, P.(1998). On Primary Commodity Prices: The Impact of Macroeconomic/

Monetary Shocks. Journal of Policy Modeling.

7. Marquis, M.H. and Cunningham, S.R.(1990). Is There a Role of Commodity Prices in

the Design of Monetary Policy? Some Empirical Evidence. Southern Economic Journal.
8. Sephton, P. S.(1991). Commodity Prices: Policy Target or Information Variables? A

Comment. Journal of Money, Credit and Banking.

9. Toda, H.Y. and Yamamoto (1995). Statistical Inference in Vector Auto regressions 10. Alquist, R. and L. Kilian (2010), .What do we learn from the price of crude oil futures?

Journal of Applied Econometrics, forthcoming.

11. Anzuini, A., P. Pagano and M. Pisani (2007), .Oil supply news in a VAR: Information from

financial markets., Temi di discussione No. 632, Banca d.Italia. 12. Barsky, R.B. and L. Kilian (2002) .Do we really know that oil caused great stag.ation? A monetary alternative., NBER Macroeconomics Annual. 13. Deffeyes, Kenneth (2005) Beyond Oil: The View from Hubberts Peak (Hill and Wang). 14. Dornbusch, Rudiger (1976) "Expectations and Exchange Rate Dynamics" Journal of Political Economy.
15. Frankel, Jeffrey (1995) "Expectations and Commodity Price Dynamics: The Overshooting

Model," Amer. J. of Agric. Reprinted in Frankel, Financial Markets and Monetary Policy, MIT Press.
16. "Commodity Prices and Money(1984): Lessons from International Finance," American J.

of Agr. Economics 66.

17. Frankel, Jeffrey and Gikas Hardouvelis(1985): "Commodity Prices, Money Surprises, and

Fed Credibility," Journal of Money, Credit and Banking 17. 18. EBSCO Database
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19. Prowess Database

20. www.capitaline.com 21. www.indiastast.com 22. www.rbi.com 23. www.wikipedia.com 24. www.mcxindia.com 25. www.ncdex.com 26. www.wikipedia.com 27. www.moneycontrol.com 28. www.oecd.org

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Appendix

Analysis of NCDX (Ganya)

Minitab Analysis of same monetary indicator with other Commodity Index

Ver sus Fi ts
(response is Dhnaya Monthly) 250 200 150 Residual 100 50 0 -50 -100 600 700 800 900 Fit t ed V alue 1000 1100

The regression equation is Dhnaya Monthly = - 8.1 + 0.00129 Money Supply R-Sq = 87.1%

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Ver s us Fi ts
(response is Dhnaya Monthly) 300

200

Residual

100

-100

-200 600 700 800 900 1000 Fit t e d V a lue 1100 1200

The regression equation is Dhnaya Monthly = - 472 + 4.50 IIP R-Sq = 62.5%

Ver sus Fi ts
(response is Dhnaya Monthly) 300 200 100 0 -100 -200 700 800 900 Fit t ed V alue 1000 1100

The regression equation is Dhnaya Monthly = 1675 - 69.9 Prime Lending Rate R-Sq = 44.8%

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Residual

Ver sus Fi ts
(response is Dhnaya Monthly) 300 200 100 Residual 0 -100 -200 -300 700 750 800 850 Fit t ed V alue 900 950 1000

The regression equation is Dhnaya Monthly = - 300 + 25.1 Ex R-Sq = 27.1%

Ver s us Fi ts
(response is Dhnaya Monthly) 200 150 100 Residual 50 0 -50 -100 600 700 800 900 Fit t e d V a lue 1000 1100

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TRENDS IN INDEX OF INDUSTRIAL PRODUCTION

TRENDS IN INDEX OF INDUSTRIAL PRODUCTION Sector Weight Period Mining & Quarrying 10.473 Index Growth Rate (per cent) 2 3 131.9 1.3 -3.7 139.6 5.8 -8.4 146.9 5.3 -6.2 153.4 4.4 -4.3 154.8 0.9 -0.9 Manufacturing 79.358 Growth Rate (per cent) 5 2.9 -86.6 6 -86 7.4 -86.4 9.2 -90.4 9.1 -93.2 Electricity (Base : 1993-94=100) General 100 Growth Rate (per cent) 9 2.8 -100 5.8 -100 7 -100 8.4 -100 8.1 -100

Index

Index

1 2001-02 2002-03 2003-04 2004-05 2005-06 P

4 172.7 183.1 196.6 214.6 234.1

6 159.2 164.3 172.6 181.5 190.9

10.169 Growth Rate (per cent) 7 3.1 -10.8 3.2 -5.4 5 -6.8 5.2 -5.7 5.2 -5.8

Index

8 167 176.6 189 204.8 221.4

Monthly Average Data for All Monetary Indicators

Mone y Supp ly IIP
87853 2 87189 7 84080 6 82621 3 82301 3 81452 6 83244 9 82515 2 79873 5 331.5 325.7 323 346.3 325.9 323.9 323.9 373.8 331.1

MCX
3220. 38 3239. 99 3085. 39 2922. 42 2798. 73 2728. 37 2726. 87 2644. 65 2633. 75

CPI
570 566 562 557 554 547 540 538 536

Prime Lending Rate

8.5 8.5 8.5 8 8 8 12 12 12

Exchan ge Rate
45.31 44.81 46.04 44.54 44.92 47.08 46.46 46.6 46.45

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2680. 67 2645. 29 2637. 87 2528. 58 2724. 37 2672. 75 2606. 5 2450. 8 2476. 22 2329. 54 2343. 4 2235. 73 2017. 91 1978. 07 1881. 97 1726. 82 1645. 34 1859. 17 2051. 08 2762. 67 2734. 58 2889. 35 3182. 65 3116. 3 2825. 54 | P a g e

538 542 538 532 522 515 508 499 484 475 468 463 462 461 459 460 459 455 450 442 434 431 429 423 417

76803 3 75538 6 74214 5 73826 6 72369 1 71287 0 69027 9 67912 9 67596 3 69036 2 69487 0 68712 7 66545 0 65012 0 63380 4 62655 0 61898 7 61086 0 58614 6 58670 8 60288 5 60418 2 60259 8 58931 9 56841

331.2 334.3 299.8 289.7 302 292.8 290.8 291.6 280.3 269.3 305.9 276.8 284.8 284 267.6 262.9 276.2 264.7 271.3 269.2 274.6 266.3 304.9 276.2 281.9

12 12 12 12 12 12 12 12 12 12.25 12.25 12.25 12.5 12.5 12.5 13.25 13.5 14 14 14 13.25 12.75 12.75 12.75 12.75

44.44 45.14 46.23 46.37 46.68 46.48 46.96 48.04 48.88 48.16 47.87 47.29 50.22 50.95 50.73 49.02 48.45 49.84 49.25 46.94 43.79 42.49 42.95 42.59 40.46

38 2722. 13 2667. 03 2405. 78 2382. 98 2347. 92 2319. 62 2210. 47 2056. 68 2189. 06 2121. 38 2106. 96 2133. 03 2132. 57 2162. 31 1996. 96 2139. 4 2123. 88 2087. 52 2323. 48 2280. 04 2162. 83 2308. 34 2189. 72 1917. 12 55 | P a g e

413 413 414 413 410 408 404 399 395 394 392 392 391 390 390 386 380 375 372 370 365 360 358 357

0 55420 4 54419 6 53401 0 52511 3 50606 8 48638 7 48655 4 49563 2 50114 3 50392 2 50261 2 48280 5 48243 9 47198 1 46162 4 45218 0 45166 5 43403 7 43785 6 43518 6 43691 6 43616 2 43163 9 41311 9

284.7 261 262.6 260.5 260.3 255 255.3 263.1 250.7 289.1 252.2 265.5 263.7 248.8 234 243.5 234.8 235.5 234.4 237.9 225.2 251.9 227.3 237.9

13.25 13.25 13.25 13.25 13.25 13.25 13.25 13.25 13.25 13.25 13.25 12.5 12.5 12 11.5 11.5 11.5 11.5 11.5 11.25 11.25 11.25 10.75 10.75

39.97 39.92 39.39 39.41 39.67 39.32 39.74 40.96 40.44 40.75 40.73 41.29 43.59 44.31 44.17 44.23 44.76 45.02 45.96 46.55 46.51 46.08 46.43 44.97

1838. 77 1938. 63 1783. 86 1742. 92 1763. 7 1670. 44 1607. 15 1636. 67

357 358 360 356 354 352 350 345

41109 2 40353 4 39465 2 38774 7 38033 6 36452 8 37146 9 37098 8

232.5 214.8 223.9 217.4 212.9 208.1 213.6 213

10.75 10.75 10.75 10.75 10.75 10.75 10.75 10.75

44.61 44.44 44.07 45.07 45.94 45.11 43.99 44.04

56 | P a g e