Fdocuments - in Dissertation On Commodities Marketdocx

INTRODUCTION
1.1: Development of Commodity Futures Market in India
1.2: Current Scenario of commodity Futures Trading
1.3: Future Trading
1.4: Impact of Future trading on Commodity prices
1.5: Few Commodity Exchanges
Ranjeet Singh, IVth Semester, FMS-BHU

INTRODUCTION
Globally, commodity markets have occupied a very important place in the economic growth
and progress of countries. The concept of organized trading in commodities evolved in the
middle of the 19th century. Chicago had emerged as a major commercial hub with rail roads
and telegraph lines connecting it with the rest of the world, there by attracting wheat
producers from mid-west to sell their produce to the dealers and distributors. However, lack
of organized storage facilities and the absence of a uniform weighing and grading mechanism
often confined the producers to the dealer’s discretion. There was an inherent need to
establish a common meeting place for both farmers and dealers to deal in “spot” grain to
deliver wheat immediately and receive cash in return, which happened in the year 1848.
Gradually, the farmers (sellers) and dealers (buyers) started committing to exchange the
produce for cash in future. This is how the contract for “futures” trading evolved where by
the producer would agree to sell his produce (wheat) to the buyer at a future date at an agreed
upon price. In this way, the farmer knew in advance about what payment he would receive,
and the dealer knew about his costs involved. This arrangement was perceived beneficial to
both sellers and buyers. These contracts became popular very quickly and started changing
hands even before the delivery date. If a particular dealer felt uninterested in having wheat,
he would sell his contract to some one else, who needed it. Similarly, the producer who didn’t
intend to deliver his wheat would pass on the responsibility to another by buying new
contract. The price of the contract would depend on the price movement in the wheat market
depending upon demand and supply.
Commodity markets had a dominant presence in global markets ever since the first
commodity exchange “Chicago Board of Trade (CBOT)” was established in Chicago in the
year 1848, which is one of the largest commodity exchanges in the world. In the second half
of the 1980s several developing countries established their own commodity future exchanges.
Some of the world’s largest exchanges were established in Brazil and China. Some newly
liberalized economies, such as Russia and Hungary, have also setup commodity future
exchanges. Commodity exchanges occupy an important place in the world, and it has been
estimated that the volume traded on these exchanges are a multiple times those on stock
exchanges.
1.1 Development of Commodity Futures Market in India
India is one of the top producers of agricultural commodities and a major consumer of bullion
and energy products. Given the importance of commodity production and consumption in
India, it is necessary to develop the commodity markets with proper regulatory mechanism
for efficiency and optimal resource allocation. In this section we review the growth and
performance of commodity markets in India.
Evolution of Commodity Futures Trading In India:

Commodity futures trading in India is almost as old as that in the United States.
India’s first organized futures market was the Bombay Cotton Trade Association Ltd., which
was set up in 1875. Futures trading in oil seeds started with the setting up of Gujarati Vyapari
Mandali in 1900. Gold futures trading began in Mumbai in 1920. During the first half of the
20th century, there were several commodity exchanges trading in jute, pepper, turmeric,
potatoes, sugar, etc.
However, during 1940s, trading in forwards and futures became difficult as a result of price
controls. Major policy decisions taken after independence, mainly because of the scarcity
situation then prevailing adversely affected the development of futures and forwards markets
in the country. In 1952, the forward contract regulation act was passed which controls all
transferable forward and futures contracts. This again put restriction on futures trading.
During the 1960s and 70s, the Government of India suspended trading in several
commodities like cotton, jute, edible oilseeds, etc. As the government felt that these markets
were increasing the prices of commodities.

The twin policies of government offering to buy agricultural produce at a “Minimum Support
Price” (MSP) and gaining a monopoly in storage, transportation and distribution of
agricultural produce along with a ban on futures and options trading were the major factors
that weakened the agricultural commodity markets in the country. The ban on futures trading
in agricultural commodities were removed in the seventies, but the futures markets never
regained the levels of liquidity that they had enjoyed earlier.
The government appointed two committees to study the commodity futures sector, that is, the
Dantwala Committee in 1966, and the Khusro committee in 1980, which recommended the
re-introduction of futures trading in major commodities. The government finally brought
back forward trading in agricultural commodities in the early 1980’s. But, it was done for
commodities that did not have a very significant role in the economy, that is, castor seed,
castor oil, jaggary, jute, pepper, potato and turmeric. Several localized exchanges started
trading in the same commodity, each of them with a local broker and wholesale-merchandiser
constituency. However, even after a decade, none of the markets achieved the levels of
liquidity that existed prior to the ban on commodity futures trading.
Once futures trading became operational, in spite of liberalization, it has been difficult for
trade to be transferred from illegal black markets, which have zero tax liability and no
reporting requirements to the legal authorities as compared to the regulated markets, where
taxes and reporting are part of the legal producers. Further, responding to the need for
commodity futures in India, in 1994, a committee was set-up for assessing the scope for
forwards and futures trading in commodities and for recommending steps to be taken for
development of futures trading in India. The committee so instituted was known as the Kabra
Committee and much of its recommendations have been implemented.
Currently, there are three major National Level Commodity Exchanges and 21 regional
exchanges operating in India. The national exchanges include National Multi- Commodity
Exchange of India Limited (NMCE), Multi Commodity Exchange of India limited (MCX)
and National Commodity and Derivatives Exchange Limited (NCDEX), which have been
working since 26th November 2002, 10th November 2003 and 15th December 2003
respectively.

Structure of Commodity Market in India: Trading in commodity market takes place in
two distinct forms such as the Over-The-Counter (OTC), which is basically spot market and
the exchange-based market. Further, as in equities, there exists the spot where participation is
restricted to people who are involved with that commodity, such as the farmer, processor,
wholesaler, etc. and the derivatives segments where trading takes place through the
exchange-based markets like equity derivatives.
At present, there are 23 exchanges operating in India and carrying out futures trading
activities in as many as 146 commodity items (see Fig-1). As per the recommendation of the
FMC, the Government of India recognized the National Multi-Commodity Exchange
(NMCE), Ahmedabad; Multi Commodity Exchange (MCX) and National Commodity and
Derivative Exchange (NCDEX), Mumbai, as nation-wide multicommodity exchanges.
NMCE commenced in November 2002 and MCX in November 2003 and NCDEX in
December 2003. Unlike the stock markets, the commodity markets in India have a single
product (only futures) and a single user11 (only traders including corporates).
Growth of Commodity Futures Market: The volume of trade has increased exponentially
since 2004-05 to reach Rs. 40.65 lakh crore in 2007-08. Almost 95% of this is now accounted
for by the two national exchanges viz., Mumbai (MCX), with around 75 % share and
NCDEX, with 20 % share (see Figure-2). There are more then 3000 members registered with
the exchanges. More than 20,000 terminals spread over more than 800 towns/cities of the
country provide access to the trading platforms (EC, 2008). Gold, silver and petroleum crude
recorded the highest turnover in MCX; while in NCDEX, soya oil, guar seed and soyabean
was dominant; in NMCE, pepper, rubber and raw jute were the most actively traded
commodities. Though in India, agricultural products dominate the commodity sectors, trading
in non-agricultural commodities has been dominating particularly, from 2006-07 onwards.
The trading volumes of non-agricultural commodities have shot up almost twice that of
agricultural commodities during the same period. Overall, the Indian commodity market has
shown tremendous growth in terms of both value and the number of commodities traded in
the last five years. As the largest commodity futures exchange during 2006-07, both in terms
of turnover and number of contracts, the growth of

MCX is comparable (see Figure-3) with some of the international commodity futures
exchanges such as Dow Jones AIG Commodity Index (DJAIG) and Reuters/Jefferies
Commodity Research Bureau (RJCRB).
Performance of Indian Commodity Derivatives Market: There are few empirical studies
on the performance of Indian commodity derivatives market. A study by Lokare (2007) finds
that although Indian commodity market is yet to achieve minimum critical liquidity in some
commodities (sugar, peper, gur and groundnut), almost all the commodities show an evidence
of co-integration between spot and future prices revealing the right direction of achieving
improved operational efficiency, albeit, at a slower pace. Further, hedging proves to be an
effective proposition in respect of some commodities. However, in a few commodities, the
volatility in the future price has been substantially lower than the spot price indicating an
inefficient utilisation of information. Several commodities also appear to attract wide
speculative trading. One of the reasons for low volumes could be attributed to some of the
measures that FMC undertook in the recent period such as daily mark to market margining,
time stamping of trades, demutualisation for the new exchanges, etc., with a view to promote
market integrity and transparency. The exchanges have attributed subsequent fall in the
volume of trade to introduction of these measures (Kolamkar, 2003). Thomas (2003) reports
that major stumbling blocks in the development of derivatives market are the fragmented
physical/spot markets.
Supporting this view, Lokare (2007) suggests that national level derivative exchanges cannot
be founded on fragmented localized cash markets. Because of fragmentation, prices of major
commodities vary widely across Mandis. These differences arise because of poor grading;
differential rates of taxes and levies, and inadequacy of storage facilities (Bhattacharya,
2007). Similarly, Raizada and Sahi (2007) found that commodity futures market is not
efficient in the short-run and social loss statistics also indicate poor price discovery in the
commodity market. Spot price leads the futures price determination and the futures markets
are not performing their main role of price discovery. There were also doubts that the growth
of commodity futures market volume has an impact on the inflation level in India. Though
EC (2008) report does not find any conclusive evidence between futures trading in
agricultural commodities and their price level. . The analysis of the EC report does not show
any clear evidence of either reduced or increased volatility of spot prices due to futures
trading. Further, the fact that agricultural price inflation accelerated during the post futures
period does not, however, necessarily mean that this was caused by futures trading. One
reason for the acceleration of price increase in the post futures period was that the immediate
pre-futures period had been one of the relatively low agricultural prices, reflecting an
international downturn in commodity prices.
1.2 Current Scenario of Commodity Futures Trading in India

With rising prices, the functioning of futures markets came under suspicion during 2006–07
and the government ordered a possible delisting of futures contracts for commodities like
Urad, Tur, Wheat and Rice to avoid the abnormal rise in their domestic spot prices. Followed
by this, Sugar, Oil, Rice and Potato were also added to the list in 2007, but were subsequently
delisted in 2008. In a similar line of thought, the India Government again banned future
trading in Chana, Potato and Soya oil in May 2008. However, a steady process of opening up
has been visible in future market for commodities over the last two years.

As a result of significant policy change, liberalization of world markets and other
developments, Indian commodity markets notched up phenomenal growth in terms of number
of products on offer, participants, spatial distribution and volume of trade. The cumulative
value of commodity trading in India during April to December 2010, as reported by FMC, is
82.71 lakh crore with a growth of 49.66% from the same period in the last year. The overall
growth of commodity futures market in India over the last decade can be depicted through
Figure F1. Even if the growth in all commodities is quite significant, the growth in
agriculture commodities in India for the same period is found to be only 7.48%. Futures
trading in India are currently permitted in 4 national level multi-commodity exchanges and
18 regional level commodity specific exchanges, and almost 200 different futures contract
written on almost 100 commodities. Out of the total, number of agricultural commodities
traded in national level exchanges is almost 28 to 30. In fact, there seems to be no limit to the
number of commodities eligible to be traded in commodity exchanges, except the fact that the
commodity should fulfill the criteria of becoming ‘Goods’ as defined in the Forward Contract
Regulation Act (FCRA – 1952). In order to widen the scope of commodity futures trading in

India, it has also been proposed to widen the definition of commodity through the necessary
amendments in the concerned laws, and allows the exchanges to trade even on immovable
and intangible assets like real estate, commodity price indices, rainfall, weather indices,
carbon credits, etc.
1.3 FUTURES TRADING
WHAT ARE FUTURES?
‘Futures’ are standardized financial contracts traded in a futures exchange. A futures contract
is an agreement to buy or sell a certain quantity of an underlying asset at a certain time in the
future at a predetermined price.
When futures contracts are traded, there isn’t necessarily an actual delivery of goods. The
trader only speculates on the future direction of the price of the underlying asset, which may
be a commodity, foreign exchange, bonds, money market instruments, equity or any other
item. The terms "buy" and "sell" only indicate the direction the trader expects future prices to
take, i.e. he would buy it if he expects the price of the underlying asset to rise in the future
and sell if he expects it to fall. Futures contracts are usually closed by making an opposite
transaction, i.e. the buyer of the contract sells it before the expiration date.

The price at which the contract is traded in the futures market is called the futures price.
Futures contracts have one‐month, two‐month and three‐month expiry cycles, and they
usually expire on the last Thursday of the respective month.
There are two systems that may be followed in the settlement of futures contracts:
Futures Rolling Settlement: At the end of each day, all outstanding trades are settled, i.e
the buyer makes payments for securities purchased and the seller delivers the securities sold.
In India, futures exchanges function on the T+5 settlement cycle, wherein transactions are
settled after 5 working days from the date on which the transaction has been entered.
Weekly Settlement Cycle: This system provides the traders a longer time frame to speculate
because the settlement is made at the end of each week.
There are three categories of participants in the futures market – speculators, who bet on the
future movement of the price of an asset; hedgers, who try to eliminate the risks involved in
the price fluctuations of an asset by entering futures contracts; and arbitrageurs, who try to
take advantage of the discrepancy between prices in different markets.
While hedgers participate in the market to offset risk, speculators make it possible for
hedgers to do so by assuming the risk. Arbitrageurs ensure that the futures and cash markets
move in the same direction.
WHY FUTURES TRADING?
Over the past two decades, food prices have been more volatile than the prices of
manufactured goods. The uncertainty of commodity prices leaves a farmer open to the risk of
receiving a price lower than the expected price for his yield. At times, the crop prices fall so
low that the farmer is unable to repay the loan. Inadequate price risk management is one of
the most important reasons for poor farmers remaining poor.4 Price risk management refers
to minimizing the risk involved in commodities trading. Through futures contracts, the risk
may be shifted to speculators or traders who are willing to assume the risk. A hedger would
try to minimize risk by taking opposite positions in the futures and cash markets. Since the

two markets usually move in the same direction, the profits of one market will cover the
losses in the other. In the case of a commodity seller, like a farmer or a merchant, futures
contracts offer protection from declining prices.
Price discovery refers to the process of determining the price level of a commodity based on
demand and supply factors. Every trader in the trading pit of a commodities exchange has
specific market information like demand, supply and inflation rates. When trades between
buyers and sellers are executed, the market price of a commodity is discovered. According to
V. Shunmugam, Chief Economist at the Multi Commodity Exchange of India Ltd.,
commodity futures help policy makers take better preventive measures by indicating price
rises beforehand.
Apart from the basic functions of price discovery and price risk management, futures
contracts have a number of other benefits like providing liquidity, bringing transparency and
controlling black marketing.
Futures contracts can easily be converted into cash, i.e. they are liquid. By buying or selling
the contract in order to make profits, speculators provide the capital required for ensuring
liquidity in the market. They provide certainty of future revenues or expenditures, hence
ensuring concrete cash flows for the user. Futures markets allow speculative trade in a more
controlled environment where monitoring and surveillance of the participants is possible.
Hence, futures ensure transparency. The transparency benefits the farmers as well by
spreading awareness about prices in the open market.
Futures also help in standardization of quality, quantity and time of delivery, since these
variables are agreed upon by the participants and specified in the futures contract.
HISTORY OF FUTURES TRADING
GLOBALLY
Futures trading in commodities is said to have originated in Japan in the 17th century for silk
and rice.6 The Dojima Rice Exchange in Osaka, Japan, is said to be the world’s first
organized futures exchange, where trading started in 1710.
Strategically located at the base of the Great Lakes, close to the farmlands and well‐
connected by railroad and telegraph lines, Chicago became a commercial hub in the 1840s.
Inadequate storage facilities led to surplus or shortages in the markets, which in turn led to
huge fluctuations in the commodity prices. In order to hedge themselves from the risk of
declining prices, grain merchants, farmers and processors began entering ‘forward contracts’,
wherein they agreed to exchange a certain quantity of a specified commodity for an agreed
sum on a certain date in the future. This was beneficial for both parties involved: the seller
knew how much he would receive for his produce and the buyer knew his costs in advance.
However, not all such contracts were honored. For instance, if the price agreed upon in the
forward contract was far lower than the prevailing market price, the seller would back out.
On April 3 1848, the Chicago Board of Trade (CBOT) was established by 83 merchants to
facilitate trade in spot produce and forward contracts. It was only in 1865 that standardized
futures contracts were introduced. The Chicago Produce Exchange was established in 1874
and the Chicago Butter and Egg Board in 1898. In 1919, it was reorganized to enable future
trading and was renamed Chicago Mercantile Exchange.
FUTURES TRADING IN INDIA
It is believed that commodity futures have existed in India for thousands of years. Kautilya’s
‘Arthashastra’ alludes to market operations similar to modern futures markets.
However, organized trading in commodity futures in India commenced in the latter part of
the 19th century at Bombay Cotton Trade Association Ltd. (established in 1875). The number
of commodity markets in the pre‐independence era was limited, and there were no uniform
guidelines or regulations: trade depended on mutual trust and social control.
In 1947, the Bombay forward Contracts Control Act was enacted by the Bombay State. The
legal framework for organizing forward trading and the recognition of Exchanges was only
provided after the adoption of the Constitution by a central legislation called Forward
Contracts (Regulation) Act 1952.

Through a notification issued on 27 June 1969, by exercising the powers conferred upon the
Central Government by the Securities Contracts Regulation Act 1956, forward trade was
prohibited in a large number of commodities, leaving only 7 commodities open for forward
trade. The decline in traded volumes on stock markets led to the evolution of an informal
system of forward trading by the Bombay Stock Exchange in 1972, but this created payment
crises quite often.
In 1994, the Kabra Committee recommended the opening up of futures trading in 17

commodities, excluding wheat, pulses, non‐basmati, rice, tea, coffee, dry chilli, maize,
vanaspati and sugar. There were a number of other expert committees, including the Shroff
Committee, Dantwalla Committee and the Khusro Committee, which laid the foundation for
the revival of futures trading. Many reports, notably a UNCTAD and World Bank joint
Mission Report ‐ India: Managing Price Risk in India’s Liberalised Agriculture: Can Futures
market Help? (1996), advocated the repeal of the notification prohibiting forward trade.
After the Securities Laws (Amendment) Bill was passed in 1999, the Central Government
lifted the prohibition on forward trading in securities on 1 March, 2000.
The National Multi Commodity Exchange (NMCE) was the first exchange to be granted
permanent recognition by the Government, where futures trading commenced on 26
November, 2002 in 24 commodities. The Multi Commodity Exchange of India (MCX) was
established in November 2003 and the National Commodity and Derivatives Exchange
Limited (NCDEX) commenced operations in December 2003.
Today, futures trading is permissible in 95 commodities in India. There are 25 recognised

futures exchanges with more than 3000 registered members. Trading platforms can be
accessed through 20,000 terminals spread over 800 towns/cities. The volume of trade in the
exchanges in 2006‐07 was Rs.36.77 lakh crore, 97.2 per cent of which is accounted for by the
four national exchanges, viz. National Commodity and Derivatives Exchange Ltd. (NCDEX),
Bombay; Multi Commodity Exchange (MCX), Bombay; National Multi Commodity
Exchange (NMCE), Ahmedabad; and National Board of Trade (NBOT), Indore. The
commodity exchanges are regulated by the Forward Markets Commission (FMC), which was
established in 1952. In terms of value of trade, agricultural commodities constituted the
largest commodity group in the futures market till 2005‐06 (55.32 per cent). Since 2006‐07,
bullion and metals has taken this place. Between April 2007 and January 2008, agriculture
futures amounted to Rs.7.34 lakh crore, 23.22 per cent of all commodity futures.
1.4 Impact of Futures Trading on Commodity Prices
Impact of futures trading on physical market prices is, probably, the most contentious issue
among policymakers and researchers. For futures markets to be effective, the futures forum
should not only have a close relation with the physical markets and thereby help hedging
through a process of arbitrage between both the markets, but it should also serve as a forum
whose prices should be taken as a “reference price” by physical market functionaries. This
service of “reference pricing” is popularly known as “price discovery”.
However, the fact of the matter is much deeper than what meets the eye. The advocates of
derivative markets have traditionally argued that speculation in the futures markets primarily
helps the twin economic functions of hedging and price discovery. Yet, traditionally, futures
markets have been vilified as the speculators’ haven with the allegation that excessive
speculation in the futures forum has led to price volatilities and inflation in the economy. It is
again axiomatic that greater the price volatility, higher the speculation.
Hence, while advocates of commodity markets feel that speculators take up the hedgers’ risk
and provide liquidity to the markets, and thereby help futures markets to perform the dual

functions of price risk management and price discovery, the anti-market sentiments argue that
speculators in the futures markets can create havoc in the physical market segment in two
ways: first, by increasing price volatilities (contrary to the futuresmarkets’ axiomatic role of
price stabilization), and second, by creating inflationary pressures on the economy.
The suspicion of excessive speculation causing food price inflation has become stronger in
the background of the worldwide increase in prices of wheat, rice, oilseeds, and pulses last
year. The hypothesis has been tested and investigated worldwide. In a recent independent
investigation on the wheat futures contract at the Kansas City Board of Trade (KCBT), there
have been indicative evidences of building up of “long” positions between April 2005 and
July 2006, and “short” covering in the subsequent period till March 2008. Wheat prices
increased more than twofold during this period with “open interest” positions declining to
half of what prevailed at KCBT. Between March and December 2008, wheat prices declined
by 50%, and open interest declined by more than 25%—probably because of the liquidation
of longs.
There have been allegations that speculation causes price volatilities in India as well. While
there is some research on whether futures trading is responsible for such volatilities, such
research has often been criticized on theoretical and methodological grounds.
The Expert Committee to study the impact of futures trading on agricultural commodity
prices, chaired by Abhijit Sen, failed to arrive at any unanimous conclusion.
Though a majority of the Committee members opined that such trading has no adverse
influence on commodity prices in the physical markets, Abhijit Sen, however, remained
ambivalent on this issue; he felt that the available data was inadequate to draw any
meaningful inference.
In any case, increasing volatility cannot always be attributed to speculation. It is often a lack
of speculation that leads to low liquidity, which in turn can lead to a wider chasm between the
bid-ask spread and cause high price fluctuations in the markets.

Unfortunately, many research papers have taken extreme positions by considering time
dummies (on before and after commodity trading), and the commodity futures market is then
vilified and treated as a “whipping boy,” without solid empirical evidence. Such anti-market
statements have traditionally been based not so much on concrete empiricism underlying
long-run rationality as on irrational emotional sentiments based on myopic observations. On
the other hand, there is also a widespread misconception of the notion of “price discovery.”
The methodological issues involved in testing the relationship between the futures and
physical markets have been discussed in details by Rutten (2009). In most cases,
econometricians have used Granger causality tests or Garbade-Silber frameworks to test
whether futures prices cause physical market prices. If the hypothesis is found to be true, it is
inferred that the price discovery function is performed by futures markets. While the attempts
are appreciable, there is a need to exercise caution.
Relationships might often be spurious, and at times away from reality. It is essential to
develop a general equilibrium framework, and on the basis of a computable general
equilibrium (CGE) model, the influence of the futures markets on the physical markets can be
deliberated. On the other hand, it is essential to carry out primary-level surveys to cross-
check the results, and publish the primary survey results.
There is another aspect to price discovery function of the futures markets, as also the
econometric models used to test them. The anti-market faction has often interpreted results as
per its convenience. If futures prices act as reference prices for the physical markets during
the time of a price rise, this faction assumes that the rise in futures price is responsible for the
commodity price rise in the economy. Eventually, the entire blame for the inflationary trend
is placed on the speculative elements in the futures markets, without considering the fact that
price, fundamentally, is a function of demand and supply. An efficient futures market will be
able to access this information, process it and pass this on to the physical markets. The
question of efficiency of the futures markets in acquiring and processing this information was
discussed in a paper by Sangeeta Chakrabarty and Nilabja Ghosh at the TAER-ISID seminar.

1.5 Few Commodity Exchanges
In enhancing the institutional capabilities for futures trading the idea of setting up
of National Commodity Exchange(s) has been pursued since 1999. Three such Exchanges,
viz, National Multi-Commodity Exchange of India Ltd., (NMCE), Ahmedabad, National
Commodity & Derivatives Exchange (NCDEX), Mumbai, and Multi Commodity Exchange
(MCX), Mumbai have become operational. “National Status” implies that these exchanges
would be automatically permitted to conduct futures trading in all commodities subject to
clearance of byelaws and contract specifications by the FMC. While the NMCE, Ahmedabad
commenced futures trading in November 2002, MCX and NCDEX, Mumbai commenced
operations in October/ December 2003 respectively.
National Commodity and Derivatives Exchange (NCDEX)

National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally
managed on-line multi commodity exchange. The shareholders of NCDEX comprises of
large national level institutions, large public sector bank and companies.
Promoter shareholders: ICICI Bank Limited (ICICI)*, Life Insurance Corporation of India
(LIC), National Bank for Agriculture and Rural Development (NABARD) and National
Stock Exchange of India Limited (NSE).
Other shareholders: Canara Bank, Punjab National Bank (PNB), CRISIL Limited, Indian
Farmers Fertiliser Cooperative Limited (IFFCO), Goldman Sachs, Intercontinental Exchange
(ICE) and Shree Renuka Sugars Limited
The following points explain about NCDEX:
 NCDEX is a public limited company incorporated on April 23, 2003 under the
Companies Act, 1956. It obtained its Certificate for Commencement of Business on
May 9, 2003. It has commenced its operations on December 15, 2003.
 NCDEX is a nation-level, technology driven de-mutualized on-line commodity

exchange with an independent Board of Directors and professionals not having any
vested interest in commodity markets. It is committed to provide a world-class
commodity exchange platform for market participants to trade in a wide spectrum of
commodity derivatives driven by best global practices, professionalism and
transparency.
 NCDEX is regulated by Forward Market Commission in respect of futures trading in

commodities. Besides, NCDEX is subjected to various laws of the land like the
Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act
and various other legislations, which impinge on its working.
 NCDEX is located in Mumbai and offers facilities to its members in more than 550
centres throughout India . The reach will gradually be expanded to more centres.
 Online Screen based Future Trading in about 45 Commodities presently.
 More than 100 commodities proposed in near future.
 Daily average turnover of more than Rs. 4, 000 Crores.
 Daily average turnover expected to be more than Rs.16, 000 Crores in a years time
and more than Rs. 25,000-30,000 Crores in 4-5 years.

 Excellent hedging tools against price risk.
 All trades backed by Trade Guarantee Fund of respective commodity exchanges thus
almost no risk of default.
 Worldwide largest consumer of traditional form of investment.
 Low margins on trade as compared to equity market.
 Online spot trading, future trading in option and commodity indices are also to be
introduced in near future.
 Delivery in Demat Form.
 NCDEX is the only commodity exchange in the country promoted by national level
institutions. This unique parentage enables it to offer a bouquet of benefits, which are
currently in short supply in the commodity markets. The institutional promoters and
shareholders of NCDEX are prominent players in their respective fields and bring
with them institutional building experience, trust, nationwide reach, technology and
risk management skills.
 NCDEX is a public limited company incorporated on April 23, 2003 under the
Companies Act, 1956. It obtained its Certificate for Commencement of Business on
May 9, 2003. It commenced its operations on December 15, 2003.
 NCDEX is a nation-level, technology driven de-mutualised on-line commodity

exchange with an independent Board of Directors and professional management -
both not having any vested interest in commodity markets. It is committed to provide
a world-class commodity exchange platform for market participants to trade in a wide
spectrum of commodity derivatives driven by best global practices, professionalism
and transparency.
 NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to

various laws of the land like the Forward Contracts (Regulation) Act, Companies Act,
Stamp Act, Contract Act and various other legislations.

 NCDEX headquarters are located in Mumbai and offers facilities to its members from
the centres located throughout India.
 The Exchange, as on May 21, 2009 when Wheat Contracts were re-launched on the
Exchange platform, offered contracts in 59 commodities - comprising 39 agricultural
commodities, 5 base metals, 6 precious metals, 4 energy, 3 polymers, 1 ferrous metal,
and CER. The top 5 commodities, in terms of volume traded at the Exchange, were
Rape/Mustard Seed, Gaur Seed, Soyabean Seeds, Turmeric and Jeera.

Multi Commodity Exchange of India Limited (MCX)
Headquartered in the financial capital of India, Mumbai, Multi Commodity Exchange
of India Ltd is a demutualised nationwide electronic commodity futures exchange set up by
Financial Technologies (India) Ltd. with permanent recognition from Government of India
for facilitating online trading, clearing & settlement operations for futures market across the
country. The exchange started operations in November 2003.
MCX has achieved three ISO certifications including ISO 9001:2000 for quality
management, ISO 27001:2005 - for information security management systems and ISO
14001:2004 for environment management systems. MCX offers futures trading in more than
40 commodities from various market segments including bullion, energy, ferrous and non-
ferrous metals, oil and oil seeds, cereal, pulses, plantation, spices, plastic and fibre. The
exchange strives to be at the forefront of developments in the commodities futures industry
and has forged strategic alliances with various leading International Exchanges, including
Tokyo Commodity Exchange, London Metal Exchange, New York Mercantile Exchange,
Bursa Malaysia Derivatives, Berhad and others.
MCX an independent and de-mutulised multi commodity exchange has permanent

recognition from Government of India for facilitating online trading, clearing and settlement
operations for commodity futures markets across the country. Key shareholders of MCX are
Financial Technologies ( India ) Ltd., State Bank of India, HDFC Bank, State Bank of Indore,
State Bank of Hyderabad, State Bank of Saurashtra, SBI Life Insurance Co. Ltd., Union Bank
of India , Bank of India , Bank Of Baroda, Canara Bank, Corporation Bank.
Headquartered in Mumbai, MCX is led by an expert management team with deep

domain knowledge of the commodity futures markets. Through the integration of dedicated
resources, robust technology and scalable infrastructure, since inception MCX has recorded
many first to its credit.
Inaugurated in November 2003 by Shri Mukesh Ambani, Chairman & Managing

Director, Reliance Industries Ltd, MCX offers futures trading in the following commodity
categories: Agri Commodities, Bullion, Metals- Ferrous & Non-ferrous, Pulses, Oils &
Oilseeds, Energy, Plantations, Spices and other soft commodities.
Key shareholders
Promoted by Financial Technologies (India) Ltd, MCX enjoys the confidence of blue
chips in the Indian and international financial sectors. MCX’s broadbased strategic equity
partners include, NYSE Euronext, State Bank of India and its associates (SBI), National Bank
for Agriculture and Rural Development (NABARD), National Stock Exchange of India Ltd.
(NSE), SBI Life Insurance Co. Ltd., Bank of India (BOI) , Bank of Baroda (BOB), Union
Bank of India, Corporation Bank, Canara Bank, HDFC Bank, Fid Fund (Mauritius) Ltd. - an
affiliate of Fidelity International, ICICI Ventures, IL&FS, Kotak group, Citi Group and
Merrill Lynch.

Indian Commodity Exchange Limited (ICEX), Gurgaon
Indian Commodity Exchange Limited is a screen based on-line derivatives exchange

for commodities and has established a reliable, time tested, and a transparent trading
platform. It is also in the process of putting in place robust assaying and warehousing
facilities in order to facilitate deliveries. It is jointly promoted by Indiabulls Financial
Services Ltd and MMTC Limited, and has Indian Potash Ltd., KRIBHCO and IDFC among
others, as its partners.
This exchange is ideally positioned to tap the huge scope for increasing the depth and
size of commodities’ market and fill in the structural gaps existing in the Indian market. Our
head office is located in North India (Gurgaon), one of the key regions in India's Agri belt,
with a vision to encourage participation of farmers, traders and actual users to hedge their
positions against the wild price fluctuations.
Corporate Vision & Mission
Provide fair, transparent and efficient trading platform to all participants.

Meet the international benchmarks for the Indian commodity market.
Provide equal opportunity and access to investors all over the country through the
modern communication modes.
Attract a wide array of end users, financial intermediaries and hedgers.
Become a major trading hub for most of the commodities.
To provide product portfolio to suit the trading community needs in an efficient manner
Shareholders and Shareholding pattern

Indiabulls Financial Services Limited is part of Indiabulls Group, one of the top
business houses in the country with business interests in Real Estate, Infrastructure, Financial
Services, Retail, Multiplex and Power sectors. Indiabulls Financial Services is one of India's
leading and fastest growing private sector financial services companies. Indiabulls Financial
Services is an integrated financial services powerhouse providing Consumer Finance,
Housing Finance, Commercial Loans, Life Insurance, Asset Management and Advisory
services. The company is focused on providing multiple financial services through an
extensive network of customer touch-points covering tier I, tier II and tier III cities. Indiabulls
serves more than 500,000 customers across different financial products through its branch
network, call centers and the Internet. It also ranks among the top private sector financial
services and banking groups, in terms of net worth.
MMTC Ltd, a Government of India enterprise, is the largest international trading

company of India having annual turnover of more then US$ 7Billion or Rs. 36000 Crores. It
is among the leading international trading company of South Asia having experience of more
then 45 years in bulk trading of diverse commodities and products. It is present in 56
locations in India through offices, warehouses, port offices & retail outlets.
It is the largest exporter of Minerals and single largest importer / supplier of Bullion
& Non-Ferrous Metals in India. MMTC is also leading in trading of Agro products,
Fertilizers, Coal & Hydrocarbons, textiles, chemicals etc. MMTC Ltd has a fully owned
subsidiary, MTPL in Singapore and also a promoter of NINL in Orissa, an Iron & Steel plant.
Indian Potash Ltd, the biggest canalizing agency (State Trading Enterprise) for import
of Urea and other fertilizers on behalf of Government of India, is a major player in Indian
Fertilizer Industry with offices and dealers network across the country. This network is
serviced by a huge chain of Warehouses (total capacity 8 lakhs MT) spread across the
country.
Shareholder Shareholding Pattern

Indiabulls Financial Services
40%
Limited
MMTC Limited 26%
Indian Potash Limited 10%
KRIBHCO 5%
IDFC 5%
Others 14%

National Multi Commodity Exchange of India Ltd.
(NMCE)
National Multi Commodity Exchange of India Ltd. (NMCE) was promoted by Central
Warehousing Corporation (CWC), National Agricultural Cooperative Marketing Federation
of India (NAFED), Gujarat Agro-Industries Corporation Limited (GAICL), Gujarat State
Agricultural Marketing Board (GSAMB), National Institute of Agricultural Marketing
(NIAM), and Neptune Overseas Limited (NOL). While various integral aspects of
commodity economy, viz., warehousing, cooperatives, private and public sector marketing of
agricultural commodities, research and training were adequately addressed in structuring the
Exchange, finance was still a vital missing link. Punjab National Bank (PNB) took equity of
the Exchange to establish that linkage. Even today, NMCE is the only Exchange in India to
have such investment and technical support from the commodity relevant institutions.
NMCE facilitates electronic derivatives trading through robust and tested trading
platform, Derivative Trading Settlement System (DTSS), provided by CMC. It has robust
delivery mechanism making it the most suitable for the participants in the physical
commodity markets. It has also established fair and transparent rule-based procedures and
demonstrated total commitment towards eliminating any conflicts of interest. It is the only
Commodity Exchange in the world to have received ISO 9001:2000 certification from British
Standard Institutions (BSI). NMCE was the first commodity exchange to provide trading
facility through internet, through Virtual Private Network (VPN).
NMCE follows best international risk management practices. The contracts are
marked to market on daily basis. The system of upfront margining based on Value at Risk is
followed to ensure financial security of the market. In the event of high volatility in the
prices, special intra-day clearing and settlement is held. NMCE was the first to initiate
process of dematerialization and electronic transfer of warehoused commodity stocks. The
unique strength of NMCE is its settlements via a Delivery Backed System, an imperative in
the commodity trading business. These deliveries are executed through a sound and reliable
Warehouse Receipt System, leading to guaranteed clearing and settlement.

REVIEW OF LITERATURE
Empirical literature on Futures Market and inflation compare spot market volatility before
and after the introduction of futures trading and investigate the impact of futures activity on
spot volatilities.
Kamara (1982) finds that the introduction of commodity futures trading generally reduced
or at least did not increase the cash price volatility.
Further, Singh (2000) investigated the hessian cash (spot) price variability, before and after
the introduction of futures trading (1988- 1997) in Indian markets using the multiplicative
dummy variable model and concluded that futures trading had reduced the price volatility in
the hessian cash market.
However, Yang et al. (2005) showed that an unexpected and unidirectional increase in
futures trading volume drove up the cash price volatility.
On the other hand, the study by Nitesh (2005) reveals that futures trading in soya oil futures
was effective in reducing the seasonal price volatilities, but not the daily price volatilities in
India.
Similarly, Sahi (2006) finds that the nature of volatility did not change with the introduction
of futures trading in wheat, turmeric, sugar, cotton, raw jute and soya oil. Nevertheless, a
weak destabilizing effect of futures on spot prices was found in case of wheat and raw jute.
Further, the results of granger causality tests indicated that the unexpected increase in futures
activity in terms of rise in volumes and open interest caused an increase in the cash price
volatilities in all the commodities listed.
Nath and Reddy (2007) find that futures activity leads to price volatilities in the case of
urad dal but not in the case of gram and wheat. Therefore, the study concludes that the belief
that futures trading contributes to rise in inflation (WPI) appears to have no merit in the
present context.
A study by the Indian Institute of Management, Bangalore (IIMB) in 2008 explains that
changes in fundamentals (mainly from the supply side) along with government policies were
causing higher post-futures price rise and the role of futures trading remained unclear.
EC (2008) while analyzing the impact of futures trading on commodity prices found that out
of 21 commodities, price volatility increased in 10 commodities, remained unchanged in two,
and declined in 9, after the introduction offutures trading15. However, the committee could
not find any strong conclusion on whether introduction of futures trade is associated with
decrease or increase in spot price volatility. Looking at price growth and price volatility of
top ten agricultural commodities consisting major future trade, it is not clear whether future
trading contributes to price rise or price volatility.
By considering various agricultural products, Garbade and Silber (1983), Khoury and
Martel (1991), Fortenbery and Zapata (1993), have made an attempt to establish the
interrelationship among the spot and futures market in agricultural sector, and have revealed
the strength of futures market in successfully discovering the spot prices. Some of these
studies have also highlighted on the impact of futures contract on the volatility of the
underlying agri-commodity market. Apart from establishing a unidirectional and / or
bidirectional flow of information between the spot and futures market, depending on the
nature of market and prevailing economic and other conditions, some of the studies have also
supported the role of market size and liquidity in discovering prices.
Similarly, several researchers such as Oellermann and Farris (1989), Brorsen,

Oellermann and Farris (1989), Oellermann, Brorsen and Farris (1989), Koontz, Garcia
and Hudson (1990), Bessler and Covey (1991), etc. have conducted the similar kind of
studies but based on Cattle and Livestocks. These studies have investigated the direct impact
of futures trading on the spot market and have found the futures market as the centre of price
discovery for live cattle. It was generally found that the introduction of futures trading have

improved spot market efficiency, but may be with a chance of increased short run spot price
volatility.
Even if the prices of nearby futures and spot contract showed some evidence of cointegration,
the same may tend to disappear when more distant futures contract was considered. But
Koontz, Garcia and Hudson have found a dynamic nature of dominance due to structural
change in the spot and futures market.
On the other hand, Quan (1992), Schwarz and Szakmary (1994), Foster (1996), Silvapulle
and Moosa (1999) have studied the interrelationship between the spot and futures market in
the petroleum sector. Unlike Quan, Schwarz and Szakmary have shown that petroleum
futures and spot market are cointegrated and the futures market dominates the spot market.
The results derived by Foster (1996), Silvapulle and Moosa (1999) indicated that though the
futures market plays the dominent role in the price discovery process, such dominance is
strongly temporal and time varying and also largely affected by the market conditions.
Even if there is large number of studies on the interrelationship between spot and derivatives
markets, there is a very strong concentration on equity products. Ng. (1987); Kawaller,
Koch, and Koch (1987); Herbst, McCormack andWest (1987); Harris (1989); Stoll &
Whaley (1990); Cheung and Ng (1990); Chin, Chan and Karolyi (1991); Chan (1992);
Wahab and Lashgari (1993); Grunbichler, Longstaff and Schwartz (1994); Harris et al.
(1995); Hasbrouck (1995); Abhyankar (1995); Shyy (1996); Iihara (1996); Koutmos
(1996); Fleming, Ostdiek and Whaley (1996); Jong and Nijman (1997); Choudhry, T.
(1997); Pizzi (1998); De Jong (1998); Chatrath (1998); Abhyankar (1998); Min and
Najand (1999); Tse (1999); Frino (2000); Cellier (2003); Thenmozhi (2002); Liena and
Yang (2003); Simpson (2004) etc. have investigated the interrelationship between the spot
and futures prices in underlying equity market, either for an equity index or for the
underlying stocks. Most of the studies have found the fact that even though both the markets
are cointegrated with a strong contemporaneous relation, there is a significant lead-lag
relationship between the spot and derivatives viz. futures and options markets. By applying
various models, starting from multiple regression to VAR, Granger-causality, GARCH, etc.,

most of the studies have suggested that the leading role of the futures / options market varies
from five to forty minutes depending on the nature of markets, but the reverse causality from
spot to futures market rarely exist, and not beyond a time lag of 5 minutes. Given the fact that
India have experienced a long-term but turbulent history of commodity derivativesthe same
may tend to disappear when more distant futures contract was considered.
But Koontz, Garcia and Hudson have found a dynamic nature of dominance due to
structural change in the spot and futures market.
On the other hand, Quan (1992), Schwarz and Szakmary (1994), Foster (1996),
Silvapulle and Moosa (1999) have studied the interrelationship between the spot and futures
market in the petroleum sector. Unlike Quan, Schwarz and Szakmary have shown that
petroleum futures and spot market are cointegrated and the futures market dominates the spot
market.
The results derived by Foster (1996), Silvapulle and Moosa (1999) indicated that though the
futures market plays the dominent role in the price discovery process, such dominance is
strongly temporal and time varying and also largely affected by the market conditions.
Given the fact that India have experienced a long-term but turbulent history of commodity
derivatives market, few significant research have been conducted during last half decades to
bring out the necessity and effectiveness of futures contract, especially on agricultural
commodities, to curb the unexpected price movement of the essential 14 commodities in
India. These studies include Karande (2006), Ahuja (2006), Raizada and Sahi (2006),
Lokare (2007), Nath and Lingareddy (2007), Bose (2008), Singh ( ), Kumar, Singh and
Pandey (2008), Sen and Paul (2010), etc. Karande (2006) in his doctoral thesis has
examined the three important aspects of commodity futures markets in India, viz basis risk,
price discovery and spot price volatility. His study on castorseed futures market, both at
Mumbai and Ahmedabad, has found that the castorseed futures market traded both at
Mumbai and Ahmedabad exchanges performs the function of price discovery, and the
introduction of castorseed futures market has had a beneficial effect on castorseed spot price

volatility. In light of the fear that derivatives fuelled unnecessary speculation and were
detrimental to the healthy functioning of the underlying commodity market, Ahuja (2006) has
tried tobring out some facts regarding India’s attempt to re-introduce the futures contract on
several commodities, and also the issues, such as introduction of new market-based products,
standardization of Warehousing, nature of contract settlement, functions of regulator (s),
integration of the markets, etc., which need urgent attention for the successful functioning of
the market.
Raizada and Sahi (2006) in their study have shown that the wheat futures market is even
weak-form inefficient and fails to play the role of spot price discovery. Spot market has found
to capture the market information faster and therefore expected to play the leading role. This
inefficiency of the futures market may be attributed to the lack of necessary data to truly
capture the actual lead-lag relationship between the spot and futures market. They have also
suggested that the trading volume in commodity futures market, along with other factors,
have a significant impact on country’s inflationary pressure. Sahi ( ), in her paper again has
empirically proved that in case of few agricultural commodities, the nature of spot price
volatility was unchanged even with the onset of futures trading, where as the same was not
true for Wheat and Raw Jute. The paper also confirmed that any unexpected rise in futures
trading volume or open interest may unidirectionally cause an increase in spot price volatility
for some of the agricultural commodities in India.
Given due focus on the phase of long and turbulent historical break in Indian commodity
derivatives sector, Lokare (2007) in his work has tried to shown the efficacy and
performance of commodity derivatives, viz. futures contract in steering the price risk
management of underlying commodities. He intended to prove that the significant
cointegration in spot and futures prices of the selected commodities exhibits the operational
efficiency of the concerned markets, may be at a slower pace. At the same time, lower
volatility of futures prices for some commodity demonstrates the possibility of inefficient
utilization of available information expected to be captured in the prices of futures contract.

Nath and Lingareddy (2007) in their study have attempted to explore theeffect of introducing
futures trading on the spot prices of pulses in India. Favoring the destabilization effect of
futures contract, their study found that volatilities of urad, gram and wheat prices were higher
during post-futures period than that in the pre-futures period as well as after the ban of futures
contracts. However, they believed that the suspicion of futures trading contributing for a rise
in inflation appears to have no merit in the present context.
Bose (2008) has tried to investigate the efficiency, in terms of price dissemination, of Indian
commodity indices, both based on metals and energy products and also on agricultural
commodities. The results on the former indices clearly exhibit the informational efficiency of
the commodity futures market with a significant effect on stabilizing the volatility of the
underlying spot market. Unlike of such results, agricultural indices clearly failed to exhibit
the feature of market efficiency and price discovery. Singh ( ) in his paper has tried to
investigate the Hessian spot price variability before and after the introduction of futures
trading and ascertained that the futures market definitely help in reducing the intra-seasonal
and/or inter-seasonal price fluctuations. His results clearly suggested that futures market may
be indeed viable policy alternative for policy-makers to reduce uncertainty in agricultural
markets.
Kumar, Singh and Pandey (2008) have examined the hedging effectiveness of futures
contract on a financial asset and commodities in Indian markets. By applying different time
series models, the authors have found the necessary cointegration between the spot and
derivatives markets and have shown that both stock market and commodity derivatives
markets in India provide a reasonably high level of hedging effectiveness. But unlike the
other studies, Sen and Paul (2010) have clearly suggested that future trading in agricultural
goods and especially in food items has neither resulted in price discovery nor less of volatility
in food prices. They observed a steep increase in spot prices for major food items along with
a granger causal link from future to spot prices for commodities on which futures are traded.

Beside this existing literature there are other review which have been divided into three parts.
The reviews of literature have been presented under the following heads:
1.2.1 Organizational structures of institutions

1.2.2 Market share analysis
1.2.3 Market integration
1.2.1 Organizational structures of institutions
Alibekov (1994) found that Commodity exchanges are envisaged as a key element.
There is a need for widespread education of agricultural producers in fundamentals of
business and marketing, and also essential for organization of futures trading in grain, sugar,
and vegetable oils, creation of proper futures market infrastructure, introduction of clearing
accounts for participants, and provision of adequate information services.
Srinivasan (1997) studied the organization and management effectiveness of regulated

market committee; he observed more or less uniform organizational structure of regulated
markets in Tamil Nadu. In Thirukoilur regulated market alone the post of junior
superintendent existed. However, the number of posts in each cadre and the number of posts
filled up varied directly with the quantum of arrivals.
Ramandev (1998) observed the management appraisal of Cashew processing industry in

Uttara Kannada district of Karnataka. He found line organizational structure in cashew
processing industry, which is simple and clear cut responsibility and authority with fast and
easy feed back from the employees. The discipline among employees maintained easily and
effectively. Similarly, increase in size of the unit their salary expenditure also increased.
Efremenko (2000) presented an overview of the main aspects of organizational structure that
currently exists in the Belarussian agricultural sector. Prospects for the development of new
organizational and legal forms of commercial enterprises in the agricultural sector were
considered, taking into account the impact of the new Civil Code of the Republic of Belarus.

It was suggested that a new structure for "agribusiness" could gradually be established, and
this would embrace a whole range of ownership and management types, including
corporations (open and closed joint stock companies, and limited liability companies),
partnerships, cooperatives (production and consumer) and individual ownership (unitary
enterprises, and daughter or subordinate companies).
Izvekov (2000) observed the switch from a centralized to a market economy in Russia has
led to a change in the structure of the food distribution network and the rise of the wholesaler
as the link between producer and retailer. An analysis was made of the wholesale sector, with
particular reference to its role in shaping the operating system employed. With regard to
Russian conditions, the organizational structure and management system of the MERKA fruit
and vegetable company, set up in Moscow in 1992, was described. A private company, it had
a 2-tier structure: one embraces the commercial director, the chief engineer and accounts
department, while the other operates the commercial trading operations. Its modus operandi
was said to permit it to undercut its rivals' prices by 10-15per cent, not least by operating
through regular foreign importers, an important factor in view of the current import levels of
80per cent of all fruits and vegetables.
Kozachuk (2001) reported that any management practices existing in Russian enterprises
wereinappropriate for operating in market conditions. There was a clear need for
management functions to be extended, and for new methods and approaches to management
that are suitable for different ownership types to be developed. The process of managing a
trading enterprise should be based on market principles and modern management
methodologies. Key ideas in western management theory were considered, and used as the
basis for different models of organizational structure in trading enterprises. These models
include: the functional structure, where positions are grouped according to their main
functional area; the divisional structure, where positions are grouped by similarity of products
or services; and hybrid structures, which incorporate elements of both functional and
divisional structures. Different management styles were also considered, specifically the
directive and democratic styles. It was stressed that the choice of management style

influenced by the economic situation and functional characteristics of any given trading
enterprise.
1.2.2 Market share analysis
Briem (1993) analysed the market for American style super-premium’ ice cream in
France. It was found that the market leader. American manufacturer Haggen-Dasz had a
market share of 84 per cent, easily out-performing Gervais (10.5 per cent) and motta (5.5 per
cent).
Zimmermann and Borgstein (1993) analysed the growth in sales of organic products via the
natural food stores in the Netherland. They expected that the total market share of organic
foods will either stagnate or decline in the medium term if no further efforts are made to stop
the declining trends in sales of organic products.
Kaku (2001) studied the broiler futures in Kanmon Commodity Exchange and he found that
in 1973, in the Japanese Chicken meat market, the share of whole birds, cut-ups, parts and
deboned meat and imported chicken meat was 59.3, 37.3 and 3.4per cent, respectively.
However, in 1994 the share shifted to 8.9, 59.7 and 31.4per cent, respectively. The
specification for commodity futures market should be the boneless leg meat of domestic
broilers.
Jairatt and Kamboj (2005) reported that the total commodities traded in the agricultural
commodities accounted for nearly 95 per cent during 2002-03, which hovered around 92 per
cent in 2004-05. He mentioned that the removal of ban, share of national commodity
exchanges increased from nearly 6 per cent and that of regional exchanges declined from 94
to 27 per cent during the period.
Labys and Cohen (2006) studied the global wine market has witnessed major changes in
recent years. Some of these changes are structural in nature or trend-following, whereas
others are cyclical. Recently, new market entrants have increased their exports not only to
traditional European markets but to other importing regions as well, whereas Old World

producers have experienced declining market shares. However, the evidence examined here
suggests that market share data also contain strong cyclical components. Mixed results also
occur when the wine export data are disaggregated into products.
Madlapure et al. (2002) analysed the business turnover, and operational efficiency of dairy
cooperative societies in Konkan Region, Maharashtra, India. Results reveal that: the sample
cooperative societies have more share capital and borrowings compared to the progressive
societies, but the latter have more accumulated funds; the cooperative societies do their
business with very small working capital but with great efficiency; and the progressive
societies have lower turnover compared to the other societies.
Kunnal and Shankarmurthy (1996) studied that the critically analyses the performance
ofthe Karnataka State Seed Corporation (KSSC) with respect to its seed marketing activity.
KSSC has adopted a mixed distribution network to sell seeds in the state. The quantity of
seeds of different crops marketed by the KSSC increased during the study period. Though
sales of seeds showed fluctuating trends, sales turnover showed an increasing trend. The
share of cooperatives in the distribution of seeds of KSSC was not appreciable.
1.2.3 Market integration
Blyn (1973) estimated the degree of market integration by computing correlation coefficients
for detrended and deseasonalized prices for eight wheat markets of Punjab and
Delhi. Thus, totally nine detrended price series of twelve monthly prices were arranged and
correlated. The results showed that the overall average correlation coefficient (r) for twelve
months was 0.68. He reported that the average ‘r’ was equal to the ‘r’ between Delhi and
other markets, indicating the dependence of Delhi market prices on the prices of all other
collecting markets.
A study by Chengappa and Muralidharan (1980) on pricing efficiency of Indian coffee,

interpreted the pricing efficiency of Indian coffee markets in terms of spatial integration. The
bivariate correlations of monthly prices among geographical markets at pool sale, wholesale
and at retail levels used as indices of market integration showed a maximum at pool level

because of better control by the Coffee Board. The efficiency was in the declining order from
the wholesalers to retailers for want of adequate control by the Board. The location of
distribution points and institutional constraints of differential sales tax were found to
influence the movement of prices in vision.
An analysis of pricing efficiency in spatial markets a study by Gupta and Mueller (1982)
suggested a technique for estimating the price relationship between regional markets, which
avoids the ambiguity of the correlation coefficient. The method was based on Fama’s concept
of pricing efficiency and consists of tests based on Granger’s causality. The method was
applied to price series from three regional markets of slaughter hogs in West Germany.
Lundahl and Peterson (1982) studied the market integration for major food grains for the
period 1969-74. The number of markets for each product considered was 19 for rice, eight for
grain millet, 20 for grain corn, 11 for ground corn and 15 for seed beans. Monthly price series
were detrended and the residuals were correlated. The results showed that there was not high
correlation between the residuals. For all the food grains, there was a tendency for the
correlation to be full towards the end of each year.
Raveendran and Aiyasamy (1982) while analyzing export growth and export pricesof
turmeric from India observed cyclical pattern of variations in prices. The length of the export
price cycle varied from three to seven years. The export prices were studied for their relation
with the domestic prices. The coefficient of correlation between the two was 0.9473. The
high correlation in export and domestic prices of turmeric explained little variation in value
of the variable Rt (ratio between price Pe to domestic price Pd in the year t, i.e., (Pe / Pd) t)
and consequently its non significant influence on export trade. The very high correlation of
export price of turmeric with its domestic prices obviously confirmed the vulnerability of the
latter to international price fluctuations.
Brorsen et al. (1984) reported that the use of univariate and multivariate time series analysis
in the investigation of dynamic relationships among selected weekly import prices of rice in
the European Economic Community (EEC). EEC imported rice from US, Thailand and

Argentina. The results showed that Argentinean and US prices moved together. These two
prices were influenced by the European market and react quickly to changes in Thailand
prices. Thailand prices responded slowly to US and Argentinean prices.
The Ravallion’s regression model was used to study the integration of palm oil market in
Peninsular Malaysia (Arshad and Gaffar,1990). The crude palm oil market was observed to
be spatially price efficient. The high integration of the crude palm oil markets was not
surprising in view of the efficient and adequate infrastructure facilities available. The
standardization of crude palm oil futures contract made the product homogenous leading to
efficient price discovery thereby enhancing pricing efficiency.
Using the correlation coefficient, Gemtessa (1991) analyzed the integration of

Ethiopian coffee prices with the world prices. The correlation coefficient for the monthly
average prices secured at domestic and world markets for 12 months lag was calculated. The
bivariate correlation coefficient of the two market prices revealed that they move together
inthe same direction. The lagged cross correlations of domestic prices and world prices also
revealed that they move together in the same direction. The lagged cross-correlations of
domestic prices and world prices of coffee for the period 1979-80 to 1987-88 indicated that
the world prices of coffee had a stronger influence on the domestic prices than the domestic
prices had on the world prices of coffee.
Baharumshah and Habibullah (1994) employed the co-integration technique to analyze the
long run relationship among pepper prices in six different markets of Malaysia.
The co-integration technique was applied to weekly pepper prices for the period 1986-91.The
empirical findings of the study indicated that regional pepper markets in Malaysia were
highlyco-integrated and prices of pepper tended to move uniformly across spatial markets
indicating competitive pricing behavior.
The co-integration approach was used (Sinharoy and Nair, 1994) to analyze the pepper price
variations in the world market. It was observed that due to open trade status of pepper, its
prices had moved synchronously, indicating integration of the world-pepper market. It was
pointed out that due to the oligopolistic nature of the world market for pepper; its prices did

not deviate much. The domestic supply variables were found to be responsive to the
international market conditions.
Behura and Pradhan (1998) used bivariate price series correlation and Engle- Granger test
to analyze the market integration for Orissa marine fish markets. The bivariate correlation
coefficients for six selected market pairs ranged between 0.60 and 0.85. The test statistic
obtained for all the pair wise markets were found to be less than the asymptotic critical value
even at 10 per cent level excepting that of Cuttack-Paradip pair. Thus the marine fish markets
in the state were assumed to be not integrated and hence quite uncompetitive. This was
mainly attributed to poor infrastructure facilities at landing centers as well as the terminal
secondary markets.
Bhatta and Bhat (1998) studied the extent of price relationship for arecanut between
selected markets of Mangalore and Sirsi using the correlation coefficient method. The results
revealed that the Mangalore market was more efficient than Sirsi market. The commercial
nature of the crop and its diversified market conduct was clear from the fact that there was a
direct relationship between the supply and price.
The intra-state spatial integration of rice markets in India was investigated by Ghosh and
Madhusudan (2000) who used ML method of co-integration. Intra-state regional integration
of rice markets was evaluated by testing the long run linear relationship between the prices of
the state-specific variety of rice quoted in spatially separated locations in four selected states.
The cointegration results for Uttar Pradesh indicated that the regional markets are integrated
to such an extent that the Law of one price (LOP) holds for III and IV ARWA variety of rice.
However, no evidence was found in favour of the LOP for the coarse or common variety of
rice marketed in Bihar, Orissa and West Bengal, even though, the regional rice markets were
found to be integrated. The results pertaining to inter-state regional integration of rice
markets represented by four market centers chosen from the four selected states, revealed that
even though the markets are integrated, the LOP does not hold.
Kumar Ranjit (2000) analyzed the relationship between prices of rice in domestic market
(New Delhi) with major rice markets of the world viz., Bangalore and Houston (USA) by

using the co integration approach. The results clearly revealed that all the price series were
not stationary and were not integrated in the long run.
Naik and Jain (2001) studied that on assessing the efficiency of major commodity futures
markets in India using the cointegration theory and they concluded that a major reason for the
poor performance of Indian futures market could be the lack of adequate participation of
hedgers in these markets. The management of the exchanges and the forwardmarkets
commission has to find ways to attract hedgers in order to improve the performance of these
markets.
Basab Dasguptha (2004) in his study on the role of commodity future market in spot price
stabilization, production and inventory decisions with reference to India shows the future
price elasticity of production has always been greater or equal to one and increasing profit by
increasing price is not possible. It also shows that the future price elasticity of inventory was
inversely related with the carrying cost. Therefore, on unnecessary hoarding will increase the
carrying cost leading to a lower responsiveness of inventory to future prices.
Aviral Chopra and Blesser (2005) studied the Price Discovery in the Black Pepper Market
in Kerala, India. They explored empirically the incidence of price discovery for black pepper
in spot market, the nearby and the first distant future market by using daily data employing
the method of cointegration and directed a cyclic graphs. The study reveals that price
information is discovered in the future market and the results in these three markets are tied
together in one cointegration relationship, spot and first distant future contract do not respond
to perturbations in the co integrating on by the near future contract adjust to shock in the long
run relationships hoarding these three market together.
Zapata et al. (2005) examined the relationship between 11 sugar futures prices traded in
New York and the world cash prices for exported sugar. It was found that the futures market
for sugar led the cash market in price discovery. However, find evidence that changes in the
cash price causes changes in futures price, that is, causality is unidirectional from futures to
cash. The finding of cointegration between futures and cash prices suggests that the sugar
futures contract is a useful vehicle for reducing overall market price risk faced by cash

market participants selling at the world price (i.e., not enjoying favorable trade incentives).
Further reliability on the usefulness of the WSF as a price discovery market is found through
the impulse response functions; a shock in the futures price innovation generates a quick (one
month) and positive response in futures and cash prices.
Babula et al (2006) applied Johansen and Juselius' methods of the co-integrated vector auto
regression (VAR) model to a monthly US system of markets for soyabeans, soya meal, and
soya oil. Analysis of the error correction or cointegration space illuminates the empirical
nature of policy-relevant market elasticities, and of the effects of important policy, market,
and institutional events on US soya-related markets. A statistically strong US demand for
soyabeans emerged as the primary co integrating relation in the error-correction space.
Ghoshray (2007) in his study revealed that Durum wheat is one of the commodities for
which there is intense trade competition between the United States and Canada. Heexamined
the relationship between Canadian and U.S. durum wheat prices using cointegration and an
asymmetric error correction approach. The overall results suggest that a long run relation
holds between the U.S. and Canadian durum wheat prices. The U.S. price responds to restore
the equilibrium relationship with the corresponding Canadian price, while the Canadian price
evolves independently. Using tests for structural change, it is revealed that changes in
Canadian domestic policy (the repeal of the WGTA) had an effect on this long run relation.
Since the withdrawal of the WGTA, quality differences in durum wheat for both countries
seem to matter in the dynamics and integration of U.S. and Canadian durum wheat prices.

RESEARCH METHODOLOGY
2.1: Research objectives
2.2: Research plan
2.3: Research design
2.4: Data Collection
2.5: Data Processing & Analysis
2.6: Scope of the Study

2.1 Research objectives
Objective of a research work defines the driving force for a research action. It is
the focal point around which the whole action revolves. This dissertation was
undertaken to fulfill the following objectives:
 To study the relationship between agro-product derivatives and its effect

on inflation.
 To study the various factors that has impact on Inflation.
Further the study aims to examine the rationale behind the ban of 2008
and how logical the decision was.
2.2 Research plan

Analyse
Collection
ofThe
of data
spot
from the Conclusio
prices Interpreta
Selection of four ban Multi ns &
for the tion of
commodities Commody Recomme
four data
Exchange ndations
banned
(MCX)
commo
website.
dities
2.3 Research design

A research design lays the foundation for conducting the project and ensures
that the research plan is conducted efficiently and effectively. This research has
been carried out to examine the rationale behind the ban and study how logical
the decision to impose it is. Hence, Descriptive Research design was used in
this research.

2.4 Data Collection
Secondary data Data from magazines , articles , websites(MCX) &

other published materials
2.5 Data Processing & Analysis
. The spot prices for the four banned commodities were collected from the Multi
Commodity Exchange (MCX) website, and graphs were made using monthly
averages of the daily closing prices. For futures prices, the closing price of
futures contracts with three‐month expiry cycles were used, and the data was
sourced from the MCX website. Year‐on‐year inflation was calculated using
wholesale prices for all commodities collected from the website of the Office of
the Economic Advisor, which uses 1993‐1994 as the base year.
2.6 Scope of the Study

Scope of any project defines the boundary within which the research work was
undertaken. This dissertation covers the case of ban on four agriculature
products on May 5 2008.

DATA ANALYSIS AND INTERPRETATIONS

3.1 Ban on Future Trading in Agro Commodity
3.2 Stated Purpose of Ban
3.3 Effect of Ban
3.4 Arguments
3.5 Inflation
3.6 Cause of Inflation
3.7 Need for Ban
3.8 Effects Of The previous Ban

3.1 BAN ON FUTURES TRADING IN AGRICULTURAL
COMMODITIES
On 5 May, 2008, at the Asian Development Bank’s annual meeting in Madrid, Finance
Minister Palaniappan Chidambaram said, “If rightly or wrongly, people perceive that
commodity futures trading is contributing to speculation‐driven rise in prices, then in a
democracy you will have to heed that voice”, suggesting the imposition of a blanket ban on
trading in food futures in India. According to Bloomberg reports, Chidambaram said that the
Government may suspend some contracts because of political pressure. Wholesale prices rose
7.57 per cent in the week ended 19 April, 2008 from a year earlier, the Government said on 2
May, 2008. According to a survey of 15 economists by Bloomberg, inflation for the week
ended 26 April, 2008 was 7.66 per cent.14 On 7 May, 2008, the Government announced a
ban on futures trading in four commodities – chickpea, potato, rubber and soy oil.
India’s agriculture minister, Sharad Pawar, said on 12 May, 2008 that the decision was taken
by the regulator of futures trading, the Forward Markets Commission. However, Forward
Markets Commission chairman B.C. Khatua publicly opposed the ban.
3.2 STATED PURPOSE OF THE BAN
The report submitted on 27 April, 2008 by the Abhijit Sen Committee, a four‐member
committee constituted to examine whether futures trading contributed to the unexpected spurt
in prices of agricultural commodities, provided no conclusive answer. The committee
members felt that the futures market in India is relatively nascent in existence and hence,
there is no significant statistical evidence to infer one way or another.
According to Sen, member of the Planning Commission and chairman of the committee, “No
causal relationship has been established between futures trading and prevailing prices of
essential commodities.” However, a note that he included in the annexure of the report

submitted to the Government is said to have argued for continuation of the ban on futures
trading in rice and wheat because the Government is a large‐scale buyer of such commodities.
According to the note, spot market prices are “obviously affected by futures markets”, which
is a reasonably sound conclusion given the fact that price discovery is one of the primary
functions of futures exchanges. The note also said, “It is clearly illogical to claim that futures
trading will generally tend to improve prices received by farmers and yet maintain that
futures trading can never contribute to inflation of spot prices.” The minister of state for
industry, Ashwani Kumar, said that the fresh ban was intended to rein in inflation
expectations. “We want to see if futures trading are really affecting the prices (trading), and
so we will have it (the ban) on an experimental basis,” he said.
The Left parties have been advocating a ban in 25 commodities, and insist that futures trading
clearly contributes to price rises.
On 12 May, 2008, the Government said it has no plans to ban more farm commodities from
futures market and hoped suspension of trading in soy oil, chickpea, potato and rubber would
not be extended beyond four months.
Chickpea futures surged 89 per cent in the 12 months on NCDEX, while rubber rose 41 per
cent and soybean oil advanced 21 per cent. However, the rationale behind banning trading in
potatoes has been questioned because the prices had already been declining due to the
bumper harvest when the ban was imposed.
3.3 EFFECT OF THE BAN
The first and most obvious effect, and the one that led to so much opposition to the ban, was
the reduction in trading volumes for commodity exchanges. Analysts suggested that about
Rs.300‐400 crore of business would be affected on a daily basis on NCDEX and NMCE
alone, the two largest exchanges for trading in agricultural commodities. They added that the
ban would dampen investors’ sentiments apart from affecting the turnover and volumes. The
total trading volume for the four commodities in the three national exchanges was valued at

Rs.15000 crore a month, almost 10 per cent of the total traded volume (estimated at
Rs.164080 crore a month).
Soy oil, chickpea and potato futures had been showing a declining trend, while rubber futures
had been rising for a couple of weeks before the ban due to the rise in crude oil prices. Spot
rubber prices hit a record Rs.120 on 7 May, 2008, but the ban immediately brought prices
down by Rs.4. However, the prices rose again in June, despite the ban.
Inflation, measured by weekly WPI (Wholesale Price Index) data, has been rising despite all
the measures taken by the Government. Minister for Commerce and Industry, Mr. Ashwani
Kumar told the media on 8 May, 2008 that the measures against inflation will yield results in
6‐8 weeks. Five weeks hence, inflation rates suggest otherwise, with wholesale prices rising
by 11.05 per cent from last year in the first week of June. The following graph shows weekly
inflation data for 2008, with the black line indicating the date on which the ban on futures
trading was brought into effect.

The following graphs show the spot prices for rubber (Kochi), chickpea (Bikaner), potato
(Agra) and soy oil (Indore) from 1 April, 2008 to 10 June, 2008.
Of the four banned commodities, only the prices of potatoes have decreased steadily since the
ban. However, since prices were declining even before the ban, experts have argued that the
decrease in prices is due to the bumper crop, and not the ban on trading.

In the case of chickpeas, the prices haven’t moved consistently in a particular direction. They
declined immediately after the ban but began rising again in June. They are now higher than
they were in January 2008 and lower than they were in April 2008. Chickpea output has
increased over the past month.

Rubber and refined soy oil have shown approximately 31 per cent and 11 per cent increases
in price respectively since the ban was imposed. The two commodities show a high degree of
positive correlation with crude oil prices: a rise in crude oil prices leads to a shift from
synthetic rubber (a petroleum product) to natural rubber, hence pushing rubber prices up; and
there is a shift in demand from crude oil to bio‐fuel, which is produced using edible oils.

3.4 ARGUMENTS
There have been two main viewpoints expressed in the media.

One viewpoint is that the ban is anti‐farmer and not anti‐inflation. It is believed that the move
was purely political, and that futures prices don’t contribute to inflation. Proponents of this
view argue that the futures market provides farmers an opportunity to hedge risks and receive
signals about the future movements of prices. Futures contracts also help farmers avoid
storage costs and the interest charges for storing the product till the sale is made. However,
according to Mr. P.K. Joshi, Director of the National Centre for Agricultural Economics and
Policy Research (NCAP), “It [the futures ban] has not made any impact on small and
marginal farmers (>80 per cent) who have little marketable surplus. It might have made some
impact on traders dealing in bulk quantities.” (Personal communication, 16 June, 2008)
According to Dr. Abhijit Sen, “Most of them [the farmers], especially the small ones, are
geographically or physically far away from the market. There is a strong market in edible
oils, but they are mostly firms.”
Some sections of the media also argued that the ban will lead to a shift in business to overseas
markets and an increase in dabba (illegal) trading. However, FMC Chairman B.C. Khatua
said that there won’t be a large‐scale movement to overseas exchanges because most of the
participants in the futures markets are retail investors, but the ban may cause the market to
collapse like it did in the case of jute. He also said that it was not realistic to expect large‐
scale participation of farmers in India futures markets when even USA and Canada haven’t
achieved it. He argued that the suspension of commodity trading prevents regulation from
improving.
The other point of view is that futures trading merely leads to unnecessary speculation, and
pushes the prices up. Suneet Chopra, Joint Secretary of AIAWU (CPI‐M’s All India
Agricultural Workers Union) asserted that traders and hoarders buy out the products cheaply
through future contracts and raise the prices artificially by creating false scarcity. He cites the
example of global crude oil prices, where a US Senate Panel inquiry concluded that hedge
funds had contributed to the spurt in crude prices. However, in the absence of speculators,

price‐risk would not be transferable and price discovery would not be possible, hence
defeating the purpose of futures markets.
3.5 INFLATION
Inflation is a significant and sustained increase in the price level of an economy. Generally,
an inflation rate of 3‐5 per cent is considered healthy for a developing economy. In India,
inflation is calculated according to the wholesale price index on a weekly basis. Provisional
WPI data is announced every Friday with a two‐week lag. Final data is announced after an
eight‐week lag. Weights of the commodities are derived on the basis of the volume of the
commodity traded in the domestic market.
While Consumer Price Indices (CPI‐AL: Consumer Price Index for Agricultural Labourers,
CPI‐RL: Consumer Price Index for Rural Labourers, CPI‐IW – Consumer Price Index for
Industrial Workers, CPI‐UNME: Consumer Price Index for Urban Non‐Manual Employees)
may also be used to measure inflation, but the WPI is the RBI’s preferred tool of
measurement. Inflation rates as per CPI estimates are usually higher than the WPI. CPIs are
compiled on the basis of the general standards and guidelines set by the International Labour
Organisation (ILO).

The use of the WPI as a measure of inflation has been questioned by many experts. It has
been argued that the WPI is not representative enough and is inaccurate. Official figures often
underestimate inflation due to price controls and lack of data. Delays in data collection lead
to significant differences in the provisional and final inflation figures. For instance, the final
inflation\ figure for March 2008 was 6.21 per cent, more than one percentage point higher
than the original estimate of 5.11 per cent.
Currently, the WPI has 435 items. According to a research paper by V. Shunmugam and D.G.
Prasad, 100 of the 435 commodities have ceased to be important from the consumption point
of view. These commodities include coarse grains that are used for making livestock feed.
The Abhijit Sen Committee has been updating the base year of the WPI from 1993‐94 to
2004‐05, and expanding theindex to include 1200 items. It has been suggested that inflation
should be measured by a monthly all‐commodity index since weekly data is only available
for primary commodities but is difficult to obtain in the case of the manufacturing sector. A
more representative WPI, which the Government has been working on for almost two years,
will be introduced in October 2008. Currently, all agricultural commodities (including
processed items) account for 25.397 per cent of the WPI.
Wholesale price index from Office of the Economic Advisor Website (Base year: 1993‐94)
In November 2007, headline inflation increased in the US, the EU, Japan and China. High
food prices have pushed up inflation in many emerging market economies (EMEs), while
high oil prices are aggravating inflation directly as well as indirectly by causing an increase
in the demand for oil substitutes, which leads to an increase in food prices.
In India, year‐on‐year weekly inflation breached the 6 per cent mark on 6 January, 2007, and
remained above 6 per cent until April 2007. It was well below 5 per cent from 6 September,
2007 to 9 February, 2008. With threats of a recession in the US, rising crude prices and a
global food crisis, inflation crossed 7 per cent in the second week of March 2008, was over 8
per cent in the latter half of May 2008 before hitting 11.05 per cent in the first week of June.
In March, the rupee hit 42.66 against the dollar due to inflation worries. The Indian rupee fell
by 7 per cent against the US dollar between January and May 2008.34 Rising inflation has
also had an adverse impact on the stock markets, with the Sensex (the Bombay Stock
Exchange’s Sensitive Index) falling below the 14000 level on 24 June, 2008.
The increasing rate of inflation has also aggravated the impact of the food crisis. Despite the
glum picture painted by these figures, a report by the Organisation for Economic
Development and Cooperation (OECD) said that India had managed food inflation better than
fourteen other developing nations, though food inflation in India is higher than that of
developed nations. Prices of food articles rose 5.8 per cent in India for the period February
2007‐08. Experts said that record food grain production estimates of 227.32 million tons
during 2007‐08, an increase of 10.04 million tons from the previous year, helped keep
inflation under control. According to the report, recent yield shocks in pulses and oilseeds
have contributed to the increase in food prices.
3.6 CAUSES OF INFLATION

Rising inflation has been attributed to the increase in global oil and food prices due to
temporary supply shocks. Although the Indian economy has largely been shielded from the
fuel price rise through Government subsidies, the 56 per cent increase in the average price of
food in the last 12 months has contributed significantly to inflation. In fact, global food prices
have been rising for three years.
It has also been argued that increasing food prices are a result of a money‐fuelled cyclical
boom due to loose monetary conditions in emerging economies, which has boosted domestic
demand. Tighter monetary conditions would have caused rising food prices to be offset by
declines elsewhere, keeping inflation under control. With inflation at 11.42 per cent and the
prime lending rate at 12.75 per cent – 13.25 per cent, the real interest rates are extremely low.
Rising iron and steel and cement prices have also played a significant role in contributing to
WPI inflation. The component for iron and steel shot up from 287.4 on 1 March, 2008 to
344.1 on 8 March, 2008. The weakening dollar has caused investors to shift to oil, metals and
agricultural commodities. The rise in steel prices has been attributed to increased demand and
lack of investment. The global demand for steel has risen significantly with a large number of
infrastructure projects like bridges and houses underway in India and China, and a higher
demand for automobiles and appliances in the two economies. The investments in new steel
plants in the past decade have been rather low, which has caused the price of hot‐rolled steel
sheet to rise by $170 in the US (from $850 a tonne in April to $1020 in May). High prices for
iron ore and energy have caused an increase in the price of making and transporting steel.
Lower imports have caused a shortage of the metal in the US, and have led to an increase in
prices.
The reasons cited for rising food prices include the diversion of land to bio‐fuel production;
the drought in Australia and Ukraine; and the rapid economic expansion in India and China,
which strains global food markets through increased imports and export bans. In an article in
the New York Times, Dr. Amartya Sen suggested that the global food problem is not being
caused by a decrease in world production or by lower food output per person, but by
accelerating demand. Hoarding by farmers and middlemen has also led to the escalation of
prices.
The hugely subsidised US and EU policy of replacing petroleum with bio‐fuel to cut
pollution has been widely criticised, since bio‐fuel is more expensive then petroleum in real
terms, and bioethanol only yields about 10 per cent more energy than the amount required to
produce it, according to British Government figures. The prevailing food crisis may be a
consequence of this policy, since the production of bio‐fuel involves the use of agricultural
crops like corn and soy bean.
The increase in crude oil prices has also pushed fertiliser prices up, especially nitrogen
fertilisers, because natural gas is a key component in their production. This has further
aggravated the food crisis.
Certain sections of the media argued that the food crisis is an outcome of an incessant push
towards the ‘Green Revolution’ agricultural model and the trade liberalization policies
advocated by the World Bank, the World Trade Organization and the International Monetary
Fund. Forcing developing countries to dismantle tariffs and open their markets to global
agribusiness, speculators and subsidized food exports from rich countries have led to the
diversion of land for the production of global commodities or off‐season crops for developed
markets. Along with structural adjustment policies and a number of bilateral free trade
agreements, these measures have led to the collapse of the system that developing economies
had created to protect local agricultural production.
However, experts have argued that

“…the boom that India has seen since 1993 is largely because of the open and market‐
oriented policies started in 1991. It may be true that by keeping the economy closed, we
would have fewer crises. But to live in perpetual poverty to avoid occasional poverty (since
the word ‘crisis’ applies to the latter) would be foolish strategy.”
It has also been suggested that the Government’s expansionary fiscal policy: the pay hike to
the bureaucracy, the farm loan waiver and income tax cuts, during a period of high
inflationary pressure has stoked inflation and created a huge fiscal deficit.
However, global food prices have declined over May 2008. Wheat is trading at a nine‐month
low in international markets, and rice has become cheaper after the Japanese Government
released some of its food stock (most of which it had imported from the US) into the global
market. According tothe CGD (Centre for Global Development – an American think tank)
blog, India’s rice and wheat crops may increase by over 10 million tons from last year.

3.7 NEED FOR THE BAN
An analysis of spot and futures prices of the four banned commodities shows a high degree of
positive correlation between the prices. A cause and effect relationship, however, is difficult
to establish. The black line indicates the date on which the ban was brought into effect. The
charts show that the ban hasn’t been effective in reining in the prices of the four
commodities. Analysis of pre and post futures data by the Abhijit Sen Committee did not
indicate a clear increase or decrease in the volatility of spot prices due to futures trading. The
report categorically stated that futures trading can’t be held responsible for the increase in
spot prices because the evidence was, at best, ambiguous.
The high level of correlation between the spot and futures markets is due to the presence of
arbitrageurs, who ensure that the two markets move in the same direction by exploiting any
discrepancy in the prices of the two markets to their advantage. However, it isn’t possible to
find out the number of hedgers, speculators and arbitrageurs participating in the market.

Most attempts to establish cause‐effect relationships between the futures and spot prices have
been inconclusive because participation in the futures markets isn’t total. Price determination
in the spot market is based demand and supply, and the awareness about future markets is
low.
Since futures markets perform the function of price discovery, it would be inappropriate to
say that futures prices have no bearing whatsoever on the spot prices. However, establishing
to what extent one market is dependent on the other is far more important. Futures prices are
not independent variables. Speculation has a basis. If a speculator believes that the price of a
certain commodity will rise in the future, it is due to certain conditions prevailing in the
economy. Speculation may magnify the rate of increase in prices, but it isn’t possible for
speculation alone to push prices up. Unhealthy speculation is said to be driving prices up, but
when farmer participation in the future markets is low, there is essentially a disconnect
between the two markets.

The total contribution of the four banned commodities to the WPI is approximately 0.8 per
cent (potato: 0.256470 per cent, soy oil: 0.178380 per cent, rubber: 0.150800 per cent,
chickpea: 0.223650 per cent). In fact, share of food articles in the WPI has steadily decreased
over the last few decades. Even if futures trading had been contributing towards inflation, the
impact on the WPI wouldn’t have been very significant. In fact, primary articles constitute
only 22.03 per cent of the WPI (1993‐94), and the weight assigned to food articles has
declined considerably. So why did the Government impose the ban?
The motive behind the ban may have been purely political: an attempt to appease the voters,
perhaps, in the run up to the elections. It may also have been an attempt to affect the market
sentiment in order to curb inflationary expectations. Either way, food prices continue to stay
high in India despite the ban.

3.8 EFFECT OF THE PREVIOUS BAN
In January 2007, the Government banned futures trading in wheat, rice, tur and urad in an
attempt to control inflation. The increasing inflation rates were attributed to greater price
volatility due to futures trading. However, the 12 food grains included in the WPI basket only
have a weight of 5.01 per cent. Of the 12 items, rice (2.449070) and wheat (1.384080) have
the highest weights.
The ban was held responsible for the reduction in trade volumes of the future exchanges by
many sections of the media. However, since these four commodities only constituted 6.65 per
cent of the total agriculture futures traded in 2006‐0752, the Abhijit Sen Committee
concluded that the ban probably had an adverse effect on market sentiments, rather than
directly contributing to the decline in future trade.
The following chart shows that inflation rose despite the ban, and decreased later in the year
when the RBI hiked interest rates. However, Dr. Sen felt the ban should not be revoked for
commodities like wheat and rice due to the significant role that the Government plays in the
market for these commodities. He felt futures markets can’t work for commodities “where
even the spot market is highly controlled.” In an interview with Mint, he said, “The
fundamental problem with futures trading in food grains is that the huge difference between
global prices and Indian prices will always reflect on and contribute to the instability in local
prices.”

FINDINGS
 Food prices and inflation data show that the ban didn’t help curtail the price rise.
Banning futures is an illogical solution because it obstructs the development of a
mechanism to regulate unhealthy speculation.
 The rising inflation rate has been attributed to a number of factors, including the
global rise in prices of food and oil, the diversion of land for bio‐fuel production,
loose monetary policy in emerging economies, and the adoption of an expansionary
fiscal policy by the Government.
 An analysis of spot and futures prices of the four banned commodities shows a high
degree of positive correlation in the prices of the two markets. The prices are
interdependent: the futures markets gives signals to the spot markets on the direction
in which prices will move in the future and the futures prices are determined on the
basis of the conditions in the spot markets.
 The high level of correlation between the spot and futures markets is due to the
presence of arbitrageurs, who ensure that the two markets move in the same direction
by exploiting any discrepancy in the prices of the two markets to their advantage.
 The motive behind the ban may have been purely political: an attempt to appease the
voters, perhaps, in the run up to the elections. It may also have been an attempt to
affect the market sentiment in order to curb inflationary expectations. Either way,
food prices continued to stay high in India despite the ban.

SUGGESTIONS
 Efficient functioning of futures markets pre-supposes the existence of efficient spot
markets. Reforming spot market should also be a top priority.
 National Exchanges are launching a pilot scheme of Aggregators’ that will collect
retail produce of the farmers and hedge it on the platform of exchanges on behalf of
the farmers. Farmers Groups, Co-operative institutions, RRBs, CCBs, NGOs, State
Agricultural Marketing Boards, Warehousing Corporations, Commodity Development
Boards which work in the rural areas and thus, have a close association and trust of
farmers, should be allowed and encouraged to act as aggregators. The rules and
procedures of futures trade in Exchanges should clearly lay down conditions to enable
these entities to access the markets on behalf of the farmers.
 An efficient futures market requires government and markets working together in a
synergistic manner. Both the government and markets, have to recognize the
important role played by each other. Governments can provide the legal, regulatory
and infrastructure support to enable markets to function without manipulation and
‘excessive speculation’. On the other hand, markets need to provide the government
with efficient mechanisms to achieve its objective of ‘inclusive growth’.

 Greater integration of the spot and future markets by encouraging higher participation
by the farmers is necessary, so that the futures markets perform the function of price
discovery more effectively, and the intended beneficiaries are able to use the market
to hedge risks. In the absence of integration, the debate about the ban on futures
trading becomes irrelevant.
 Banning futures is not a logical solution to rising prices. It obstructs the development
of a mechanism to regulate the markets and discourage unhealthy speculation. Futures
markets should be developed along with spot markets and integrated effectively to
bring about greater participation from the producers and consumers of the underlying
assets.

Limitations
Some of the limitations of the project are listed as below:
1. Limited statistical tools have been used. To establish cause-effect relationship
between parameters more sophisticated statistical tools ought to be used.
2. The considered time span of the study is less.
3. The study scope is limited to secondary data only.
4. Another limitation could be lack of knowledge. Being a student I undertake this
project as a learning experience. I have made many mistakes and then learned from
them. I have tried my best to be as authentic and as accurate as possible in the
research analysis taking the help of my project mentor on relevant data.

CONCLUSIONS
Spot prices and futures prices are interdependent. While the futures market provides
indications to the spot markets on the direction in which prices will move in the future, the
futures prices are determined on the basis of the conditions in the spot markets. Speculation
may drive prices further up, but a speculator expects prices to rise due to the market
conditions, and doesn’t arbitrarily bet on a price rise. Although futures markets may influence
spot prices, banning them will only cause speculation and will take on a new form – dabba
trading, which can’t be regulated, although the number of participants will probably be lower
due to higher risks.
Banning futures is not a logical solution to rising prices. It obstructs the development of a
mechanism to regulate the markets and discourage unhealthy speculation. Futures markets
should be developed along with spot markets and integrated effectively to bring about greater
participation from the producers and consumers of the underlying assets. One may argue that
the market mechanism takes time to come into effect and that this isn’t an effective solution
in the short run. However, commodity prices show that banning futures hasn’t been a viable
short‐run solution either.

REFRENCES
Internet:
 http://ncdex.com/
 www.mcxindia.com
 en.wikipedia.org/wiki/Commodity
Books:
 Commodity derivatives: markets and applications By Neil C.
Schofield
 Commodity Investing: Maximizing Returns Through
Fundamental Analysis By Adam Dunsby, John Eckstein, Jess
Gaspar, Sarah Mulholland
 Guide to world commodity markets By John Buckley
Research Papers:
 Hoffman, G.H. (1931), ‘Factors affecting prices in
organized commodity markets’, Annals of the
American Academy of Political and Social
Science.’Working, H. (1948), ‘Theory of inverse
carrying charge in futures markets’, Journal of Farm
Economics 30 February. - (1962), ‘New concepts
concerning futures markets and prices’, American
Economic Review 52 June

Abhijit Sen Committee. (2008). Report of the Expert Committee to study the impact of
futures trading on agricultural commodity prices. Ministry of Consumer Affairs, Food and
Public Distribution,
Government of India
Abraham, T.A. (2008, May 8). India bans rubber, soybean oil futures to cool prices.
Bloomberg
Ajayan (2008, January 21). Derivative Market always needs speculators to facilitate risk.
Mint
An old enemy rears its head (2008, May 22). The Economist
Attack on inflation should yield results in 8 weeks (2008, 8 May). Mint
Babcock, B., Commodity Futures Trading for Beginners. Retrieved May 19, 2008, from
http://www.rb‐trading.com/begin.html
Bailey S. & Crofts D. (2008, June 26). Arcelor chief sees global steel shortage as demand
increases.
Mint
Basu, K. (2008, June 7). All hands on the deck. The Hindustan Times
Bentil, K. (2008, June 6). Twelve Step Program to Poverty. The Daily Times (Malawi)
Bhoir, A. & Roy, A. (2008, July 7). Interest rates on savings accounts likely to rise. Mint
BriteFutures (2007). Futures and Options Data and Resources. Retrieved from
http://www.britefutures.com/quotes/news.aspx Cabinet to decide on futures trade in essential
items (2008, June 5).
Chakrabortty, A. (2008, July 4). Secret report: biofuel caused food crisis. The Guardian

Chakravarty, M. & Philipose, M. (2008, April 20). Banning futures will do little. Mint
Chakravarty, M. & Philipose, M. (2008, June 22). The odd thing about oil prices. Mint
Chakravarty, M. & Philipose, M. (2008, June 4). Inflation and the Stock Market. Mint
Chopra, S. & Sabnavis M. (2008, May 14). Did agri futures have a premature start?.
The Economic Times
Devraj, R. (2008, April 24). India: Futures Trade in Farm Commodities ‐ The Wrangle
Continues. IPS
Economic Survey of India (2004‐05). Futures Trading in Agricultural Commodities.

Ministry of
Finance, Government of India
Economic Survey of India (2007‐08). Prices and Monetary Management. Ministry of

Finance,
Government of India
Farmers, traders question govt. decision to ban potato futures (2008, May 8).
Food and Agricultural Organisation of the United Nations (2006). Agricultural

Management,
Marketing and Finance Working Document 12: An introduction to market ‐based instruments
for
price risk management. Rome, Italy
From Water Street to the World. (2007). CME Group Magazine (Summer 2007 Issue)
Gaping holes in computing inflation: Experts (2007, June 6).
Garg, N. (2008, January 24). Commodity Futures – Facts and Fantasies. Assocham
International
Conference
Global Monetary Policy (2005, May 22). The Economist
Government unhappy with inflation, can take more steps: Montek (2008, May 6).

Gupta, G. (2008, June 13). Inflation surges to 7‐year high. International Business Times
Hadas, E. (2008, March 24). Commodity Bubble may be next to burst. Mint
Heald, A.D. (1999, March 8). Fuel price increase impacts fertiliser prices. College of
Agriculture, UK
University of Kentucky
Himanshu (2008, June 17). Tread with caution in food futures trading. Mint
Himanshu (2008, June 3). Will farmers benefit from futures markets?. Mint
How India calculates Inflation (2007, June 7). Commodity Online
India Extends ban on futures trading to cool prices (2008, May 8). International Herald
Tribune
India's food inflation lowest among 15 nations (2008, May 30). The Financial Express
Inflation leaps to 8.1 per cent (2008, May 30). PTI
Inflation soars to new 13‐year high of 11.42 per cent (2008, June 27).


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INTRODUCTION

1.1: Development of Commodity Futures Market in India

1.2: Current Scenario of commodity Futures Trading

1.3: Future Trading

1.4: Impact of Future trading on Commodity prices

1.5: Few Commodity Exchanges

Ranjeet Singh, IVth Semester, FMS-BHU

1.1 Development of Commodity Futures Market in India

Evolution of Commodity Futures Trading In India:

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

1.2 Current Scenario of Commodity Futures Trading in India

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

1.3 FUTURES TRADING

WHAT ARE FUTURES?

Ranjeet Singh, IVth Semester, FMS-BHU

WHY FUTURES TRADING?

Ranjeet Singh, IVth Semester, FMS-BHU

HISTORY OF FUTURES TRADING

FUTURES TRADING IN INDIA

Ranjeet Singh, IVth Semester, FMS-BHU

In 1994, the Kabra Committee recommended the opening up of futures trading in 17

Today, futures trading is permissible in 95 commodities in India. There are 25 recognised

1.4 Impact of Futures Trading on Commodity Prices

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

National Commodity and Derivatives Exchange (NCDEX)

The following points explain about NCDEX:

 NCDEX is a nation-level, technology driven de-mutualized on-line commodity

 NCDEX is regulated by Forward Market Commission in respect of futures trading in

 Online Screen based Future Trading in about 45 Commodities presently.

 More than 100 commodities proposed in near future.

 Daily average turnover of more than Rs. 4, 000 Crores.

Ranjeet Singh, IVth Semester, FMS-BHU

 Worldwide largest consumer of traditional form of investment.

 Low margins on trade as compared to equity market.

 Delivery in Demat Form.

 NCDEX is a nation-level, technology driven de-mutualised on-line commodity

 NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

MCX an independent and de-mutulised multi commodity exchange has permanent

Headquartered in Mumbai, MCX is led by an expert management team with deep

Inaugurated in November 2003 by Shri Mukesh Ambani, Chairman & Managing

Ranjeet Singh, IVth Semester, FMS-BHU

Indian Commodity Exchange Limited is a screen based on-line derivatives exchange

Corporate Vision & Mission

Provide fair, transparent and efficient trading platform to all participants.

Shareholders and Shareholding pattern

Ranjeet Singh, IVth Semester, FMS-BHU

MMTC Ltd, a Government of India enterprise, is the largest international trading

Shareholder Shareholding Pattern

Ranjeet Singh, IVth Semester, FMS-BHU

MMTC Limited 26%

Indian Potash Limited 10%

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU

Similarly, several researchers such as Oellermann and Farris (1989), Brorsen,

Ranjeet Singh, IVth Semester, FMS-BHU

Ranjeet Singh, IVth Semester, FMS-BHU