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BW Businessworld

Futures Imperfect

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The government's idea of banning futures trading in some food commodities is reminiscent of one of Idries Shah's tales about the inimitable Mulla Nasrudin.

Late one evening, a friend finds him searching for something under the light of a streetlamp. When asked, Nasrudin says he's looking for some coins he lost. "Where did you lose them?" asks the friend. Nasrudin points to a place several yards away in the darkness. "Why are you looking here?" asks the surprised friend. "Because there's more light here," says Nasrudin.

Food minister K.V. Thomas's concern about rising food inflation is not misplaced. But linking high prices due to deficient supply with futures trading may be.

Prices have been rising and volatile across many commodities, including those in which there is no futures trading —vegetables, for example.

Only 2 per cent of all futures contracts in commodities result in actual physical delivery; the rest are settled before delivery dates. So speculation is intrinsic to agri-commodity markets. The question of how much speculation impacts food prices and creates volatility is still hotly debated.

Many economists believe futures markets are the solution to, not the cause of, price volatility. When there's a supply crunch when inventories are running low, it becomes a political hot potato.

Regulation is supposed to enhance confidence in the market; but bans don't do that.

After trading volumes grew by nearly 50 per cent in the past three financial years, they declined 7-10 per cent since April this year after the Forward Markets Commission banned futures trading in guar gum in March. Unlike Nasrudin, the government should look in the right place for the solution to high prices.

(This story was published in Businessworld Issue Dated 06-08-2012)