The Role of Government in MCX Commodity Exchanges

Most strategies that farmers can use to reduce income risk are likely to increase their production cost or might not be sufficient in the case of natural catastrophes. Such market failures have been used to justify government intervention in risk management in agriculture.

Risk in agriculture is often considered as having specific characteristics that explain the more frequent government intervention in risk management than in other sectors. Specifically, the relationship with nature, in particular the dependence on climate and biological processes, makes risk more difficult to control than with mechanical processes. Inelasticity of both demand and supply also contribute to fluctuations in agricultural commodity prices. In consequence, variability in agricultural prices is often higher than that in other products and annual income from agricultural activities can vary to a large extent in the absence of offsetting policy interventions. However, futures markets help to reduce price volatility but do not prevent longerterm price downturns.

When government intervention in risk management involves elements of support, as has often been the case in OECD countries, farm families have no incentive to adopt risk strategies at the production and consumption level, or to use market-based approaches. This in turn hampers the development of market, risk-shifting solutions. In addition, reducing risk faced by farmers may encourage them to take production decisions that are not sustainable. Hence, it is argued that some degree of instability can be good as it encourages technical progress and innovation in marketing.

Various underlying elements contribute to increasing the costs of intervention and lower its efficiency. Appreciating these concerns, some governments have tried to encourage farmers to use futures markets. It is established widely that futures markets, where they exist, help to reduce price fluctuations within a given year. Recognizing this, government’s first contribution could be to provide information on prices and contracts, and training programmes to farmers on how to use futures markets. In some cases, governments have acted as intermediaries between farmers and futures exchanges, with or without subsidy. 

Risk Management Techniques in mcx commodity market

Traditionally risk pooling and risk spreading techniques are utilized by farmers for risk management. Risk pooling techniques include all price smoothing mechanisms organized by groups of producers. For example, average pricing for a crop year as offered by co-operatives is a very efficient risk management instrument. The farmer delivers his crop at harvest time and receives an advanced payment. He will receive a bonus in June in order to obtain the average market price of the past crop year.

Some co-operatives offer a price averaged according to specific periods of time. For example, a farmer who decides to store his grain on the farm can contract at harvest a February delivery. He will receive the average price of a three-month period based on the date of delivery. For livestock production, some co-operatives offer moving average prices; for example, a twelve-week average price. These price smoothing techniques reduce the impact of price volatility and the related risk premium for the farmer. However, the use of reference markets – centralized and organized markets, spot markets and/or futures markets – is necessary.

Futures & Options as Risk Hedging Instrument

The outcome from a study in USA states that when a producer combines a forward sale with the purchase of crop insurance, the probability of low revenue is reduced dramatically for each of the locations, compared with the no-strategy case. The cost-effectiveness of futures contract and options to protect farmers against price risks is contingent on yield variability, on the correlation between yield and price variability (natural hedge) and on the distance from markets. In case of high yield variability, production becomes less predictable, consequently a farmer may only hedge a small volume in order to avoid having to buy additional products to fulfill his futures contract in case of low yields. In this scenario, the hedge ratio, i.e. the optimal share of actual production to be hedged, and the risk reduction efficiency is low.

The need and acceptance of risk-hedging instruments depends on the strength of negative relationship between yield and price, called the “natural hedge”, for a particular commodity in a particular region. For instance, widespread low corn yields can cause prices to increase significantly. Conversely, low prices are often associated with bumper-crop years. This partially “offsetting” relationship between prices and yields tends to stabilize farm revenues over time. Yield and price variations are less likely to offset each other where the natural hedge is weak. In states such as North Carolina, low corn prices and low yields (or high prices and high yields) are more likely to occur at the same time than in the Corn Belt, making corn revenues inherently more variable. This is because these areas have less impact than the Corn Belt on national output and prices. Forward selling reduces revenue risk substantially in areas where the natural hedge is relatively weak.

Delivery Centers in mcx commodity market

Presently availability of few delivery centers and price difference across physical markets limits the farmers across the country to participate in trading. The need is to increase the reach and provide services of assayer and means for reduction of transportation cost.

KEY OBJECTIVES IN MCX COMMODITY MARKET

KEY OBJECTIVES

• To provide a status report on pilot project “Enabling Farmers to Leverage Commodity Exchanges” highlighting a clear analysis of the outcomes, learning and way ahead for scalingup linkages between farmers and exchange.

• To suggest possible areas of intervention in for facilitating scaling-up of intervention between MCX, aggregators/facilitators, farmers, and other relevant stakeholders.

• To capture and document the constraints and limitations faced by stakeholders involved in the initiative for hedging the price risk of farmers’ through MCX.

• To identify the nature and level of support required from various stakeholders like MCX, farmers organizations, government, facilitating agencies, funding organizations, other voluntary agencies and key players to provide boost to participation of farmers in commodity trading. 

Physical Market Price Difference in Commodity Exchange

In the existing scenario the prices in the physical market differs across the mandis present within a state. i.e Prices for Shankar 6 (B) 30MM variety during Mar-Jun, 06 for Rajkot & Chotila markets differs in the range of Rs 150-180/Quintal. During 80% of time prices were higher in Rajkot market; however distances between two markets is 60 Kms only. In this situation the spot prices polled from Surendranagar market doesn’t bear close resemblance with other major mandis in the state or major producing regions. The underlying difference between polled prices & actual mandi specific prices finally results in deterrence for farmers of other major producing regions to participate into commodity trading. To bridge this difference, it is necessary to poll the prices from other prominent mandies of the same area instead of just one major mandi.

MTM Requirements in Commodity Exchange

Similarly arranging money for MTM requirements can be more cumbersome or difficult for the small & marginal farmers. Moreover there are other issues in case of intra-day high volatility such as providing timely notice to farmers on margin calls, arranging for money at a short notice and timely transfer of margin call amount to their trading account. In absence of prompt actions during these conditions farmers may face the risk of liquidation or squaring off of their positions.

Academy Disclaimer

These educational recommendations are based on author’s personal observations & on the study of technical analysis and hence, do not reflect the fundamental validity of the script. Due care has been taken by the author while preparing these comments & outcomes, But still no responsibility will be assumed by the author for the consequences whatsoever resulting out of acting on these recommendations.

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