Explained: Why Is SEBI Banning Agricultural Commodity Trading?

The Securities and Exchange Board of India (SEBI) has passed an order to ban trading in several agricultural commodities.

The step appears to be an attempt to curb price increases in these commodities. These commodities include paddy, wheat, crude palm oil, chana, soya bean, mustard and moong.

SEBI has barred traders from initiating any new contracts in these commodities. Market participants who have already entered into contracts would be allowed to square off their position.

Inflation Is A Cause Of Concern

India’s retail inflation, as measured by the Consumer Price Index (CPI), has reached 4.91 per cent. The inflation at wholesale levels, as measured through the Wholesale Price Index (WPI), stands at around 14.23 per cent against 12.54 per cent a year ago.

Increasing inflation has been a concern for the government, as higher prices could make sustenance difficult.

A factor that could be affecting the food prices is the weakening of Indian currency. As a result, importing goods from other countries becomes much costlier. Just a few months back, the government had imposed stock limits on pulses to prevent hoarding and a consequent increases in prices.

Despite having a bumper crop year, soya bean prices have continued rising — growing more than 70 per cent within a month. The commodity has a high divergence from the minimum selling price — as a result, poultry farmers who use soya as feed stock have asked for a ban on soya trading.

According to reports, soya bean could be among the worst affected of the banned commodities.

How Is Inflation Related To Futures Trading?

By banning trading in commodities, the government hopes to reduce price rises due to speculative activities in food prices. Speculation could result in higher volatility in prices, and an increase in prices on the domestic markets.

It is also said that volatility in the global market could be transmitted to the Indian markets through futures trading.

However, this isn’t the first time that trading in agricultural commodities has been suspended. Trading in commodity derivatives had been banned in the 1960s and was strictly enforced for decades until 2003.

“Since the early 60s, when the environment of shortage prevailed in most of the primary agricultural commodities, futures’ trading was banned in many of them,” said a report by the Forward Market Commission (FMC).

The FMC was responsible for derivatives regulation until it was merged with SEBI.

Nevertheless, despite the liberalisation, trading in sensitive commodities has been monitored quite heavily. For instance, trading in sugar had been banned in 2009, which was later lifted almost a year later, when the prices fell due to a bumper crop.

Rice, Urad, and Tur — three staple commodities had been banned by the Forward Markets Commission in 2007. So far, only the trading ban on rice has been lifted.

Are Bans On Commodity Futures Trading Effective?

So far, opinions have been divided on the efficacy of such outright bans on commodities. While banning derivative trading can help discourage speculative activity, it could inhibit price discovery as well.

In addition, it has been pointed out that most commodities track the price movements globally — hence, a ban might only be effective over the short term.

For instance, palm oil and soybean oil move in tandem with international prices, which could yield the ban ineffective. According to S&P, some participants have said that inhibited price discovery could result in formation of commodity cartels.

Further, the regular bans on commodity trading could stop India from developing a deeper commodity market as well. Commodity futures markets have seen several large scale government interventions in recent years, making it tougher to get more traders on the markets.

The former finance minister P Chidambaram had once said that the perception that food prices rise due to futures trading in commodities has resulted in the bans — rather than being based on the actual underlying reasons for the same.

Supporters of futures trading believe that in a globalised economy, it is difficult to insulate domestic prices from international prices. Further, without price discovery, it would be difficult for farmers and consumers to use price signals to make decisions accordingly.

The previous bans do not offer much conclusive evidence of prices de-escalating solely due to bans — possibly as there are several factors that affect commodity prices.

Hence, establishing a causal relationship with prices and lower speculation could be difficult.