Current Economic Statistics and Review For the Week 
Ended June 18, 2005 (25^th Weekly Report of 2005)

  I

Highlights of  Current Economic Scene

CORPORATE SECTOR  

• NEW VENTURES  

o       French oil major Total is considering setting up a refinery in India , and entering the country’s  newly opened oil retail sector.

o       Indian carriers have committed themselves to buying over 350 planes with a list price of some $26-27 million.

o       Over 200 planes are expected to be pushing for space in the domestic budget carrier space over the next five years as per the current pace of expansion and launch of new airlines. The latest entrant is IndiGo, which is to airborne in the next five years. The budget airline currently comprise Air Deccan, Kingfisher and Spicejet. On the cards are MagicAir, Go Airlines and now IndiGo.

o       Sun network’s Kalanithi Maran has acquired the No 3 Tamil daily Dinakaran for an undisclosed sum.

o       MNCs like IBM and Percot Systems are among  the top software exporters from the country for the first time. IBM Global Services has disclosed  that it exported software worth Rs 1,867 crore ($412m) from India during 2004-05. This makes IBM  Global the sixth largest software exporter from the country.

• MERGERS & ACQUISITIONS 

o       US-based Pequot Ventures is picking up a 30 per cent stake in Aircel for $ 350 million.

o       The increasing globalisaton of the Indian economy has resulted in one-third of the country’s blue-chip companies passing into ‘foreign hands’.

o       The merger of the Indian Iron and Steel Company (IISCO) with Shipping Authority of India Limited (SAIL) has been approved by the cabinet.

o       ICICI Venture, a 100 per cent subsidiary of ICICI Bank, has emerged as the leading contender for domestic pharma major Ranbaxy Laboratories’ allied business operations. The allied business, which includes diagnostics, fine chemicals and animal healthcare is likely to be sold as a combined entity. The deal, which is valued at around Rs 130 crore, may be conducted within a few weeks.

o       The Escorts group, promoted by the Nandas, is bringing in a strategic partner for the hospital business in an attempt to expand operations.

o       The struggling  Indian carmaker Hindustan Motors is in talks with a host of foreign carmakers, including  Germany’s Volkswagen, to supply components and is eyeing an over  Rs 300-crore business from component outsourcing in the next three years.

o       INDO Rama has signed up with a small US-based office products chain Office 1 Superstore International to be their master franchisee for India . Office 1 sells office products including, small business machines and office furniture through self-service superstores, direct and telemarketing.

o       The UB Group has announced the completion of acquisition of Shaw Wallace and its subsidiaries and associates following the financial closure facilitated by ICICI Bank.

o       NIIT is learnt to be close to acquiring a mid-sized  BPO company.

o       Auto major Mahindra & Mahindra has signed a 51:49 joint venture agreement with the US-based  International Truck & Engine Corporation (ITEC) to produce medium and heavy commercial vehicles, apart from making India a supply base for sourcing components  and materials.

o       Sun network’s Kalanithi Maran has acquired the No 3 Tamil daily Dinakaran for an undisclosed sum.

•  COMPANY RELATED ISSUE

o       Consumer durables industry is growing with increase in volumes of colour televisions, refrigerators, washing machines and air-conditioners. 

o       The ITC board has announced issue of bonus shares  in the ratio of 1:2. 

o       HLL is continuing focus on the foods business in India . Foods, which include beverages, jam and squash and ice-creams, contribute around 15 per cent of its turnover, down from 28 per cent in 2001.

o       Second-tier cities in India are emerging as the new growth centers for several consumer goods majors like Reebok, LG Samsung, Adidas Nokia, BMW, Audi, Bacardi-martini , India Pizza Hut and others.

o       Paint companies are benefiting from an increase in housing activity and growing automobile sales.

o       Steris, a $ 1.1 billion healthcare equipment company,  plans to set up a wholly-owned arm in India to sell its devices and products in the country’s booming healthcare market.

o       The corporate sector is not waiting for employees fighting their own tax battles.  The companies willing to bear burden of the fringe benefit tax such as running and maintenance of  cars, use of telephone, employee’s welfare, conveyance, tours and travel, hotels, maintenance of cars and so on. 

o       JP Morgan Chase, the second-largest US bank, has reached “an agreement in principle” to pay $2.2 billion to settle a class-action lawsuit from Enron stock and bond holders. 

o       The younger generation of Piramal family is assuming higher position in management. The Rs 3,000 crore Piramal group, which has diversified interests in pharmaceuticals, real estate, textile and engineering, is undergoing a reorganization of its top management. 

o       Differences have risen between Hutch and Essar, the two key partners in Hutchison Max Telecom Ltd, over the Essar Group’s move to bid for seven telecom licenses on its own. 

• POLICY ISSUES

o       The Insurance Regulatory and Development Authority (IRDA) will be taking a close look at Indian promoters of life insurance companies to examine whether there is any indirect foreign control.

BANKING HIGHLIGHTS

• Canara Bank and Mico-Bosch has signed a memorandum of understanding (MoU) for financing power tools. As per the MoU, the bank will extend loans up to Rs.1 lakh to carpenters, wood workers, electricians, auto technicians and persons engaged in sanitary repairs for purchase of modern power tools.

• National Bank for Agricultural and Rural Development (NABARD) plans to cover three crore rural poor families by linking two million self-help groups (SHGs) by March 31, 2007. As on March 31, 2005 cumulatively 16.19 lakh SHGs have been covered by NABARD as against 10.79 SHGs on March 31, 2004. The financing scheme has linked over 15 lakh SHGs to provide credit access to 2.42 crore families covering 12 crore rural poor. For the current fiscal, it has envisaged a target of linking 2.5 lakh SHGs.

• The Reserve Bank of India (RBI) has notified banks to submit a statement as on December 31 each year if aggregate forex utilisation by the customers of international debit cards (IDC) exceeds $100,000 in a single calendar year. In a circular to banks, which are authorised to deal in foreign exchange, the RBI said, while issuing IDCs, banks may ensure that the extant procedures and documentation required for release of foreign exchange, the international banking divisions/foreign exchange departments of banks may submit a statement as on December 31 each year.

HOUSING

• Signaling a rise in interest rates, major housing loan financiers like HDFC, ICICI Bank and Standard Chartered Bank has hiked rates by 50 basis points across all maturities, with effect from 16^th June 2005. This is the first time that major housing loan institutions have hiked their rates after the RBI hiked its reverse repo rates twice by 25 basis points during the past six months.

INSURANCE

• The government has cleared the foreign direct investment (FDI) proposal of South African insurer Sanlam for entering the Indian life insurance market in collaboration with Sriram Group. Sanlam will bring in Rs.82.5 crore in capital in the joint venture with Sriram Group. The South African insurer will hold 26 per cent in the joint venture, which will start operations with a minimum capital of Rs.100 crore. Sanlam is the second South African company, which has entered India ’s life insurance market. Earlier, Old Mutual has tied up with Kotak Mahindra for life insurance venture.

INFORMATION  TECHNOLOGY

• Reiterating its commitment and to exploit the huge potential in India, IBM Global Services India (IBM India) has launched its global delivery centre in Hyderabad, the fifth in the country, to serve clients around the world with technology services and solutions in the area of application development and management.

• Intel India has entered into a memorandum of understanding with Small Industries Development Bank of India (SIDBI) for reaching out to small and medium businesses (SMBs) to help finance and educate them on the benefits of adopting technology. At present, only about 18 per cent SMBs use information technology.

TELECOM

• Bharti Group has signed a contract with Swedish telecom giant Ericsson worth $250 million (about Rs.1075 crore) for setting up and maintaining GSM cellular network in 3000 towns across India .

FINANCIAL MARKET DEVELOPMENTS

• Capital Markets

• Primary Market

• In the first six months of calendar 2005, the three fixed price issues which hit the market have generate returns in the range of 75 per cent to 370 per cent. In the same period, the returns from book-built issues have been in the range of (–) 7 per cent to 110 per cent.

• Jindal Poly Films limited tap the market through an IPO of 8,333,325 equity shares of Rs. 10 each for cash at a price of Rs. 360 per equity share aggregating Rs. 3,00 crore. The issue opened on June 09 and closed on June 15,2005

o       Sebi has approved 12 IPOs worth Rs 1,400 crore in the last one and half month, while 15 offer documents are still awaiting the regulators approval. 

• Nectar Lifescience Limited tapped the market through 100 per cent book-building IPO issue of 3,870,000 equity shares of Rs. 10 each, the issue opened June 22 and it closed on June 28.

• Secondary Market 

o       Uncertainty over the monsoons and high crude prices acted as deterrents for the BSE sensex from hitting its all time record high. However, the index continued to be in the positive zone for the seventh concecutive week. Inflation falling to a 13-month low of 4.22 per cent for the week ended June 4, buoyed the market sentiments. Further, with the cabinet approving FII investment in print, radio and television has also supported the sentiments. The sensex gained 124.53 points over the week to end at 6906.52 compared with previous week’s close of 6781.99. The broader 50-share S&P nifty gained 32.80 points to close the week at 2123.40. While the average turnover on BSE rose to Rs 2280.67, the average turnover on NSE ruled lower at Rs 4,231.13 crore. 

o       During June 1 to June 17, the FIIs have been net buyers in equities to the extent of Rs 841.80 crore with purchases of Rs 11143.30 crore and sales of Rs 10301.70 crore. During the week under review, the FIIs were net sellers on June 17 to the extent of Rs 2131 crore, on the other days of the week, they have been net buyers to the extent of Rs 1,258.3 crore, thus over the week, they have become net sellers of Rs 873 crore.

o       During the period between June 1 and June 18, mutual funds have been net sellers to the extent of Rs 432.26 in equities, with purchases of Rs 2615.91 crore and sales of Rs 3048.17 crore

o       Among the shares of  BSE sensex group, Bharti Televentures topped the gainers list, followed by the shares of Reliance group.   

o       Sebi Chief has made three pertinent oberservations  against the working of mutual funds which has retarded industry’s growth. One, mutual funds have failed to communicate market risks and returns clearly to investors. Second, the practice of cannibalizing investors from other through rebates and other tricks. Third, subscribers continue to have an extremely poor perception about the industry.

• Derivatives

o       The derivatives market witnessed choppy trading for most part of the week. The trading has been highly concentrated among few shares with the Reliance shares being the most active. The outstanding position has increased in majority of shares.

o       During the week, the daily turnover ranged between Rs 8274 crore and Rs 11274 crore. FIIs were net buyers for stock futures as well as for nifty futures.

o       According to International Options Market Association (IOMA), NSE is the largest stock exchange in terms of volumes generated in the stock futures, followed by Russian RTS Stock Exchange.

o    The finance ministry is set to notify the eligibility norms for availing the facility wherein the income arising out of sundry trading in derivatives on NSE and BSE, will soon be eligible for set-off loss suffered in any year against income in the following year for the purpose of income-tax assessment.

• Government Securities Market 

• Primary Market

o       RBI auctioned state loans for eleven states for 10-year paper for a notified amount of Rs 2481.15 crore. The cut-off yield for the loans has been set at 7.39 per cent (except for Tamil Nadu, the cut-off yield has been 7.35 per cent). 

o       RBI along with the central government, with a view to increase liquidity and improve the pricing in the market as well as to evolve a zero coupon yield curve is considering a proposal to consolidate the number of government securities outstanding in the market to around 40 from the existing 107. 

o       About a dozen states appraised the Center of their inabilities to tap the market directly due to concerns over cap on market borrowings, compulsory borrowings from the NSS at 9.5 per cent.

• Secondary Market

o       Liquidity concerns have resurfaced in the money markets due to the outflows towards state loan auctions and advance tax payments. The deployments in RBI’s LAF have declined to Rs 8,000 crore. Resultantly, the call rates touched an intra-week high of 5.20 per cent. However, by the end of the week, the call rates edged down to around reverse repo rate of 5 per cent.

o       With  a sharp spurt in crude oil prices, the bond market turned subdued as it instigated fears of pushing domestic inflation rate. However, the market remained impervious of the yearly inflation at 4.21 per cent below the psychological mark of 5 per cent.  

• Bond Market 

o       During the week, Syndicate Bank and Rajasthan Rajya Prasaran Nigam Ltd tapped the market to mobilize Rs 500 crore (plus Rs 500 crore) and Rs 120 crore, respectively.

• Foreign Exchange Market

o       The rupee-dollar exchange rate during the week oscillated between appreciation and depreciation. The rate fell from Rs 43.56 on June 10 to Rs 43.62 on June 13 and further to Rs 43.66 on June 15. Thereafter for the last two days of the week, the exchange rate rose to Rs 43.61 and further to Rs 43.59.

o       India ’s holding of US treasury securities has fallen from US $ 18.4 billion as on end March to $18 billion as on end April.

COMMODITY FUTURES

o       As per the data put out by FMC for the first fortnight of June, the highest traded commodities have been guar seed, chana, silver and crude oil.  

• NSE and NABARD announced strategic equity participation the Multi Commodity Exchange of India

PUBLIC FINANCE

• In a meeting held between Finance Minister and Planning commission deputy chairman, it has been decided that states will be required to compulsorily borrow from the National Small Savings Fund in order to meet their financial needs rather than go to the markets as recommended by the Twelfth Finance Commission. While the Planning Commission was of the opinion that states should be allowed approach the markets for borrowings, the finance ministry has said that the states need not go to the markets to borrow when they have surplus of funds in the NSSF. Many states have shown interest in borrowings from the market, as the rate of interest is lower. States have also argued that rates at which NSSF is offering loans should be reduced.

• Chattisgarh and Madhya Pradesh governments have hinted at adopting value added tax. However, both the states have stressed that unless the finance minister or empowerment committee clarify on central sales tax, the states would not go for VAT.

• In an attempt to stop the misuse of Cenvat credit on services tax, the government has directed companies that have a centralised system of procurement of inputs for manufacturing at multiple locations to register their main office. Companies that fail to register with the central excise authorities will not be eligible to transfer the service tax paid on inputs manufacturing units and offset the tax against excise  duty on their factory output after June 16. A notification issued by the revenue department requires “input service distributors” besides providers of taxable services with turnover of more than Rs 3 lakh to register with superintendent of central excise for claiming credit on service tax.

• The revenue department is considering starting a structured exercise in the current fiscal year to corner high net worth individuals (HNIs) who circumvent taxes. Annual information returns of banks and financial institutions and their monthly reports on cash withdrawal tax would be used to close in on HNIs. It is found that there is a huge mismatch between the income tax department data and information gathered by other independent agencies about the number of high income individuals.

o       The Finance Minister will launch helpdesks for small taxpayers to bring in more people in the tax net and collect over Rs 2,73,000 crore worth revenue. The move is part of the government’s revenue raising efforts to reduce revenue and fiscal deficit.

INFLATION

o       The annual rate of inflation, as measured by WPI, on point to point basis, stood at a benign 4.22 per cent (provisional) for the week ended June 04, 2005 as against 5.20 per cent (provisional) for the week ended May 28, 2005.

• WPI for ‘All Commodities’ (Base: 1993-94=100) for week under review increased by 0.16 per cent to 192.5 from 192.2 for the week ended May 28, 2005 stood at 184.7 in the corresponding period last year. The index of primary articles group declined by 0.21 per cent to 188.7 from 189.1 in the previous week. Within this group, the food articles index group declined by 0.52 per cent while the index of non food articles rose by 0.45 per cent. In comparison to the previous week, prices of fruits and vegetables were cheaper by 3 per cent.

• Fuel, power, light and lubricants group index increased by 1.09 per cent to 296.3 from 293.1 in the previous week because electricity prices went up by 5.9 per cent in comparison to the previous week. However, prices of naphtha decreased by 12 per cent over the previous week.

• The index of manufactured products group declined by 0.06 per cent to 170.6 from 170.1 for the previous week. Within this group, the index for chemicals and chemical products group declined by 0.11 per cent, from 186.7 in the previous week to 186.5 in the week under consideration. This is due to prices of purified terephthalic acid (pta), which were lower by 11 per cent in comparison to the previous week.

• For the week ended April 09, 2005, the final WPI for ‘All Commodities’ and the annual rate of inflation stood at 191.4 and 5.86 per cent respectively as against the provisional levels of 190.7 and 5.48 per cent respectively.

LABOUR

• According to the recently released Census figures, education doesn’t seem to improve chances of getting a job. The unemployment rate for graduates, which stands at 17.2 per cent, is in fact significantly higher than the overall unemployment rate of 10.1 per cent. The Census revealed that the number of jobless in India grew by more than four times in 10 years, i.e. from 10.8 million in 1991 to 44.5 million in 2001. Those seen as unemployed are non-workers who are either seeking job or are available for work, excluding students and pensioners who may not be working but would not be looking for employment either. The Census also found that nearly 40 per cent of the graduates are not productively employed. The technical and non-technical graduates registered as many as 32 per cent and 39 per cent non-workers, respectively. Surprisingly, graduates in rural India have a much higher work participation rate (68.4 per cent) than urban India (58.7 per cent).  However, most of this is due to the differential in the female work participation rate, indicating that a large percentage of urban women voluntarily remained unemployed and did not make use of their qualifications.

• According to the Census, there were 313 million main workers, 89.2 million marginal workers and 626.4 million non-workers. This means that 39.1 per cent of the country’s population was engaged in some form of economically productive activity. The main workers are those who had participated for any economically productive activity for more than six months in the preceding year and the marginal workers are defined as those who have worked for less than six months during the year.  

EXTERNAL SECTOR

o       According to an official statement, Directorate General of Foreign Trade has notified standard input-output norms for 12 new export items and carried out amendments, corrections or deletions in the norms for 18 existing export items. Out of the 12 new items, nine relate to chemicals and allied products and three relate to plastic products.

o       India ’s exports registered a healthy growth of 22.28 per cent in May but imports surged faster by 35.46 per cent resulting in a larger trade deficit. Exports increased to $7.2 billion during May from $5.9 billion in May 2004, while imports jumped to $10.8 billion as against $8 billion during the same month previous year.

o       The government has cleared foreign direct investment (FDI) proposal of South African insurer Sanlam to enter the Indian life insurance market in collaboration with Sriram Group. Sanlam Life Insurance Company’s proposal was among 19 FDI proposal cleared by the finance minister and it will bring in Rs 82.5 crore.

o       The cabinet relaxed foreign investment norms in print media by allowing non-resident Indians, persons of Indian origin, overseas corporate bodies and recognised foreign institutional investors to invest in Indian newspaper companies. Besides, the printing of foreign editions of international publications in India has also been allowed. However, the overall foreign investment limit in news and current affairs will remain at 26 per cent. Until now, only foreign media companies were allowed to invest.

o       The US rejected as many as 251 Indian export consignment in May, this year, on various quality and technical parameters. The European Union has also rejected 16 food consignment from India in May and one such consignment in the first week of June.

o       Prime minister wants India to achieve a trade target of $500 billion by 2010 and has asked ministers to work towards removing constraints like infrastructure bottlenecks and rigid labour laws in order to achieve this target.

CREDIT RATINGS

• Fitch has affirmed the F1 ( ind ) rating assigned to the Rs. 50 crore commercial paper/short-term debt programme of Hyundai Motor India Ltd. The rating reflects company’s strong liquidity arising from larger operating cash flows and large cash and bank balances.

o       In an another exercise, it has assigned a rating of AAA ( Ind )(SO) to the preferred (Class A) units, to be issued by Benchmark Split Capital Fund-Balanced (issuer). This rating address the likelihood that investors will receive payment of principal on the maturity date as stated in the information memorandum / offer document. The agency has also upgraded the ratings assigned to the fixed deposits programme of both Shriram Transport Finance Company Ltd and Shriram Investment Ltd. to tAA- ( Ind )/stable.

• Meanwhile, following the delay in consummating Development Credit Bank (DCB) business plan, Fitch has downgraded DCB’s Rs. 160 crore subordinate debt programme to A ( ind ) from A+ ( ind ).

• Icra has assigned A1 (so) ratting to the Rs. 40 crore short-term non-convertible debentures of Fortis Finvest. The rating draws strength from the unconditional and irrevocable guarantee to the tune of Rs. 40 crore provided by Oscar Investment, the holding company of Ranbaxy Laboratories, to support the repayment obligation.

• It has also assigned LAA (so) rating to the Rs. 100 crore long-term bond programme of Karnataka Water and Sanitation Pooled Fund.  The agency has also assigned an A1+ s rating to the Rs. 10 crore commercial paper programme of Bajaj Electricals Limited (BEL). The rating is based on the Stand-by Letter issued in favor of BEL by State Bank of Bikaner & Jaipur for the entire amount of Rs. 10 crore.

Theme of the week:

Commodities Trading in India -Evolution and Scope

Introduction

India is an agrarian economy subjected to the vagaries of rains and therefore, not only the production of farm products is affected but also the spot prices and future prices are adversely affected. With no effective hedge against these vagaries, agriculture remains a gamble against the rains. Introduction of futures market in agricultural commodities is expected to provide the farmers with an indicator of future prices, which would help them to make production decisions as well as to lock the spot prices for future deliveries. For instance, a firm price trend in commodities is a cause for concern for the government and the people. It fuels inflation and results in depressed demand and consumption. A strong upward trend in prices may prove disastrous to farmers as well, as it would affect demand, encourage imports, distort the cropping pattern and bring about cyclical fluctuations in crop production in the long run. What farmers and consumers actually need are stable commodity prices. An active commodity futures market seeks to achieve precisely that by reducing seasonal and abnormal cyclical swings. The futures market is designed to help the process of price discovery and become a medium to transfer risks.

Though the commodity exchanges have been in operation for many years, recently national level exchanges have also began their operations. These newer exchanges have used the available state of art technology,  thus widening their reach to various geographical areas. Also, the number of commodities available for trading has expanded rapidly. However, some of these recently introduced commodities are not evoking any noteworthy investors’ interest, thereby questioning the logic of spreading futures trading in these newer commodities vis-à-vis investors’ appetite. This is likely to affect the liquidity in the exchanges. Given the extensive application of modern technology, these newer exchanges have managed to draw investors away from the old exchanges, which has led to drying up of volumes on some of the latter exchanges.  

Brief History

The first commodity exchange was set up in India by the Bombay Cotton Trade Association and formal organised futures trading was started in cotton in 1875. Subsequently, many exchanges came up in different parts of the country for futures trade in various commodities. The Gujarati Vyapari Mandali came into existence in 1900, which undertook futures trades in oilseeds for the first time in India . The Calcutta Hessian Exchange and East India Jute Association were set up in 1919 and 1927, respectively for futures trade in raw jute. In 1921, futures in cotton were organised in Mumbai under the auspices of the East India Cotton Association (EICA). Many exchanges were set up in major agricultural centres in north India before world war broke out and they were mostly engaged in wheat futures until they were prohibited. The existing exchanges in Hapur, Muzaffarnagar, Meerut , Bhatinda, etc, were established during this period. The futures trade in spices was first organised by India Pepper and Spices Trade Association (IPSTA) in Cochin in 1957. Futures in gold and silver began in Mumbai in 1920 and had continued till the government prohibited it by mid-1950s.

The commodity options[1] were traded during the pre-Independence period. Options on cotton were traded until they, along with futures[2], were banned in 1939 (Ministry of Food and Consumer Affairs 1999). However, the government withdrew the ban on futures with passage of Forward Contract (Regulation) Act in 1952. The act provided for the establishment and constitution of a Forward Market Commission (FMC) for the purpose of exercising the regulatory powers assigned to it by the Act. The FMC was actually set up in 1952. But, the shortages in agricultural products on account of climatic factors and successive border conflicts during the early and mid-60s led to futures trades being altogether banned by the government in 1966 in order to have control on the movement of prices of many agricultural and essential commodities.

As a result of the ban, many traders started resorting to unofficial and informal trade in futures. On the recommendations of Khusro Committee in 1980, government reintroduced futures in some select commodities including cotton, jute, potatoes, etc. As part of economic liberalisation in early 1990s, an expert committee on forward markets under the chairmanship of K .N. Kabra was appointed by the government of India in 1993. Its report submitted in 1994 recommended the reintroduction of futures, and also to widen its coverage to many more agricultural commodities as well as silver. (Sahadevan 2002)

The liberalised policy being followed by the Government of India and the inefficiencies that have crept into the practice necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management. The National Agriculture Policy announced in July 2000 and the announcements of the Finance Minister in the Budget Speech for 2002-2003 were indicative of the Government’s resolve to put in place a mechanism for the promotion of futures trade/market. As a follow up, the Government issued notifications on   April 01, 2003 permitting futures trading in commodities. With the issue of these notifications, futures trading are not prohibited in any commodity. Options trading in commodities, however, continue to be prohibited.

The trading on commodity exchanges is no longer confined to agricultural crop and agro products; it has been extended to cover precious metals and non-precious metals, plantation crops, energy products among others. Also, futures trading is no longer restricted to movable goods, as prescribed by the Forward Contracts (Regulation) Act, 1952. It is sure to be extended over time to all sorts of services, and even immovables. In fact, all tradables (entering the input-output matrix of the economy and required for both short-term and long-term planning of production,[3] distribution, consumption, imports and exports) call for active trading in futures and their derivatives to cover the direct and indirect price risks arising out of them. Verily, the sky seems to be the limit for the commodity and non-commodity domains of futures trading.

Commodity Contracts

Commodity futures contracts are tradable standardized contracts, the terms and conditions  of which are set in advance by the exchanges regulating the trade. The commodities are required to meet certain pre-set quality specifications; in the case of gold, for instance, it should have a minimum fineness of 0.995 and a serial number of an approved refinerer, for the commodity to trade on NCDEX. Each contract has a lot size and a delivery size, which is dependent on the commodity. The market participants are allowed to negotiate only the quantity and price of the contracts as all the other parameters are pre-set by the exchanges.

Unlike equity futures which have a standard life cycle of three months, the duration of commodity contracts varies as per the commodity. Hence the market participants can hedge their positions over a longer period of time. 

The commodity exchanges follow somewhat similar margining system as in equities. However, an additional delivery margin has to be maintained once the contract enters the delivery period in case of delivery settlement.

The Delivery Process

A seller intending to give delivery has to approach the accredited warehouse for the availability of space and the assayer, who certifies the quality of the goods; as per the pre-set quality specifications. The seller bears the storage cost until the date of demat credit, as also loading/unloading and all other incidental charges, including assaying charges. Further, not all goods can be delivered to all warehouses because they vary commodity-to-commodity and also exchange-to-exchange. Nevertheless, the seller has the option of choosing the delivery centre among the accredited ones.  The buyer intending to take physical delivery has to approach the warehouse with the document (re-materialisation form or warehouse receipts). All incidental charges pertaining to taking delivery are to be borne by the buyers.      

Data Analysis of Trades

It is found that though there are 23 exchanges in operations, there is considerable concentration of futures trade in the country. As shown in Table 1, the turnover of the first four exchanges (NCDEX, MCX, NMCE, NBOT) account for more than 90 per cent of the total commodities exchanges turnover. Of these, three are national level exchanges set up using advance modern technology. 

Commodities Turnover Across the Exchanges

Of the 116 commodities, almost 50 per cent of the total trading is concentrated in four commodities: Guar seed, Soya oil, Silver and Guar gum.

Guar seed has been among the most actively traded commodities in India in 2004. India is the major producer of guar seed accounting for 80 per cent of the total guar produced in the world, followed by Pakistan and US. While demand for guar is stable throughout the year, supply varies largely between years, leading to price volatility. 

The FMC is keeping a strict vigil on the trading in guar trading as it is the highest traded commodity on the exchanges and also, the underlying spot market is relatively small. Guar is not included in the measurement of the official whole price index (WPI) which is said to represent an average inflation rate based on important commodities. The end use of guar is also limited to consumption and some industrial use. In view of excessive trading, the FMC imposed 20 per cent margin to correct the volatility at end March 2005. However, due to the delayed imposition of margin by NCDEX, the price volatility increased. Subsequently, the FMC issued a show cause notice to the exchange. The NCDEX said that they had already imposed a 20 per cent margin on all long positions in excess of 2 per cent of the open interest on March 31, 2005 well ahead of FMC’s order.   

Illiqudiity  of Some Contracts

The exchanges have been introducing futures on various commodities at a rapid speed which has rendered some of  them illiquid as very few trades are executed in such futures. For instance, on NCDEX, the following commodities have displayed almost nil or very less trading during the period between June 13 and June 20, 2005

Development Initiatives: Rainfall and Commodities Indices

The NCDEX has started displaying a rainfall index for Mumbai from June 01. The index encompasses rainfall at both Colaba and Santacruz weather stations and is structures on the basis of past rainfall data. A higher index would mean that, compared to the cumulative long period average rainfall up to the date of index there has been more rainfall. A lower index would mean the converse. Thus, the index at any point of time would tell what percentage of cumulative normal expected rainfall (till the date of index) it has actually rained. The value is scaled by 1,000 to represent a number.

For the first time, a commodity index has been launched by NCDEX on May 3 comprising of 20 agricultural commodities. The index acts as a barometer of the agriculture sector performance. It also indicates the relative performance of the sector vis-à-vis the reference period and acts as a powerful information tool and benchmark for investment performance. The base 2000-01 has been chosen  because the year was considered to be a normal one. The base value is set to 1000.   The index is calculated by assigning equal weights to all the constituent commodities. The index is updated twice on week days and once on Saturdays. 

NCDEX Agri futures index is constructed on the prices of the nearest month expiry contracts for the same basket of commodities that forms the part of the NCDEX Agri spot index. The advantages of the futures index would be two fold. The futures index, if looked in tandem with the spot index, would convey to the market participants the returns the commodity markets are offering for one month period by buying the futures index. Second, since the futures index are constructed based on the futures contracts traded in the exchange, it would get updated on real time basis as against the spot index that is updated twice a day. Also, the base period for the construction is the same for both, i.e., the average of the prices prevailed during the year 2001 and also the base rate of 1000.

MCX launched a real time composite commodity futures index MCX-COMDEX, with 2001 as the base. It also launched spot and futures indices in metals, crude oil and agricultural commodities. MCX-COMDEX combines all these three categories of commodities. On MXC-COMDEX agricultural sub-groups carries 33 per cent weighting and includes wheat, Urad, refined soya oil, rubber, guar seed and kapas khalli, all carrying equal weightings within the group. Metals also carry 33 per cent weightage and comprise gold, silver and copper. The energy sub-group consists of crude oil and carries 34 per cent weightage.

Merger of Sebi and FMC

In the union budget 2004-05, the finance minister announced the government’s intention to integrate the commodity futures market with securities market based on the recommendation of report of the Inter-Ministerial Task Force on the Convergence of the Securities and Commodity Derivatives Market in May 2003. The Taskforce expects that the merger of the two would open new avenues of business opportunities to securities market participants, thereby deepening and broadening the commodity derivatives market too.

The consumer affairs department (CAD) is making a case for a separate regulator for the commodities market, while the finance ministry is keen on vesting the powers of the futures market with the Sebi. The CAD said that a report by USAID had also suggested that India should have separate regulators for the commodities and the securities market. The report was in favour of a common regulator only for smaller countries. The other concerns: there are fears that in the large securities exchanges, there would be certain lack of focus on agricultural commodities and the focus will be on organising derivatives trading only in commodities with close semblance to the financial market. Also, the department is making a case for greater participation of farmers in the commodities market and is of the opinion that Sebi, with its limited reach, may be unable to go beyond the metros. Further, the department is also making a case for greater market participation.  

Dematerialization of Warehouse receipts

A commodity futures market is primarily a hedging market, and not a market for delivery. Deliveries need to be issued and received only in a residual sense to maintain a parallel or near-parallel relationship between the physical and futures market prices to facilitate efficient hedging. While farmers, merchants, stockists and importers need hedging against price decline, processors, manufacturers, exporters and even traders with forward sales commitments require hedging against adverse price increase.

The RBI appears to be in favour of cash settlement for commodity derivatives, while the existing government policies appear to favour physical deliveries. The report of the working group on commodity futures set up by RBI feels that the physical settlement would be a burden for banks. Currently, all contracts must incorporate a physical delivery mechanism. However, physical delivery in many contracts depends on both options, making it essentially cash-settled. In these contracts, delivery happens if both the buyer and the seller agree.

Even if physical deliveries is about 1 to 2 per cent of total trading, the deficiencies of physical delivery in terms of quality certification, warehousing limitations including absence of warehouse receipts system undermines confidence in commodity futures market substantially. The constraints on the physical commodity market such as movement, taxes, seasonal factors, infrastructure (warehouses, roads, transport), and warehouse receipts system and quality factors all become important components. Considering the continental size of the country and regional variations in product quality, these constraints become prominent in stifling derivatives market.   

Given the realties at the base level, not many sellers of commodity futures will prefer to stock their commodities in exchange designated warehouses for fear of their goods being graded as sub-standard, with a near expiry date of the certified standard, requiring thus frequent re-testing for valid certification over time.

Not only will the storage costs in such exchange -designated warehouses be much higher than at the other storages, but the carrying costs will tend to increase, owing to the repeated quality certification requirement that may render such storage uneconomical. Consequently, the deliverable supplies in the designated warehouses will inevitably be a fraction of the actual production and aggregate stocks of any commodity in the country. As it is, the contracts traded in futures at most of the commodity exchanges in the country are only for a specified variety deliverable at a single centre, excluding all other varieties and market centres. As a result, these contracts are too narrow to perform either the price discovery or the price risk management function effectively. The trading volumes in them is negligible, and more notional than real.

Due to paucity of the technologically advanced modern pre-processing plants for most agricultural and plantation crops, quality of commodities is affected adversely. Given the high standards set by the exchanges for deliveries, small and marginal farmers will find it difficult to effectively hedge their commodities and also despite the awareness about the prices of commodities, they may not be able to fetch the rates disseminated by the exchanges.

The commodity exchanges even in the United States, which leads the rest of the world in the futures trade, is still very cautious in introducing the demat delivery system, despite the development of electronic commerce in it on a much wider scale than in any other country of the developed world, leave aside the developing economies like India.

Efforts to Expand the Reach of the Exchanges

MCX along with Financial Technologies and National Agricultural Co-operative Marketing Federation (NAFED) is to set up India ’s first electronic exchange for spot trading in commodities, called the National Spot Exchange for Agricultural Produce (NSEAP). It will be a national level electronic exchange linked to agriculture produce marketing co-operatives (APMC) and other physical market players. This will facilitate consumer-producer linkages across the country and there will be dissemination of critical information, including prices to all  participants.

NCDEX, in its endeavour to reach out to poor farmers and enable them to know correct prices in the market and also manage their price risk, has installed a price ticker at village Narnur in Adilabad has started to display real time prices for the benefit of growers.

In an interesting development, Tirmalai Tirupati Devasthanam, considered to be India ’s largest pilgrimage centre, has set up a commodity futures terminal in its premises. As they are one of the largest purchasers of commodities like sugar, cashew and turmeric in the country, the terminal would facilitate the monitoring of the price fluctuations in these commodities      

Regulators Initiatives

In it endeavour to strength the regulatory process, the FMC has made the registration of brokers mandatory with an aim to regulate intermediaries, which is expected to be in line with the Sebi registration process. They have also banned trading of agricultural commodities in the evening, though metals, bullion and crude are traded in the evening session.  This was done in response to the various complaints received by FMC especially from rural areas against the excessive speculation in evening trades.

Comparison of Spot and Futures Prices of Select Commodities Traded on NCDEX.

The general trend observed is that the spot prices have ruled below the futures prices which at the time of expiry of contracts appear to be converging for the commodities under consideration: guar gum, guar seed, chana, gold, castor seed, refined soya oil and silver. However, in case of silver, it is observed that the spot prices have ruled above the futures (Graphs A to G).

In their pioneering work on futures market, John Maynard .Keynes and John Hicks (1939) had  argued that the price of a futures contract for delivery of a commodity would be generally below the expected spot price of that commodity. This was termed as ‘normal backwardation’. This was largely because hedgers shifted their price risk onto speculators in return for a risk premium. However, the commodities reviewed in the Graphs annexed do not display normal backwardation.

Conclusion

A pious hope is that with the introduction of futures trading some concrete developments would take place in the spot market which includes better storage facilities, warehouses, pre-processing of commodities and other sophistication that should penetrate across the country. However, this is possible only if the futures market is physical delivery based, because this will motivate market participants to upgrade the existing facilities and also set up new capabilities.

Further, it would be prudent if the exchanges focus their efforts towards improving the liquidity of the existing contacts rather than introducing various futures and turning them illiquid.

Reference

SahaDevan K.G.:‘Sagging Agricultural Commodity Exchanges’, EPW, July  2002

Nair C.K.G.: ‘Securities Market and Commodity Derivatives Market’, NSENEWS,    December 2001

(This note has been prepared by Piyusha D Hukeri with the assistance of Nileshwari S Engineer).

*These statistics and the accompanying review are a product arising from the work undertaken under the joint ICICI research centre.org-EPWRF Data Base Project.

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