Indian commodity markets, especially commodity futures markets, saw important changes in the last few years. One major change in 2015 was when the Forward Markets Commission (FMC) was brought under SEBI. Consequently, regulation of commodity markets also came under the ambit of SEBI.
The big advantage of the move was that SEBI could regulate the financial markets in a more coordinated manner. However, volume growth in commodity markets has been spasmodic and yet to see the kind of growth that equity and equity derivatives markets have seen. Here is the agenda for commodity markets in Budget 2021.
Commodity transaction tax (CTT) needs to go
There is hardly a Union Budget when the Commodity Participants Association of India (CPAI) does not reiterate this point. Unlike the STT, which contributes close to $1.5 billion annually to the exchequer, CTT is a very marginal contributor. Also, commodity trading is viable only when margins are low and volumes are high.
The presence of CTT is distorting commodity markets and preventing volumes from picking up meaningfully. Commodity market volumes fell sharply after 2013 when CTT was first introduced and has lagged despite the introduction of new products. Considering the need to encourage commodity markets, it is a good idea to abolish CTT altogether.
Streamline spot versus futures anomaly in commodities
If CTT is one major issue for commodity markets, the other is the dichotomy between the futures and spot markets. That is nothing unique. Even in equity markets, spot market and derivatives markets are distinct. The difference is in the way it is regulated. For example, in the case of equities, spot and futures are regulated by SEBI.
In contrast, commodity markets have dual regulation. For example, the commodity futures markets are regulated by SEBI while the spot markets are regulated by the respective state governments. This has been a major roadblock in the launch of innovative futures and options products as managing the underlying becomes a big challenge.
Time to integrate, e-NAM, new Farm Policy and commodity markets
When the government passed the Farm Bill in both houses of parliament in 2020, it may not have anticipated such a strong reaction from farmers. However, the Farm Bill was long due. If the Farm Bill has to really help farmers, it pre-supposes a robust secondary market for agri-futures where farmers can manage price risk. Budget 2021 can make a start by standardizing rules for contract farming across states.
In 2016, the government introduced the electronic National Agricultural Market (eNAM), which was supposed to offer farmers a platform to directly sell their produce online rather than to go through Mandis. States with maximum mandis have been most lax in eNAM implementation. Budget 2021 must seriously take e-NAM to its logical conclusion if the Farm Bills have to be really effective.
Cross licensing will only work with cross-hedging
Budget 2017 allowed stock exchanges and commodity exchanges to enter into each other’s territory. NSE and BSE set up their commodity businesses but it is yet to really take off. The real edge will come only if cross hedging is permitted. While this may be capital market specific issue, Budget 2021 can give the direction.
Today, cross margining is available between equity and equity futures but not between equity futures and commodity futures. They still operate as discrete markets. Budget 2021 is expected to take a step in the direction of enabling such cross hedging products.
NSEL fiasco still remains inconclusive
It is more than 7 years since the National Spot Exchange Ltd. (NSEL) fiasco raised serious questions over the functioning of spot exchanges. It also dampened the enthusiasm of many global investors with respect to commodity markets in India. While the investigations are on, 7 years is long enough to bring the investigation to a conclusion and restore confidence.
What really disturbs investors is that nearly $1 billion of investor money evaporated more than seven years back and nothing was done about it. The Budget must look to end this fiasco in the interest of the integrity of commodity markets in India.
How to get institutions interested in commodity markets?
Foreign investors were permitted into commodity futures in 2014 but there has been little traction. Even domestic mutual funds can actually hedge their risk in commodity markets but the response has been tepid. Both these institutional investors are looking for some leadership and ideally Indian banks must show the way.
Currently, banks are not allowed into commodity futures due to price volatility but ironically many banks run commodity risk as lenders. One way is to allow them to hedge commodity risk through offsetting futures positions. That is the norm globally. Above all, the presence of banks will attract other institutions into commodity markets. Budget 2021 can set the ball rolling.
The unfinished agenda for commodity markets is huge and Budget 2021 is the right time to make a quantum shift in approach.