Commodity Futures in India â A Product of ... - MCX in Marathi

Commodity Futures 

in India – A Product of 

Globalisation and 

Liberalisation 

By Mr. Lamon Rutten 

A beginning has been made towards transforming the Indian commodities sector, from its 

current status of being a ‘price taker’ to a ‘price setter’, with the national online commodity 

futures exchanges taking the lead. These exchanges are offering the benefits of 

liberalisation and globalisation directly to the industry and consumers by empowering 

them to influence the global prices of commodities they deal in. It is time the markets were 

made much more vibrant and efficient by allowing participation of a larger number of new 

categories of economic stakeholders and introduction of innovative derivative 

instruments. This is to plug risks at the roots rather than when they finally sneak into the 

prices of end products. And this will make the Indian markets a force to reckon with on the 

global commodity map, turning them into a ‘price setter’ indeed. 

Economic liberalisation took off in the early 1990s in 

India. Like in many countries, policymakers, 

practitioners and academics responded to the growth 

of financial markets worldwide, and a new-found 

ebullience surrounding emerging markets, by 

advocating wide-ranging reforms. International trade 

and investment were opened up, a process of 

deregulation and privatisation initiated, the tax regime 

reviewed. 

India's economy greatly benefitted. In 2007, the 

country clocked its highest ever GDP growth rate of 9% 

the second-fastest in the world after China and a far cry 

from its annual GDP growth in the three decades post- 

Independence. However, the reform process is still 

incomplete, and the financial sector has been lagging 

behind many parts of the real economy. Stakeholders 

have still not reaped the fruits of greater competition in 

financial markets, unlike what has been seen in sectors 

such as telecom, banking, insurance, and aviation. But 

now, Indian financial markets are poised to scale to the 

next growth orbit. 

India increasingly integrates with markets around the 

world. This opens a window of opportunity to Indian 

companies but also, exposes them to a whole new 

world of risks. Among these risks, of key importance to 

many, is commodity price volatility. Companies need to 

be able to manage these risks if they are to be globally 

competitive, and this is where an efficient commodity 

futures market plays a primordial role not only in 

facilitating price/volatility risk mitigation but also 

catalysing near-perfect price discovery. 

After decades of decay, India's organised futures 

industry was revived in 2003. As it matures over time, its 

backward and forward linkages will strengthen, 

resulting in widening and deepening of the market 

through increased participation by various ecosystem 

players. This in turn is changing the ways producers 

make their cropping decisions, traders trade their 

products, and banks lend against commodities or 

those with exposure to commodity price risk. The 

ultimate results will be 'Financial Inclusion' and 'Market 

Inclusive' growth. 

The Enabler of Efficient Price Risk Management and 

Price Discovery 

The price discovery process should not be left to just a 

handful of traders in asymmetrically informed or illinformed, 

segmented markets. Rather, the best price 

discovery comes when a large number of various 

categories of market players with a wide range of 

22 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

objectives and interests converge on an organized 

futures platform. Such a platform and the Multi 

Commodity Exchange of India Ltd. (MCX) is one 

ensures that all relevant information is absorbed in the 

price formation process, and the “right price” is 

discovered. The more efficient the discovered prices on 

a futures platform is, the more effective are the 

business and policy decisions that are taken based on 

these prices. 

The efficiency and transparency of price discovery 

depends on the robustness of the trading platform; its 

regulations; the right mix of its participants with 

relevant price information; making participation costeffective 

vis-à-vis alternatives available for risk 

management and/or investment; effec tive 

management of the participants' varied risks and, last 

but not the least, a robust and transparent clearing 

policy. 

In just about six years, the national commodity futures 

exchanges in India performed better than the 

policymakers expected in terms of catching up with 

their age-old global counterparts on most of the 

aforesaid parameters. A lot of efforts delivered from a 

base of strong domain knowledge and technical skills 

went behind this spectacular growth. Selection of 

commodities relevant to the stakeholders; right 

contract design; keeping ears and eyes to market 

needs; taking them to appropriate participants; 

creating awareness; expanding infrastructure; and 

bringing in world-class technology and global best 

practices are some worth mentioning. 

To make these markets more relevant and useful to 

different categories of stakeholders and thus their 

participation more effective, it is necessary that various 

risks to the participants be effectively managed. Risk 

management tools on a futures platform include 

margining, limits on open positions, and effective 

surveillance (see table 1). Price volatility of 

commodities traded on an exchange is an indicator of 

how effectively these tools are used by the exchange 

managers to improve the efficiency of price discovery. 

That is to gauge the capability of its futures contracts to 

predict its maturity prices more accurately (indicated 

by the percentage deviation between the first traded 

price and the last traded price of a given contract). The 

efficiency of price discovery is also indicated by the 

nearness of the spot and futures price movements. In 

the case of MCX, the correlation between its gold 

futures contract and gold spot prices is around 99.8% 

(from January 2007 to August 2009), which indicates a 

strong inter-linkage between domestic spot and 

futures markets. For the same period, MCX gold 

contract's correlation with the global benchmark, 

COMEX gold futures contract, is around 99.9% (the 

rupee adjusted). This reflects how efficient the Indian 

futures market is in capturing global cues. 

Table 1: MCX vis-à-vis global parameters 

Particulars 

Domestic Exchanges 

Commodity 

exchange (MCX) 

Stock 

exchange (NSE) 

Global Exchanges 

COMEX 

and CBOT 

Remarks 

Position limit to 

physical market 

size (%) 

Gold - 0.9% 

- 

COMEX Gold - 18.7% 

Position limit is significantly lower than that 

of global benchmark exchanges indicating 

that the domestic futures market cannot be 

distorted by single/a few players. 

Avg. daily volatility 

in January 2007 

to August 2009 

Gold - 1.3%, 

Ref. Soy Oil - 1.2% 

MCX Comdex 

- 1.4%. 

NIFTY - 1.60% 


CBOT Soybean Oil 

- 2.1% 

The lower price volatility on MCX compared 

with global exchanges reflects that price 

discovery on the domestic platform is 

happening with more price stability. 

Impact cost 

Gold - 0.027% 

NIFTY - 0.16% 


The lower impact cost on MCX at par with 

global exchanges reflects better liquidity in 

terms of market depth and width. 

Note: In the case of price discovery, we considered August 2009 contracts – MCX Gold contract, COMEX Gold and Nifty Futures. 

Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore sourced from NSE website on September 9, 2009. 

Impact cost for Nifty was calculated based on trading happened on a regular trading day. Impact cost of MCX gold calculated for a portfolio size of Rs.2 crore. 

Impact cost of COMEX Gold calculated for a portfolio of USD4 lakh (app. Rs.2 crore). 

EXPERTS’ VIEWS | 23

Again, as the same table shows, MCX gold contract is 

more efficient than COMEX gold contract in terms of 

price discovery. The lower volatility on the Indian 

commodity exchanges is due to the close monitoring 

and the robust margining system adopted by them. 

MCX follows strict vigilance with an automated system 

in place. The system, for example, provides automated 

alerts when a member’s margin utilization crosses 

various levels. If the margin utilization crosses 100%, 

the member in question is put automatically on a 

“square off” mode. This innovative risk management 

system has been adopted to prevent any spread of 

financial contagion. Besides the functional efficiency of 

trading, the technological robustness (both hardware 

and software) also adds value to the MCX participants 

by enabling cost reduction. It has a constant 

collaboration with FTIL, the parent company, aimed at 

improving the software through telecom technology, 

and this works towards cost-effectively connecting the 

stakeholders to the market. 

Commodity Derivatives - the Road So Far 

The introduction of commodity derivatives has 

remained one of the most significant developments in 

the Indian commodity market sector. The three 

national online exchanges brought in revolutionary 

changes in this sector by bringing in spatial integration 

and temporal price discovery of commodities at the 

national level. In the span of just six years, they have 

performed well, being successful in bringing various 

ecosystem participants such as producers, hedgers, 

arbitragers, and speculators on to a single platform. The 

annual turnover of domestic commodity exchanges 

increased from Rs.5.7 lakh crore ($127.6 billion) during 

2004-05 to about Rs.52.48 lakh crore ($1,143.1 billion) 

in 2008-09 at 74.10% CAGR. 

The exchanges clocked this robust growth despite 

continuance of various restrictions. For example, on 

instruments such as options and indices; participation 

of commercial banks, mutual funds and FIIs; and so on. 

What helped these exchanges to leap forward and 

attain higher levels of efficiency and trade volumes are 

their innovative products, functional transparency 

based on sound regulation, innovative applications of 

technology, effective adoption of global best practices, 

etc. These exchanges’ efforts and performance helped 

make Indian companies and economy globally 

competitive. The robust growth numbers reflect the 

stakeholders’ strong faith in these exchanges’ 

functional efficiency and transparency, as well as 

indicate the commodity markets’ growing influence 

over the Indian economy. The prices efficiently and 

transparently discovered on these exchanges are 

gradually being transmitted to the physical markets, 

and this will lead to increased competitiveness both in 

the manufacturing and services sectors. 

Global commodities traded on these Indian exchanges, 

such as bullion, ferrous and non-ferrous metals 

(copper, aluminium, steel, etc) and energy (crude oil 

and natural gas), account for more than 80% of their 

average daily turnover. These commodities are largely 

linked to the global markets as their imports and 

exports are allowed subject to a marginal tariff 

incidence. Obviously, most of these commodities are 

largely governed by their fundamentals (the supply 

and demand conditions) at the global level and partly 

by developments on the domestic front. Therefore, it is 

necessary for the users of these commodities to take 

positions on a futures platform with global linkages in 

order to hedge their risk. Such users may participate in 

exchange-traded contracts with their underlying 

physicals being the same as their raw materials and 

whose prices are linked to the prices discovered on the 

international benchmark exchanges. But in the 

absence of such an arrangement, trading on 

exchanges having the right mix of arbitragers between 

the domestic and global benchmark exchanges will 

also serve the hedging purpose. However, the second 

option may not be workable due to lack of clear 

participation norms for international exchanges, while 

the option of indirect participation will be costly for 

most of today’s corporate hedgers. 

For globally traded commodities, particularly metals 

and crude oil, the prices discovered on MCX have very 

high correlation (96%, on an average) with the 

international benchmarks (see table 2) despite the high 

volatility in USDINR in the recent past. This also shows 

that the prices of MCX’s futures on globally traded 

commodity follow efficiently — and in tandem — the 

combined forces of domestic and international 

fundamentals. And this makes the domestic online 

exchanges a cost-effective and superior alternative to 

their international counterparts. 

Table 2: Price correlation – MCX vs. global benchmark 

exchanges in globally-linked commodities from 

Apr ‘05-Mar ’09 (in %) 

Gold 94.3 

Silver 94.8 

Copper 94.4 

Crude oil 97.6 

Average 96.0 

Data Source: Exchanges' websites 


The Way Forward 

At this juncture when the Indian markets are on their 

way to the heights achieved by the global benchmark 

markets, it is essential that they are allowed to have the 

right mix of participants —and products — to have the 

necessary liquidity depth and width. Corporates and 

physical market players in India are gradually realising 

the importance and need to participate on commodity 

exchanges. An increased participation of such players 

will go a long way in streamlining commodity trading 

in India by bringing in relevant information about the 

fundamentals into the markets and, thus, making the 

price discovery process more efficient. Besides, this will 

also help corporate best practices percolate into the 

markets to fine-tune their functioning and efficiency. 

Given the current trend of globalisation of economies, 

competitiveness remains one of the most defining 

factors for developing economies. And this not only 

means having competitive manufacturing and services 

sectors but also necessitates promotion of markets to 

make them globally-competitive. 

To cite an example, in I ndia, neither the 

automobile/ancillary industries manage their input 

costs effectively nor do the suppliers of their raw 

materials. This is partly due to lack of policy guidelines 

allowing and promoting them to effectively participate 

in the market and partly because of lack of awareness 

on their part. However, of late, the coming up of the 

national commodity exchanges, armed with their 

global alliances, has provided industrial users of 

primary commodities with easy access to an alternative 

platform to trade on. The domestic exchanges offering 

such an opportunity to the industry ought to be 

effectively harnessed to efficiently manage their profit 

margins and safeguard their investor and consumer 

interests by infusing efficiency and economy into their 

procurement operations. Effectiveness of participation 

in global exchanges can only be replicated if the 

domestic exchanges meet the efficiency of trading in 

the global benchmark exchanges, especially in the 

globally traded commodities (with least trade 

distortions). 

Although India has a long way to cover in harnessing 

the potential in the major commodities, the story of its 

bullion market is bright. The Indian bullion market has 

demonstrated its resilience to remain the “price setter” 

for gold and silver in the Euro-Asian time zone. Indian 

(MCX) bullion prices have strong correlation with those 

of the international benchmark markets. 

Gone are those days when policymakers successfully 

used MSP as an instrument to influence the cropping 

pattern and production of farmers. It is the functioning 

of the domestic commodity exchanges which will 

strengthen the market-based trading system in India 

making it useful for Government procurement. The 

exchanges will create an environment where farmers 

have multiple selling options (for their produce) such 

as the spot market, the futures market, and the futures 

market-referred over-the-counter forward market. The 

futures market in electronic format being executable at 

the national level, integration of banks and 

institutional traders into the market will create several 

institutional options for farmers. Further, once allowed 

options will help farmers lock in their prices on the 

commodity exchanges in a more efficient way than 

they can currently do with the existing instruments. 

Besides the price risk, which can be mitigated by 

trading in relevant commodity derivatives, the weather 

risk has a profound impact on a farmer’s income under 

the predominantly rainfed farming (about 70% of net 

cultivated area) conditions prevalent in India. And if 

there could be a single most positive and defining step 

that can be taken towards solutions to such problems 

as mentioned above it shall be the passage of the longpending 

amendment to For ward Contracts 

(Regulation) Act. The Act, once effective, will work 

towards an efficient and vibrant commodity market in 

India (both on the physical and futures fronts) and 

bring a world of good to the entire commodity market 

ecosystem. The multi-faceted benefits will include 

introduction of a number of innovative instruments, 

such as farmer-friendly weather derivatives. 

India is a land of billions that 

consume a large portion of most 

primary commodities produced in 

the country. For the domestic 

exchanges to rise to the challenge 

of turning the country into a ‘price 

setter’ it is necessary that India has 

strong and transparent markets 

with robust infrastructure for 

efficient transactions. 


India is a land of billions that consume a large portion of 

most primary commodities produced in the country. 

For the domestic exchanges to rise to the challenge of 

turning the country into a ‘price setter’ it is necessary 

that India has strong and transparent markets with 

robust infrastructure for efficient transactions. This in 

turn necessitates that Indian commodity exchanges 

have an upright regulatory framework under a robust 

regulator. Therefore, strengthening FMC through the 

FCRA will be a momentous step towards strengthening 

the commodity futures market as a whole. 

First, once amended, the FCRA will clear the deck for 

introduction of long-awaited instruments such as 

options, intangibles like weather derivatives, 

commodity indices and freight indices, which through 

value additions will attract risk-averse participants. 

And the deepening of the commodity market, thus 

achieved, will enhance the market’s efficiency of price 

discovery and efficacy of risk management. And this 

will eventually result in fairer returns to farmers. 

Second, the amended FCRA will pave the way for 

participation of banks, MFs and FIIs in the commodities 

market. This will not only democratise the price 

discovery process on the exchange platform but will 

also stabilise the market forces and, thus, the overall 

economy. Participation of financial institutions on 

exchanges will also enable lending at market-linked 

prices, which in turn will lead to the benefits of price 

discovery flowing down even to small farmers, as their 

holding power will be enhanced. 

Warehouses and the related institutions (quality testing, 

standardization, and marketing yards) form a vital cluster 

in the logistics sector linking the producers of agricultural 

commodities with their end-users ensuring effective 

carryover of the commodity from the farm gate to the 

consumers’ table. Efficient warehousing creates efficient 

linkages among the participants in a value chain resulting 

in improved efficiency with which the produce is being 

marketed, enhanced income of the farmer, availability of 

credit through warehouse receipts (WR) etc. Besides the 

revenue earned from scientific stock management, the 

coming into force of the Warehousing (Development and 

Regulation) Act, 2007 (WDRA) and setting up of the 

authority will create an efficient warehousing ecosystem 

that will include quality testing and certification, 

standardization, and marketing. Following this, issuance 

of WRs and collateral management services will enable 

earning of higher revenues than the plain-vanilla storage 

charges levied on their clients. 

As the WR draws its power under the act, the value to it is 

added by the linkages that the warehousing institution 

creates with the funding institutions and the strength of 

the collateral management services for the funding 

agencies and their clients at a cost which would keep 

both the financial institutions and clients happy. 

The WDRA will also create efficient linkages between 

producers and markets. Application of information, 

communication and technology (ICT); innovative 

solutions to practical constraints; and effective 

nurturing of the linkages will go a long way in creating 

a healthy warehousing system in the country. 

Development of the warehousing sector — through 

the linkages to be created between the players and the 

institutions in the agricultural supply chain ecosystem 

— will help achieve the ultimate objective of creating 

win-win supply chains for producers, intermediaries, 

and consumers. 

MCX – Unrelenting in Its Endeavour 

Since its inception in 2003 MCX has taken a number of 

initiatives to help the farming community to realize a 

better value for their produce. It launched two major 

infrastructure projects - National Spot Exchange Ltd 

(NSEL) and National Bulk Handling Corporation Ltd. 

(NBHC). The combined strengths of MCX, NSEL and NBHC, 

along with its strategic partners, is committed to 

transforming the Indian rural economy to international 

standards by providing the last mile connectivity to rural 

areas and developing the required infrastructure. 

Availability of liquid futures contracts on various key 

commodities on the MCX platform has dramatically 

changed the spot market scenario. The fact that these 

prices are arrived through collective participation of the 

stakeholders from various parts of the ecosystem and the 

country makes it suitable to be benchmarked for the 

commodities underlying the futures contracts for the spot 

markets. This is despite the standardised nature of 

contracts and terms and conditions of futures trading. This 

has ensured emergence of benchmark prices of various 

commodities representing the most prevalent varieties in 

the most active physical markets in India. Thus, these 

benchmark prices, discovered on the MCX platform, 

reflect the sentiments of the entire producing, trading and 

consuming community representing a one-India market. 

The futures market is also increasingly acting as a guiding 

light for the physical markets to assess the upcoming 

underlying fundamentals and sentiments, and provide 

price signals to the physical markets. 


Creating a silent revolution… 

Why Can India Not Be a ‘Price Setter’ 

A pre-WDRA entity, NBHC, which was floated by MCX 

with the felt need for delivering the underlying at the 

maturity of contracts, is an end-to-end solutions 

provider in the entire gamut of collateral management; 

procurement; warehousing; bulk handling, grading and 

quality certification; commodity care and pest 

management; audit; accreditation and commodity 

valuation; trade consultancy and disposal of 

commodities. In just a few years, NBHC, with its robust 

standardisation and quality-testing facilities, developed 

its own sustainable business model and came out of 

MCX’s shadow. One such business opportunity that 

evolved was collateral management undertaken to 

facilitate trading against collaterals (warehouse 

receipts). NBHC, with about 437 warehouses spread over 

18 states with a total capacity of 16.5 lakh million tonnes 

by the end of 2008-09, facilitated in its first year of 

operation (2006-07) collateral funding of Rs.1,500 crore, 

which rose to a cumulative 

figure of over Rs.8,800 

crore in the current fiscal. 

NBHC also facilitates 

government procurement 

(cumulative of 5,34,007 

tonnes of rice and wheat by 

2008-09). 

Taking the market to the 

masses… 

M C X h a s a c h i e v e d 

remarkable success in 

reaching out to a large 

n u m b e r o f a g r i - 

c o m m o d i t y 

producers/farmers hitherto unreached through its 

unique Gramin Suvidha Kendra (GSK) model. The 

innovative outreach network in tie-up with India Post 

to leverage the latter’s vast rural infrastructure in costeffective, 

traditional modes of communications for 

price dissemination and providing other services like 

redressal of technical queries and supplies of farm 

inputs such as seeds, pesticides/fungicides/weedicides 

and fertilizers, has now spread over 768 villages served 

by about 160 branch post offices, across five states, 

benefiting over 3,800 registered farmers more directly. 

Farmer registration with GSK shot up by 34% to 3,897 as 

on March 31, 2009 vis-à-vis 2,869 in 2007-08 — 

testifying the growing popularity of the model. 

Despite the fact that it is fast developing into a major 

‘economic powerhouse’ in the global arena India 

continues to look up at other markets to decide the 

local prices of commodities. With the country being the 

largest producer and consumer of a large number of 

commodities, is it not just logical that the Indian 

markets upgrade to the level of ‘price setter’ from their 

current tag of a ‘price taker’ And this assumes more 

relevance and priority with the Indian markets 

increasingly opening up and integrating with markets 

around the world. As for commodity markets, in which 

it is either one of the largest producers or consumers or 

both, India has immense potential to have a domestic 

market that is strong enough to set global market 

prices. In fact, given its share in global supply and 

demand as a dominant player in the world market (see 

table 3), the country has the potential to become the 

price setter in 17-odd commodities. 

Table 3: India's share in global production and consumption 

Commodities 

Share (%) in 

total global 

output 

Share (%) in total 

global consumption 

Global rank in 

production/consumption 

Rice milled 19.4 20.5 2nd largest producer behind China 

Wheat 12.1 12.0 

Soybean Oil 3.8 6.1 

3rd largest producer behind EU-27 

and China 

6th largest producer and 5th largest 

consumer 

Gold - 22.7 Largest consumer 

Coal 7.6 7 

Aluminium 3.1 3.2 6th largest producer 

Source: USDA, GFMS, BP Statistical review 

To transform the country into a 'price setter' the first 

logical step would be to democratize its markets to 

enable an efficient flow of information for effective 

determination of commodity prices. And this has partly 

been taken care of by the modern national-level 

commodity exchanges, thanks to policy liberalization 

of 2002-03. The rapid ICT developments helped 

penetration of the online electronic exchanges 

through reduced participation costs and increasing 

awareness. With the development of liquid futures 

contracts in many of the aforesaid commodities, India 

has started emitting price signals to the linked global 

markets of those commodities. To a large extent, such 

benchmark futures prices of the standardised 

contracts, as discovered on the MCX platform, have 

started influencing the global counterparts. They have 


started discounting the Indian fundamentals and 

sentiments in Indian time zone. For example, in 

commodities such as gold, of which it is the world's 

largest importer and consumer, and chana, of which it 

is the largest producer and consumer, India, on the 

strength of its futures market, is slowly gaining the 

rightful place among the world markets, in terms of 

influencing or setting the prices. 

Although it is still a long way to go, a beginning has 

been made towards transforming the country's 

commodities sector from being a price taker to a price 

setter, with the national commodity futures exchanges 

taking a lead. They are offering the benefits of 

liberalisation and globalisation directly to the Indian 

industry and consumers by empowering them to 

influence the global prices of the commodities they 

deal in. With increased accuracy of the prices 

discovered and more effective price risk management, 

the efficiency of the Indian industries and commodity 

markets will increase significantly. And this will result in 

a “multiplier effect” on the national economy. 

the participants tended to discount the global pricemoving 

factors rather than domestic information. 

Indian markets have to enable cost-effective 

participation of all those with information to effectively 

discover prices, and the national online commodity 

exchanges are already helping various categories of 

participants get all such available information to 

converge. 

It is time these markets were made much more vibrant 

and efficient by allowing participation of a larger 

number of new categories of economic stakeholders 

and introduction of more innovative derivative 

instruments, besides carrying out other next-level 

reforms. This is to plug risks at the roots rather than 

when they finally sneak into the prices of end products. 

And this will make the Indian markets a force to reckon 

with on the global commodity map, turning them into 

a 'price setter' indeed. 

While proliferation of products and participants is 

evident from the phenomenal 110% annual 

compounded growth rate at which the trade on the 

domestic commodity futures exchanges grew 

between 2003-04 and 2008-09 (source: FMC and 

Economic Survey data), in many global commodities 

Mr. Laman Rutten is MD & CEO of Multi Commodity Exchange of India Ltd. Views expressed in this article are personal.

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