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The future of commodity market
Monday, April 16, 2007
A strong and vibrant cash market is a pre-condition for a successful and transparent futures market.
As funds seamlessly flow from one market to the other and the Indian commodity market begins to integrate with the global market, the risk perception is beginning to heighten. Adoption of risk management or risk mitigation tools is now sine qua non for success in businesses with exposure to commodities. A serious look at futures trading as a tool for price discovery and price risk management is inevitable.
Before we examine commodities futures trading — its principles and benefits — it may be worthwhile to crystal gaze into the future of this market. Some features of the emerging scenario in India as far as the commodity market is concerned:
Expansion of commodity trade: Very clearly, trade volumes are set to expand rapidly. Demand for a wide variety of commodities covering food, fibre, metals and energy is certain to expand. India is likely to produce many of the aforesaid commodities, as investment in production facility expands. If demand growth outstrips domestic supply growth, imports will become inevitable. The possibility exporting certain commodities also exists. In commodity production, consumption and trade, India will become an important player in the international market. This will lead to a massive expansion in commodity trade volumes over the next, say, 15-20 years.
Competition from imports: Whether or not domestic producers like it, the competition from imported commodities is inevitable. This could be true in case of food crops, metals and energy. In the short/medium-term, indigenous output will trail consumption demand because of the lagged effect of investment. To fuel growth and rein in inflation, the government and the business houses will have to resort to imports. As imports are unrestricted (Quantitative Restrictions have been abolished), there will be liberal inflow of goods from abroad. Often, imports from developed countries are low-priced and subsidised. Such competition will result in inefficient domestic units falling by the wayside, but will eventually lead to greater efficiency among domestic producers.
Role of MNCs: Multinational corporations cannot be wished away. They bring with them a certain superior knowledge of operating in developing or emerging economies. They also have deep pockets and, often, are long-term players. In the Indian commodities sector, global companies will increasingly play a role as producers, suppliers, traders and service providers. Indian producers will have to learn to face competition from MNCs.
Consolidation of fragmented capacities: It is well-known that commodity producers and industrial consumers in India suffer poor scale economies because of their small size. Fragmentation of business that is resulting in scale-diseconomies and other infirmities is likely to give way to consolidation.
Competition is now driving smaller players to explore opportunities for merger. Bigger companies with expansion plans follow the acquisition route. Mergers and acquisitions will lead to consolidation of fragmented businesses, albeit slowly.
Dominance by a few large firms: In the developed economies, a handful of companies share a big slice of the business pie. Typically, four-five companies would account for, say, 60-75 per cent of aggregate business and several smaller players compete for the rest. The commodity sector will inevitably move towards such a situation. The process of consolidation and dominance by a few large firms is already visible, however incipient. Take edible oil imports, for instance. Of the total imports of 45-50 lakh tonnes a year worth over Rs 10,000 crore, five companies (of which two are MNCs) account for roughly 70 per cent of business; the rest being shared by over 20 importers.
Waning role of government: As part of the economic liberalisation process, the Government has not only freed the commodities market of controls and restrictions but has also, by and large, distanced itself from the market. The interventionist role of the government is now minimal. Of course, some restrictions still remain, like those on the sugar industry.
The government's role is changing from controller to facilitator. It must, however, be mentioned that "liberalisation is not licence''.
Use of information technology: Very clearly, IT will play a key role in bringing about greater transparency in the commodities market. The country's strengths in IT will increasingly be leveraged to connect stakeholders and link markets.
IT will be used for delivering price and market information to primary producers (farmers). E-commerce will be the modern way of doing business. Several corporates have already begun to employ IT to derive value, ITC's e-chaupal being a remarkable initiative. The agricultural produce markets (numbering nearly 7,500 across the country) will soon be networked so that growers can get to know prices prevailing in various marketing yards or mandis.
Strong cash market: These developments will result in a stronger cash market for commodities. Initiatives are already underway to launch electronic spot trading in farm commodities that will help growers and others not only discover prices almost real time, but also help capture value by taking trading positions. A strong and vibrant cash market is a pre-condition for a successful and transparent futures market.
It is this emerging scenario that market participants must gear themselves to face.
As funds seamlessly flow from one market to the other and the Indian commodity market begins to integrate with the global market, the risk perception is beginning to heighten. Adoption of risk management or risk mitigation tools is now sine qua non for success in businesses with exposure to commodities. A serious look at futures trading as a tool for price discovery and price risk management is inevitable.
Before we examine commodities futures trading — its principles and benefits — it may be worthwhile to crystal gaze into the future of this market. Some features of the emerging scenario in India as far as the commodity market is concerned:
Expansion of commodity trade: Very clearly, trade volumes are set to expand rapidly. Demand for a wide variety of commodities covering food, fibre, metals and energy is certain to expand. India is likely to produce many of the aforesaid commodities, as investment in production facility expands. If demand growth outstrips domestic supply growth, imports will become inevitable. The possibility exporting certain commodities also exists. In commodity production, consumption and trade, India will become an important player in the international market. This will lead to a massive expansion in commodity trade volumes over the next, say, 15-20 years.
Competition from imports: Whether or not domestic producers like it, the competition from imported commodities is inevitable. This could be true in case of food crops, metals and energy. In the short/medium-term, indigenous output will trail consumption demand because of the lagged effect of investment. To fuel growth and rein in inflation, the government and the business houses will have to resort to imports. As imports are unrestricted (Quantitative Restrictions have been abolished), there will be liberal inflow of goods from abroad. Often, imports from developed countries are low-priced and subsidised. Such competition will result in inefficient domestic units falling by the wayside, but will eventually lead to greater efficiency among domestic producers.
Role of MNCs: Multinational corporations cannot be wished away. They bring with them a certain superior knowledge of operating in developing or emerging economies. They also have deep pockets and, often, are long-term players. In the Indian commodities sector, global companies will increasingly play a role as producers, suppliers, traders and service providers. Indian producers will have to learn to face competition from MNCs.
Consolidation of fragmented capacities: It is well-known that commodity producers and industrial consumers in India suffer poor scale economies because of their small size. Fragmentation of business that is resulting in scale-diseconomies and other infirmities is likely to give way to consolidation.
Competition is now driving smaller players to explore opportunities for merger. Bigger companies with expansion plans follow the acquisition route. Mergers and acquisitions will lead to consolidation of fragmented businesses, albeit slowly.
Dominance by a few large firms: In the developed economies, a handful of companies share a big slice of the business pie. Typically, four-five companies would account for, say, 60-75 per cent of aggregate business and several smaller players compete for the rest. The commodity sector will inevitably move towards such a situation. The process of consolidation and dominance by a few large firms is already visible, however incipient. Take edible oil imports, for instance. Of the total imports of 45-50 lakh tonnes a year worth over Rs 10,000 crore, five companies (of which two are MNCs) account for roughly 70 per cent of business; the rest being shared by over 20 importers.
Waning role of government: As part of the economic liberalisation process, the Government has not only freed the commodities market of controls and restrictions but has also, by and large, distanced itself from the market. The interventionist role of the government is now minimal. Of course, some restrictions still remain, like those on the sugar industry.
The government's role is changing from controller to facilitator. It must, however, be mentioned that "liberalisation is not licence''.
Use of information technology: Very clearly, IT will play a key role in bringing about greater transparency in the commodities market. The country's strengths in IT will increasingly be leveraged to connect stakeholders and link markets.
IT will be used for delivering price and market information to primary producers (farmers). E-commerce will be the modern way of doing business. Several corporates have already begun to employ IT to derive value, ITC's e-chaupal being a remarkable initiative. The agricultural produce markets (numbering nearly 7,500 across the country) will soon be networked so that growers can get to know prices prevailing in various marketing yards or mandis.
Strong cash market: These developments will result in a stronger cash market for commodities. Initiatives are already underway to launch electronic spot trading in farm commodities that will help growers and others not only discover prices almost real time, but also help capture value by taking trading positions. A strong and vibrant cash market is a pre-condition for a successful and transparent futures market.
It is this emerging scenario that market participants must gear themselves to face.
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Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.
