THE FUTURE OF COMMODITY

MARKETS IN INDIA
The Indian commodity futures landscape has been evolving and the national
commodity exchanges have made a big headway since their inception, with
volumes surging with every passing year. The turnover on the Indian
commodity bourses has increased 120 times after electronic trading was
introduced in 2003, according to the Forward Markets Commission (FMC),
the commodities market regulator.
The MCX is the world's largest exchange in silver, the second largest in gold,
copper and natural gas and the third largest in crude oil futures. However, as a
whole, exchange-traded commodities account for only a fifth of the total
volume of commodities traded in India. Globally, the futures market in
commodities is 30-40 times the size of the underlying physical commodity
trade. The higher the multiplier, the more thinly the commodity price risks
can spread across the market. So, it is evident that there is a large scope for
increase in the volume of commodity futures trading in India.
Part of the reason for the rising trade volumes on the Indian commodity
futures exchanges is that they provide an efficient platform for hedging against
price uncertainty and global volatility. The exchanges provide transparent
price discovery and hedging platform for trading futures contracts of different
commodities. On these exchanges, the fair value prices are determined
through active participation of a large number of stakeholders of the
commodity value chain, who have access to information on the demand and
supply conditions.
In recent years, with the globalisation of the Indian economy and sensitivity of
prices of commodities to global factors, commodities have witnessed
heightened price volatility. This has exposed all stakeholders to price shocks,
from primary producers, such as farmers, to end-users, such as the
manufacturing sector. For instance, in 2010, the high volatility in
international prices of most commodities was reflected in the Indian prices.

Volatility in the MCX Comdex, the benchmark index of the MCX, was 17.7 per
cent in 2009 and 11.37 per cent during 2010 (January-October), while that for
its Agri Index stood at 13.35 per cent and 12.48 per cent, respectively, during
the same period. This has prompted a growing demand for hedging among
commodity users. The high correlation between domestic and international
prices is reflected in the close intertwining of the Goldman Sachs Commodity
Index and the MCX Comdex during the 21-month period between January
2009 and September 2010 (see graph).
With heightened volatility in commodity prices and increasing execution of
price risk management through the exchange platform, the Indian commodity
futures market grew by 38 per cent in 2008, 41 per cent in 2009, and by 51 per
cent between January and October 2010, in comparison with the
corresponding period of the previous year. The commodity futures trading
volumes, taken as a whole, have risen at a compounded annual growth rate of
97.9 per cent between 2003-4 and 2009-10.
The MCX has developed different contract denominations to accommodate
the needs of varied market participants, ranging from all types of traders such
as hedgers (jewellers, importers, retailers, and others from the physical
market), and speculators, to investors (HNIs and retail) and arbitrageurs.

Crude, Eurozone Turbulence Drive

Volatility; But India Remains
Preferred Market
In The Long-Term how do they
affect India?
Not since the 2008 financial crisis have the global markets seen the level of
volatility it is witnessing
currently. Already, in the first few trading sessions of 2015, steep corrections
have been seen in the

global and domestic markets, with US, EU and Asian markets falling nearly
3% in last 5 sessions. The
Eurozone economic slowdown, the impact of the ECBs expected decision
(later this month) to
announce a QE-style monetary policy action, uncertainty over Greece elections
that could potentially
throw the EU-led bailout plan out of gear, US 10-year government bond yield
falling below 2%, and
perhaps most significantly for India, the crude oil price free-fall, are all factors
that point to an
anticipated increase in short-term volatility.
The impact on Indian markets has been seen over the last few days with FIIs
cutting down on risk and
emerging as key sellers of Indian equities. According to stock exchange figures
for Tuesday, FIIs were
net sellers having sold a net of Rs.1,570.76 crore, while domestic institutional
investors were net
buyers at Rs.1,189.65 crore. The repercussions of global volatility could cause
some turbulence in the
domestic market and it is prudent for short-term traders should remain
cautious till this volatility in
the currency/credit markets reduces.
That said, fundamentally, India is more stable and less vulnerable to external
shocks than we were a
year ago. Therefore corrections led by international triggers may offer
excellent entry levels in
domestic markets. Historically, a fall in Indian markets owing to global
pressures have proved to be an

ideal buying opportunities for buying into preferred themes and picks with a
time horizon of more
than a year. Hedging long portfolios may help in countering the expected
surge in volatility and sharp
price declines.
So what is the outlook for these global conditions, are these falls sustainable,
and
The Fall Of Crude Oil Prices And Its Implications
Brent crude has dropped 53% percent since June to about ~$51 a barrel from
a peak of about $110 a
barrel just six months ago, while WTI has slumped from US$101 a barrel to
US$54 a barrel over the
same time period. This is largest fall since the 2008 financial crisis. But the
fundamentals strongly
suggest that US$55 a barrel for WTI crude is an unreasonable and
unsustainable price as:
Supply and demand are not significantly out of balance and does not justify a
50% price drop
Overreaction to projections of future oversupply has caused fear. At a low
crude oil price, the
projection is likely to be wrong.
Cash-strapped oil-producing countries will become more unstable, leading to
fears of supply

The main reasons for this slump have been

A strong US dollar: Crude oil is denominated in US dollars. The tradeweighted dollar has appreciated by

~12% since the summer, which implies this factor alone accounts for a fifth of
the decline in crude oil.
Weakening global demand: Fears of falling demand expectations played a part
to some extent in
bringing down crude oil price, but when it comes to the actual consumption of
oil, there is nothing in the
data that would justify the freefall. In fact, crude oil demand, in both OECD
and non-OECD economies
has perked up in the past couple of months (which is partly a seasonal effect).
Accelerating supply from US Shale Oil: The strongest component of supply
growth is the US shale patch,
and there is little that will alter that dynamic. In general terms, non-OPEC
world crude oil output is
leading the supply surge. But, OPEC is not yielding ground by maintaining its
overall output level despite
geopolitical events that have in recent years kept significant portions of Libyan
and Iranian crude off the
market. US shale oil supply has been augmented by new fracking and drilling
techniques to extract oil
from shale formations in North Dakota and Texas states. The US alone has
added 4 million new barrels of
crude oil per day to the global market since 2008. Global crude production is
~75mn barrels per day, so
this is significant
Implications on Global Markets
Global energy producers and linked markets are witnessing tremendous
pressure in terms of viability of
production and financial stability.

US Shale Oil: Below US$60 a barrel, a significant number of Canadian oil sand
& US Shale projects
become unviable. If low prices persist, many US shale projects will not be
viable, which could impact
long-term supply. Reduced budgets will begin to rein in production growth
over the next 12 months. In
fact, some major companies are already pulling out of Texas' Permian Basin
for now. The catch is that no
one quite knows how much lower crude oil prices need to go to rein in the US
shale oil boom. Analysts
often focus on a metric called the "breakeven price" for oil-drilling projects.
But, other drillers may try to
cut their costs, grit it out, and keep drilling. It really varies from company to
company. That makes it very
hard to predict how this all shakes out or where global oil prices will bottom
out. The US Energy
Information Administration still expects that overall US oil production will
grow by another 700,000
barrels per day in 2015 though that's slightly lower than the prediction
when prices were high.
OPEC: Many OPEC countries will be unable to cut supply since their fiscal
budget is highly dependent on
crude. Breakeven prices to balance budgets for Iran ($ 140), Venezuela($121),
Nigeria($119), Iraq ($106)
are much higher than the current oil prices. Markets are looking at a
psychological support at around
~$50 for brent crude oil, hence prices are unlikely to fall substantially below
this level.

Russia: Russian economy is largely dependent on crude export, with oil

revenues making up 45% of the
government budget. Falling crude prices along with the sanctions imposed by
the west on Russia, has
caused turbulence in the Russian currency & equity markets. The Russian
Rouble has depreciated by
~81% in the last six months. The steep fall witnessed in Russian Ruble is one
of the steepest for any
major currency in the last 15 years. The RTSI index is also depicting the
pressure in Russia; it has fallen by
44% since June. If such low levels of crude persist, Russia's economy is
expected to shrink ~4.5% next
year. The escalation of the Russian scenario has caused risk aversion across
the globe.
Venezuela: With oil accounting for roughly 96% of its export earnings and
48% of budget revenue, the
slump in oil prices have taken a toll on the country's already dire finances. The
nation's economy
heavily dependent on oil revenue is set to shrink by ~3% this year and
inflation remains rampant,
leading to a growing concern that the crash in crude oil could cause Venezuela
to default. Global Markets Volatility

Saudi Arabia: There is no question that Saudi Arabia, the world's largest crude
oil producer, will suffer
financially from cheap oil. If crude oil stays ~US$60 per barrel next year, the
government will run a deficit
equal to 14% of GDP.

For now, however, the Saudis are trying to grit this out and show no sign of
panic by propping up prices as
they have done in the past. The kingdom has built up a stockpile of foreign
currency worth ~US$740bn,
which it will use to finance its deficits. Still, if low oil prices persist, Saudi
Arabia may have to cut back on
some of the social programs it had instituted after the Arab Spring.
Implications on India
Lower crude prices leads to higher savings and increased consumption
An average Indian consumer spends ~9.5% of his income on Fuel & Light
(energy). Lower crude oil prices
have helped ease inflationary pressures in the country. Other than the direct
impact on fuel prices, lower
crude prices also have a spillover effect on food inflation.
Low crude prices imply low CAD and high Forex Reserve
India is a major importer of crude oil as it imports ~70% of its annual
requirements which comes to
~US$3.86mn barrels per day. India also exports back ~40% crude imports
after value additions (Reliance
Industries Ltd is having the major share of that export). So, the significant fall
in crude oil prices would help
the country to not only reduce pressure on CAD, it would also help to create
healthy forex reserve, which
will provide stability to INR against USD in a scenario of appreciating USD
against all major global currencies.

A word of caution
The overall impact of crude oil on India will be positive. Although India stands
to gain from lower oil prices,
such a steep fall increases the risk of contagion due to trouble energy credit
markets and leads to risk
aversion in the global markets. Specifically, risk lies in the form of a potential
crisis in Emerging Markets like
Russia. If the situation there escalates, there could be panic like situation
which would lead to risk aversion
and FII capital outflows from other EMs like India.
UNTAPPED POTENTIAL
Although India has to cover a long distance to be able to harness the potential
in many commodities, it has substantial opportunities to develop consumer
demand and uncover latent consumption. Despite having significant benefits,
commodities trading has been mostly limited to large corporates, trading
houses and high net worth individuals (HNIs). The key reason that
discourages retail investors from actively participating in commodities trading
is lack of familiarity.
Moreover, the current tax regime is not favourable for investors. Finally, the
institutional and policy-level issues associated with commodity exchanges
have to be addressed by the government in coordination with the FMC. This
will help take necessary measures to pave the way for a significant expansion
and further development of the commodity futures markets.
REGULATED GROWTH
The FMC has initiated several measures to stimulate active trading interest in
commodities. Steps such as lifting the ban on futures trading in commodities,
approving new exchanges which offer modern infrastructure and systems, and
removing legal hurdles to attract more participants have increased the scope
of commodity derivatives trading in India. This has boosted both the spot
market and the futures market in the country. The trading volumes are
increasing while the list of commodities traded on the national commodity
exchanges also continues to expand.

The FMC has continued its efforts to broadbase the market by undertaking
various regulatory measures to facilitate hedgers' participation and promote
delivery in agricultural commodities. These include introduction of Exchange
of Futures for Physicals (EFP), Alternate Futures Settlement Mechanism and
introduction of an early delivery system in select commodities. In addition,
efforts have been made to develop an aggregation model in collaboration with
the commodity exchanges to promote participation of farmers (these will
become feasible once options are allowed, which requires amendments to the
Forward Contracts (Regulation) Act, 1952).
GOING FORWARD
The commodity markets are at a juncture where investment in education and
research is important to sustain their growth. The MCX has been taking
various initiatives to systematically develop markets through continuous
innovation, education and research focused on spreading awareness of the
modern trading mechanisms facilitated by commodity exchanges. The MCX,
in association with the FMC, conducted 95 joint awareness programmes
during January-October 2010 for physical market participants, especially
farmers, who are the primary beneficiaries of this market, for hedging against
price risk or for future price discovery.
To widen and deepen our commodities market for the future, policymakers
need to strengthen the institutional infrastructure through market-friendly
policies on taxation, enabling of institutions, such as banks and mutual funds,
to participate in the commodity futures market, and the provision to initiate
trading in options and intangible commodities. These would fructify as and
when the Forward Contracts (Regulation) Act, 1952, under which the
commodity futures market operate, is amended by the Parliament. Besides,
innovative application of ICT, increased awareness programmes and outreach
initiatives, best-in-class technological advancements by bringing solutions
that address our customers' top trading needs, product innovation in line with
the changing market dynamics and emerging challenges, and domain
knowledge would ensure that the Indian commodity futures market scales
global heights.

THANK YOU.