How far can Essential Commodity Act address hoarding?

No empirical evidence to prove that action against hoarders will bring down price of commodities

Doubts have been raised in the recent times about the effectiveness of the Essential Commodity Act in the current form to control prices. On the other hand, there is no empirical evidence to prove that acting against the hoarders will bring down the price of commodities.

The annual report of the Department of Consumer Affairs gives some interesting facts about the effectiveness of the Essential Commodities Act:

		2008-09	2009-10	2010-11	2011-12	2012-13
1	Raids Conducted	268,775	157,179	187,049	173,177	132,336
2	Persons Arrested	8,001	7,725	10,754	4,235	4,057
3	Persons Prosecuted	6,425	4,073	4,329	4,214	3,269
4	Persons Convicted	790	52	148	29	413
5	Goods Confiscated (Rs Cr)	60.95	164.23	104.55	61.73	229.78

Source: Compiled from the Annual Report of Department of Consumer Affairs

It is even more interesting to observe that the conviction to arrest percentage in the post-election period of 2009 was 9.87 per cent. It was 10.18 per cent during the pre-election period (2012-13) but fell dismally below 1.5 per cent during the intervening period.

The Essential Commodities Act is often supplemented by stock control orders. Thus in some cases, the regulatory authority or prosecutor are able to get direct evidence that stocking of the commodities was done with the intention for profiteering.

It is often difficult to get direct evidence – either through documents or testimony. State government has to enforce the provisions of the Essential Commodities Act.

The short-duration spurt in onion prices, which is encountered every year and seen this year too, needs to be seen whether it is a case of price rise or price gouging.

Price gouging (a term not often used) is a situation when a seller prices commodities at a level much higher than what is considered reasonable.

In the US, laws against price gouging have been held constitutional at the State-level as a valid exercise of the police to preserve order during an emergency and may be combined (like in India) with anti-hoarding measures. Laws against price-gouging have been enacted in 34 States in the US. Exceptions are prescribed for price increases that can be justified in terms of increased cost of supply, transportation or storage.

Proponents of laws against price gouging assert that it can create an unrealistic psychological demand that can drive a non-replenish able item into extinction.

As the new Government in India is embarking on enactment of changes in the Essential Commodities Act, we must understand that statutes generally give wide discretion not to prosecute. In some of the states in the US, only one-third of complaints were unfounded and a large fraction of the remainder was handled by consent decrees, rather than prosecution.

What if an anti-hoarding law is passed where arrests are non-bailable for hoarders to symbolise opposition to scarcity? Let’s abolish causes of scarcity. Will sending people to jail bring down the scarcity?

Published in the Business Line on July 31, 2014

Why the delivery system has to be strengthened

Price discovery has often been defined as the process of arriving at a transaction price for a quality and quantity of a commodity at a particular time and place.

On the other hand, to protect margins one has to look at price drivers such as storage cost, transportation cost and natural quality deterioration. Even the usage of old or new gunny bags for packing commodities affects transactional margins.

These dynamic elements have significant impact on the margins of trade transactions.

Arbitrage rates

Some of the commodity futures contracts introduced during the last decade have “dream arbitrage” where storage rates are fixed and quality deterioration has been considered to be the responsibility of custodian of the physical goods.

On the practical side, the price of storing a physical commodity from one month to the next is freely set in the storage market. No doubt, price occurs at the intersection of supply and demand for storage services, which changes over time. As the demand for storage services rises, the price of physical storage also rises, all else remaining equal.

In contrast, the storage fees for deliverable commodities are set by futures exchanges.

Naturally, a section of the ecosystem participants take advantage of the lacuna and make profit out of this surreal situation.

Frequent tweaking of contract terms on the exchange have also resulted in participation and volumetric inconsistency from year to year.

For some of the deliverable futures contracts, prices no longer represent the expected cash market price.

Instead, it represents the price of the delivered commodities which has higher value than physical commodities because it incurs artificial storage fees without any natural shrinkage and topped with predetermined premium fixed by the exchanges.

Naturally, the market does not converge at the expiry.

Delivery structure

Non-convergence leads to welfare losses among less informed market participants, so futures exchanges and stakeholders have an interest in preventing such future episodes.

During most period of 2005-10, the price of expiring US corn, soyabeans and wheat futures contracts settled much higher than corresponding delivery market cash prices and are most likely to be repeated elsewhere if unintended results of the market delivery structures of traditional market are ignored.

We must appreciate the fact that in India (unlike CBOT/CME) we do not deal with deliverable instruments and shipping certificates. We first need to strengthen the delivery issue based on our own ecosystem.

The sooner some of these “dream arbitrages” are controlled and a move is made towards “normal arbitrage” contracts aligned to the reality of physical market, the faster agricultural futures markets will grow. This will also result in wider participation and deeper penetration.

Published in The Business Line on 17 July, 2014

Develop physical market for commodities

It will help futures market, suffering from lack of multiple pricing points, succeed.

Futures exchanges apparently have difficulty in predicting the success or failure of futures contracts. Only 15 per cent of the contracts that are introduced survive before they get delisted.

Physical market size, risk-reduction ability of the contract, cash price variability and liquidity costs influence the volume of trade and open interest of futures contracts.

During 1994-98, 140 new commodity derivatives were introduced across the world. During 2005-13 almost the same number were introduced in Indian commodity futures. In India, major farm commodities such as cotton, oils and oilseeds and jute have lost their importance in the futures market arena.

A few other agricultural commodities such as guar, chana, castor, cottonseed oil cake, rubber and mentha oil display volumes though metals (precious and base) and energy products continue to preponderate on the commodity futures scene.

The attributes of commodity that are considered crucial for qualifying for futures trade are: Commodity should be durable and it should be possible to store it; units must be homogeneous; commodity must be subject to frequent price fluctuations with wide amplitude; supply and demand must be large; supply must flow naturally to market and there must be breakdowns in an existing pattern of forward contracting.

Though the attributes mentioned above answers the question whether commodities are suitable for futures trade, however, it does not answer a more important complementary question whether the market will adopt a commodity contract for trade or not.

The economic utility of a commodity futures contract for effective price discovery and efficient price risk management depends on wide participation of the physical trade in the commodity and also non-commercial participation, giving it a desired equilibrium.

Lack of multiple pricing points in physical market and supplier concentration often causes contract failure. Energy futures contracts without the participation of the energy players (crude and natural gas producers and users) would have sufficient ingredient for failure. A market deserted by hedgers is unlikely to survive for long, as it will surely be neglected by speculators.

Without getting into the argument of “chicken or the egg”, we need to appreciate that a futures market for any commodity presupposes a close correlation between the prices in physical market.

And if the landscape of the country for the commodity has a controlled price mechanism or an oligopolistic market structure, the futures contract will have very remote chances of success beyond a certain time, however well the contracts may have been designed.

It is important that the country should direct its efforts toward developing active physical cash market with multiple players and multiple pricing points, the success of futures market will follow naturally.

Published in The Business Line on 3rd July 2014