FMC needs real-time data to stay in touch with reality

Three developments during the last two weeks will have significant impact on how commodity futures shall be regulated. The first was the non-passage of the FCRA Bill in Parliament. Second, placing the FMC chairman and the secretary of the Consumer Affairs Ministry in the High-Level Coordination Committee (HLCC) is an acknowledgement of the important role of FMC. The HLCC is an inter-regulatory coordination committee comprising the finance secretary and heads belonging to RBI, Sebi, Irda and PFRDA. Third, Parliament passed a bill providing for a mechanism to resolve disputes between financial regulators as an ad-hoc arrangement. 
Drastic steps like redrawing the reporting ministry or the merger of regulators do not go down well in India. However, in times to come, we can expect the emergence of a new role for the regulator. While FMC currently does not have the status of a financial regulator, it is apparent that FMC cannot be denied the same for long. (This may look remote under the current reporting structure to the Consumer Affairs Ministry). 

Therefore, it is imperative that the operating regulations are strengthened to ensure that we have a safe commodity dealing environment. FMC needs to develop in-house real-time market surveillance capabilities rather than rely on the capabilities that may currently exist at the exchanges. Unless regulators collect high frequency data from exchanges and encourage their staff to explore it, they risk becoming progressively disconnected with the reality that they are supposed to regulate. 

Competition alone is not the solution to market efficiencies when it comes to commodity exchanges . FMC has an array of four national commodity exchanges and two more are in the pipeline. The first three exchanges have created a niche for themselves in bullion and metals, agriculture and plantations spaces. The late entrant is trying to replicate the success and the pipeline cases seem to wager on the share value. 

We have seen exchanges in the commodity space whose promoters have and had large trading arms. In a situation when the ownerpromoter of financial entities hires professionals to execute plans for exchanges, the logic of watertight compartments does not hold any good and a conflict of interest is inherent. Do we need to remind ourselves about the spirit of “demutualisation” for exchanges or should it be restricted to letters only? 

Published in The Economic Times 16 Aug, 2010

Milk co-ops need Agile bosses

Dairy cooperatives have a lot to do with India emerging as the world's leading milk producer. However, most of the co-operative federations are not professionally managed today. In fact many of them outside Gujarat are now run like `regular' parastatals, invariably headed by career bureaucrats. The alternative does not lie in changing organisational design and the operating system which will undermine the role of co-operatives.

Success in dairy industry shall continue to be in the ability to build a robust procurement network which gives raw material cost advantage along with assurance of regular supply. Large MNCs in India have failed in the dairy sector on this account. “Aarth Shakti” (money power) has not got translated into “Lok Shakti” (people power). Moga (Nestle) and Etwah (Levers) have remained laboratory cases while Anand (Amul) has got replicated. A strong backward integration in the form of cattle-feed supply, vaccination availability, breed improvement programmes and profit-sharing with farmers are some of the things that none of the private sector companies nor the MNC’s have been able to replicate and amplify. Farm gate price paid for milk in India is the highest in the world largely due to a strong co-operative presence. Failure of integrated dairy experiments like “Aarey” has not deterred a non-milk co-operative to branch out in the same direction recently. Also joint ventures and foreign collaboration have become order of the day.

Lately, India is under intense pressure to open up its market in dairy produce, especially cheese, from European nations. The EU is keen to get any market opening abroad in a bid to compensate for the troubles facing milk farmers at home. A few years back there was a sudden interest in advising India how to manage the dairy sector and cooperatives when it was emerging as the world's leading milk producer. No doubt the advice came from a Netherland based entity. The US dairy industry is also itching for access to India and the U.S. government is examing legal alternatives for access.

In Europe, when the entire milk requirement for production of cheese and value added products are satisfied “profit is maximized”, the remainder is processed into butter and SMP (Skimmed Milk powder), often referred to as ‘residual production’. This is distinct from patterns of production that is followed in India where priority is given to production and distribution of liquid milk for masses. In India, SMP is important for curbing excess supply due to strong seasonal fluctuation of milk and reconstituting the same during milk shortages.

The recent incident of protestors vandalizing the tankers of imported milk only demonstrates the lack of understanding by the political class of machinations of the large milk producing nations. It is even more surprising that when a minister promotes private sector dairy in his constituency instead of a co-operative dairy, these protestors don’t even raise an eyelid for the local farmers. Perhaps it is time that India demonstrates that if it can produce 112 MMT (Million MT) of milk (09-10) compared to only 10.40 MMT in 1961, it also knows what the best way to manage a growing dairy industry. For this, Indians need to move from “Me” to “We” mentality.

The dairy sector has assumed critical importance for India as it provides work and income to landless farmers. The ruling dairy and milk managers are yet to demonstrate the leadership quality, passion and logic in negotiations, political acumen and stubbornness that Dr. Verghese Kurien “father of White revolution” had demonstrated. Once confronted abusively about the market share by an arrogant New Zealand High Commissioner, Dr Kurien had fittingly replied “If all of us Indians decide to get together and spit on your country, your country will get drowned in our spit”. Unfortunately, the current breed of milk leaders are more concerned in protecting their own turf by creation of ‘services’ to ensure that they remain at the helm of affairs.

Published in The Economic Times , Aug 09, 2010

A run on bullion banks may have just begun

Description of gold by Keynes as “barbaric relic of human irrationality” is nowhere more evident than Indians insatiable appetite for gold. Gold demand shall continue to remain inelastic for Indians as it is bought mainly for store of value, future consumption (gift and wedding), last resort during bad days or mere speculation. Though India is the largest consumer, it shall remain a price taker of gold from London & New York.

A look at the last month’s price graph will show that the prices have been falling. However, a one and ten year’s price data gives an upward trend. The banks are evidently en-cashing on the Indian consumer behavior and earning handsome profits of 5 to 7 percent from gold coin sales. The banks do not buyback the gold coins sold (even though coins shall remain preserved in tamperproof packing along with Assayer certificate). Inspite of the quote variance by the banks, the gold coin sales remain buoyant.

A look at the last month’s price graph will show that the prices have been falling. However, a one and ten year’s price data gives an upward trend. The banks are evidently en-cashing on the Indian consumer behavior and earning handsome profits of 5 to 7 percent from gold coin sales. The banks do not buyback the gold coins sold (even though coins shall remain preserved in tamperproof packing along with Assayer certificate). Inspite of the quote variance by the banks, the gold coin sales remain buoyant.


LBMA, the London-based trade association that represents the wholesale bullion market with focus on international OTC (Over-the-Counter) market for gold, with a client base that includes majority of the central banks that hold gold, producers, refiners, fabricators and other traders throughout the world has just taken the highly unusual step of blocking access to statistics relating to the trading activities of its member bullion banks. This information has been available to the public since January 1997 but since last week it is available only to LBMA members. When the LBMA first made its trading statistics available, observers and analysts were shocked. No one could reconcile the statistics with other market data, nor comprehend how the bullion banks could be trading on a net basis of more than 240,000 tonnes of gold annually while the global mine output was only 2,400 tonnes.

At a recent public hearing of the CFTC on precious metals futures markets, some people had cited the LBMA's own statistics to label the "unallocated gold" accounts of the bullion banks as a Ponzi scheme. There were bullion bank representatives at the hearing but no one expressed an objection. In fact at that hearing, one of the world’s foremost authorities on the markets for precious metals, Jeffrey Christian CEO of the CPM Group had stated that 100 ounces of paper gold are traded for every 1 ounce of physical gold.

This June, the LBMA trading statistics showed that in May 2010 the average net daily trading in gold by LBMA member banks had moved to 24 million ounces per day from 16 million ounces per day…..A massive 50 percent jump within a month. That translates to $7.5 trillion annually. If an operation is running on a razor-thin fractional reserve basis, such step changes are often fatal.

Typically when people are exposed in a scandal their first reaction is to cover-up. It seems that the LBMA has now commenced a cover-up with respect to the gold trading activities of its member bullion banks, withdrawing statistics from the public domain. There is a cover-up of back-door injections of liquidity of physical gold, and the LBMA now is trying to conceal trading information. …..It appears that a run on the bullion banks has commenced.

Published in The Economic Times, August 2, 2010

Bihar now a trusted source of maize

Bihar, which a few years ago was more in news due to the fodder scam, is now known for being one of the trusted sources of maize origination. Productivity of maize in Bihar is 2,541 kg/ha, which is far greater than the all-India average productivity of 1,907 kg/ha. Bihar’s maize, which is primarily a rabi crop, has been a success sector mainly due to the quality of the produce as well as a simplified tax structure compared to other states. Both traditional and hybrid seeds are grown in the state and are increasingly replacing up-land rice in the kharif season and wheat in the rabi season.

With rich water resources and available irrigation in winter and summer seasons, irrigated area under maize increased and so have the yields. For the last two seasons, increased participation of national players and a few multinationals has led to a structural change in the maize ecosystem in Bihar. Earlier, procurement was done by three Kolkata-based traders with a long deferred payment condition of 45 days. However, with a broad-based participation, improvement in overall payment conditions to producers has taken place and more transparent price discovery is already happening.

It is important that the state government continues with the efforts of having more secured enabling environment and also insulates the industry from kneejerk reactions, which some of the other states have sometimes resorted to. Any slippage on this account would lead to the underpinning being shaken in the maize sector. The differential (the spot market price minus the market support price) has increased from`100 to `1,600/mt (currently spot prices at `10,000/mt). This has led to higher farm-gate realisation in all the states including Bihar.

While a number of national and regional players are trying to set up the starch and feed industry, it would be more important if the state government acts in a rational manner rather than with a fear of price rise and pursues a consistent policy. This would enable Bihar to steal a march over the other states.

The National Commission on Farmers had found that the main anchor states of our food security system — Punjab, Haryana and Western Uttar Pradesh — are in a state of ecological and economic crisis. The “Alternative Fertile Crescent” has a large untapped yield reservoir, particularly Bihar, Eastern UP, Chhattisgarh, Orissa, West Bengal and Assam. This region has a well-endowed water resource. The commission recommended that the region can become another fertile crescent, if a synergetic package of technology, services and market opportunities are introduced. Bihar seems to be better positioned than any other state in the eastern crescent.

While the lack of market infrastructure and market information system is said to have dogged Bihar during the last few decades, an improvement in the environment has lead to creation of more feed processors showing interest in the state and a few starch manufactures have already started setting up units in Bihar. The value chain is being increasingly integrated in the state, new traders and players have already become active and the processors are trying to set up units.

The state will no longer remain only a sourcing destination but will be an important region of value chain in the maize industry. The state needs to guard itself from short-term reactive actions, greed of the petty local political interests and local-level officials who are disconnected with the overall development pursed by the policy makers of the state.

Published in The Economic Times 26 July, 2010

Commodity finance to stay fragmented unless banks understand market topology

A former banker working for the one of the largest trading houses of India often jokes that he is a supplier’s supplier. He is consistently emphatic that in commodities trading, the raw material is liquidity — the speed of availability of funds creates price arbitrage and liquidity creates price discounts.

The need of finance is more critical in this sector now than ever before. Commodity finance is nothing new in India although often glamourised by sophisticated MNC bankers. With the entry of private sector banks in the late nineties, the domain started becoming more fashionable attracting the ‘tie-walas’. One big bank (currently licking the commodity finance wounds) went to the extent of saying it was the pioneer in commodity funding in India, unfortunately not realising that some public sector cousins have more advanced products along with a more robust risk management system.

At present, most of the banks are in commodity lending out of sheer compulsion of meeting the priority sector-lending targets rather than making a self-concerted effort to be a reputed player in the market. Unless banks start to understand the entire commodities topology in India and put an operating system in place, they will continue to remain fence-sitters or marginal players. Although large individual players and corporates continue to use the banking system to their advantage, commodity financing remains sectorally fragmented.

A large number of products that are being offered by some of MNC banks are basically copies of the products that have been in use in the western economy. They either get entrenched in the quagmire of Indian regulations or remain unscalable. Local banks combining the knowledge of local markets with superior network have been able to deliver solutions which have been identified uniquely with the customer’s needs. A nationalised bank in central India has been offering freight financing for over the last decade.

Without announcing to the world, it only tried to tailor a client solution and captured the trade flows by financing the logistical leg which others were unable to identify. There is no shortcut in banking and especially not in commodity banking. Commodity-based collateral funding and warehouse receipt financing in the last few years have taken the fancy of many banks due to their short term and self-liquidating nature.

The nationwide finance is a mere estimate, fluctuating between `8,000 crore and `20,000 crore. “Measure twice but cut once” is an old and popular saying in the trade. However, the trade has hardly measured itself. If this is not the responsibility of RBI, then at least some state agency should start accounting for it.

Published in The Economic Times 19 July, 2010

Amarnarth

Serious players avoid commodity futures market

Commodity markets in India have become synonymous with the exchange-traded commodities on futures market for the last five years. However, after initial enthusiasm, the large players are no more serious about the roles of these exchanges, policy makers view this market with a doubtful look however perfect theoretical correctness it may have in price discovery.

Traders in commodity markets have benefitted from the opacity in price information from time immemorial. The transparency of prices on screen-based trading has not benefitted physical small-time traders and commission agents (aratiyas) and rather the most vociferous opponents are these interest groups. The indirect benefits of price transparency have percolated to the farmer community compressing the margin of these small-time traders. I recall, in a very comical incident, when the government was contemplating the ban on sugar contracts, one of these small-time traders was on a live show of a popular business channel, chastening the government for banning sugar. Within a few seconds of coming out of the live show, he was giving price execution orders on futures contracts contrary to the stance taken on the TV show. Sheepishly he told me 'desh ke sath sath, apna be khayal rakna parta hai' (along with the interest of the nation, I have to take care of myself).

Politicians have also benefitted by misrepresenting the reasons for the price rise and blaming the futures market for it. Incidentally, wheat futures were banned at a time when the government had decided to import wheat and there was a price spiral due to low perceived production. Even more surprising was the timing of the lifting of the ban on wheat. No logic, no reason.

Does that mean that one "discovers price" only when the agricultural commodity prices are going down? Unfortunately, the regulator, due to the lack of legislative teeth and regulatory mechanism, has often buckled under political pressures.

The regulators have often tried to control the market rather than trying to create a robust operating and governance mechanism for market growth. The focus should have been first to find out whether there is adequate representative participation from physical players rather than questioning the exchanges why prices have gone up or down and embarking on controlling prices through open interest and margin controls regimes. Secondly, to do a nationwide campaign to create an environment for broadbased participation rather than organising 'awareness programmes' in pockets.

While futures exchanges in India have seen a fantastic volumetric growth in monetary terms, the commodity futures sector lacks a clear policy roadmap. The lack of consistent policy, sudden ban on contracts, lack of active participation by commodity user groups and lack of legislative teeth for the regulator will make it a cesspool of financial market gamblers and keep the serious organised players away from this market. This is a point in case for not only for agricultural commodities but also for non-ferrous metals and energy contracts that are widely traded on commodity exchanges in India.

Published in The Economic Times 12 July, 2010