FUTURES TRADE, PRICE DISCOVERY AND RISK MITIGATION IN PLANTATION CROPS: Some first order lessons from natural rubber and black pepper

Abstract

This paper seeks answers to three express questions germane to the role forward markets play in the price discovery-risk management in the context of two plantation crops, viz; black pepper and rubber. Quintessentially, forward markets are touted as an effective vehicle for realistic price discovery in an underlying asset; acting as a leveler by ironing out price volatility, the bane of commodity markets. Since futures price acts as a beacon, the prices in cash markets are posited to stay steady in the near-term ‘if other things remain same’ ensuring a winwin deal for both producers and consumers. An a priory price also minimise the risk associated with the trade since it is an insurance against any wild swings in prices capping both upside and downside risks. The study assumes importance in the context of the raging debate on the root cause of commodity inflation and the green signal given to the Forward Contracts (Regulation) Amendment Bill 2010, which promises to be a game changer by ushering in sweeping changes in commodity forward markets. To put it succinctly, the answers elicited by the study from the published data paint a grim picture as far as the efficacy of forward market in price discovery and in its risk mitigation, roles were concerned. In all counts, the answers found by the study are in negative, in the case of both the commodities in question. These revealing answers have far reaching policy implications. The most important is that the government should not try to put the cart before the horse, and instead, approach the market reforms on a step-by-step fashion. Instead of hastily joining the reform bandwagon, a calibrated approach is the need of the hour. Learning from the past mistakes in other markets – equity, forex and foreign commodity markets – cautious gradualism should be the guiding principle leading the commodity markets reforms. Analytically, the study, so far, banked heavily on simple arithmetic measurements and visual presentation of the facts to arrive at its conclusions. A part reason for this is the difficulty in crunching the futures data which is beset with inconsistency and gaps. The study intends to take the analytics further forward by reconciling the time-series data, thereby surmounting the data deficiency and inaccuracy using relevant methods to give the early findings the much needed analytical rigor.