March 30, 2020
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Commodity Exchanges And Their Role In The Indian Economy

Commodity Exchanges And Their Role In The Indian Economy
Commodity Exchanges And Their Role In The Indian Economy

When the Union government in 2002 allowed the setting up of national multi commodity derivative exchanges, MCX was one of the first commodity exchanges to be created. Leveraging on innovative product design, sound domain knowledge, and cutting-edge technology, commodity exchanges grew at a pace unprecedented in any other industry. According to Futures Industry Association, MCX was world’s seventh largest commodity exchange during 2017, by the number of commodity futures contracts traded. Today, the Exchange and its subsidiary, the MCX Clearing Corporation Ltd., offer trading and settlement services respectively in derivative contracts across varied commodity segments including bullion, industrial metals, energy and agricultural commodities.

The existence of an institution like MCX, and the commodity market it serves, is beneficial for multiple stakeholders in the economy – from producers to traders and end-consumers - irrespective of their direct involvement in derivatives trading. Directly, this market helps producers, traders and other commodity stakeholders lock in the prices of their future output or inputs, therefore, helping to hedge against the volatility in these prices. This provides a very effective and cheap ‘proofing’ of future incomes against volatility-induced shocks. Indirectly, the Exchange helps them by providing a platform for efficient discovery of commodity prices and their wide dissemination across the country. Indeed, the prices discovered on the MCX platform are used as reference prices for physical market transactions as traders place high trust in the integrity of the price discovery process of the exchange mechanism. In many commodities, notably gold and cotton, the Exchange-discovered prices are used by market stakeholders to fix the physical market price. Besides, commodity Exchanges like MCX help reduce the price volatility in the spot markets and also help stakeholders know the future returns on their produce, thus aiding in their decision-making on production, warehousing, timing of sales, etc.

The role of commodity exchanges like MCX in promoting inclusive growth and development of India’s commodity markets has primarily been through linking stakeholders to markets and, thereby, facilitating the flow of benefits of market institutions to its stakeholders. Apart from enabling participants to discover prices and manage risks arising from price volatility, these twin functions have also led to a number of associated benefits which have helped developed the commodity ecosystem as a whole. For instance, through its very operations, MCX has incentivised the growth of modern warehouses and other support infrastructure. Indeed, a well-developed commodity derivatives market necessitates the existence of modern warehousing, grading, sorting and quality certification, etc. Through its fifteen years of operation and derivative contracts in multiple commodities, MCX has facilitated the creation of a large number of such infrastructural facilities. Such development of infrastructure has brought about cascading beneficial effects on the physical commodity markets too, viz. helping producers and consumers time their sale/ purchase and thereby transact at fair prices.  

A collateral benefit of warehousing is the ease it provides in making finance available. Producers can obtain warehouse receipts after delivering the products and use the same as collateral for short-term working capital loans and later sell the produce when they deem fit. With MCX recognizing and accrediting warehouses which are of high quality (and recognized by WDRA in case of warehouses storing agricultural commodities), the owner of the commodity can take their produce to any such warehouse/ vault, procure a warehouse/ vault receipt and offer it for accessing cheap credit.

The commodity sector is often starved of institutional capital because of the associated price risk. In the absence of proper risk management tools, even a small movement in prices can lead to erosion of investment capital, thus making it very difficult to pay back any loan. This leads to reluctance on the part of banks and organized financial institutions to fund commodity producers, users or traders. MCX, by providing a risk-mitigation mechanism to stakeholders, has been providing some comfort to commodity lenders, thus providing easier loans to hedgers for capital investment in the commodity sector.   

The Indian commodity derivatives market is currently undergoing a number of reforms, aimed at broadening and deepening the market. Intermediaries and Exchanges are being strengthened and more products and participant categories, most notably institutional participants, are being progressively allowed in this market. These reforms are expected to bring in vibrancy and inclusion to the commodity market, which would surely benefit not only the commodity sector and its ecosystem but also the entire Indian economy which is, and shall remain, highly commodity intensive for a long time to come.  

Views are personal

Attributed by the Head Of Research, MCX -
- Dr. Venkatachalam Shunmugam

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