Indian Commodities market pricing of commodities in the spot and the futures markets

Abstract

India, a commodity based economy where two-third of our one billion plus population depends on agricultural commodities directly and almost the entire economy indirectly depends on commodities for undertaking business activities. This makes it imperative for the economy to have a tool for price risk management and hedging in the form of well developed, efficient commodities markets. In the recent past there have been a lot of debates on the functioning of the commodities markets in the country, especially about the inter relation between the spot and futures market for agricultural commodities; the price discovery in these markets and the government’s role in price management of agricultural commodities. Through our report we have attempted to study the price discovery mechanism in the spot and futures markets for two agricultural commodities- soybean and wheat. More specifically, our objective was to obtain an understanding of the commodities markets in India, study the price discovery mechanism for future and spot prices of commodities (soybean and wheat), study the factors that affect the spot and future prices such as climate, regulations, speculation, etc and finally understand how the expected future prices have had an impact on the current prices. Our secondary research on studying the inter-relation between spot and futures prices revealed that there is no conclusive evidence on the causation and the lead lag effect in case of the future prices impacting the spot prices. On interviewing people involved in the commodities markets, we were explained that it is the expectation of future prices that drives current prices. First half of the report is a summary of the primary and secondary analysis (literature survey) on the commodities market in India both spot and futures. It deals with the history, evolution and the need for each of these markets. It also deals the functioning of these markets and briefly touches upon the legal framework governing the market. The second half of the report is the analysis of the price discovery mechanism in the spot and the futures market for two commodities:- Soybean and Wheat. The report first deals with soybean. Various factors affecting prices of soybean like:- rain, area of production, soymeal demand, exports, international market etc. have been studied and their impact on soybean prices have been studied. We discovered that rainfall plays a significant role in affecting the prices only in the month of monsoon. The most important factor affecting the prices of soybean are the international soymeal markets. We also studied the futures market and discovered that the futures market runs very closely with the spot market. The premium/discount over the spot market is decided by the future outlook of the prices as determined by current factors. We then similarly deal with the wheat market. We found that the government regulations play a significant role in affecting the prices in the wheat market. We studied the impact of ban on exports and also the impact of ban in the futures market on the spot prices of wheat. The most important factors affecting the price of wheat are:- the demand of wheat, production, imports, crude oil prices and the world wheat markets. At the end of the CCS, we have developed a better understanding of the price discovery mechanisms in the commodities markets. This understanding will be useful tool in developing better risk management frameworks for commodity markets.