Devinder Sharma: A futures shock from FCI

Last Updated: Sat, Nov 10, 2012 04:11 hrs

At a time when the Global Hunger Index 2012 ranks India 65th among 79 countries, K V Thomas, minister of state for food and public distribution and consumer affairs, has revealed that the Food Corporation of India (FCI) will soon trade wheat in the futures market.

Seeking clearance from the Forward Markets Commission, the minister said: “The market has to perform the economic function of price discovery and price risk management.” Well, what I can see as the basic objective is to replace the open market sales scheme with trading in the futures market. In other words, futures trading will provide an opportunity for FCI to make some profits, which in turn can be ploughed back in its procurement operations, thereby reducing the subsidy outgo.

The issue isn’t as simple as is being made out. In addition to performing the sovereign role of procuring foodgrains, FCI’s relatively lesser known role is to keep a tab on food inflation. Whenever wheat and rice prices shoot up in the domestic market, open market releases are made from FCI stocks to bring down the market prices. For the year ending July 2012, the UN Food and Agricultural Organisation estimates that the wheat price rise in India was the second highest after Sudan. In the case of rice, price rise in India was third largest globally and that too, despite holding massive stocks of grain surplus.

To ease the pressure on market prices, FCI had made open market releases of 2.6 million tonnes of wheat for tender sales to bulk consumers and to small private traders in July-August. This helped stabilise domestic wheat prices.

I, therefore, see no economic justification and political wisdom in doing away with this crucial role that FCI plays in taming food inflation. In fact, it is the other way around. By entering the futures market, and trading available surplus wheat at higher prices, fixed in advance, FCI will eventually emerge as the biggest player in fanning inflation. It will be able to swing the futures market by the sheer power of the huge volume of physical stocks it holds. The resulting domino effect will see wheat market prices panicking.

Let’s take a look at the international markets and see if we can draw any inferences. In 2007, when the global food crisis was it its peak, with 37 countries witnessing food riots, the UN Special Rapporteur on Human Rights had said speculation in food was primarily responsible for the spike in food prices. Food prices were no longer driven by supply and demand, but by the actions of financial speculators and their investments. Profiteering on human misery and hungry stomachs had brought in a huge windfall for some of the biggest agri-business giants.

Global food prices are again on the upswing in the second half of 2012. The looming drought in the US, followed by a production shortfall in Russia and Ukraine, has already turned the fortunes for Cargill Inc, the world’s largest grain trading company. Its earnings in the first quarter of 2013 (ending August 31) reached a record $975 million compared to $236 million a year ago. Glencore, another giant trading firm, is ready for the kill. “The environment is a good one. High prices, lots of volatility, a lot of dislocation, tightness, and a lot of arbitrage opportunities,” Chris Mahoney, Glencore’s director of agriculture, was quoted as saying.

Turning FCI into a commercial entity is, therefore, fraught with dangers. In a country like India, which holds the dubious distinction of having the largest population of hungry people in the world, FCI performs essentially two roles. First, it provides an assured price to farmers by buying at the pre-fixed procurement price. For the Indian farmer, it is the procurement price that makes him realise a remunerative price for his harvest. Although procurement prices are announced for some 22 crops every year, it is only for wheat and rice that FCI makes purchases. And, it is primarily for this reason that production of wheat and rice has grown steadily.

Withdrawing the procurement and market intervention roles of FCI would see agriculture collapsing. Farmers in several parts of the country where FCI is not active have to resort to distress sale of wheat and rice. Even in Punjab, the food bowl, all efforts to diversify the cropping pattern have come to nought simply because farmers see an assured market only existing for wheat and rice. Price discovery and price risk management, therefore, are roles FCI plays. To expect the futures market to perform these economic functions is simply a fallacy, if we were to look at the American experience.

In the US, which hosts the biggest commodity exchange in Chicago, commodity trading has not helped farmers realise better prices. It is primarily because of the failure of commodity trading to convert agriculture into an economically viable proposition that the US provides for massive federal support to agriculture every five years. The Food Bill 2008 had made a provision of $307 billion, which includes direct income support, subsidies for land improvement, environment protection and crop insurance.

There is no denying that grain handling, storage and distribution are mired in corruption. But that is also true for the futures market. A recent multi-crore scandal in commodity trading of guar seed and guar gum had resulted in a temporary ban on a number of agricultural commodities. And, despite Thomas promising to initiate an enquiry by the Central Bureau of Investigation, it is business as usual for the commodity exchanges. FCI’s functioning, therefore, has to be improved, but to turn it into a commercial venture would be the first step to destroy the country’s hard-earned food self-sufficiency. It will also acerbate hunger.

The writer is a food and trade policy analyst and blogs at Ground Reality

More from Sify: