This year’s GHI report focuses particular attention on the issue of food price spikes and volatility, which have played a large role in the global food crises of 2007-08 and 2010-11. Prior to the GHI release, another international report admitted to the speculators’ role in the food futures markets while defending the role of futures market as platforms for price discovery by farmers and traders and for transfer of price risk. Captioned ‘Price Volatility in Food and Agricultural Markets: Policy Responses’, the report was jointly prepared by FAO and the Organisation for Economic Cooperation and Development (OECD) with the support of eight other multilateral institutions in June 2011.
The report says: “Speculators also trade in the futures markets; they buy and sell futures contracts and take on the risk of future price fluctuations to gain a risk premium. They are “non-commercial” participants as they have no involvement in the physical commodity trade in contrast to “commercial” participants, such as farmers, traders and processors. Since the beginning of the last decade, commodity derivative markets, including those for agricultural commodities, have experienced significant inflows of funds from non-traditional investors, such as commodity index funds, swap dealers and money managers. These financial investors hold large futures positions including in basic food commodities such as wheat, maize and soybeans as well as in cocoa, coffee and sugar.”
The Indian consumers, groaning under double digit food inflation, would have to bear the double shock of price volatility. The first shock would obviously come the global price speculations, apart from periodic supply-demand mismatches. The second one would emerge from the liberalisation of futures and options market that the government is undertaking, riding roughshod over concern from various quarters including parliamentary committees.
Everyone, from the civil society activists to the high-profile heads of G20 countries, appears to be worried about the impact of forward trading on food prices. Neither G20 nor any multilateral development institution is willing to spare food from futures trading.
The ‘commoditisation’ of food such as corn and palm oil as bio-fuel feedstock not only contributes to their price spiral but also puts pressure on crop inputs. Speculation is already rife among potash mine developers as to how much potash price American corn farmers can afford. One mine developer has estimated a potash price of $ 1000/tonne, which is almost double the prevailing global average price.
As the price of such biofuels crops, both edible and non-edible is linked to price of petrol and diesel, the crop prices are susceptible to frequent volatility. This provides perfect opportunity for speculators to take positions not only on foodbiofuel crops futures but also on fertilisers and fertiliser raw materials futures.
Speculation in one commodity derives speculation in another. We thus have a complete value chain of speculative prices on the futures markets, which is distinct from manageable price speculation in cash or physical delivery markets.
The price trends on futures markets influence prices at wholesale and retail markets to varying degrees across the globe.
At home, transmission of signals from futures to retail markets would improve once the warehousing receipts become popular and when the overhaul of agricultural market infrastructure is completed. The government has so far been claiming that the prices on commodity exchanges do not influence retail prices.
The futures-retail prices matrix has, however, been studied abroad well. As put by a discussion paper issued by IFPRI in June 2010, “Price changes in futures markets lead to price changes in spot markets more often than the reverse, especially when examining returns.”
Liberalisation of commodity futures, agricultural market reforms, growing penetration of wireline and wireless broadband is creating opportunities for speculators to treat food as a commodity to be cashed on day in and day out. There is no escape from periodic commodity bubbles of which food price is a vital ingredient.
Noting that the implied volatility for major crops has increased significantly since 1990, the FAOOECD report says: “Implied volatility reflects the expectations of market participants on how volatile prices will be and is measured as a percentage of the deviation in the futures price (six months ahead) from underlying expected value. Broadly speaking, increases in implied volatility reflect how market conditions and unpredictable events translate to higher uncertainty ahead for traders and other market participants.”
The global discussion boils down to the usual advantage-disadvantage matrix, ultimately resulting in vague suggestions to study the issue further, regulate agricultural futures, improve price dissemination and monitoring and facilitate farmers’ participation in futures and options.
The G20 Study Group on Commodities, for instance, has done a wishy-washy job on the impact of increased participation by investors inthe commodities market.
In its report released at G20 Leaders Summit at Cannes in France held in the first week of November 2011, the group quoted contradictory research findings to contend that: “there is insufficient evidence to admit general and persistent impacts of financialisation on commodity prices.”
Similarly, The International Organisation of Securities Commissions (IOSCO) has done a slew of studies on commodity and derivatives markets to only lay down principles that market regulators in each country should follow. Some of its reports have been prepared at the behest of G20. The IOSCO’s report on ‘Principles for the Regulation and Supervision of Commodity Derivatives Markets’, released in September 2011, thus concluded: “The occurrence of multi-market trading abuses which have involved commodity futures, OTC derivatives and physical commodity markets, requires that there be a market authority in the IOSCO member’s jurisdiction charged with the responsibility to actively conduct surveillance and enforcement to detect and prosecute such abusive schemes. Although no market authority can prevent every market abuse, credible efforts are necessary.”
In their joint declaration issued on November 4 this year, the heads of G20 countries stated: “We welcome the G20 study group report on commodities and endorse IOSCO’s report and its common principles for the regulation and supervision of commodity derivatives markets. We need to ensure enhanced market transparency, both on cash and financial commodity markets, including OTC, and achieve appropriate regulation and supervision of participants in these markets. Market regulators and authorities should be granted effective intervention powers to address disorderly markets and prevent market abuses.”
At the global level, all attempts are being made to reform both the commodity and financial derivatives markets. This implies no escape for food price speculation.
FAO has thus launched the “Agricultural Market Information System” (AMIS) in Rome on September 15, 2011 to improve information on markets. It will enhance the quality, reliability, accuracy, timeliness and comparability of food market outlook information. As a first step, AMIS will focus its work on four major crops: wheat, maize, rice and soybeans. The issue is whether a farmer, who lacks access to roads or primary agricultural markets, benefits from such initiative. Would the improved market information not help speculators hone their skills to multiply wealth at the cost of hungry masses?
It is thus clear that the concept of food as a commodity to be speculated and traded as a paper or electronic security/asset cannot be wished away, whatever be the state of global hunger and food insecurity. The whirlpool of food price volatility is bound to become wider and wider as developing countries are coaxed to take positions on global grain futures markets. This would attract pure-play investors as the markets would become more risky and more rewarding.
The Indian government has perhaps hardly ever entered into any grain futures and options contracts. It would have to sign such contracts after it binds itself into a statutory obligation to supply specified quantity of food at fixed prices to people living below the poverty line. The government would have to inevitably dabble in the global grain futures and options markets taking into view the periodic drought and flood-related downslide in food production. It would have to do this to ensure import of food grain to not only comply with the proposed National Food Security Act (NFSA) but also to prevent depletion of buffer stocks. The yearly volume of food imports would not only depend on domestic shortfalls but also on the norms for inclusion of poor and fixation of food entitlement under the proposed law.
The challenging issue has been succinctly driven home by FAO’s report captioned: ‘The State of Food Insecurity in the World 2011’. Without identifying any country, the report notes: “The principal instruments that could be used to manage the price volatility of food imports are futures and options contracts. By buying futures contracts, a government that wishes to protect itself against a possible surge in the price of grain locks in a price agreed at the time the contract was concluded. Futures contracts give the country greater certainty of the price it will pay for the grain but do not offer flexibility. Should the market price move lower, the government will still have to pay the agreed price and hence pay more than it otherwise might have had to.”
It continues: “In poor countries this can create considerable political difficulty, in addition to the financial loss. In practice, futures may not be a useful instrument for governments since there is an unpredictable and potentially large liability associated with taking a futures position.
Call option contracts lock in a maximum price but with no obligation to buy at that high price if market prices move lower. This is an attractive option if the goal is to protect a food-importing country against a price surge, because the country will still be able to benefit from lower prices after the agreement. Thus, a call option provides greater flexibility than a futures contract. However, this flexibility comes at a cost – call options are more expensive than futures contracts – and governments must be willing to pay the premium”.
At home, the challenge before the government is to provide food to all poor and yet manage food inflation to protect the interest of population not covered by the proposed NFSA. This requires a multi-faceted strategy requiring tight rein on fiscal deficit, keeping investors and money managers at bay from the commodity exchanges and allowing only compulsory physical delivery-based forward trading in food grain.
The government can curb the irrational exuberance over food as an investment product by focusing on the supply side. For instance, it can do a lot to help farmers manage their production and price risks. The initiative should include provision of subsidised drip irrigation and liquid fertilisers, revamp and expansion of crop insurance and procurement price mechanism and massive investments in agricultural markets, storages and rural roads.