Effectiveness of commodity exchanges in India

Abstract

Abstract Commodity trading in India is very old and dates back to 1875, just about a decade after the birth of the world's first commodity trading exchange at Chicago, the first futures exchange was set up in India. In 2002, the FMC decided to set up national level electronic exchanges to overcome the structural impediments to the modernization of this sector. As a result of its efforts the first de-mutualized electronic exchange, the National Multi-Commodity Exchange (NMCE) was set up in Ahmedabad. This was followed by two more exchanges in Mumbai, the National Commodity & Derivatives Exchange Limited (NCDEX) & the Multi Commodity Exchange of India Limited (MCX) both of which started functioning in late 2003. Commodities market in India can be divided into two: 1. Cash Markets or Spot Markets where physical trading of commodities takes place 2. Futures markets where futures underlying commodities are traded on exchanges. We have discussed in detail, the design of these two markets, its benefits as well as short¬comings, We have taken National Multi-Commodity Exchange (NMCE) at Ahmedabad as a live example for how exchanges exactly work and have studied it in detail. Price dissemination, transparency along with lack of standardization and certification seem to be the issues at the forefront for commodity markets in India along within other issues. We have analyzed the relationship between spot price and future price using various modeling techniques. We have concluded that future prices are not good indicators of future spot prices. We have discussed some of the policy proposal^ like cash settled derivatives and warehouse receipts as tradable securities. Finally, we have analyzed the relationship between spot and futures prices. The results of the Dickey-Fuller unit root tests indicate that the time series of spot and futures prices are non-stationary. Subsequently, we have tried to analyze whether there is any cointegration between the spot and futures prices at lags of 0, 5, 10, 15, 20, 25 and 30 lags. However, the results indicate that there is no co integration between the spot and futures prices, which casts a doubt on the ability of futures prices to predict the future spot prices. Thereafter, we have analyzed the volatility that is exhibited by the basis, which is expressed as a percentage of the spot price. We have seen that there is strong evidence of volatility clustering in the basis percentage in the case of the 14-month sugar contract, which means that one large shock to the basis percentage persists for several periods. « However, the volatility clustering in the case of 4-month wheat contract is very less, which shows that the short term contracts are much more liquid.