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The bitter story of Indian reforms

Sugar prices in the last quarter (October–December) of 2010 have gone up by approximately twenty percent. On an annualised basis that works out to eighty percent (yes 80%). And that is the unnoticed, uncommented bitter-sweet story.

Interestingly, this increase has been achieved gradually on a weekly basis. That this has come in a period when the festival season is well and truly behind us makes the matter all the more absorbing.

Data now available now suggests that after a couple of years of low production India is expected to produce approximately 25 MT of sugar in 2010-11 as against an anticipated consumption of 23 MT, leaving a reasonable domestic surplus. Common sense dictates that when production outstrips demand as is the case here, prices should fall. Yet prices have risen in the past three months. Intrigued?


India is ideally “expected” to use this excess production in building up the buffer stocks of sugar, which fell drastically during the past two years. However, under pressure from sugar industry, “analysts” believe that the government is even contemplating allowing exports in the following months. Already “analysts” have pointed to the poor sugar crop in Brazil, the world’s largest producer of sugar. Naturally, that is expected to create shortages in supply at the global level.

Sugar owners are keen to take advantage of this global shortage. And in anticipation of a policy shift to favour sugar exports, there is a surge in domestic sugar prices. But all this is plausible if and only if the government allows exports of sugar which it has banned till date. In other words, sugar prices in the domestic markets are going up in anticipation of the lifting of the export ban – not due to economic fundamentals of domestic demand and supply.

The government is simultaneously expected to withdraw the extant relaxed import policy in the backdrop of improved domestic supplies. Either way, it is expected that sugar prices will harden in coming months and be dictated by the export policy of the government, not otherwise.

But does all this explain this sudden surge in prices when pundits across the board predict a bumper harvest? The answer to this question is not far to seek. It is indeed a remarkable coincidence that this surge in prices has come at a time when the Forward Markets Commission (FMC) has finally granted permission to the Indian commodity exchanges to re-launch futures trading in sugar from 27 December, 2010. It may be recalled that the ban on the commodity was imposed in May 2009 when sugar prices were rising in the context of poor output. It is generally assumed that this move to allow forward trading would offer some sort of assurance to producers and would permit hedging against possible price fall. India’s bumper crop will push supplies and lifting of the ban will make the pricing mechanism more efficient.

But this argument for allowing futures markets as an efficient price discovery mechanism is bogus. Standard economic textbooks explain the efficacy of the futures market through a standard yet hypothetical illustration, that even a “child of five could understand this.” What it means in effect is that one must lower his intellect to the level of a five-year old!

According to the illustration, the futures markets was supposed to provide a wheat farmer indication of the prices of his crop three of four months hence when his crop would be ready for harvest. This is supposed to eliminate uncertainty. Similarly, a baker who needed wheat for his bakery could buy three months hence as he too could eliminate uncertainty. 

Nothing illustrates better the disconnect between economic theory and practice than this illustration on futures trading in the commodity markets. Simultaneously, there is a complete disconnect between the physical commodity markets and futures commodity markets, with only mass psychology and sentiments – not economic fundamentals – linking the two. Little do our economists realise that our farmers and bakers are still tuned to the physical markets only and have little or no linkage to the futures markets. Crucially, when there is a domestic surplus, why talk of Brazilian production or global shortage except to psychologically tutor the collective minds of players in these markets? And when markets are psychologically mass tutored, it is easy to manipulate…

That begs the next question – whom does the futures market benefit? It is pertinent to note that only global financial players who dot the commodity markets. No wonder, approximately 99% of the trade are squared off with less than 1% of the contracts entered in these markets squared through physical delivery.

That brings us to the ultimate question – how to profit from taking position in the futures market? It is obvious that only those who have the power to fashion policies pertaining to that particular commodity would have interest in taking position in the futures market. Let me amplify. As already pointed out, sugar prices could harden further should India allow exports of sugar. And in case India does not allow sugar exports, prices of sugar may show significant signs of moderation in the following months on account of a bumper domestic production.

Likewise, even when domestic production falls short and India resorts to imports, one must have the power to ensure that imported sugar does not reach the markets and bring down the prices of sugar in the domestic market. This is ostensibly to ensure that one fully profits from the position already taken. Bewildered? Consider this from the Economic Survey of 2010 - “In case of sugar, delay in the market release of imported raw sugar may have contributed to the overall uncertainty, thereby allowing prices to rise to unacceptably high level in recent months.” [Para 1.38]

Ideally those who were responsible for this delay in the release of the imported sugar should have been shot six inches below the belly button for such inept action, more particularly when sugar prices shot up in 2009 on account of poor domestic production. With such a lax administration and corrupt polity, market mechanisms are sure to be dynamited from within.

Needless to emphasise, only those who have the innate ability to shape, de-shape and re-shape the policies of the government, can take positions in the futures markets. And it is the global financial players who wield considerable influence in the decision making of the government who can afford to take positions in these markets, knowing pretty well how markets will play out three or four months later. Only they have the ability to play up on the psyche of the markets and increase prices. Similarly they can depress the prices in a jiffy. And with their deep pockets, a pliable media can be used to rationalise anything.

And that to me is the sad story of reforms in India where we have reduced every single market mechanism to a rigged casino. And in a rigged casino, only those who have the capacity to rig emerge winners. Other can simply watch, lament or comment.

Last modified on Sunday, 07 July 2013 07:36

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