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Transparent derivatives mechanism proposed to arrest onion price volatility

Futures trading with a price band to give signals or forward trading with delivery have been suggested

Rajesh Bhayani | Mumbai October 13, 2017 Last Updated at 00:49 IST

With onion price volatility every year, experts suggest futures trading with an action plan based on a price band and forward trading with delivery-based settlement. 

At times, farmers throw away their onion produce due to excess supply making the cost of taking this to the wholesale market higher than the prevailing price. It happened in Madhya Pradesh last year. On the other hand, consumers sometimes suffer due to soaring prices, due to supply shortage or trader cartelisation. Both situations occur frequently.

Annual production is 19-20 million tonnes, concentrated in a few states; the consuming states are many.

Several sowing cycles and intermittent gaps between sowing and harvesting usually create ripples and prices go up sharply and fall as sharply. A 40-50 per cent price movement in a month is no surprise.

Some years ago, the retail price touched Rs 100 a kg, raising fear of unrest.

A need was felt for a long-term solution by introducing derivatives trading, to smoothen the volatility while balancing the farmer’s need for a better price with consumer interest.

Vijay Sardana, an agri business expert, says: “Futures trading in onions can be introduced with minimum and maximum price bands; any breach requires some regulatory action. This will help check the speculative interest.” The government has already notified onion as a permissible commodity for derivatives trading on regulated exchanges.

However, the price of onion is a politically sensitive one. If futures trading is allowed and prices start rising, the blame will fall on futures rather than the fundamentals.

Sardana’s suggestion is designed to address this, of a price band-based derivative, with pre-explained transparency. Futures should be injected when the price falls below the average production cost for farmers.

When prices go up, say, three times the cost, governments have to introduce stock limits, taking it as a signal of unusual movement. If prices rise further, say, four times the cost of production, futures trade would be suspended. The price base, band and the permissible rise is to be determined on a study of price movement and volatility.

Such a mechanism, goes the argument, would stay traders from cartelisation, as there will be fear of regulatory action, including suspending of futures, if prices go beyond a permissible higher band. The price is to remain in a prefixed band and ensure farmers and traders get to earn a profit, while allowing customers a right to get the commodity at a reasonable price.

An exchange official says while introducing futures, there is a need for a transparent spot market price which can be used to arrive at a settlement price. Polling is one way but that is not transparent. Storage is another issue with onion.

Traders invariably face complaints of cartelisation; three years earlier, when it was retailing at Rs 100 a kg, the Competition Commission of India began a probe. The agri-centric National Commodity and Derivatives Exchange (NCDEX), which has set up a commodity repository, has proposed forward trading in onion to address price volatility and storage issues.

Forwards are different from futures, which trade in standardised contracts and may be settled in cash.

According to sources, the commodity advisory committee of the Securities and Exchange Board of India (Sebi) believes forward trading is fine insofar as the exchange proposes settlement in delivery, while taking care of grading, assaying and delivery centres.

An NCDEX source said they’d be interested in launching forward trading in onions if permitted by the regulator. The Sebi Act permits forwards and futures, as well as options and derivatives.