Why SEBI banned futures trading in key agricultural commodities?

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admin December 23, 2021
Updated 2021/12/23 at 3:04 PM

The Securities and Exchange Board of India (SEBI) issued instructions to commodity derivatives stock exchanges on Monday to immediately suspend trading in derivative contracts in key farm commodities such as non-basmati paddy, wheat, chana, mustard seeds and derivatives, soya bean and derivatives, crude palm oil, and moong for a year.

According to a SEBI notification dated August 16 and October 8, derivative transactions in certain commodities have previously been stopped.

What are derivative contracts, and how do they work?

In this instance, agricultural commodities are the underlying asset. Derivative contracts are agreements between two or more parties in which the value of the derivative is determined by the underlying asset.

The price changes of the underlying assets determine the pricing of derivatives. Derivatives may be traded over the counter or on an exchange (OTC).

What is derivatives trading and how does the system work?

Derivatives trading is when traders bet on the future price of an item by buying or selling derivative contracts in order to maximise profit rather than purchasing the underlying asset outright.

Traders also utilise derivatives to hedge existing positions to reduce risk. Traders may use derivatives to go short and benefit from declining asset prices. They also employ derivatives to protect themselves against any long holdings they may have. The ultimate goal is to make money. This is seen as a disincentive to bringing in market pricing discipline.

What exactly does the SEBI order imply?

There will be no new contracts established until there are more orders. No new positions will be permitted to be taken on ongoing contracts. Only position squaring has been permitted. Imports of such goods, particularly edible oils, will fall in the near term due to the lack of a hedging platform for dealers. Hedging, which is inherently speculative, has been made more difficult. This will result in the release of previously halted local product supply onto the market, lowering prices. Commodity imports for speculative purposes will be discouraged.

What is the purpose of the complete ban?

Its purpose is to prevent the growing prices of key goods from fueling inflation. India is the world’s largest importer of vegetable oil, and this action will make it impossible for edible oil importers and merchants to do business, since they rely on Indian markets to hedge their risks.

It is considered that speculators have a role in inflating prices, which must be discouraged in order to reduce inflation and boost growth while the economy recovers from the effects of COVID-19.

Following a letter from the Department of Economic Affairs, which is carefully monitoring price changes, trade in certain commodities has been halted.

How alarming is inflation?

According to the RBI governor’s latest monetary policy announcement, CPI inflation rose to 4.5% in October from 4.3% in September, after decreasing considerably between June and September. Since June 2020, the continuance of strong core inflation (CPI inflation minus food and fuel) has been a source of policy worry, since input cost pressures might quickly be passed on to retail inflation as demand grows.

Price pressures, according to the governor, may prevail in the short term. He noted that government supply-side initiatives have mitigated the impact of persistently high international edible oil prices on local pricing.

While cost-push forces continue to exert pressure on core inflation, inflation readings are expected to rise somewhat during the balance of the year as base effects deteriorate. However, headline inflation is predicted to peak in Q4 of 2021-22 and then moderate. According to the RBI, CPI inflation is expected to be 5.3% in FY22.

What steps are being taken to combat inflation?

Apart from the SEBI’s suspension of futures trading in major agricultural commodities, the government and RBI are using a variety of steps to combat increasing inflation.

As edible oil prices approached all-time highs, the Union government slashed import duties on palm, soy, and sunflower oil, but the action had only a minimal influence on inflation.

The Union and state governments have decreased excise tax and VAT on petrol and diesel, with the goal of lowering inflation via direct and indirect impacts such as lower fuel and transportation expenses.

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