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FUTURES TRADING

Commodity exchange market: Its requisites

Muhammad Al Amin
Bangladesh government has recently taken an initiative to establish a commodity exchange market. The immediate past caretaker government at a meeting on April 16,2007 took the initiative to conduct a feasibility study on the establishment of this type of market. Even though the concept of commodity exchange market is new to us, it has long been in practice in the western countries. Recently this concept is gaining popularity in many of the Asian countries such as India and China, who are already accustomed to this market and have been in operation since 1993 and 2002 respectively.
Besides India, in South Asian context, Pakistan and Nepal have also established the commodity exchange market in their countries in 2007 and 2009 respectively. Sri Lanka is on the verge of introducing the commodity exchange. Among the African nations, Ethiopia initiated the commodity exchange market in April 2008 followed by Kenya. African country Ghana is also considering initiating this type of market immediately. The African commodity exchange markets trade only agricultural produces, whereas, the Indian commodity exchange market is trading 24 goods consisting of cash crops, food grains, plantations, spices, oil seeds and metals Pakistan commodity exchange market trades gold, cotton, yarn, sugar, rice and wheat in their exchange centre in Karachi, while Nepal is exchanging cash crops, food grains, vegetables, spices, oil seeds, metals and bullion.
The traditional definition of commodity exchange market is that it is an organised market for purchase and sale of enforceable contracts to deliver commodities such as wheat, rice, gold, or cotton or a financial instrument like US Treasury bills or Eurodollars at some future date. Such contracts are known as futures and are bought and sold by means of a competitive auction process on the commodity exchange. This market in effect provides insurance against the risk of price changes by transferring that risk to speculators who are willing to assume it (Encyclopaedia Britannica, 2009). Commodity exchanges are divided roughly into three main types: metal exchange, fuel exchange, and soft (agricultural) commodity exchange. This market is also called commodity futures market.
The main purpose of this market is to establish a dynamic, efficient, and orderly marketing system that stabilises volatility in daily commodity market and helps set up a better functioning domestic market. While ensuring transparency, setting up an agrobased commodities exchange market (in Bangladesh) will protect the farmers from price drops and the buyers from price hikes.
Farmers can lock in prices through forward contracting and can reduce risk of drastic price drop. It also helps the farmers take a more educated planting decision depending on futures prices. Eventually it will empower farmers' choices.
The existence of a commodity market helps increase the liquidity or working capital of the farmers. Instead of borrowing from traditional sources like banks or usurers with high interests, this market assists farmers to accumulate funds without any interest.
Speculators and investors inject cash to the system through buying and selling the futures contracts. Commodity exchange market has the option to permit international traders to operate in the domestic market. However sometimes their unregulated access aggravates domestic inflation. Ethiopia is one such example. Its neighbouring food-deficient countries bought products and its domestic prices doubled.
The purpose of establishing this market in Bangladesh is many folds. This type of market is supposed to help the government effectively monitor the movement of prices of essential commodities and lubricate the supply chain. Another major objective is to create competitiveness and bring efficiency in market mechanism. It is also helpful in protecting drastic price fall after bumper harvest. In our country it is usually observed that after a bumper harvest, the prices of agricultural commodities like paddy and potato fall drastically. The commodity exchange market can protect this severe fall by selling the product in future market.
However establishment of such a market requires some basic infrastructure, storage capacity and manpower, and efficient computer network. It will also require trading floor, warehouse delivery locations, and electronic price tickers. The huge investment that is necessary may come from government treasury, donor funds or from private sector. This market also needs strong quality certified tlon and standardisation facilities, which will require a strong standard testing institution. To fulfil this Bangladesh will need to strengthen the BSTI, its existing standard testing institution. A network ol warehouses in surplus
areas, a network of remote access terminal centres in major markets and market information points at district level need to be created.
To establish warehouses, private sector investment can be an option but the question remains whether the private investors are interested to set up warehouses at their own cost. Ensuring incessant electricity supply is another important challenge, which will have to be met from the existing scarce stock unless significant investment takes place in this sector.
This market may reduce the number of intermediaries by establishing a direct relationship between farmers and traders. But ensuring farmers' participation will be tough. It is assumed that only big farmers will be able to enter this market because of their greater capacity, whereas the small farmers will have to rely on intermediaries. The government will have to think how the small and medium farmers can take part in this market.
To run the market effectively, a regulatory and monitoring body will be needed. However there arev some questions attached to it -whether this exchange market will be regulated by the Ministry of Finance or the Ministry of Commerce or by the Securities and Exchange Commission; what the legal infrastructure will be; whether it will be self-regulatory or a publicprivate joint company, etc.
However before initiating this kind of market, the government should assess its prospects in the context of Bangladesh and evaluate the experiences of other LDCs and performances of neighbouring countries. Before launching a full -fledged version of this market, th government can also imple ment a pilot project with less price sensitive products like potato and jute.
The writer is a research associate for Centre for Policy Dialogue (CPD). who can be reached at alamm@cpd org bd. Views expressed here do not necessarily reflect those of CPD
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