Business   

Physical delivery a `must' in commodity trade

It is necessary to address the challenges as well to make this work well

— Photo: Johney Thomas

GOES ONLINE: The Coconut Development Board and the National Multi Commodity Exchange of India (NMCE) have joined hands to introduce online futures trading in copra. This is the first time that copra trade has gone online.

IT IS boom time for commodity trading in India with more and more items traded and the market estimated to touch a growth of 252 per cent in the year ahead. Volumes also are expected to skyrocket to touch an estimated Rs. 12 lakh crore annually against the current volumes of Rs. 3.4 lakh crore.

While such momentum is good, for long-term sustenance of the same, some good fundamentals have to be built. In this context, it is relevant to analyse the need to choose physical delivery as the mechanism over cash settlement.

Cash settlement is a process for settling a futures contract by payment of the money difference rather than by delivering the physical commodity or an instrument representing such physical commodity such as warehouse receipt. The main drawback in cash settlement is that the commodities spot wholesale market is not an organised one (globally).

Commodity prices vary from location to location and also in accordance with their quality characteristics, variety and preferred end-uses in different locations. There is no single unique cash price quotation for a commodity valid throughout the country at any given time. For example, wheat will have different prices in Gujarat, Madhya Pradesh, Uttar Pradesh and Punjab. In most cases the price that is fixed is subject to manipulation and hence discourages investors/farmers/traders from investing in the commodity market.

Coming to physical delivery, it is a method in which the bylaws of the exchange provide both the buyer and the seller the right to demand/supply physical delivery of the asset at the final settlement of any future contract. Delivery is at the option of the sellers. The physical delivery model is ideal for a country like India where every commodity sold is of varying quantities in different parts of the country. The seller can thus deliver goods of a prefixed quality determined by the exchange to the warehouse identified by the exchange.

The warehouse undertakes quality verification to ensure that goods conform to the standards set by the exchange. Once the quality is confirmed, the goods are delivered to the buyer in the form of a warehouse receipt.

While there is thus a strong case for physical delivery vis-a-vis cash settlement, it is necessary to address the challenges as well to make this work well.

At present, physical settlement of commodities in India is a complex process because of inadequate storage facilities in different states, restrictions on movement, State level octroi, stamp duty, sales tax, warehousing charges, and insurance. There needs to be also wider acceptance and awareness of warehouse receipts as legitimate instruments for various financial transactions.

With the Central Warehousing Corporation working on putting such a system in place in many centres in addition to the many where it already has quality storage facilities, it is just a question of time before this problem is addressed. As regards acceptance of such receipts, the trend is clearly changing for the better. With the Forward Markets Commission also being proactive and watchful, it can be expected that the emphasis on physical delivery will aid sustained growth of commodity trading in India with adequate safeguards for all stakeholders.

Kailash Gupta

(The author is Managing Director, National Multi Commodities Exchange of India (NMCE). He can be reached at comex@icenet.net).

Printer friendly page  
Send this article to Friends by E-Mail

Stories in this Section

Full convertibility, a gradual process
Intellectual capital — India's hidden wealth?
Reduced avenues for reinvestment under Sec. 54EC
Physical delivery a `must' in commodity trade
Will developing nations' hopes be realised?

Copyright © 2006, The Hindu. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu