Wednesday, August 6, 2008

Miscellaneous: Commodities Trading; Venture Capital, etc.

1. Commodities Futures Trading

A few papers and columns have recently appeared in this area. In a paper titled Futures Trading in Agricultural Commodities, Sandhya Srinivasan finds that the ban on futures trading on 4 agricultural commodities in May this year has not been effecting in bringing down the price of all these commodities. Here is the abstract:

“On 7 May, 2008, the Indian Government announced the ban futures trading in four agricultural commodities - chickpea, potato, rubber and soy oil. The purpose of this paper is to examine the rationale behind the ban and study how logical the decision to impose it is. The stated purpose of the ban was to control inflation. However, of the four banned commodities, only the price of potato declined after the ban due to the bumper crop.

The rising inflation rate, pegged at 11.42% for the week ended 14 June, 2008, has been attributed to a number of factors, including the 56% increase in global food prices over the past year, record crude oil prices (over $140 a barrel), the diversion of land for bio-fuel production, loose monetary policy in emerging economies, and the adoption of an expansionary fiscal policy by the Government.

An analysis of spot and futures prices of the four banned commodities shows a high degree of positive correlation in the prices of the two markets. The prices are interdependent: the futures markets give signals to the spot markets on the direction in which prices will move in the future and the futures prices are determined on the basis of the conditions in the spot markets. Speculation may drive prices further up, but a speculator expects prices to rise due to the market conditions, and doesn't arbitrarily bet on a price rise. The extent to which two markets influence each other depends on the level of integration of the two markets. Developing the spot markets along with the futures markets and ensuring higher participation from the farmers is essential to integrate the futures and spot markets. When the participation by consumers and producers of agricultural commodities in the futures market is low, the debate over the futures ban becomes irrelevant.”
However, in spite of such findings, which are in tune with the Abhijit Sen committee report which found no correlation between futures trading and the price rise, news reports indicate that the ban on futures trading on these essential agricultural commodities is likely to continue. Despite the ban, commodity exchanges appear to be witnessing a surge in trading, mostly in metals and energy (see Business Times Online: India News – subscription required).

The impending introduction of the commodities transaction tax may act as a dampener. In a recent column, MR Mayya argues that the “imposition of commodities tranaction tax will add to the cost of transactions in all these commodities, including those having a modicum of liquidity, with serious adverse consequences.”

2. Possible Restrictions on Venture Capital Funds

There seems to be a proposal to restrict the sectors in which venture capital funds can invest. Here is a report:

“Reserve Bank of India (RBI) has asked the Union finance ministry to prevent foreign investors from side-stepping foreign investment norms by taking recourse to the venture capital (VC) route.

With increasing concerns of foreign capital driving up real estate prices, RBI has recommended that foreign venture capital investments (FVCIs) be restricted to nine sectors (investment in other sectors being treated as foreign direct investment). It has suggested that capital market regulator SEBI set up a screening mechanism for all pending and future FVCI proposals.”
Today Economic Times carries a column by TK Arun who forcefully argues against any such restrictions. Here is an extract:

“The vision that only investment in technology-intensive sectors constitutes venture investment is to grossly misconstrue venture investment and to forgo the venture capital industry’s truly revolutionary potential to nourish entrepreneurship in the country.

VC funds make entrepreneurship more democratic, by taking it away from the preserve of the wealthy. Policy should promote rather than discourage such evolution of financial intermediation. Limiting venture funds to particular sectors is to hold back social progress.”

3. Financial Market Regulation

The recent credit crisis has brought about calls for revamping the entire system of regulation of financial markets. In this column in the Financial Times, Henry Kaufman sets out eight precepts of sound financial regulation that should be considered while drafting new rules and eliminating old ones.

No comments: