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Welcome to the IVM Podcast Network.
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Imagine you're a farmer with an empty bank balance and little cash.
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You're about to sow your crops at the start of the season and are filled with uncertainty.
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What if the monsoon is bad?
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What if the harvest isn't good for some other reason this year?
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If you're unable to sell your produce at the end of the season, you will be deeply in debt
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and will not be able to put food on the table.
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Just as you're getting stressed out over this thought, a man in a floral t-shirt and Bermuda
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shorts appears in front of you.
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He gives you a sunny smile, a plate of fried eggs sunny side up and then grabs you by the
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hand and takes you to a Las Vegas style casino.
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There, he takes you to a roulette table and he says, spin.
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And even as your first instinct is to get away from him, a voice in your head says,
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don't worry, this is exactly what you need.
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Welcome to the Seen and the Unseen, our weekly podcast on economics, politics and behavioral
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Please welcome your host, Amit Verma.
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Welcome to the Seen and the Unseen, my weekly podcast in which I talk about the seen and
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unseen effects of public policy.
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Today's subject is futures markets in agriculture.
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The government in India has always been wary of futures markets in agriculture, either
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regulating them heavily or simply banning them outright.
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What is the seen effect of this?
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The seen effect of restricting futures markets in agriculture is that farmers don't become
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After all, their place is on a farm, not in a casino.
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Oh well, you could argue that the whole world is a casino and that the farmers are already
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To speak more about the subject and to take us through the unseen effects of such regulation,
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I have with me Karthik Shashidhar, a renowned quant with a cult following, a management
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consultant, a columnist at Mint who also corrupts young minds by teaching at IIM Bangalore.
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Karthik, what are futures in agriculture?
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Okay, first let me talk about what are futures, right?
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And then we'll come to the agriculture.
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So let's say for example that like, actually I'll take the agriculture example.
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I want to sell something, let's say six months down the line and I don't know what the price
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So futures is basically a contract I strike with you saying, let's say on the 26th of
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May, 2017, I'm going to sell you a hundred kilos of rice for which you're going to pay
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So it's a contract you strike on one day for execution on a future date.
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So at the simplest level, that's a futures contract and futures are typically traded
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So in commodities you have like the multi commodities exchange and NCDEX and so on.
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For stock market you have BSE and NSE and things like that where futures are traded.
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So why do governments tend to be distrustful of future markets and why, for example, has
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there over the years been so much regulation in futures trading in agriculture?
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Yeah, just to give a little history into this, futures trading in agriculture had been blanket
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banned in 1952 or something like that.
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There was some forward contract regulation act which banned it.
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What was the logic for it?
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Logic for it is that like it's an anti-farmers, futures are anti-farmer.
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It like supports evil speculators who can buy cheap from the farmer and sell at an expensive
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And if you were to take out the evil speculator and instead like kind of force the farmer
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to sell through regulated markets, then both the farmers and the consumers can gain.
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So that was the logic back then.
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2003 they figured out the fault in the logic and they undid that regulation and futures
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So what did they understand?
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What is the flaw in that logic?
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The flaw in the logic that like futures are anti-farmer.
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It's very hard to simply describe what the flaw in the logic is, but the basic logic
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is that futures are pro-farmer because they allow, they're a key risk management tool
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for a farmer because for a farmer, one of the biggest sources of risk apart from monsoon
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failing and electricity and things like that, a big source of risk is price risk.
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If I am going to grow coffee today, I need to, if I may need to make a decision that
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I want to grow coffee, I need to know how much that coffee will fetch me when I'm going
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And futures markets is one excellent way for me to know what it's going to fetch me.
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And if the government decides to ban that, I have absolutely no information on price
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and I have to speculate.
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So the lack of futures market actually results in farmers speculating.
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And instead of the certainty provided.
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So the scene effect of regulating or banning futures market would appear to be that there's
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no speculation and it's, you know, you don't introduce the logic of the casino into something
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as initial as agriculture, but the unseen effect is the opposite happens you're saying.
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So let me just take a recent example.
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I think in August this year, the government recommended Sebi to ban futures trading in
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The trigger for that was that prices of sugar had been increasing and the government in
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its wisdom said the festival season is approaching.
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You don't want the consumers to suffer because sugar prices are going to go up.
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So and it's because of evil speculators that like prices are going up.
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So let's ban speculating, let's ban all the futures contracts.
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But then like think about it, right?
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I mean, what a futures price essentially recommends or represents is actual demand supply imbalance
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Why would you speculate?
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Let's say you're a hoarder, right?
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You think of all those hoarders who were villains of all the 1970s Hindi movies.
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If you're a hoarder, I would hoard something if and only if I know it's going to fetch
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me a higher price in the future.
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And how do I know it's going to fetch me a higher price in the future?
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For whatever reason I have info on the market, I'm probably, I have my eyes and ears close
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to the market and I know that there's a shortage of this coming up sometime soon.
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And because of that, I'm going to hoard.
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And yes, so it is a logical thing to say that futures markets possibly encourages hoarding,
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but then hoarding also encourages efficient distribution of resources.
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So that's the other thing, right?
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I mean, this is something I wanted to talk about.
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So basically, if you're a farmer, think about a socialist utopia.
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In a socialist utopia, the government or whoever it is decides that, okay, this year we need
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to plant a hundred kilos of rice, 200 kilos of wheat, whatever.
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And these are the farmers who need to plant that and so on, right?
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And in the presence of perfect information, possibly it might work, but then that leads
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So how do you come up to the same conclusion in terms of how do you get millions of farmers
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across the country to coordinate on who grows what every year?
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For that, you need a way to capture information.
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So if I am a farmer, if I need to be steered towards growing what others are not growing,
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the futures market is a great place for me to know what others are growing.
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So let's say, for example, lots of people are growing rice and they have sold rice in
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the futures market because they know they're going to grow rice.
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Then I'll see that the price of rice in the futures market is down.
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So it makes less sense for me to buy rice and maybe I'll grow wheat instead.
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So when a large number of farmers take a look at this futures market and participate in
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it because as soon as they make the decision on what to grow, they need to lock in the
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price on the futures market, they are exchanging information with each other and they together
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will collectively come up to a decision on what is good for the country.
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So is it correct to say that just as prices convey information, futures market are one
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great mechanism for actually propagating that information efficiently?
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So I would put it a little differently.
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You say prices convey information.
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Futures markets are again like, they're again futures prices.
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They convey information of what the market looks like in the future.
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So it helps people make more efficient decisions because they have more information on what
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things are going to be like in the future, right?
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So instead of going to the village astrologer to know what the price of rice is going to
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be, you go to the futures market to know what the price is and make your decision accordingly.
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Where the wisdom of crowds come into play basically.
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Where the wisdom of crowds come into play and the important thing is this, it's the
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So it's important for futures markets to work.
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It's important that a lot of people are participating in the market.
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If I only use the futures market as a price reference and don't actually trade on it,
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what will happen is like whatever my information on what I'm going to grow is not going to
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get disseminated to the larger group of farmers.
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So basically to use a phrase from another context, you don't want lurkers in the futures
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So if I'm participating in the futures market, it's good for me because it locks in my price
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and it's good for everybody else because they know what I'm growing.
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They get that information.
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And it happens in a completely anonymous fashion.
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You don't need to know which is the farmer who is growing rice so that you can go beat
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him up so that he doesn't grow rice because it happens at a large decentralized level.
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Moving aside agriculture for the moment, can you give me examples of futures markets in
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So for example, India has one of the most vibrant futures markets when it comes to stocks.
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So if you take, let's say for example, you want to bet that so Nifty is trading at around
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You want to bet that it's going to go to 8,500 in six months down the line.
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So if there's a six month futures, sell on the futures market and then like you can lock
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So that locks in your preference and it sends information of your perception to everyone
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So it's a way to collect the wisdom of crowds as you mentioned a while back.
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So it's profitable both for you and for everybody else.
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So it's a kind of a Pareto optimal thing to have futures markets.
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So now you mentioned before I rudely interrupted you that the ban on futures markets in India
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was lifted in 2003, I think it was.
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But regulation has continued on an ad hoc basis.
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So the biggest problem with the futures markets now is one problem is that you have large
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So this is there in the financial futures also the logic is that like the small retail
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investor needs to be protected or small farmer needs to be protected.
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So you don't want small farmers to be gambling their money away in the futures markets.
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So you need to have like, like to buy futures in stocks, you need to have at least two lakh
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rupees for commodities.
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So so because of that, all farmers cannot participate in the futures market.
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So they are one denied the information to their denied the opportunity to convey their
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So the second thing and which is more kind of problematic in terms of the use of futures
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markets is this whole ad hoc banning.
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So earlier this year, for example, the prices of sugar were going up and the government
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decided that, okay, so the way they did it was this one, prices of sugar are going up
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to futures markets exists in sugar.
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And then they come up with the causation that because futures markets exist in sugar, the
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prices are going up, ban the futures markets.
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So the good thing now, and this is an important piece of reform from this year's union budget,
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which people have missed, is that earlier you used to have this entity called the forward
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markets commission who used to recommend, who used to regulate all futures and options
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markets in both agriculture and single stocks and so on.
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After a scam, I mean, a lot of reform in India, I think happens on the back of scams.
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After a scam last year on the national spot exchange, what the government decided was
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to merge the FMC with SEBI, who's the securities market regulator and who has a great reputation
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of fair securities market regulation over the last 25 years.
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So now earlier FMC was a very pliable kind of a regulator.
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Government would say ban futures in this, they would go and ban it.
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This year, two times government asked SEBI, why don't you ban futures trading in sugar
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It's a, we know markets better and if you're banning futures trading is not going to kind
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of really result in kind of curbing the price, so we are not going to ban it.
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So given the role of futures market in a bringing some certainty to say a farmer in this case
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and also in disseminating information, is there any circumstance in which it is correct
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to ban futures markets?
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You can't think of any?
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And is it therefore any reason to regulate them at all?
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You need to regulate them in terms of like, let's say for example, like you were to regulate
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stock markets because you need to make sure that like, for example, there's counterparty
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Let's say I pledge to sell you 10,000 kilos of rice and then like you go bankrupt.
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My kind of contract needs to be upheld, which is why you need to have futures trading on
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an exchange where counterparty risk is protected and so on.
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Second thing is you don't want fraud in the futures market.
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I mean, see the thing is protecting the small farmer is actually a good kind of intention
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and you need to protect him against fraud and so on.
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So how do you kind of prevent that?
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A little bit of a gray area here is in terms of like marketing and sales of futures because
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sometimes like, I mean, there's no, I can't think of a good way to regulate them because
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you don't want, there can be massive miss selling if you were to actually allow it.
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I mean, that's possibly the reason why governments don't allow small farmers to actually trade
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in futures markets and so on because they can be like massive.
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Like if I'm an investment banker looking to make a good buck, I can go catch some poor
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guy and like sell him some, like there's a recent case of Goldman Sachs selling a large
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number of some fairly, some call options on Citigroup to Libya in 2008.
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Libya thought they were buying Citigroup stock, Goldman had sold them options and the Libyan
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investment authority lost more than a billion dollars or something and recently they sued
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Goldman and the case got thrown out by court in England.
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So in regulatory terms now that SEBI, which as you say has a very good record of regulation
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over the past 20, 25 years is in charge of regulating future markets.
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Is this an ideal situation or in policy terms, is there something else that you would suggest?
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I think it's a good situation that SEBI is regulating now because like there's no reason
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why commodities futures are different from stock futures and why stock futures are different
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So it's good that everything is under one umbrella and it's under a good umbrella because
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I think SEBI has had a fantastic record in the way it has regulated stock markets in
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In the, the, one of the things is, I mean, you do have restrictions in the market.
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Like for example, you can only use futures for hedging and not for speculation.
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There's actually, so you, like any other law, this law has been written in a way that it's
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very hard to kind of be enforced.
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It's very hard to kind of follow without breaching.
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So the ambiguity needs to be removed.
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There's an ambiguity in terms of if, am I a farmer, am I using it for hedging and so
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So that bit kind of needs to be kind of removed so that the regulation is far simpler while
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on the other hand, you need to have some ways of consumer protection because you don't want
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too much of like mis-selling and stuff to go on, which can potentially happen.
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So to sum it up, why don't you tell me again, what are the unseen effects of either banning
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or over regulation of futures markets?
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The main unseen effect is that it results in speculation.
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The scene effect of futures banning is that it cuts speculation.
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The unseen effect is that it results in speculation because people are denied information.
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And when you have information, there's no need to speculate.
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It's only when you don't have information that you try and speculate and that's what
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people do in the futures market.
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So by not allowing farmers in the futures market, we're turning them into gamblers.
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We are turning them into gamblers.
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Karthik, pleasure having you on the show.
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If William Shakespeare had been used to thinking probabilistically, he would have no doubt
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said that all the world's a casino, all the men and women merely gamblers.
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Every action we take is in some way a gamble of some sort based on our estimate of probabilities
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and our weighing up costs and benefits.
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Maybe we don't think about it in these terms, but intuitively that's what we're doing.
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After the irony then that futures markets, which seem to us to be an arena for gambling
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actually reduce the risk in a farmer's life, who would have thought?
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Next week on the scene and the unseen, Amit Varma will be talking to Bharun Mitra about
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the anti-defection law.
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For more, go to www.sceneunseen.in.
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If you enjoyed listening to the scene and the unseen, check out another show by IVM
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Podcasts, Symblified, which is hosted by my good friends, Naren, Chuck and Sriketh.
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You can download it at Audioboom or iTunes.
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Hey man, just help me out man, I need some, I need some podcasts man, I haven't had a
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fix in a week, just need some.
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Don't you worry about it, I got podcasts galore for you man.
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Just go to ivmpodcasts.com, you can also find us on Facebook, Twitter and Instagram.
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Thanks man, I'm gonna check it out.
