Will Commodity Markets Change the Landscape of Nepali Agro-Markets?

With the endorsement of the Commodity Act finally behind us, the question now arises whether the Agro-Markets of Nepal can benefit from the full functionality of the industry. In the past, the market practitioners from the commodity industry bore the brunt of the harsh reality while approaching any intended stakeholders for partnership since the market was not overseen by an authorised government entity. However with the Commodity Act in place and SEBON assuming the reins of a regulator, the commodity markets gear up to develop agro-markets of Nepal in the near future. As we turn the pages of history, among the numerous objectives behind the establishment of a commodity market, the major one was to assist the farming community and develop the scenario of the agro-markets by bringing on board the various stakeholders related to it. While Commodity Markets have been recognised as a medium for risk management, its use was limited only to a few developing countries due to the sophisticated market structure it possessed. During the 1990s, as various economies embraced liberalisation and opened doors to international trade and commerce, agro-markets were exposed to a symposium of elements dependent on the domestic and international market forces. The need for an effective price risk management mechanism for the protection of commodity sector from price volatility was realised. With the ever-changing economic environment coupled with changing demand and supply position of agricultural commodities, wider roles for futures market was necessitated in the agricultural economy. Although the Commodity Market in Nepal had grown at an alarming rate since its penetration a decade ago, the major objective as stated earlier has not yet been realised. The futures market segment of a commodity market performs two important functions: price discovery and price risk management. With a given commodity in question, it is highly useful for all segments of the economy i.e. producers, consumers, exporters and importers. For a producer, it is useful since he can get an idea of the likely price at a future point of time and can decide which commodities to select for farming purpose. For a consumer, he can get an idea of the price at which the commodity will be available in the near future. The futures market is also useful to an exporter and an importer as it provides an advance indication of the price likely to prevail. It helps the exporters and importers to quote a realistic price and secure the contract in a competitive market. As the exporter and importer enter into a contract, it enables the parties to hedge their risk by entering the futures market.

HEDGING

Hedgers are market participants who are exposed to the price risk forces in the ensuing days. The futures market attracts the hedgers for risk management and encourages external competition from those who own market information and price judgment to trade in these commodities. While hedgers possess long-term perspective of the markets, the speculators prefer a short-term view. Given that the market participants have both long and short-term view of the markets, all the users participate in the buying and selling of the commodities based on the various domestic and international criteria such as climate, demand and supply among others. This results in efficient price discovery mechanism allowing a large number of buyers and sellers to trade on the exchange platforms. In hindsight, hedging is the practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. For example, if a farmer producing wheat has entered into a contract with a manufacturer of selling 20,000 Kg in three months’ time but is afraid that the price could drop in the ensuing future incurring losses. The farmer can offset the risk by entering the futures market and initiating a sell position in a wheat contract of the similar quantity. After three months, if the price does drop, the farmer can mitigate the losses while selling to the manufacturer by generating profits in the futures market. This mechanism is useful in long-term requirements for which prices have to be confirmed but avoids buying the physical commodity immediately to prevent blocking of funds and incurring humongous holding costs.

PRICE DISCOVERY

According to an article written by Simon Constable in The Wall Street Journal titled What Is ‘Price Discovery’ and Why Does It Matter? – ‘Price discovery is the mechanism by which competing buyers and sellers determine the price of a security or an asset.’ The futures price of a commodity increase or decrease largely because of the myriad of factors that influence buyers and sellers expectations in the price at a given time in the future. As new market forces influencing demand and supply pattern emerges, judgments are reassessed and price inclines or declines. The process of price discovery constantly changes with time. On a given day, the price of a January 2018 contract of coffee will reflect the consensus of buyers and sellers opinions about the value of the commodity when the contract expires in January 2018. When new and accurate information enters the framework, the January 2018 price of coffee will decrease or increase. Price discovery is the major economic function and benefit of the futures market. Through this competition, all available information about the future value of the commodity is continuously reflected in the language of price providing a dynamic barometer of supply and demand. The transparency of the process assures that everyone has access to the same information at the same time.

NEPALI PERSPECTIVE

Being an agrarian economy, Nepal contributes one-third to the GDP from the agriculture sector and likewise, has two-thirds of the population engaged in it. While the tremendous potential in the agro-markets cannot be undoubted, the fact remains that due to the numerous benefits, the commodity market can definitely provide the thrust to claim spectacular heights. With the introduction of the Commodity Act and SEBON taking over the role of an apex institution, the agro-markets of Nepal will definitely witness a shining light at the end of the tunnel.

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Vivek Risal is associated with Mercantile Exchange Nepal Limited in the capacity of Manager in Research and Development Department. He can be contacted at r&[email protected]