EFFICIENCY, SEASONALITY AND MACROECONOMIC ISSUES IN INDIAN COMMODITY FUTURES MARKET

Abstract

Commodity futures markets provide a platform to commodity producers, consumers and traders to hedge their price risk. Price discovery and risk management are two essential roles of the commodity futures market. The commodity futures market has to be efficient to perform these functions. Agro-commodities futures market plays a crucial role in the economic foundations of a country like India that is substantially driven by the agricultural sector performance. At the same time, non-agro-commodity futures markets are imperative to both the policy makers and the other stakeholders in India since they carry a direct implication for the captive consumption and exports. This study analyses the efficiency, seasonality and macroeconomic issues in commodity futures market in India for commodities namely gold, crude oil, copper and chana (chick pea). The period of this study is 2004-2017. There are 113 commodities traded on commodity exchanges. Owing to time and resource constraints, the scope of this study is limited to four commodities namely gold, crude oil, copper and chana (chick-pea). These commodities (gold, copper, crude oil, and chana or chick pea) belong to precious metals, non-precious metal, energy, and agri-commodities categories respectively. The selected commodities are the top weighted commodities (in Comdex) of their own category collectively accounting for more than 60% weight in Comdex-the commodity index of MCX. As such it may be taken as representative of the commodity market. The data on the select commodities has been collected from Multi Commodity Exchange (MCX), India, National Commodity and Derivatives Exchange (NCDEX) Ltd., India, New York Mercantile Exchange (NYMEX) and Shanghai Futures Exchange (SHFE). Here, the efficiency of commodity market has been studied by analyzing the price discovery role of futures market. To investigate the efficiency of select futures markets, this study uses Johansen's cointegration and Granger Causality techniques for the two sub-periods, i.e., the pre-crisis period (from 2004 to 14thSeptember 2008) and the post-crisis period (from 15thSeptember 2008 to 2017). Johansen's test results indicate that the spot and futures prices are cointegrated for all the select commodities. In other words, futures and spot prices bear a long-run equilibrium relationship with each other for the select commodities in both the sub-periods. Causality results report that futures marketshave ability to estimate spot prices for gold and copper is higher as compared crude oil and chana, and has improved across the periods. Thus from the results of cointegration and causality, it is concluded that the futures market for all select commodities namely chana, gold, crude oil, and copper are efficient. v Seasonality is an important price determinant amongst factors like government policies like Minimum Support Price (MSP), demand of commodity, the price of substitutes, etc. The seasonality, in turn, may interfere with futures market efficiency. Most of the agri-products traded in the futures market are seasonally grown. For instance, Chana (chickpea) is also a seasonal commodity. During the sowing period, the prices may be trending upwards. But post-harvest, the prices are usually expected to fall. Thus, the seasonality may interfere with futures market efficiency. Therefore, this study also investigates the seasonality effect of chana crop on its futures market efficiency at NCDEX. To analyze seasonality, a dummy is introduced in the regression model wherein futures price is dependent variable and spot price is the independent variable. The dummy assumes value 1 for the months of the season of the crop (from March to September) and 0 for off-season months (from October to February). To test the linearity of the regression model, Ramsay RESET test has been employed here. The results of the Ramsay RESET test for the given regression model shows that the relationship between natural logarithmic returns on spot price and natural logarithmic returns on futures prices is linear in nature. On introducing dummy variable in the regression model, the results show that there is a significant influence of futures returns on spot prices returns while the impact of seasonality is insignificant. It means the relationship between the chana futures and spot prices is not affected by the seasonality. Moving to macroeconomic issues related to commodity futures trading, Inflation is a matter of economic concern all over the globe. In 2007, India's parliamentary standing committee on food and public distribution held futures trading responsible for inflation in India. Following the suggestions of the panel and increasing pressure from political circles, the GoI banned futures trading on some essential agro-commodities like wheat, rice and two varieties of lentils while temporarily suspended futures trading in commodities like chana (chick pea), soyoil, rubber, and potato. AbhijitSen committee (2008), the committee by GoI, did not find sufficient evidence of the inflationary effect of futures trading in India. Thus, this study attempts to bridge up the research gap by analyzing the causal relationship between commodity (argi, metals, and energy) futures trading, and commodity specific Wholesale Price Index (WPI) inflation in India. Toda Yamamoto modified Granger causality technique has been employed on the monthly futures volume and commodity specific WPI data. The results indicate that crude oil futures trading lead to a surge in crude oil prices in the spot market. However, there is no causality from futures trading volume to WPI for chana, gold, and copper. In a nutshell, this study vi doesn't find any relationship between futures trading and inflation for three out of four select commodities. Thus, this study concludes that commodity futures trading does not lead to higher inflation in India. Over the last couple of decades, financial integration and volatility of international markets have increased. International linkage of markets proved to be a bane for events like the recent global financial crisis that affected stock and commodity markets almost all over the globe. Thus, the crisis may have affected the spot market volatility of internationally traded commodity crude oil. Moreover, Futures prices play a better role than cash prices, in absorbing and reflecting market information for high trade volume commodities like gold, crude oil, and copper in international markets. Thus, there is a possibility of international associations of gold, crude oil, and copper futures markets of India. This study employs Johansen's cointegration and Granger causality techniques to analyze the linkage and causality between the select markets. From results, this study concludes that the global financial crisis affected the return on crude oil spot prices but did not affect the volatility of the crude oil spot market. The possible reason for the volatility of crude in 2008 could be financialization of commodity exchanges and excessive speculation in crude oil futures. Without dummy, the results show the presence of ARCH and leverage effects up to three lags. The results also support the existence of volatility clustering. Thus, from the results of linkage analysis of Indian commodity futures market with international markets this study concludes that futures markets of copper and crude oil are not efficient as their market at MCX and their respective foreign futures market are cointegrated. However, the gold futures market at MCX and NYMEX are not cointegrated and hence efficient. However, the gold futures market at NYMEX leads MCX market.