How Commodity Exchange Benefit Indian Farmers

In India, marginal farmers are farmers cultivating (as owner, tenant or sharecropper) agricultural land less than a hectare. They account for 63% of land holdings and an even larger part of the agricultural workforce. They tend to be poor, and many are illiterate. They operate in difficult market conditions, with weak support infrastructure and poor access to credit. They are about the last people that many would expect to be able to benefit of a sophisticated financial market like the commodity exchange.

But experience shows otherwise. Modern exchanges started in India in 2003, and in the years since, many Indian farmers have been enabled increased access to global market through the commodity exchanges (but admittedly, most farmers are still excluded because the crops they produce are under tight government control, making it impossible for commodity exchanges to operate).

What is a commodity exchange?

A commodity exchange is an organized, regulated market platform where commodities and derivatives products are traded. While in the past, traders used to meet face-to-face in a trading pit (this is called open outcry trading), nowadays trade generally takes place on an electronic trading platform which people access through computers and mobile phones.

Commodity exchanges were given room to grow in India because of a government policy of market liberalization that started in the early 2000s. Exchanges quickly advanced to leading positions among global commodity exchanges, until around 2013, when the sudden introduction of a large transaction tax radically curtailed volumes (the Multi Commodity Exchange of India, which the author of this blog led, as CEO and Managing Director, to a position of the world’s second largest commodity exchange in 2012, was ranked 8^th in the first half of 2019, with 142 million contracts traded).

The exchanges not only build large volumes, but also very large networks, with multiple traders in even small agricultural market members becoming active on the exchange – typically, traders would have piles of produce at the front of their shop, and a trading terminal at the back. While the largest contracts were for gold, crude oil and base metals, the exchanges were also able to introduce several agricultural contracts, such as cereals, oil and oilseeds, pulses, fibers (cotton and jute), plantation crops such as coffee and rubber, spices, guar seed (an oil seed used to produce oil used in oil drilling), mentha oil, potato, sugar etc.

Not all these products survived the attacks from political interests, but those that did had a large positive impact on traditional farmers. Impact found in various studies included, for all commodities, a strong increase in farmgate prices (as many as 90% of farmers surveyed said that the price transparency created by the exchange helped them get better prices), and a reduction of marketing costs between producers and consumers.

For cardamom and mentha oil, because of the quality assurances that the exchange was able to give, India’s exports considerably increased – mentha oil production tripled in three years because farmers (in one of India’s poorest states) now could be certain that they could deliver it for a fair price into one of the exchange delivery centers. Jute farmers (some 20 million of them) were able to improve their share of the end user price because of improved price transparency.

For potatoes and mentha oil, there were many new private sector investments in quality testing and storage facilities. For wheat and soyabeans, never before had farmers shifted so fast from one crop to another, reacting to the exchange’s futures prices rather than to past price information. On the back of commodity futures trade, warehouse receipt finance was dramatically improved, giving tens of thousands of small farmers access to low-cost working capital.

Unlocking Opportunities: How India’s Commodity Exchanges Gave Marginal Farmers Access to Better Markets

Marginal farmers have been victims of fragmented, disorganized markets where they are compelled to sell their products for low prices. Where commodity exchanges were allowed to become active, farmers got access to real-time price information helping them in their marketing negotiations and their planting decisions, and in certain cases (when they are not too far from exchange delivery locations) also to more stable, more ethical trading platforms, and to new sources of credit.

In summary, the emergence of commodity exchanges has helped marginal farmers in India to cultivate more with better access to market and increased incomes. Farmers enjoy improved price discoveries and transparency through the exchanges, and some were enrolled in tight value chains that provide better market outlets and financing to the farmers - made possible through the agricultural value chain linking to futures markets.

Impact studies on agricultural futures markets in other countries like Brazil, China and South Africa have found similar effects… suggesting that agricultural futures markets are a prospect well worth pursuing for policy makers in other countries with a significant presence of large smallholder agriculture.