Reforms and Integration in Commodity Markets

1. Reforms and Integration in Commodity Markets NICR Workshop Presented by: Anshuman Jaswal

2. Outline of the Presentation • Purpose • Literature Review • Propositions • Methodology • Data

3. Proposed Research • Objective: To understand working of Commodities’ Spot and Futures Markets • Effect of reform • Transmission of world prices • International Integration

4. Introduction • First futures market in India in 1921 (Bombay Cotton Exchange) • Post liberalization • Committee on Forward Markets (1993) • 17 commodity groups allowed futures trading • In 2003 • Government notification permitting futures trade in 103 commodities • Total notional turnover of commodity futures markets • 4.6% of the GDP in 2003-04 to 90% of the GDP • The literature on futures markets in developing countries is quite sparse (Ramaswami and Singh, 2006)

5. Theory • Defining a Market • Defined as “the area within which the price of a commodity tends to uniformity, allowance being made for transportation costs” (Stigler, 1969) • Price convergence through • Market integration • Law of One Price (LOP) • For purposes of this study, two stages of reform • 1992-93 • 2002-03

6. Literature Review(LOP & Integration) • Ardeni (1989) proved (for Aus, Can, US, UK) • LOP failed uniformly as a long-term relationship and • Deviations from the pattern were permanent • Baffes (1991) • Supportive evidence for LOP with regard to specific commodities and time periods • Failure of LOP could be due to transportation costs • Ravallion (1986) found (for Bangladesh) • Conditions for short and long-term integration were not met • Possible reasons for this result were: • Interference from the government that prevented free flow of food-grains • Frequent flooding affected transport costs and risk-taking ability of the traders

7. Literature Review (Transmission of prices) • Mundlak and Larson (1992) • Global commodity price variation constituted a major part of the variation of the domestic commodity prices • Quiroz and Soto (1993) found • Transmission of global commodity prices did not really occur • Hazell, Jaramillo and Williamson(1990) • Variability in world prices had been transmitted to LDCs in export unit values ($), but not in average producer prices • Trade restrictions, exchange rate or domestic distortions responsible for discrepancy between domestic and world prices • Morriset (1998) • Upward movement in world prices were clearly passed through in domestic prices, downward movements were not

8. Literature Review (Reforms & stock market) • Ammer and Mei (1996) • Found high real and financial integration between the U.S. and U.K. economies • Henry (2000a) • Higher abnormal stock returns in the period leading up to the stock market liberalization • Post which there was a fall in the rates of return and lower cost of capital • Henry (2000b) • Concluded that stock market liberalizations lead to private investment booms • Forbes and Rigobon (2002) • Found high level of market co-movement between international stock markets during stable periods as well as crises

9. Literature Review(Reform & commodity market integration) • Baffes and Gardner (2003) • Looked at the degree of integration into the global economy for eight countries that underwent reforms in mid-1980s & early 1990s • Found only three countries had a high degree of integration • Commitment to reform lacking in rest • De Jong & De Roon (2005) • Found integration of emerging stock markets into global stock markets • But to varying degrees due to the level of segmentation of the market • Jain (1981) • Commodity markets in U.S. & U.K integrated only imperfectly • Sekhar (2004) • Found volatility in Indian markets lower for most agricultural commodities due to greater integration into world markets

10. Propositions Proposition 1 a: Indian commodities markets have become integrated into the global commodity markets after the reforms Proposition 1 b: There is a structural break in the degree of integration following the reform year

11. Methodology • Follow Baffes & Gardner (2003) methodology, using regression analysis: • Testing for units root in the following uni-variate process • (pdt – pwt) ~ 1(0) • If the price differential as defined above is stationary, then one can conclude that domestic prices follow world price movements in the long run (Pdt -pdt-1)= μ + α (pwt-1- pdt-1) + β (pwt- pwt-1) + u t Where pdt = domestic prices pwt=world commodity prices pdt-1= domestic prices with one lag pwt-1 = world prices with one lag • β indicates how much of a given change in world price of commodity will be transmitted to the domestic price in the current period (short-run effect) • α indicates how much of the past price difference between domestic and world prices is eliminated in each period thereafter (speed of adjustment effect) • Speed of adjustment at period n : • k = 1 – (1 – β)(1 – α)n • H0: k1 ≠ k2 • Subscripts 1 and 2 refer to pre-and post-reform periods

12. Data • Domestic commodity prices will be taken from: • Government publications • NCDEX for 2004-07 • World prices (mainly from the World Bank site) will be converted by using the official exchange rate

13. Thank you