Study On The Preference Of Coffee Traders To The Traditional Methods Of Trading Compared To Commodities Exchanges
Dr. Satish Y.M. Professor,
Department of Management Studies
M.S.Ramaiah Institute of Technology Vidya Soudha, MSR Nagar, Mathikere, Bangalore –560054
Devasimha .L, MBA Student
Department of Management Studies
M.S.Ramaiah Institute of Technology Vidya Soudha, MSR Nagar, Mathikere, Bangalore –560054
ABSTRACT
Agricultural commodity exchanges provide a national level market ensuring level playing field for all the participants. Despite this it has been observed that the volume of trading is less than the traditional method. Hence, study was carried out to understand the reasons for the preference to traditional methods of trading for Coffee at Chikmagaluru, one of the prominent coffee producing districts of Karnataka. Response to the questionnaire from the fifty growers and traders were collected and analyzed. After analyzing the data using Z test with5% significance it was observed that the primary reason for the non-preference of commodity exchanges is that the trading is not flexible in commodity exchanges. This is because exchange has limited trading option such as grades, lot size of coffee etc. Another hindrance is the numbers of participants trading coffee being very less. To address these issues, awareness about the commodity exchanges and its benefits to growers should be created with the help of NGOs and local individuals.
Key words : Agricultural Produce Market Committee , coffee trading, commodity market, Futures contract.
Introduction
A commodity market is a market that trades in primary economic sector rather than manufactured products. Soft commodities are agricultural products such as wheat, coffee, cocoa and sugar. Agricultural commodities include grains, food and fibre as well as livestock and meat. Hard commodities are mined, such as gold and oil.
A commodity market facilitates trading in various commodities. It may be a spot or a derivatives market. In spot market, commodities are bought and sold for immediate delivery, whereas in derivatives market, various financial instruments based on commodities are traded. These financial instruments such as 'futures' are traded in exchanges. Participants in commodity markets are investors, farmers/producers, importers/exporters, commodity financers, hedgers, speculators, arbitrageurs, and large-scale consumers such as refiners, jewellers, textile mills.
Trading and investing in commodities can be very different from investing in traditional securities such as stocks and bonds. Global economic development, technological advances and market demands for commodities influence the prices of staples such as oil, aluminium, copper, sugar and corn. For instance, the emergence of China and India as significant economic players has contributed to the declining availability of industrial metals, such as steel, for the rest of the world.
Basic economic principles typically follow the commodities markets: lower supply equals higher prices. For instance, investors can follow livestock patterns and statistics. Major disruptions in supply, such as widespread health scares and diseases, can lead to investing plays, given that the long-term demand for livestock is generally stable and predictable.
Commodities can quickly become risky investment propositions because they can be affected by eventualities that are difficult, if not impossible, to predict. These include unusual weather patterns, natural disasters, epidemics and man-made disasters. For example, grains have a very active trading market and can be volatile during summer months or periods of weather transitions. Therefore, it may be a good idea to not allocate more than 10% of a portfolio to commodities (unless genuine insights indicate specific trends or events).
With commodities playing a major and critical role in the global economic markets and affecting the lives of most people on the planet, there are multitudes of commodity and futures exchanges around the world. Each exchange carries a few commodities or specializes in a single commodity. For instance, the U.S. Futures Exchange is an important exchange that only carries energy commodities.
The most popular exchanges include the CME Group (www.cmegroup.com), which resulted after the Chicago Mercantile Exchange and Chicago Board of Trade (CBOT) merged in 2006, Intercontinental Exchange, and the London Metal Exchange (www.lme.com).
In India, National Commodity & Derivatives Exchange Ltd. (www.ncdex.com) and Multi Commodity Exchange of India Ltd. (www.mcxindia.com) are the major commodity exchanges with national presence. Commodities exchanges are regulated by SEBI after the merger of FMC with it on 28th September 2015.
Volume of trading done on these above mentioned electronic commodity exchanges by farmers and producers is less compared to local mandis (a colloquial term for market place in Indian language). Main reason for low participation of farmers in commodity exchanges is APMC act. Physical trading of agricultural commodities in India falls under the jurisdiction of the state governments. Each state has its own Agricultural Produce Market Committee (APMC) Act to regulate physical trading of commodities. On account of the APMC Act, farmers cannot sell directly to ultimate buyers such as processors, exporters and retailers, and hence sell their produce to traders or local aggregators. Processors, exporters, and retailers in turn buy from local aggregators. This increases the number of intermediaries and leads to higher costs. Besides these non-value-adding transaction costs, there is a lack of standardization across the regulated market yards, in terms of quality or other costs. Different state governments levy different taxes on transactions carried out at these market yards. As a result, the spot prices prevailing at these markets vary widely for a commodity.
Therefore, this study is undertaken to identify other factors which contribute to low trading of agriculture products in commodity exchanges by farmers/producers.
During the course of the study the following research literature related to agricultural commodity were studied:
1. Impact of Futures Trading on Commodity Prices
(Nath and Lingareddy, 2008) in their article attempted to explore the effect of the introduction of futures trading on spot prices of pulses. It finds that volatility in urad as well as pulses prices was higher during the period of futures trading than in the period prior to its introduction as well as after the ban of futures contracts.
2. Impact of Futures Trading on Indian Agricultural Commodity Market
Besides the well-established fact towards the requirement of market based instrument, there is always been a doubt, as expressed by different bodies, on the usefulness and suitability of futures contract in developing the underlying agricultural commodity market, especially in agricultural based economy like India. Therefore, an attempt has been made to re-validate the impact of futures trading on agricultural commodity market in India. The daily price information in spot and futures markets, for a period of 7 years (2004 – 2010), for 9 major agricultural commodities, taken from different categories of Agri-products, are incorporated into various econometric models to test the concerned objective. Like most of the other studies undertaken on world and Indian commodity market, the present study have also exhibited that even though the inflationary pressure on commodity, especially agricultural commodity, prices have gone up sharply after the introduction of commodity futures contracts, the destabilizing effect of the futures contract is casual in nature and tends to vary over a long period of time. The empirical findings significantly shows that comparative advantage of futures market in disseminating information, leading to a significant price discovery and risk management, that can again help to successfully develop the underlying commodity market in India. Therefore instead of curbing the commodity futures market, it can always be suggested to strengthen the market structure to achieve the broader target. (Mukherjee, 2011)
3. Examining the Dynamic Relationship between Spot and Future Prices of Agricultural Commodities
This study by (Hernandez and Torero, 2010) examines the dynamic relationship between spot and futures prices of agricultural commodities. They first briefly discuss what the non-arbitrage and asset pricing theory has to say about the relationship between spot and futures markets. Next, using recent price data for corn, wheat, and soybeans, they perform Granger causality tests to empirically uncover the direction of information flows between spot and futures prices. Linear as well as nonlinear (nonparametric) causality tests are conducted on both spot and futures returns and their volatility. The results indicate that spot prices are generally discovered in futures markets. In particular, they found that changes in futures prices lead changes in spot prices more often than the reverse. These findings also contribute to the debate on alternative instruments to address excessive volatility in grain markets. Their results support, for example, the viability of implementing a global virtual reserve, recently proposed by von Braun and Torero (2008, 2009), to prevent disproportionate spikes in grain spot prices through signals and, if necessary, market assessment in the exchange of futures.
Even though significant attempts have appeared in literature, the current perception of comovement of commodity prices appear inadequate and static. In particular we focus on price movements between crude oil futures and a series of agricultural commodities and gold futures. A comparative framework is applied to identify changes in relationships through time and various co-integration methodologies and causality tests are employed. Our results indicate that co-movement is a dynamic concept and that some economic and policy development may change the relationship between commodities. Furthermore we show that biofuel policy buffers the co-movement of crude oil and corn futures until the crude oil prices surpass a certain threshold. (Natanelov, Alam and McKenzie, 2011)
5. A New Forecasting Model for Agricultural Commodities
This paper by (Yong, 1995) presents a mathematical model for forecasting the production of some agricultural commodities. This method takes into account the general trend of the time series and random fluctuations about this trend. It has the merits of both simplicity of application and high forecasting precision. In particular, the forecast values of the model are more precise than those of other models such as the index smoothing method and the grey dynamic model, for data sequences with large random fluctuations. The case study of the silkworm cocoon production in Zhejiang province shows the merits of the model.
6. Factors Influencing Commodity Futures Prices in India
The objective of this paper by (Chakraborty and Das, 2015) is to study the factors influencing commodity futures prices of the Indian commodity market. Five factors have been considered in this study, namely: spot price, the U.S. dollar exchange rate against rupees, market wide information, risk free rate of interest, and financial speculation. To test the long-run equilibrium relationships between commodity futures prices and the factors, Johansen’s Co-integration test has been used. The short-run relationships have been verified by Vector Error Correction Model. Finally, the lag relationships of these factors with the commodity futures price, is modelled by Almon Polynomial Distributed Lag model. The study shows that spot price, market wide information, financial speculation and exchange rate of the US dollar influence the futures price. However, the degree of impact depends on the commodity and on the period of analysis. Additionally, risk free rate of interest does not show influence on the futures prices.
7. The Impact of Coffee Market Reforms on Producer Prices and Price Transmission
(Krivonos, 2004) evaluates the impact of coffee sector reforms during late 1980s and early 1990s on coffee growers in the main coffee producing countries. Earlier evidence suggests that the reforms increased the share of producer prices in the world price of coffee. She tests this hypothesis with the help of cointegration analysis, and the results show that in most countries the long-term producer price share has indeed increased substantially after the liberalization. Moreover, the results suggest that the reforms induced a closer cointegrating relationship between grower prices and world market prices. Finally, estimation of an error-correction model reveals that short-run transmission of price signals from the world market to domestic producers has improved, such that domestic prices adjust faster today to world price fluctuations than they did prior to the reforms. However, there is some evidence of asymmetries in the way positive and negative world price changes are transmitted to domestic markets. This paper is a product of the Trade Team, Development Research Group.
Digital platforms for buying and selling agricultural commodities have generated significant interest in the trade literature as a way to link rural communities to the Internet. Yet, the extent to which these digital platforms actually translate into higher commodity prices for producers remains an open research question. We investigate this question by comparing transaction data on trading various grades of coffee from a recently implemented digital platform in India with similar transactions from a physical commodity auction held weekly, and farm-gate prices in the coffee producing regions of India. Although the digital platform prices closely track the physical commodity Study on Agricultural Commodity auction prices, producers obtain significantly higher prices when they sell the commodity through the digital platform rather than at the farm-gate through brokers who operate in their regions. However, coffee grades with higher price volatility and premium coffee grades that require face-to face interactions to verify quality obtain lower prices on the digital platform. Our results also indicate that market participants who control the transaction obtain better prices. We discuss the implications of our findings for governments and platform providers. (Banker, Mitra and Samba Sambamurthy, 2011)
9. Indian agricultural commodity derivatives market – In conversation with S Sivakumar, Divisional Chief Executive, Agri Business Division, ITC Ltd.
Though the agricultural sector contributes significantly to the Indian economy, it faces several bottlenecks, one of those being the antiquated laws governing agricultural marketing and price discovery, leading to low price realization by Indian farmers. In India, six national level exchanges offer commodity derivatives contracts on commodities, with some having electronic spot exchanges to facilitate spot trading of commodities. However, farmers' participation in these exchanges has been poor. ITC-ABD, one of the largest aggregators and exporters of Indian agri-commodities, has started using these exchange platforms to hedge price risk. With experience of over three decades in the agricultural sector, Mr. S. Sivakumar has a deep understanding of the commodity markets and the needs of Indian farmers. This interview aims to get an insight into his views on increasing farmers' participation in commodity derivatives trading and more importantly, to understand ITC-ABD's commodity hedging strategy. (Rajib, 2015)
Research Methodology
Title of the Study
“Study on the preference of coffee traders to the traditional methods of trading compared to commodities exchanges”
Statement of the problem
In India, coffee traders and growers traditionally trade coffee by directly dealing with each other. Along with these traditional methods, trading is also done at national level in commodities exchanges such as NMCE, MCX, NCDEX etc.
However, the volume of trading done at national commodities exchanges is less compared to traditional methods.
Therefore, this study is undertaken to identify the reasons for the preference of traditional methods to national commodities exchanges in India with reference to Coffee.
To understand traditional trading methods of coffee.
To understand how trading is done in commodity exchanges.
To compare the trading volumes of coffee traded traditionally and in commodity exchanges.
To identify the reasons for the preference to traditional trading method over commodity exchanges.
Hypotheses
Following hypotheses have been used in the Study:
H0: Percentage of Growers/Traders who are aware of agricultural commodities exchanges is less than or equal to 75%.
Ha: Percentage of Growers/Traders who are aware of agricultural commodities exchanges is more than 75%.
H0: Percentage of grower/Traders who consider trading coffee in commodity exchanges flexible is less than or equal to 60%.
Ha: Percentage of grower/Traders who consider trading coffee in commodity exchanges flexible is more than 60%.
Data collection
Primary Data – Primary data for the study purpose was collected through Questionnaires.
Fifty traders and growers of coffee in Chikkamagaluru, Karnataka were selected randomly for the study purpose.
Secondary Data from Coffee Board of India was used to determine volume of coffee produced in Chikkamagaluru.
Sampling
Non-probability sampling was chosen for the study. Traders and growers of coffee from Chikkamagaluru in Karnataka formed the sampling unit for the purpose of the study. A sample size of fifty respondents consisting of traders and growers of coffee were taken for the purpose of the study.
Plan of Analysis
The collected primary data was coded and analyzed using Microsoft™ Excel software. The frequency of responses for each option of question was calculated and responses interpreted. Further hypothesis testing was done to determine if it can be concluded for the population as well.
Statistical Tools used for research
One tailed Z test is used to test the hypotheses as it is test of one sample of proportions.
The study is confined to Chikkamagaluru district in Karnataka. It was carried out for a period of three months between January to March 2016.
Results and Discussion
Hypotheses Testing
Hypothesis 1
H0: Percentage of Growers/Traders who are aware of agricultural commodities exchanges is less than or equal to 75%.
Ha: Percentage of Growers/Traders who are aware of agricultural commodities exchanges is more than 75%.
n = sample size = No. of respondents = 50
p = sample proportion = 0.88
p0= Hypothesize population proportion = 0.75
α = 5% = 0.05 Therefore,
Z = p -p0/√(p0(1-p0)/n)
= 0.88 – 0.75 / √(0.75(1-0.75)/50) = 2.1228
p-value = 0.0168 (From Standard Normal Distribution table) Here, p-value < α {0.05}, therefore we reject H0.
Since H0 is rejected, we can conclude that percentage of growers/traders who are aware of agricultural
commodities exchanges is more than 75%
Hypothesis 2
H0: Percentage of grower/traders who consider trading coffee in commodity exchanges not flexible is less than or equal to 60%
Ha: Percentage of grower/traders who consider trading coffee in commodity exchanges not flexible is more than 60%
n = sample size = No. of respondents = 50
p = sample proportion = 0.73
p0= Hypothesize population proportion = 0.6
α = 5% = 0.05 Therefore,
Z = p -p0/√(p0(1-p0)/n)
= 0.73 – 0.6 / √(0.6(1-0.6)/50)
= 1.876
p-value = 0.0303 (From Standard Normal Distribution table)
Here, p-value < α{0.05}, therefore we reject H0.
Since H0 is rejected, we can conclude that percentage of grower/traders who consider trading coffee in
I. The reasons for the preference to traditional trading method over commodity exchanges.
Based on the analysis of responses, the reasons for preference to traditional method of trading coffee as compared to commodity exchanges is as below:
a. Trading in commodity markets is not flexible compared to trading in traditional method. (Refer to the outcome of Hypothesis 2)
b. During interaction with growers of Coffee, it was found that commodity market has only few contracts such as Grade A coffee, premium coffee etc. However, when coffee is harvested and processed, it produces different grades. In traditional market, all the grade gets traded which is not true in case of commodity market. Hence, growers have to find another market for lower grades of coffee. So in order to avoid this grower prefer single market which is traditional market for all their coffee grades.
c. Payments in commodity exchanges are often delayed and it has to go through lot of processes. However, growers usually sell their produce when there is need of money and expect immediate payment. This is possible by selling in traditional market.
II. Traditional trading methods of coffee.
It was understood from interacting with various growers and traders of coffee in Chikkamagaluru, that traditional methods being followed by them is as below:
a. Coffee flowers blossom in month of March and coffee beans is harvested starting from the month of December.
b. Raw coffee is cured and graded by Coffee Curing works units. These curing works also act as warehouse to stock coffee. There are charges for warehouses to be borne by growers.
c. Growers then sells coffee kept at Curing works to traders directly as per his/her need at agreed price. The price is same as that quoted in New York and London commodity exchanges previous day.
III. Trading mechanism in commodity exchanges.
It was learnt from various contents that trading in commodity market may be “spot” or “futures” trading. Futures’ trading is very popular as it gives liberty to the investor in terms of sales. The steps to be followed by the investors are:
a. Open one bank account and separate commodity demat account from National Securities Depository Ltd to trade on commodity exchanges just like in stocks.
b. Enter into agreement with the broker. These include the procedure of Know Your Client and terms of conditions of the exchanges and broker. Besides details such as PAN no., bank account no., etc needs to be provided.
c. Minimum deposit to be made in the brokers firm for carrying out the trade.
d. Based on daily information available in financial newspapers, reports from brokers, select commodity to trade.
e. Do actual trading clearing and settlement.
IV. The trading volumes of coffee in traditional markets and in commodity exchanges.
As per the analysis of responses to question “Trading Mechanism”, it is observed that the entire volume of coffee grown in Chikkamagaluru, Karnataka is traded traditionally.The volume of coffee traded in commodity exchanges is nil.
Suggestions
Some suggestions to make commodity exchanges more popular among the growers and traders of coffee are as below:
1. Create awareness about the benefits of trading in commodity exchanges. This can be achieved by setting up information centres in Chikkamagaluru, Karnataka. By doing this farmer can be reached and given information about the commodity markets and its offerings, interact directly with the coffee growers and traders and educate about the trading mechanisms of commodity exchanges. Also, their grievances can be heard and addressed.
2. Provide incentives to small growers for trading in commodity exchanges. Commodity exchanges can provide incentives such as giving certain percentage of premium on market price of coffee if traded in commodity exchanges.
3. Conduct periodic training programs for coffee grower, traders and investors with the help of local traders and NGOs to gain their confidence
4. Periodically take feedback and suggestions from traders and growers of coffee to improve trading procedures of the commodity markets. This will ensure that these growers and traders have confidence in commodity exchanges.
5. Contract specifications should have wider coverage so that many grades of coffee can be traded such as Grade A, Grade B, Grade C of coffee etc.
6. Contract sizes should have an adequate range so that smaller traders can participate in trading in commodities exchanges.
Conclusion
Agricultural Commodity markets play a vital role in economies of the country. It provides a fair and structured mechanism for grower, producer, trader and buyer to trade in agricultural produce such as Chana, Gur, Cotton, and Sugar. Coffee, Cardamom, Pepper and so on. In India, commodity trading is regulated by SEBI. There are six major commodity exchanges which allow trading in different agricultural, metals and other commodities.
It only goes to say that agriculture plays a vital role in lives of many people in India. Hence, it is imperative that farmers and growers receive good financial benefits for their effort and contribute to growth of the nation.
Majority of farmers still depend on traditional and age old methods for trading their produce. They are either not aware of national commodity exchanges or reluctant to use the platform. This can be addressed by extensively educating them with the help of NGOs and other institutions. Also, SEBI and commodity exchanges should understand the need of farmers and growers to implement a more robust policy and features for trading in agricultural commodities. They should also address grievances of trader especially farmer and grower.
Once, the usage of commodity exchange is increased by making majority of farmers and growers to take part in the trading in either spot or futures markets, it can be ensured that India will usher into era of prosperity and happiness.
Bibliography
Banker, Rajiv, Sabyasachi and Sambamurthy V. (2011), “The effects of digital trading platforms on commodity prices in agricultural supply chains.” Management Information Systems Quarterly, Vol 35, Issue 3, pp.599-611.
Chakraborty, Ranajit and Rahuldeb Das. (2015),“Factors Influencing Commodity Futures Prices in India.” Journal of Contemporary Research in Management Vol 10, Issue 2, pp33
Hernandez, Manuel and Maximo Torero. (2010), “Examining the Dynamic Relationship between Spot and Future Prices of Agricultural Commodities.” ,IFPRI discussion paper 00988.
Kothari, C R. (2004), Research Methodology - Methods and Techniques. New age International (p) Limited, Publishers. Pp196-224
Krivonos, Ekaterina. (2004) “The Impact of Coffee Market Reforms on Producer Prices and Price
Transmission.” Policy Research Working papers, elibrary.worldbank.org,
http://dx.doi.org/10.1596/1813-9450-3358
Mukherjee, Dr. Kedar nath. (2011), “Impact of Futures Trading on Indian Agricultural Commodity Market.” National Institute of Bank Management, MPRA paper29290.
Natanelov, Valeri, et al. (2011) “Is there co-movement of agricultural commodities futures prices and crude oil?” Energy Policy, Vol 39, Issue 9, Pages 4971-4984
Nath, Golaka C. and Tulsi Lingareddy. (2008)“Impact of Futures Trading on Commodity Prices.” Economic and Political Weekly ,Vol. 43, Issue No. 03.
Rajib, Prabina.(2015) Indian agricultural commodity derivatives market – In conversation with S Sivakumar, Divisional Chief Executive, Agri Business Division, ITC Ltd. Vinod Gupta School of Management, Indian Institute of Technology (IIT) Kharagpur, Kharagpur, West Bengal, India: IIMB Management Review.
Engineering Research” Volume 60, Issue 4, Pages 227-235
Websites
1. http://www.ibef.org/industry/financial-services-india.aspx
2. http://www.moneycontrol.com/glossary/commodity/what-is-a-commodity-market_873.html
3. An Overview Of Commodities Trading - By Marv Dumon
http://www.investopedia.com/articles/optioninvestor/09/commodity-trading.asp 4. http://www.mcxindia.com/aboutus/aboutus.htm
5. http://www.ncdex.com/Aboutus/profile.aspx 6. http://www.nmce.com/aboutus.aspx
7. By MarkSweep - Own work, Public Domain,
https://commons.wikimedia.org/w/index.php?curid=41936
8. http://inspirationalarticlesonline.blogspot.in/2011/10/anand-rathi-stock-broker.html
9. https://www.rathi.com/StaticPage/sPage?pType=who-we-are-leadership-board-of-directors-8027 10. http://www.tradingpicks.com/beginners_guide.htm
11. http://www.socscistatistics.com/pvalues/
