Allowing FPIs in ETCDs could be seen as a major stride in the desired direction, which is likely to bump up liquidity, reduce pricing gaps, and promote efficient price discovery.
It will lift market sentiments and enhance participation from producers, traders, end-consumers of various commodities for risk mitigation, and investors looking to diversify their portfolios through commodities.
India being a commodity-intensive country, holds a significant position on the global platform in respect of many commodities as a producer, consumer, importer, or exporter. Despite the fact, we are not able to mark our presence as a price-setter and are still dependent on the major commodities hubs as a price-taker.
However, for strengthening the markets, Sebi has made considerable efforts like allowing the wider participation of category III Alternative Investment Funds (AIFs), Mutual Funds, Portfolio Management Services (PMS) and the progressive expansion of the product basket in the last few years for the benefit of numerous stakeholders and serve as a global benchmark for commodity pricing.
With this recent announcement, foreign investors keen to trade in the commodities derivatives segment can now participate through the FPI route without the need for mandatory actual exposure to physical commodities. Existing Eligible Foreign Entity norms, which required actual exposure to Indian physical commodities, have been done away with. As a calibrated approach, FPIs are allowed to participate in the non-agricultural commodity derivatives-cash settled contracts only and select non-agricultural benchmark indices initially, but there is scope for further progress as and when the regulator finds it satisfactory on risk parameters. As FPIs have deep pockets, adequate risk management measures and investment limits will be put in place to curb excessive volatility.
Commodities markets have witnessed a period of heightened volatility in the last two years caused by a host of factors – the pandemic induced abyss, post-pandemic recovery due to the unprecedented stimulus being doled out by the key central banks, and more recently, the Russia-Ukraine crisis and the monetary tightening campaign of the key central banks. This has impacted the value chain participants significantly while highlighting the importance of commodity price risk management. However, a key area of concern for ETCDs is a high transaction cost that is impacting volumes and has adversely impacted its efficiency in terms of both price discovery and hedging in certain key commodities. This financialization of commodities by allowing FPIs would bring in much-needed volumes and depth in the commodity derivatives market that may reduce transaction costs by achieving economies of scale. It will further provide opportunities for arbitrageurs, hedgers, and investors while facilitating more employment in the sector and the benefits could even pervade deeper into the real economy.
India has witnessed stable portfolio flows over the last several years as it provides a great opportunity to investors, with the economy having an enormous potential to grow. As FPIs have been a part of Indian equities & debt markets, now they have the option to explore the commodity derivatives market as another avenue for investment in the Indian markets. With products like options contracts and indices trading along with futures, the commodity derivatives markets are geared up to face the challenges posed by the volatile global trade environment and entice global players to hedge their exposure in this market.
Strong support from the government, easing of norms for FPIs, prospects of rapid economic growth, and a stable political environment are the key elements that shall lead to an influx of foreign investment in the Indian commodity derivatives market while offering an opportunity to integrate the domestic markets with the global markets.
(Sugandha Sachdeva is the VP-Commodity & Currency Research at Broking)
(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)