Financialization of Commodities

13.1. What  is  Financialization  of  Commodities

A rapid deregulation of commodity and financial markets coupled with swift technological advancement and financial innovation  have facilitated the entry of big financial players into both physical commodity markets and commodity derivatives markets in the major exchanges of the world . The growing integration of financial and physical commodity markets over the last decade is popularly referred to as “financialization of commodities.”

The key financial players in the commodity futures markets are very diverse and include investment banks, merchant banks, swap dealers, insurance companies, hedge funds, mutual funds, private equity funds, pension funds and other large institutional investors.

13.2. Why  are financial players interested in commodity Derivatives

Based on the current trading value of non-agricultural commodities in the Indian exchanges, a back-of-the-envelope calculation suggests that CTT (at 0.01 percent) could fetch Rs.15,950 million (about $300 million) to the cash-starved exchequer every year. This is a substantial amount in the present times when tax revenues are under severe pressure and the government’s attempts to reduce fiscal deficit through other measures are not yielding positive results.

The revenue raised through CTT could be utilized in several ways. Since the central government is concerned over the deteriorating fiscal situation, it could use a part of this tax revenue to reduce fiscal deficit. Equally important, a portion of proceeds of CTT should be utilized to enhance the regulatory and supervisory capacities of the Forward Markets Commission (FMC), which is grossly understaffed and underfunded. A part of proceeds could also be deployed to install price ticker boards at local markets and post offices across the country for displaying commodity futures prices. This would help farmers and producers to access information on a real-time basis in their local languages and benefit from the futures price movement.

Apart from revenue potential, CTT would enable authorities track transactions and manipulative activities that undermine market integrity. Currently, large information gaps exist and a centralized database of money flows is almost nonexistent. With the implementation of CTT, the government would be better equipped to track the inflows and outflows of money into the commodity derivatives markets. This could be particularly valuable to the Indian tax authorities as there are no effective mechanisms in place to track the flow of illicit money that it finding its way into the commodity futures markets. The audit trail is considered to be a key factor behind the prevailing opposition against CTT.

Another key benefit of CTT lies in its progressive outlook. It would only affect speculators and non-commercial players who often use algorithmic trading to transact a large number of commodity futures contracts at very fast speeds. In contrast, a sales tax is generally considered to be regressive because it disproportionately burdens poor people.

In addition, the CTT would be a more efficient revenue source than other taxes. It would be collected by the commodity futures exchanges from the brokers and passed on to the exchequer, thereby enabling the authorities to raise revenue in a neat, transparent and efficient manner.