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  (p dt – p wt ) ~ 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 (P dt -p dt-1 )= μ + α (p wt-1 - p dt-1 ) + β (p wt - p wt-1 ) + u t Where p dt = domestic prices p wt=world commodity prices p dt-1= domestic prices with one lag p wt-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 H 0 : k 1 ≠ k 2  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