India Opens Door to Foreigners
As Commodities Market Grows
By RASUL BAILAY
September 19, 2006
NEW DELHI -- India's commodity markets are in the midst of a regulatory overhaul that is opening the door to foreign investors.
Already, two Wall Street titans have taken stakes in Indian commodity exchanges, underscoring efforts to tap India's exploding trade in farm products and metals even before clear rules are established for such investments.
India's commodity regulatory agency, the Forward Markets Commission, also recently recommended to the Ministry of Finance that foreign institutional investors be allowed to invest and trade in commodity futures, according to S. Sundareshan, the country's chief commodity regulator.
Under his commission's proposal, the range of permitted investments for registered foreign investors would include spot and futures contracts for gold bullion, crude oil and other commodities, Mr. Sundareshan said in a telephone interview.
The finance ministry, which sets policies for India's financial markets, is also expected soon to establish foreign-investment ceilings for the commodity exchanges themselves. Such caps follow substantial investments this year by Goldman Sachs and Fidelity International in Indian commodity exchanges.
In February, Fidelity International bought a 9% stake in the largest exchange, the Multi Commodity Exchange of India, or MCX, in Mumbai for $49 million, according to Jignesh Shah, managing director and chief executive of MCX. Then in July, Goldman Sachs acquired 7% of the second-largest exchange, the National Commodity & Derivatives Exchange, also in Mumbai, for an undisclosed amount, according to Edward Naylor, a Goldman spokesman in Hong Kong. Goldman and Fidelity declined to provide other details about their investments.
The regulatory steps to open up commodity trading are part of a broader market makeover that reflects India's rising ambitions in the financial world. Exchange executives hope surging interest in commodities can translate into heavy infusions of overseas capital, provided regulators adopt rules that permit foreign positions in trading and investment in the exchanges.
The country's commodities markets are potentially attractive -- India has been the biggest global buyer of gold and silver for years and is quickly becoming a major consumer of other commodities such as crude oil, copper, zinc and nickel. But links to big foreign trading firms are needed to reach the next stage of growth, industry executives here say.
"If the Merrill Lynchs, the Goldman Sachses and the Standard Chartereds of the world can invest in CBOT [Chicago Board of Trade], why not allow them here?" says Mr. Shah of MCX.
Despite growing trade volumes, however, India's commodity markets are still underdeveloped. They remain closed to all but individual Indian commodity traders and domestic commodity brokerage firms. Only three years ago, the Indian government lifted a longstanding ban on trading futures -- contracts that permit an investor to buy or sell a product at a future date. Prices of some commodities, particularly gold, used to be much higher in India than abroad, due to high import tariffs. But several years of steady tariff cuts have brought domestic prices in line with those abroad.
Still, in a country where more than 600 million people are engaged in agriculture -- which accounts for 23% of India's gross domestic product -- the commodity exchanges are playing a growing role in the economy. Trade in futures contracts, in particular, is increasingly important in influencing the production and pricing of goods.
From just a handful of products a few years ago, the number of items listed and traded on India's exchanges now exceeds 70, ranging from gold to groundnut, or peanut, oil. The nation's two major exchanges, MCX and NCDEX, account for more than 90% of the commodities trade, and daily volume approaches $2.5 billion -- a level that surpasses trade on India's century-old Bombay Stock Exchange.
Now, regulators are moving to widen market access. As a first step, the finance ministry is expected to open the business to domestic institutional investors and banks, according to analysts, although no timetable for that move has been disclosed.
Also in the works is a government bill that is expected to allow trading in options, thereby enabling the fast-growing Indian corporate sector to hedge its risks in the local exchanges rather than doing so overseas. A ministerial task force is also exploring the possibility of putting securities and commodities oversight under a single market watchdog. Currently, there are two separate regulators for securities and commodities.
The expected changes follow years of lobbying from commodity industry executives for clearer rules. The lack of clear foreign investment policy for the exchanges, for example, prompted MCX to postpone plans earlier this year to raise about $65 million through an initial public offering, according to Mr. Shah. He suggests the foreign institutional investment limit should be on par with the banking sector, where total foreign ownership can reach as much as 74% of equity.
K.P. Krishnan, a joint secretary in the finance ministry, says his ministry is in consultations with the Ministry of Consumer Affairs to determine how much foreign direct investment to allow in local commodity exchanges. Some Indian media have speculated that the government will allow a maximum of 26% total foreign equity in any Indian commodity exchange, but Mr. Krishnan says no decision has been made. He says he expects the government to announce a decision in several weeks.
New Delhi's moves on commodity trading reflect broader reforms unfolding in the Indian economy, as investment barriers in other sectors -- from telecommunications to aviation -- are dismantled.
Still, some analysts caution about taking down barriers too quickly before regulatory powers are strengthened. Regulators, for example, need to improve methods of detecting price manipulation, these analysts say.
Regulators themselves are also recommending a cautious approach.
"Everything has to be done in a gradual process as the [commodity] market is too young," said Mr. Sundareshan, the chief commodity regulator.
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