Im­por­tance of Risk Man­age­ment in Cot­ton Value Chain

A cru­cial in­sti­tu­tion in the ecosys­tem of cot­ton is the fu­tures mar­ket of this com­mod­ity, which has been play­ing a great ben­e­fi­cial role for all stake­hold­ers in the en­tire ecosys­tem, from farm­ers to gin­ners to tex­tile mills, by pro­vid­ing an ef­fec­tive plat

Dalal Street Investment Journal - - COMMUNICATION FEATURE - Mru­gank Paran­jape MD and CEO, Multi Com­mod­ity Ex­change of In­dia Ltd.

C ot­ton is one of the prin­ci­pal crops grown in In­dia and ac­counts for a third of In­dia’s farm sec­tor GDP. The area un­der cot­ton cul­ti­va­tion cur­rently con­sti­tutes al­most 7% of the to­tal area un­der agri­cul­ture in In­dia. Cot­ton is also called ‘white gold’ be­cause of its eco­nomic sig­nif­i­cance. It is a ba­sic raw ma­te­rial for the tex­tile in­dus­try, which has an over­whelm­ing pres­ence in the eco­nomic life of the coun­try. In fact, the In­dian tex­tile in­dus­try is highly var­ied, with the hand-spun and hand­wo­ven sec­tor at one end of the spec­trum and the cap­i­tal in­ten­sive, so­phis­ti­cated mill sec­tor at the other. It is due to its large do­mes­tic pro­duc­tion that cot­ton ac­counts for 75% share in the to­tal fi­bre con­sump­tion in In­dia. In con­trast to the world con­sump­tion pat­tern of tex­tile fi­bre, which is tilted to­wards non-cot­ton fi­bres in the ra­tio of 3:4, the con­sump­tion ra­tio in In­dia is 2:1 in favour of cot­ton.

PRICE RISK IN COT­TON

In­dia be­ing one of the main par­tic­i­pants in in­ter­na­tional cot­ton trade, the com­mod­ity, as well as its user in­dus­tries, viz. tex­tiles, are ex­posed to risks in volatil­ity in cot­ton prices which arise from both do­mes­tic and in­ter­na­tional fac­tors. With in­creas­ing glob­al­i­sa­tion of the In­dian econ­omy, price risk in cot­ton has in­creased. If this price risk is not man­aged, it can quickly get trans­mit­ted to the en­tire value chain of the com­mod­ity. The size of this risk is it­self quite hu­mon­gous. Given the an­nual In­dian mar­ket size of cot­ton at ₹60,000 crore and an an­nu­al­ized volatil­ity of 18.34% in cot­ton prices wit­nessed dur­ing 2016, the in­dus­try is ex­posed to a price risk of more than ₹11,000 crore.

A cru­cial in­sti­tu­tion in the ecosys­tem of cot­ton is the fu­tures mar­ket of this com­mod­ity, which has been play­ing a great ben­e­fi­cial role for all stake­hold­ers in the en­tire ecosys­tem, from farm­ers to gin­ners to tex­tile mills, by pro­vid­ing an ef­fec­tive plat­form for risk man­age­ment and by ef­fi­ciently dis­cov­er­ing prices. Hedg­ing of cot­ton us­ing fu­tures con­tracts can help play­ers elim­i­nate or sig­nif­i­cantly lower their price risk ex­po­sure.

MCX COT­TON FU­TURES

Un­der­stand­ing the need of the In­dian cot­ton value chain par­tic­i­pants to hedge their risks, the coun­try’s largest com­mod­ity ex­change, MCX, com­menced fu­tures trad­ing in cot­ton on Oc­to­ber 3, 2011. The MCX cot­ton con­tract with 25 bales (11.95 can­dies) as the trad­ing unit has a ba­sis sta­ple length of 29 mm, with fa­cil­ity to de­liver 27 mm–31 mm at ap­pro­pri­ate dis­counts/ pre­mi­ums. MCX cot­ton con­tract is unique in that it is based on in­ter­na­tion­ally ac­cepted tech­ni­cal spec­i­fi­ca­tion of cot­ton, while the ba­sis along with a de­liv­er­able range rep­re­sents more than 75 per cent of the cot­ton grown in the coun­try. MCX cot­ton is a com­pul­sory de­liv­ery con­tract with pro­vi­sion to de­liver at des­ig­nated ware­houses across sev­eral cen­tres.

CRITICALITY OF HEDG­ING

Hedg­ing en­sures sta­bil­ity to farm­ers’ in­comes as well as the in­dus­try by giv­ing pro­tec­tion against price risk and

un­cer­tainty; sup­ports sus­tain­abil­ity of busi­nesses, es­pe­cially the small and medium en­ter­prises which play a pre­dom­i­nant role in the tex­tiles or ap­parel sec­tors. All in all, it gives a ma­jor fi­nan­cial boost and sta­bil­ity to farm­ers, traders and work­ers in the cot­ton in­dus­try. Thus, cot­ton price risk man­age­ment is cru­cial for sta­bil­is­ing in­comes of cor­po­rates, farm­ers and the econ­omy at large. Even if re­duc­ing risks may not al­ways im­prove earn­ings in the short run, fail­ure to man­age risks has di­rect reper­cus­sions on the risk-bear­ers’ long–term in­comes, mar­ket sta­bil­ity and, in case of cot­ton, fi­bre se­cu­rity. The im­por­tance of risk man­age­ment against cot­ton price un­cer­tainty, there­fore, is a crit­i­cal re­quire­ment, which can­not be un­der­mined.

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