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
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.