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Uncertainty brings fluctuation in the market, which is extremely good for trade. And today, there is nothing more uncertain than the weather; so estimating the weather and betting on it can be a good hedging tool, a means to reduce financial risk. This will benefit not only weather-dependent businesses but also institutions related to the agriculture sector, as well as the farmers associated with these institutions.”
This was shared with Down To Earth (DTE) by Jatin Singh, managing director of Noida-based private weather agency Skymet.
Skymet is helping India’s key agricultural commodity exchange, the National Commodity and Derivatives Exchange Limited (NCDEX), prepare a weather index. Singh says the formula used for the index cannot be shared. “Rainfall and temperature data of about 100 years has been collected. Data from India Meteorological Department has also been included. The weather index will be prepared on the basis of these data. The work has been completed from our side, but it is yet to get the green signal from the Securities and Exchange Board of India (SEBI),” says Singh.
There has been talk of weather futures trading in India for more than a decade now. But this year, on March 1, the Department of Economic Affairs under the Union Ministry of Finance issued a notification to expand the list of commodities to include weather derivatives. Later on July 23, Union finance minister Nirmala Sitharaman also mentioned the decision in her budget 2024-25 speech.
SEBI, too, has recommended to the Union Ministry of Finance to allow futures trading in an additional 11 commodities, including weather derivatives.
The proposed weather index will allow investors to bet on the level of rainfall and temperature (whether these will be normal, above normal or below normal) on a future date. These parameters will be defined in the index. “Government departments, weather agencies and farmers begin predicting about the weather of June in the month of February. They try to gauge whether there will be a drought, normal rain or flood-like situation. If an individual assesses these predictions and bets, say, on drought; and later in June the individual’s farm suffers damage due to drought, then his or her loss will be compensated by the gains he or she makes on the trading platform. This is called hedging, that is, reducing financial risk,” explains Diwakar Mishra, a Delhi-based trader. “An index prepared on the basis of weather data can actual-ly be useful for the Indian economy because sectors like agriculture and tourism are heavily dependent on the weather. The weather index will not only increase the options to reduce risks, but also encourage agriculture and weather-related industries to increase their participation in the commodities market,” says Ajay Suresh Kedia, founder of Mumbai-based Kedia Capital Services Pvt Ltd. Agrees Yogesh Dwivedi, chief executive officer, Madhya Bharat Consortium of Farmer Producers Company Limited. “The more options are given to farmer-producer organisations to reduce their risk, the better it is,” he says.
According to the NCDEX website, the weather index works like other indices, but there are key differences. Unlike other commodities, physical settlement of weather derivatives is not possible; they do not have spot market price; the rule of demand and supply does not work on their prices; and weather indices like rainfall and snowfall cannot be traded throughout the year because they are seasonal.
“Internationally, the snowfall index is used in North America and Europe. India needs different and indigenous parameters, like monsoon rain or heat index. There is a possibility of crop damage in case of excessive rainfall or drought. Sudden increase in temperature affects the yield, as was seen in the case of wheat crop last year,” Arun Raste, managing director and chief executive officer, NCDEX, tells DTE.
Experts also say that weather markets create new opportunities for developing countries to deal with two basic issues. They help deal with disaster risks and promote new private-based insurance prod-ucts for weather-dependent sectors.
However, the benefits of this move cannot be a reality unless the weather index is technically sound. Raghav Raghunathan, who is pursuing a PhD on risk and resilie nce of smallholder farmers from the Netherlands-based Wageningen University and Research, tells DTE that “basis risk” is very important in any index. Ba-sis risk is a technical term that indicates a mismatch between the average (temperature or rain, for instance) of a particu-lar place and the index. “If the basis risk is high, with low geographical granularity, then not too many people are likely to use the index,” says Raghunathan. “For example, farmers were somewhat disillusioned with the Pradhan Mantri Fasal Bima Yojana because they were paying high premiums but the index used to assess their losses was not accurate. In such situations, the area the index covers and the volume of high-level data it is based on play a decisive role in its suc-cess,” says a former NCDEX employee on condition of anonymity.
The weather index still has many stages of assessment before it is available. “The launch of weather derivatives is still being studied by the exchange. After this, consulta-tions will be held with users as well as external stakeholders,” says Raste. “For the index to succeed, an exhaustive regulatory framework and market infrastructure is needed. SEBI also has to assure people about its transparency,” Kedia says.