We were surprised by the editorial ‘Transaction costs: If the securities transaction tax must stay, it needs to be more broad-based’ (IE, February 25). The editorial advocates that the transaction tax levied on securities needs to be extended to commodities and, to an extent, to currencies , to reduce not only the fiscal deficit, but also the alleged distortions in the economy. The truth is that price discovery takes place not so much in equity derivatives as in commodity derivatives. Equity derivative trading is mostly confined to options in equity indices. The so-called price discovery in these index options is of little use for price risk management to institutional investors, who trade in them. Price discovery in commodity derivatives is vital for effective price risk management in that prices quoted for derivative contracts serve as the base (reference) prices for forward physical purchases and sales in both domestic and overseas markets, and are also the prices at which such purchases and sales can be hedged. Such hedges are absolutely efficient.
The commodity transaction tax (CTT) will drive away day traders, who account for the bulk of the trade volumes in commodity derivatives. They assist in efficient hedging by physical-market functionaries, since they are not only willing to absorb hedges at the prevailing futures prices, but also ensure low bid-ask price spreads, which constitutes an important element of transaction costs for hedging costs. As day traders operate on thin margins, CTT will render their trades uneconomical. They will desert the commodity markets. In their absence, the bid-ask spreads will rise, making hedging of all hues far from cost-effective. Physical-market players will then have little option but to recover the cost of their price risks (risk premium) by paying a lower price to the producer, and charging a higher price from the consumer, leading to higher marketing and processing margins, which, when spread to the entire supply chain, will have a cascading effect on the prevailing inflation in the economy.
Incidentally, the imposition of CTT on gold will make the market, bereft of low-cost risk management for a large number of jewellers, traders and SMEs engaged in the jewellery industry, uncompetitive in the export markets. CTT on energy will lead to the same fate for distributors of diverse petroleum products. Already, commodity derivative markets have generated nearly two million jobs. Insofar as CTT causes the demise of commodity derivative markets, the livelihood of nearly two million families, or 10 million people, will be adversely affected. Not only will the exchequer not earn any revenues from CTT, its net revenues will decline drastically, following the loss in income and other taxes to both the Centre and states.
The editorial ignores the fact that, unlike stock market traders, commodity players don’t enjoy such tax benefits as concessional shot-term capital gains tax and zero long-term capital gains tax. The gains and losses from commodity derivative trades are also considered as speculative gains and losses, and are not allowed to be offset by other business losses or gains. Stock market players benefit from such offsets, as all their trades are regarded as hedging transactions, even though they are not. Moreover, unlike stock exchanges, institutional players, including banks, are not allowed to trade in commodity derivatives. Options and index trading are also not permitted on commodity exchanges. It requires no sixth sense to predict that broad-basing the transaction structure to include commodities and currencies will destroy commodity exchanges, without adding any coffers to the Central government. The fiscal deficit will only widen, with net loss in revenues, following falling incomes from the participants in the two markets.
The writer is founder and group chairman, Financial Technologies (India) Ltd