Undermining the market?

Commodities transaction tax may not achieve its ends

Futures trading in commodities in India is barely 10 years old, and neither adequately stabilised nor appropriately regulated. The commodities transaction tax (CTT) proposed in the Budget may, therefore, have a notable impact on such trading - although Finance Minister P Chidambaram has sought to blunt that to an extent by keeping agricultural commodities out of its purview. In any case, most transactions are in bullion, metals and energy products, which will attract a CTT of 0.01 per cent. Though the Budget has simultaneously allowed adjustment of the CTT against the commodity traders' business income by declaring commodity derivatives as non-speculative transactions, the incremental cost of transactions may still be substantial, pushing some players to look for other options. The fear is that the commodity traders may either shift to trading on the foreign commodity bourses or resort to illicit practices such as "dabba trading", where the deals are made outside the exchange platforms while using the price signals coming from the regular commodity exchanges. Such a shift may be most pronounced for bullion, where the additional transaction cost would work out to around Rs 300 per tradable minimum lot of one kg at present gold prices. Another possibility could be the diversion of speculative energy to CTT-exempt agri-commodities.

If the motive for this measure is to restrain gold imports, it is unlikely to work. The presence of a reasonable proportion of speculators and day traders in the commodity derivatives markets is not undesirable: they create liquidity and also serve as risk bearers. Since the actual delivery in the case of derivatives trading is extremely low, it obviates the need for stocking gold. Hedging the risks through futures trading, in fact, is believed to encourage the participants in the physical market, including jewellers, to not accumulate stocks in excess of the firm demand. Most day traders operate on thin margins and may be unable to bear the higher transactions cost post-CTT.

However, regardless of the merits and demerits of imposing the CTT on non-agricultural commodities, the fact remains that such a move should have followed, and not preceded, the strengthening and revamping of the commodity sector regulator, the Forward Markets Commission (FMC). In its present form, the FMC is merely an appendage of the consumer affairs ministry; it lacks autonomy and powers of the kind the Securities and Exchange Board of India enjoys. Unfortunately, the Bill to amend the existing outmoded Forward Contracts Regulation Act, which seeks to strengthen and suitably empower the FMC, has been in limbo for a long time, despite having been widely debated and vetted by various committees. The government should get the amended law in place so that some of the unwarranted fallout of the CTT, including trading taking place outside the exchange platform, can be effectively dealt with.