Imposition of commodities transaction tax has led to a flight of trade to dabba trading or illegal market
By Divya Malik Lahiri
The finance minister, P. Chidambaram, had dropped the bombshell about imposing the commodity transaction tax in commodity exchanges in Budget 2008-09. Although the official notification is still awaited, the real impact of the move is already being felt.
Sources in the commodity exchanges and the regulator Forward Markets Commission say that a large share of business in the commodity exchanges is actually shifting to the grey market. Estimates suggest that the three main commodity exchanges in India, MCX, NCDEX and the Ahmedabad based NMCE are losing around Rs 7,000 crore of business every day, because traders have opted for the dabba market.
According to the budget announcement, a trader will have to pay Rs 17 Rs for a Rs 1 lakh contract. The amount may appear small but has huge implications because small players trade on small margins. They could end up paying more taxes than what they earn through futures contracts.
Sources say the logic is very simple. It’s the small players who provide liquidity in these exchanges and if they start moving to illegal trade or to international exchanges, liquidity in the exchanges gets affected, which in turn leads to distorted price discovery.
Ashok Mittal, vice-president and country head of leading trading house Karvy Comtrade says: “Lots of people who do arbitrage on exchanges work with very thin margins, hence implementation of commodities transaction tax will drive them away from exchanges which will reduce liquidity in exchanges. Volume and liquidity will come down because of high CTT costs.”
The shift of trade to dabba trading is bound to have a huge dampening effect on the commodity markets in India, which is still a nascent industry and is already reeling under the impact of the ban on trading in eight agricultural commodities. Internal surveys suggest that CTT is causing not only a shift to dabba trading, but also a shift to international exchanges. Nowhere in the world is a commodity transaction tax levied — only a securities transaction tax, which is much lower.
The second major implication of the move is that the government loses major revenue. A trader in a formal commodity exchange has a proper client number, so his transactions can be easily tracked. Any wrongdoing can be detected by tax authorities and the relevant government departments. But if he trades illegally, he can’t come under the government’s scanner and it is extremely difficult to track down his transactions.
Says Sanjit Prasad, senior Vice President, business development at the Multi commodity exchange, the biggest exchange for bullion in India, “With the commodity transaction tax, the basic objective of a commodity exchange gets defeated, that is hedging and price discovery. It will give impetus to illegal trade, wherein the government will lose revenue more than it intends to get through commodity transaction tax”.
The third major implication of the shift to dabba trading is that there are major risks involved for the participants in dabba trade, because there is no exchange involved which can take the counter party risk. To put it simply, when a trader trades through an exchange, he puts in a margin money, which is 5 to 10 per cent of the value of the contract.
That money is used for risk management by the exchange , incase there are defaults. But in dabba trading there are no margins that are deposited, high volumes are traded and there is no one to bear the risk, incase of defaults by a person who has suffered losses. So the one who earns a profit in that contract can’t recover the profit because there is no one to guarantee him the profits.
Despite these risks, people are being encouraged to shift to illegal trading, because they don’t want to bear high CTT costs.
The Forward market commission chairman B C Khatua admits that CTT is a serious problem and he has taken up the issue with the Consumer Affairs Ministry, the nodal Ministry for commodity exchanges. He says”WE have investigated a few cases and we have found that the tendency is on the upswing to shift to dabba trading. CTT is unprecedented in the world, it is creating insecurity. People who think CTT will be notified soon have apprehensions and that is affecting the volumes of official exchanges.”
Of the 20,000 crores of business in a day in the main official exchanges, atleast 7000 crores a day is being lost to dabba trading.
Over the last two years, trading has been banned in 8 agri commodities and Mr Khatua feels that that is having an equally dampening effect on the commodity markets.
IN February 2007, trading in wheat, rice, urad and tur was banned and then again in May this year 4 more commodities, potato, soya oil , rubber and chana were banned.
Sources estimate that NCDEX , the main platform for agri trading has lost about 3000 crores business every day due to the move.
So CTT has come as a final blow to the commodity markets . A recent report of ICRIER has also suggested that CTT is not levied anywhere in the world and this is making Indian commodity markets the costliest in the world, in terms of transaction costs. ICRIER also says that global case studies have shown that increase in transaction costs leads to increased price volatility and reduction in liquidity and volumes. This has a negative impact on market efficiency and shifts volumes to dabba trading and international exchanges, the report said. ……
Sources in the Consumer Affairs Ministry say that Minister Sharad Pawar does NOT want the notification on CTT to be issued and has been trying to convince the Finance Minister of the negatives of such a move.
The ball is now in the Finance Ministry’s court and till Mr Chidambaram takes a final call, the commodity exchanges and the traders will be on their tenderhooks.