Page 274 - DCOM507_STOCK_MARKET_OPERATIONS

Unit 13: Commodity Market

Notes

Case Study Sugar Futures Range-bound; Stockists Still Buying

Securities Tax Damaging
The rationale for introduction of STT in 2004 was mainly to track transactions and minimise
tax avoidance. This move might have helped at that point of time, as tax infrastructure was
weak and helped mop up higher revenues with higher bouyancy. The other rationale for
introduction of transaction tax is that it is expected to reduce speculation and volatility,
and help markets discover efficient prices.

However, in the empirical literature, there are no widely agreeable conclusions that
support such an argument. At least, it is very difficult to establish that post-STT in India,
both speculation and volatility has reduced in Indian stock markets. But the adverse
impact of such taxes on trading volumes has been established by many studies.
This is found to have resulted in reduction in tax base as well as tax revenues. At the same
time, it discourages small savers and new participants from entering the market. Compared
with 2004, now India has a much better tax infrastructure. It is not clear how far STT can
still help reduce tax avoidance. This calls for a rigorous cost-benefit analysis of such
policies.
Recently, banks and others have argued for introducing CTT, so as to provide a level
playing field among all segments of financial markets. This would be more ruinous.
While acknowledging that banks are not allowed to enter the commodities market —
although they should have been — the alternative cannot be introduction of CTT.
There is no clear justification for introduction of CTT in India. The role of commodities
markets is quite different from securities markets; the former is more linked to the real
economy than the latter.
Real Economy Linkages

Unlike securities market, particularly the secondary market, commodity markets play a
major role in price discovery, and at the same time help both producers and consumers
hedge their risks, which are the basic functions of any futures market. They also help
formalise the otherwise hugely informal commodity markets that were deriving inefficient
prices and eroding the tax revenue base.
In India, although the volumes in the commodity market have increased over the period,
the participants’ base is still low. The transmission mechanism of prices and risks from the
futures market to producers are still evolving. With regular intervention in the market
(which is not there in securities market) and the low base of informed participants, these
markets need to be developed further with a better regulatory framework.
Moreover, this segment of the market is already disadvantaged by issues such as the
absence of tax exemption (both on income and capital gains), limited participation, among
other things. The median tax on the commodities traded is at 19.55 per cent, which is very
high. Any introduction of CTT at this stage could potentially result in undesirable and
not-so-efficient outcomes.

Food Inflation Effects
High food inflation since 2007 has been attributed to so-called speculative trading in
commodities market. Hence, it was argued that there is a case for introduction of CTT.
Contd...

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