In the Union Budget of 2013-14, the then Finance Minister of India, Mr. P Chidambaram, announced the introduction (or rather re-introduction) of 0.01 per cent Commodity Transaction Tax (CTT) on sale of all non-agricultural commodity derivatives. The FM’s decision was based on the premises that, “There is no distinction between derivatives trading in securities market and derivatives trading in the commodities market, only the underlying asset is different…” and hence there is a need to create a level playing field between both markets.
The Security Transaction Tax (STT), which had earlier replaced the Long Term Capital Gain Tax (LTCG) had fetched the government coffers a handsome revenue from the securities market. This led Mr. Chidambaram to believe that CTT, like its securities market counterpart, will repeat the same without any detrimental effect on the commodities market. Moreover, it had always been an unsaid agenda of the Government to dissuade speculators from participating in the commodity derivative trading. The FM justified this by mentioning, “…Trading in commodity derivatives will not be considered as a ‘speculative transaction’ and CTT shall be allowed as deduction if the income from such transaction forms part of business income…”. The concept of CTT was not new and was proposed for the first time at 0.017 per cent during the Union Budget of 2008-09. It was later withdrawn on the back of rising protests from traders who claimed that CTT will choke growth of the commodity derivatives trade which was still at a nascent stage. By 2012-13, the commodity derivatives trade had become a thriving business which seemed like an opportune moment for the Government to propose CTT once again. Unfortunately, this ‘proposal’ would turn out to be a fiscal faux pas in the coming times!
Upon introduction of CTT, the non-agricultural commodity derivatives market was severely hit and trade of non-agricultural contracts took a nose dive. Figure 1 shows the movement in the futures trade of metals derivatives on MCX between 2007 and 2016.
A closer look at the figure reveals a steady trajectory of growth in trade among most metals since 2007 till 2011-2012. Gold, silver and zinc reached an all-time high in 2011 although there was a marginal fall in the next year. Copper, nickel and lead registered highest trades in 2012. Market scenario started changing since 2013 with traders worried of CTT making a comeback. Due to fear of rising illiquidity in the market, most metals registered a considerable fall in trade in 2013. Trade hit an all-time low when CTT was finally implemented in July 2014. Heavily traded metals such as silver, gold and copper suffered the most amount of damage. The number of open contracts of silver in 2014 fell to 35897523 compared to 118104250 in 2011. For gold, the corresponding figures were 12876326 in 2014 compared to 79408721 in 2011. These figures clearly showed that there was a sharp decline in trade on commodity exchanges, which prompts us to ask the next important question which is ‘where did these traders go’?
It is a known fact that in the absence of a bullion spot exchange in the country, a lot of small traders and bullion merchants use the futures exchanges to hedge price risk. This in turn make the bullion futures exchanges responsible for transparent price discovery in the market. With introduction of CTT in the country, the cost of trading on domestic commodity exchanges shot up by more than two and half times. For example, the cost trading for 100 ounce of gold on domestic exchanges prior to CTT was INR 197. Post implementation of CTT, this amounted close to INR 525, suggesting a rise of 266 per cent in the cost of trading. When compared to the cost of trading in the US and Dubai market during the same time, it was found that trading on domestic exchanges in India was higher by 747 per cent and 828 per cent respectively. On the other hand, global data suggests that trade had steadily risen on global futures exchanges around the world in the same period. Under such circumstances, it would be safe to assume that domestic trade of bullion on exchanges might have moved out to the international markets. Interestingly, transaction fees (charged by the exchange) on the domestic exchanges (both MCX and NCDEX) are much lower compared to that of major exchanges in US, Dubai or China. This helped in keeping the cost of transaction lower in the domestic market, despite of other mandatory fee and taxes. But with the introduction of CTT the domestic exchanges lost this leverage. It is not hard to believe that under such circumstances, traders with the requisite know how and financial capacity would have migrated to the more economical US or Dubai market. (Readers will find it interesting to know that Dubai recently have started an “India Gold Quanto Futures” with nil transaction cost, zero capital gains tax and no INR exchange rate risk specifically targeting Indians).
Even if we overlook the global data and neglect the low cost of trading on the international exchanges, domestic trade had been hounded by the age old illegal over the counter trading (OTC) market, commonly known as “dabba-trading”. With rising cost of trade on domestic exchanges, dabba-trading might have lured most traders to take the easier route. Either ways, the Government has lost a sizeable chunk of revenue by implementing CTT. According to MCX estimates, the loss in revenue from the decline in turnover in 2014-15 would have been about INR 4800 crore, as compared to the baseline pre CTT year of 2012-13. In 2014-15, the collection from CTT was a measly INR 540 crore. This is justifiable as the implementation of CTT caused a serious dip in volumes of trade which in turn impacted other tax revenues such as income tax, service tax, TDS and stamp duty. This in other words proves that CTT is only revenue negative and in no way helping the Government in generating revenue of INR 1500 crores per year, as speculated.
Apart from the financial loss, CTT had a negative impact on the society too. According to a Deloitte report, a large proportion of the estimated 12-13 lakh population, directly or indirectly associated with the non-agricultural commodity derivative industry had lost jobs due to introduction of CTT. Fall of trade on exchange had led traders, brokers, agents and participants to let go off their business and move out of the sector. Further, due to the implementation of CTT, small traders looking to hedge a relatively smaller exposure now have to pay much higher price, compared to what he paid earlier. With a marginal profit from trade, one needs to be highly ethical and big hearted to pay a hefty fee and hedge through a legitimate way. If shutting shop is ruled out, we know the other option!
It is clear now that the attestation made by Mr Chidambaram in his speech during the Union Budget of 2013-14, claiming that “There is no distinction between derivative trading in securities market and derivatives trading in the commodities market, only the underlying asset is different…” had failed to account for the economic functions of commodity derivatives. Several economists and analysts have proved time and again that CTT by nature is a regressive tax and it should not have been implemented in the first place. But now that it has been done it is high time that the Government scrap it. Now it is up to the current Government to decide whether the country needs a competitive and flourishing commodity trade or an incompetent age old tax policy. The public is watching though.