Stock and commodity exchanges in India will never disappoint you. Normally, when they are not fighting among themselves for the market share, they are fighting against each other over other ‘taxing’ issues. The battle lines are drawn in the bourses over a transaction tax. Only, this time, old rivals National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are on the same side and commodity exchanges led by Multi Commodity Exchange (MCX) are on the other side.

It all started a few weeks ago when Jignesh Shah, the promoter of MCX group, crossed swords with Ashishkumar Chauhan, BSE’s new MD & CEO, over two kinds of taxes: STT or the securities transaction tax that is levied for every trade on the stock exchanges (BSE, NSE) and CTT, or the commodities transaction tax that you don’t have to pay if you are trading on the commodity exchanges (such as MCX). 

The fight between the bourses is, thus, one for a level-playing field. The stock exchanges contend that commodity exchanges are hurting them badly because the presence of STT coupled with the absence of CTT are driving investors away from them towards the commodity exchanges. So they want a level-playing field. They are thus demanding that finance minister P Chidambaram should either introduce a matching CTT or remove STT (which now varies between 0.017 and 0.125 percent) in the upcoming budget to remove the “unfair” advantage that the commodity exchanges now enjoy. The BSE has said in many recent conferences that commodity trading was eating into the equity pie, as statutory costs were high in the equity segment.

The commodity segments, on the other hand, have their own grouse about level-playing fields. Shah argues stock exchanges are allowed to trade in options, which gets them more business. Additionally, foreign institutional investors (FIIs) and banks are allowed to trade in equities but not in commodities which makes it an unequal play.

Why was STT levied?

STT, a brainchild of finance minister P Chidambaram, was introduced to compel foreign institutional investors (FIIs) to pay tax in India. A majority of the FIIs had until then avoided paying tax on income as they were registered in countries with which India has signed a double tax avoidance treaty or agreement (DTAA). STT also allowed the government to keep a tab on trading volumes being generated in the country. However, there was a twist in the tale when Chidambaram changed the tax treatment for STT in 2008. Prior to 2008, STT was allowed as a rebate against tax liability if the income from securities on which the tax was levied was included under the head ‘profits and gains of business and profession’. This allowed brokers to pay less tax and generate more volumes. In 2008 he discontinued the rebate. This was also the turning point for commodity trading in the country where no such tax was levied.
In the same year (the budget of 2008-09), Chidambaram also introduced CTT saying that transactions in commodity futures had come of age. But it was never notified following serious lobbying by commodity exchanges and the food processing and consumer affairs ministry which hollered that CTT would hurt agri markets, a concern that seems misplaced for reasons we shall get to in a while.

How commodity exchanges and MCX gained an edge:

Post change in the STT regime, trading volumes in the commodity segment saw a significant jump since 2008. On the other hand, volumes in both cash and derivative side of equity segment took a beating. Day trades generate 70-80 percent volumes on the exchanges and tend to migrate to an ecosystem where the cost of trading is lower. Thus, market experts believe, Chauhan is not completely wrong in saying that commodity exchanges were eating into the equity pie because of the higher transaction cost in this segment.

This proved to be a golden period for MCX and its promoter Shah, who is known for his lobbying skills with politicians cutting across party lines. The average daily trading volumes on Shah’s MCX rose by 40 percent every year since 2008 as jobbers and arbitrageurs flocked to the commodity segment. Turnover figures bear this out. The average daily securities turnover on stock exchanges nosedived from Rs 59,615 crore in FY 2007-08 to Rs 43,118 crore in FY 2011-12, a decline of 27.67% over four years. In the same period, the average daily non-agricultural commodities futures turnover rocketed up from Rs 10,277 crore to Rs 50,147 crore in the same period, a growth of 387.95%.

It was mainly on the back of futures trading in bullion, metals and energy contracts, that MCX scripted its success story – not so much on trading in agri futures – allowing it to get a better valuation during its recently concluded initial public offer. Agricultural futures make up just 12 percent (average over six financial years, see table 1) or just one-eighth of the total futures trade in commodities. But when the topic of CTT is brought up, the commodities exchanges raise the spectre of causing an upheaval in the agri markets to stall CTT because tinkering with farmers is a touchy political issue. It is precisely for this reason that the even those who argue for CTT want the tax to cover only non-agricultural commodities. Even this suggestion the commodity exchanges are unwilling to accept because such a separation (between agri commodities and other commodities) will rip off their protective shield against CTT.

There are also reasons to believe that the concern for farmers or agri markets is only skin-deep. Firstly, even as the commodity exchange are thriving, the share of agri commodities as a percentage of the total futures trade has been dwindling over the years, from 19.5 in 2007-08 to 11.8 in 2012-2013 (Table 1). Secondly, as per the Forward Markets Commission (FMC) data, more than 99.9% of all trades on commodity exchanges, including agricultural commodities, are speculative in nature and are NOT delivered. That means futures in commodities is a kind of satta which, one can argue, hurts the farmers by manipulating prices of spot markets through futures. The Left parties have vehemently opposed futures in agri commodities because while there is not enough  evidence to show it has benefited the farmers directly, there is enough reason to believe that it has had some part to play in driving food inflation up in the last few years.

That established (99.9 percent of all trade in commodities is speculative), the stock exchanges argue, there is little difference between financial derivative instruments such as equity, bonds etc and commodities derivatives and hence they should be taxed similarly. Commodity markets players vehemently disagree. They argue that they perform the crucial role of providing the industry with a transparent hedging platform. They say both exchanges have different functions. While equity markets provide for capital appreciation, commodities help stakeholders hedge against adverse price movements and also keep food prices in check. Hence, comparing the two is like comparing oranges and apples. As MCX managing director and CEO Shreekant Javalgekar said in a signed article in The Financial Express, the stocks markets’ demand for CTT is “akin to a private cement company requesting the ministry of finance to impose a tax on the steel industry or akin to an airlines player seeing the airline business going down asking for a raise in railway fares”.

Smartly put, but commodities markets cannot skirt some key facts. While stock exchanges help build capital for the growth of the economy, tax-free trading is helping commodities markets to grow in leaps and bounds thus locking up critical capital in unproductive bullion holdings. The bullion imports have also been contributing a third to India’s trade deficit (see table 2).  

Here is further reason to believe that unbridled commodities futures trading has fuelled an insatiable appetite for bullion. India’s forex reserves are 8.81 percent of China’s forex reserves yet its gold demand is more than that of China by 37.6 percent (see table III).

Stock brokers say that equity volumes are moving towards other trading segments like commodities shrinking the stock markets and the revenue generated for the government. They argue that if the taxation disparity persists they will yield more to the commodities markets and the government’s revenue from STT could come down to as little as Rs 1,000 crore from the highs of Rs 10,000 crore. However, if neither CTT is introduced nor STT removed, it may spell bad news for the stock exchanges. Government officials say while the finance ministry may not let go of revenue from STT, it may introduce CTT which will give it more revenue than the equity segment. Commodity futures volumes are double that of the equity segment. However, commodity markets may still flourish as Chidambaram has plans to introduce the Forward Contracts Regulations Bill. This will give autonomy to the commodity markets regulator and more freedom to the exchanges to launch new products like commodity indices and options trading.