Commodity transaction tax not a prudent idea

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Surender Kumar: Feb 22 2013, 03:56 IST

This will increase the price volatility, with potentially cascading destabilising impacts on the physical markets. Again, by increasing the cost of participation, CTT will also shift trading volume either to the overseas markets or to the illegal markets, which are relatively low-cost destinations.

It is a double-whammy for hedgers as CTT will increase both the direct and indirect costs of hedging. While directly the cost-incidence will increase in proportion with amount of tax imposed, there will be an indirect cost, too.

This will be in the form of higher risk premiums to speculators, due to reduction in volume, increasing the aforementioned bid-ask spreads. As such, hedging instruments like commodity derivatives are extremely sensitive to costs of transactions. A study in China has revealed that an increase of 0.2 percentage points in stamp duty reduces the trading volume by a third. Similar evidences are available in other hedging markets like forex and interest rate derivatives.

According to a study by Icrier, the proposed CTT of 0.017% in the 2008-09 Budget (which was withdrawn in the next Budget) was supposed to increase the transaction costs by more than 950%. The study examined the relationship between volume, volatility and transaction cost for five selected commodities — gold, copper, petroleum crude, soya oil and chana. It inferred a negative relationship between transaction cost and liquidity, and a positive relationship between transaction cost and volatility, similar to results found in hedging platforms worldwide.

Two other arguments are also forwarded by the proponents of CTT, without any basis. It is

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