More cons than pros?

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SummaryAlthough the Security Transaction Tax has been implemented by many nations, its effects have varied by country.

services during 1983-91. Statistics suggest that the trading of Swedish stocks inside Sweden as a percentage of turnover in other offshore exchanges averaged 61% in 1988, falling to 56% in 1990. Moreover, STT on Swedish fixed income instruments caused a migration to other domestic substitutes such as Swedish debentures. Another case is that of Taiwan, where reduction of the tax levied on futures transactions on the Taiwanese futures market from 5 to 2.5 basis points led to a significant reverse migration of trade to Taiwan from Singapore. A few econometric studies have found that stock market trading volume elasticities with respect to transaction costs normally range between -0.5 and -1.7.

Another impact of STT is on volatility. Depending on conditions, it could be either price stabilising or destabilising. One belief is that STT has a positive impact in reducing the activities of short-term noise traders who tend to deviate from the market fundamentals and destabilise prices. In general, however, STT affects all short-term traders in an indiscriminate fashion; hence, its overall impact on price discovery depends on the composition of traders. The tax might, thus, have an adverse effect on informed traders and liquidity providers leading to distortions in pricing as well as overall efficiency. Evidence suggests that price volatility actually increased in some countries post the introduction of STT. For example, in the case of China, volatility increased significantly after the revision in the stamp tax rate from 0.3% to 0.5% in 1997.

Available evidence for India since the imposition of STT corroborates the international experience. For instance, the FII exposure in Nifty futures traded on SGX outpaced that on NSE in the previous year and this has been attributed mainly to tax arbitrage. There is also some evidence available for the migration of volumes from the equity cash segment to substitutable domestic instruments such as options as the latter have a lower STT as compared to the former. For example, turnover (in notional value) in NSE stock as well as index options--both call and put--has increased at a rate higher than the turnover in the NSE cash segment. Total turnover for NSE stock options has increased from approximately R1.6 lakh crore in 2004-05 to over R10 lakh crore in 2010-11 i.e. by more than six times. The corresponding figure for NSE index options has risen by more than 150 times from approximately R1.2 lakh crore in 2004-05

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