Stamp duty on derivatives to hit commodity futures markets

The finance ministry?s proposal to introduce a stamp duty of R300 on commodity derivatives with a transaction value of

R1 crore may have emanated from two good intentions: to boost revenue and prevent speculative elements. And better still is its intention to bring back focus on futures trading. But imposing the extra burden on a nascent market, battered and bruised by frequent bans on various commodities and uncertain policy environment, in times of a global turmoil is certainly not the best of ideas.

Picture this: after introducing futures trading in 2003, the government banned the trading of wheat, rice, tur and urad in 2007 and followed it with restrictions on soyaoil, rubber, chickpea, potato, fearing its impact on inflation.

Commodity trading is already heavily taxed in the physical market in the forms of mandi tax, value-added tax and excise duties, and futures trading requires security deposits and high initial and special margin requirements.

A stamp duty on commodity derivatives, along the lines of the one planned for stocks trading, will only add to the cost, potentially dragging down the transaction level.

There are some key issues here: First, commodity trading is no stocks trading, and any rationalisation of government policy must factor in the differences.

Stock market participants solely stress profits from soaring share value, while commodity market players operate with the twin-objectives of risk managements at a micro level and price discovery at a macro level.

Second, any fall in transaction due to a stamp duty will have a salutary effect on the revenue mop-up too, apart from crushing the nascent market by driving out players. Past experiences show the Delhi government suffered a loss when it introduced a stamp duty in 2010, while Gujarat gained, with a 43% more revenue collection, when it reduced the duty drastically by 90%.

States such as Haryana, West Bengal, Tamil Nadu and Andhra Pradesh, which don?t impose any stamp duty, witnessed significant rise in the range of 50% to 392% in futures turnover in the fiscal year through March, industry data showed.

The government had to scrap its planned Commodity Transaction Tax in 2009 after persistent protest by the industry about its adverse impact on a nascent market, but the proposal adequately reflected the government?s growing perception of the commodity market as a “cash cow”.

Third, posing hurdles in commodity futures may jeopardise the country?s growing bargaining power in the price-discovery mechanism of key items globally.

China has realised the need for a greater say in global commodity pricing and has started pumping in money through a Hong Kong-based commodity exchange, and if India continues to fiddle with its commodity markets, it will have to follow futures prices of commodities–which act as reference rates for many import and export deals–set in exchanges in New York, Chicago or London despite being a key producer, importer and exporter of several items.

Fourth, making trading through commodity exchanges more expensive will encourage illegal dabba trading and will, ultimately, defeat the very purpose of a vibrant futures market in India.

Fifth, before mulching this “cash cow”, the government must assess its own contribution towards shaping the commodity market.

The commodity market in India has mostly grown despite the government, and the country must act towards supporting it with effective policies and infrastructure to realise its own aim of being a global economic super power. An urgent need in this direction would be to give more teeth and autonomy to the regulator, the Forward Markets Commission, by amending the Forward Contract (Regulation) Act, 1952.

Sixth, The government must soon make up its mind on whether futures trading triggers a price rise to be able to formulate and implement appropriate policies.

Despite the Abhijit Sen panel report, which concluded that there was no evidence to suggest futures trading led to the price rise in 2009, policy makers keep weighing the option of banning futures trading of some farm commodities in times of high inflation. Needless to say that the stubbornly high inflation level in the past two years has been primarily triggered by items that are not traded on exchanges.

Last but not the least, every farmer knows it, and the government needs to value the practice now: if you wish to reap the fruit, plant a seed first, nurture it properly, give it adequate time to grow, keep it away from every damaging factor and pluck it only when it?s ripe.

The dynamics of the commodity futures market are no different. Whether or not the Cabinet approves the finance ministry?s proposal, preventable haste in reaping the fruit shouldn?t be allowed to destroy the tree itself.