Global Outlook

Without discrediting the government’s views on STT, those opposing it are also right in seeking the abolition of this tax

Contributed by Nirmal Bang

By Nirmal Bang

The ongoing debt crisis in Europe and the efforts by governments in the Euro zone to put their economies back on track has brought  to the fore the topic of financial transaction tax (FTT). Economists, policy groups and some nations have proposed the imposition of FTT to curb destabilizing speculation in the financial markets and increase revenue for the government.

While a concrete decision on this tax is awaited, speculations are rife that the Indian government may cut or completely roll back the securities transaction tax (STT), a version of the financial transaction tax. STT is levied on stock market transactions in India. However, it is facing stiff opposition in the country since it was initiated in the year 2004.

According to the opponents, the tax has only harmed the performance of the financial markets. It has reduced market depth and liquidity, increased market volatility, put downward pressure on asset prices, increased the costs for raising capital and also diminished competitiveness, the detractors argue.

Apart from the above mentioned issues, varying stamp duties in different states has also been a cause of concern since volumes get skewed towards certain states. Lower transaction costs for Indian products traded on the Singapore exchange is another bone of contention as volumes drift towards a foreign exchange without keeping Indian intermediaries in the loop.

Now, the question before us is  whether an emerging market like India, whose domestic savings rate as a ratio of GDP stands at 33.8% and equity penetration is as low as 2% of the overall population, needs a financial transaction tax like STT.

A host of transaction costs are levied in the equity markets. Therefore, won’t huge levies in the form of transaction costs, mainly statuary charges paid to central and state governments, curb the spread of an equity culture in the country? In fact, an investor has to incur costs under the following heads.

- Brokerage (payable to the broker who provides interface and executes trades)

- Exchange Transaction Charges (payable to the NSE/BSE)

- Depository Charges (payable to participant of NSDL/CDSL)

- SEBI turnover fees (payable to SEBI)

- Security Transaction Tax (payable to the government of India)

- Stamp Duty which varies from state to state (payable to the local government)

- Service Tax on brokerage (payable to the government of India)

From the above data, it is clear that while some of these charges go towards services provided by members and the exchanges, other  charges are statutory and regulatory in nature. Each of these impacts the overall cost of executing a trade on the exchange.

Table A illustrates the overall cost incurred by an investor for executing a trade for Rs.1,00,000. Since the various heads cause confusion in the minds of investors, a single head would have been better. The proportion of statuary taxes of the overall transaction cost is huge and a matter of concern.

Out of the total cost, nearly 55% is accounted for by various statutory levies. Further, STT alone accounts for 46% of the total statutory taxes/levies. This is extremely high when compared to the global markets.

Trades, where the brokerage is zero, the incidence of STT and other statutory levies are as high as 97% of the total cost, clearly rubbing the broking community the wrong way.

This keeps market players at bay, significantly hampering liquidity. Globally speaking, the total cost of trading is in the range of 9 basis points to 30 bps (100 basis points is 1%) of the traded value. However in India, with 27 bps, the trading costs are at the higher end of the range after China and Hong Kong, according to an IMF paper.

It may be noted that none of these countries have such high statutory levies, especially in the form of STT. Hence, from a global investor’s perspective, there is a huge cost advantage to invest in those markets.

Further, wherever STT exists, it is a very small portion of the total trading cost. Under such circumstances, there is a strong possibility of order flows moving out of India to other comparatively cheaper destinations.

Add to this, the treatment to STT, which allowed rebate against tax liability of a business entity, has been treated as business expenditure since 2008. This has increased the overall transaction cost, especially for arbitrageurs who purchase and sell the same security at the same time in two different markets to take advantage of a price difference. Such treatment has kept several arbitrageurs at bay, thus sucking liquidity from the markets.

From the governments’ perspective, STT earns the exchequer around Rs.6,000 crore to Rs.7,000 crore per annum; higher when the markets are higher and lower when the markets are lower.

There have been proposals to the ministry from the exchanges and  lobby groups to lower the STT; it looks unlikely that they would take any stand. If ever they plan to revisit the tax, they may do so only during the budget session.

Experts believe that there is a case for the government to revisit STT. In a cash-starved nation like ours where stock markets are characterized by traders, where even investment in the stock market is not fully explored and even the government waits for the right investor sentiment to tap the market, a lot needs to be done to lure investors. In fact, the government can  tackle these problems by first addressing the issue of Stt.