CTT to bleed commodity traders. Economic Times 27th March 2008

The Budget for FY09 has introduced two measures that would affect the working of commodity markets. The first is the commodities transaction tax (CTT) and the other is service tax. All new taxes naturally hurt the taxed entity, but when it can upset the trading applecart then it is more serious. The CTT is to be 0.17%, which is around five and half times the charges being imposed by commodity exchanges on the transactions. The ostensible reason is that since the market is well developed, it can be brought on par with the securities market with a similar tax rate being imposed. The immediate response has been one of umbrage as prima facie it appears that the traders would see a positive disincentive in trading in this market. How can this affect trading? The peculiarity of the market is that basic liquidity is created by day traders or jobbers, which in turn attracts hedgers and speculators. The jobber rarely holds on to the position for long and would move out as soon as possible. In fact, they would normally look at the minimum variation in price, which is in their favour and would offset the transaction to make their profit. They are not the thinkers, who look at the fundamentals and then take trading calls. Now the price movements in case of the commodities, especially agriculture, is extremely low. The tick size of contracts is as low as 5 paisa for copper, soy oil or mustard and 10 paisa for castor or 20 paisa for gur. Intuitively it can be seen that these jobbers would be putting in their orders at these minimum price variations. These price spreads are very thin here, given the nature of the commodities and the markets. Under normal conditions, when there are no harvests or harvest news in the air, price movements would be minimal and this tick mark would be relevant for traders. Given the uncertainty in waiting, the jobber would be reluctant to hold on to any position for a longer period and would exit with this minimum price movement. The new cost being imposed would make him rethink. This is juxtaposed with the profit that can be made by the trader/jobber by trading this minimum lot size when the price moves up by the tick size, which varies between commodities. The same can be ballooned up for multiple contracts when the quantity traded is larger. To evaluate the cost impact, the service tax impact, though marginal, has been added to the CTT cost. The service tax is assumed to be imposed on a service charge of 0 .01%, which is imposed in the market on an average by brokers. The option for the trader is to either wait for a better tick price change or exit at a loss. The former is always an option, but given the nature of the jobber, it may not be too attractive as one is carrying a higher risk of adverse price movement while waiting. It would make sense to move out of the market, rather than take the risk or make a loss. The repercussions on the market would be felt in case the lower participation of this class leads to declining liquidity that can impact the participation of other players who may not find it too attractive as liquidity dwindles even though they operate with a longer-term view in mind. This would affect liquidity, particularly in the less liquid commodities and even the liquid ones in the off-season periods. It is not surprising that the commodities market is dissatisfied with these twin measures, where the CTT in particular does not get an offset benefit and accounts for over 90% of the new-cost burden.