Indian commodity exchanges have come a long way since their inception and are currently at par with all major global commodity exchanges. In fact, by 2013, India had one of the exchanges across the world in terms of trading volumes (ranking within the top 3 exchanges worldwide) when it came to trading in Gold, Silver, Natural Gas as well as Crude Oil reflecting increasing efficiencies in their basic functions of price discovery and risk management. However, a lot of it changed with the introduction of the Commodity Transaction Tax (CTT) by the Government of India from July 2013. The intent of introduction of CTT during FY 2013 – 2014 (for non – agricultural commodities) was to bring parity between the equity and commodity derivative markets. However, with CTT, transaction cost for a trader increased by about 5 times, causing the trader to rethink his/her options as the propose rate does not reflect volatility conditions of the commodity vis-à-vis equity derivative markets. This resulted in CTT having a significant negative impact on trading volumes of all commodities, leading to India’s global ranking dropping to lower levels.
Impact on Gold futures
Impact of CTT on Gold futures have been probably the starkest. While the total traded value in gold futures had steadily increased from 2005 to 2012, from about Rs. 1,80,000 crores to over Rs. 37,00,000 crores (from approximately 2650 kgs to 12,600 kgs); upon the introduction of CTT in July 2013, the trade value dropped to about Rs. 30,00,000 crores (volume dropped to about 10,600 kilograms). The negative effect was more startling in 2014 and 2015 with trade values dropping to approximately Rs. 12,50,000 crores and Rs. 11,70,000 crores respectively – a drop of about 67% from its peak in 2012.
Though first introduced in the Union Budget 2008 – 09, CTT was subsequently withdrawn and this had a huge positive effect on the growth of the Indian commodity exchanges. However, CTT was reintroduced in the current form in the 2013 – 2014 Union Budget – it came into effect from July 1, 2013 and is applicable to all non–agricultural futures trade; the rate being 0.01%. In this article, we attempt to analyze the objectives, results and impact of CTT on gold futures.
Effect on revenue generation
We first look at the revenue generation aspect of CTT. To do that, as a first step, based on past data, we attempted to project revenues that may accrue to the Government both with and without the imposition of CTT for three time horizons and compare the relevant pairs; the dates chosen are: immediate (till September 2016); short term (till December 2020) and medium term (December 2025). The projections are based on the existing data using time series forecasting methodology. Based on the projections, we then calculate the revenues that would accrue to the government, with and without CTT. Realistic assumptions about the share of propriety trading in gold futures market, exchange and broking charges, other taxes such as Service Tax, Income Tax etc. have also been considered.
We find that aggregate revenues to the government reduced after imposition of CTT, especially between July 2013 and Sep 2016. Compared to the scenario if there were no CTT, the government has lost approximately Rs. 385 crores as a result of the steep decline in turnover leading to shrinking base of other taxes. By 2025, the government potentially stands to lose about Rs. 4300 crores in aggregate if CTT remains in force. These numbers exclude income tax revenues from speculators’ profits; if this is also considered, the gap in revenues will be much higher.
Effect on liquidity
What has been the effect of CTT on liquidity in the gold futures market? Although the reduction in volumes would axiomatically reduce the market liquidity, we look at ‘Bid – Ask spreads’ for various levels in MCX gold futures across two days: January 21, 2013 (before imposition of CTT) and August 5, 2013 (after imposition of CTT) to gauge the severity of liquidity drying up.
Our analysis reveals that ‘Bid–Ask spread’ has steeply increased after the introduction of CTT for all levels considered, the increase in the lowest level being about Rs. 48 and at the highest level Rs.1200.
Loss of liquidity, and consequent rise in the ‘impact cost’ of trading, has possibly been encouraging traders to switch to international exchanges as the cost of transaction is lower there than in India and there are no transaction taxes in all major commodity markets. While this may be perfectly legal, the Indian government has been losing a source of revenue and over time, Indian commodity exchanges their global status. Besides the exchanges have turned inefficient in terms of hedging avenues defeating the basic purpose for which they were set up.
Based on our analysis, it is amply clear that CTT on gold futures has reduced the volumes to such an extent that government is losing more revenue than it is collecting by way of CTT. At the same time, it is adversely affecting liquidity, encouraging traders to seek opportunities in international or unorganized bucket shops. This is seriously affecting the potential of the indigenous commodity markets to grow and emerge as price setters for commodities in the world.
The government should have a relook at its CTT policy as it does not seem to be adding value to any of the stakeholders – government, economy, commodity exchanges, brokers or traders. On the contrary, the government should consider a reduction in this transaction tax (in line with other international exchanges) if not removal as this would make Indian exchanges globally competitive thereby increasing trading volumes significantly leading to higher revenues for the government through taxation on profits made by each player in the system. In effect, the amount lost due to reduction in transaction taxes will be more than made up by other taxes on the higher volumes besides putting Indian markets in the global commodities map.
 Data used is from MCX and is publicly available. As MCX handles more than 98% of the non – agricultural futures transactions, the exchange’s gold futures volumes therefore represent the market quite effectively.
*The writer is professor, finance and accounting, IIM-Bangalore