Dampening the Bourses

As a child I often heard doctors say that how fast one recovers from an illness depends on one’s physical and mental health. It sounded strange to me then, since I thought it was the doctors’ prescription which should make the difference and not the patient’s qualities. What use of the doctor if I need to recover on my own? As I grew older and mellowed, I realized the wisdom in the argument. The doctor I now visualize is our finance minister and the patient the Indian stock markets. A few bouts of “illness” and this doctor’s “treatment” has made this amply clear. Given the sentiment of the world equity markets, one would have presumed that the Finance Minister would desist from any moves which would further dampen the bourses. The present budget hasn’t made any earth shattering changes, but given where we are, the few changes in Short Term Capital Gains (STCG), Dividend Distribution Tax (DDT), Securities Transaction Tax (STT) and Commodities Transaction Tax (CTT) may not go down well with the bourses. Before we argue on the merits, let us first understand the changes.

STCG tax has been increased from 10% to 15%, which implies that any shares sold (after having been held for less than a year) will now attract 15% taxes on the gains made. The STT paid by traders will no longer be offset against their total tax liability. This will now be eligible for deduction from taxable income instead. Transactions in the commodities market will attract CTT similar to STT in the equity markets. Service tax has been imposed on some of the services provided by the stock exchanges. Having imposed all these taxes, the budget has also alleviated a little bit of pain wrongly inflicted through the earlier budgets. Changes have been made in DDT so as to prevent double taxation and STT on options will now be charged only on the premium unlike in the past where the tax was levied on the contract value.

The two positives are logical, given that they were undoing past mistakes. The increase in STCG isn’t fundamentally flawed, but the question is timing. All over the world, short term trading gains are charged at rates much higher than 10% and that is reason enough for us to have to increase STCG tax at some point in time or the other. But given the sentiment prevailing in our equity markets at present, this move is likely to further reduce trading volumes, thereby making transaction costs higher due to low liquidity. Similarly the changes to STT accounting will make the cost of arbitraging even higher. Added to that is the service tax on exchanges. Hence the overall markets will see an increased transaction cost thereby further dampening the volumes on the bourses. The worst hit would be the commodities market, where the lack of depth in trading volumes will only be furthered by the CTT.

STT and CTT are charged on the transactions in securities and commodities markets and have to be paid irrespective of profits made and hence is likely to squeeze out short term investors. The budget has made the bourses less attractive for arbitrageurs and traders. Healthy markets require a right blend of investors, traders and arbitrageurs. The present budget might have unwittingly upset the balance owing to the poor timing of what may otherwise have been right moves.