Commodity Online
NEW DELHI: The Indian government decision to impose the commodities turnover tax (CTT) on futures trading will considerably dampen futures business in commodity exchanges, says a study from the Confederation of India Industry (CII).

Finance Minister P Chidambaram had proposed in the Budget a tax of 0.017% on the seller of a commodity contract and 0.125% on the buyer. Besides, a service tax of 12% on the exchange levy and an education cess on the tax are also planned.

Commodity exchanges, brokers and the apex Forward Markets Commission have opposed CTT saying it would adversely affect futures trading in commodities.

Now, a study released by CII says implementation of CTT would lower the volume of futures trading in the range of 18 per cent to 59 per cent, depending upon the commodities, within a short span of just seven days of its imposition.

CII conducted the study over a sample of five major commodities for a period of two years (May 2006-April 2008). It says if the CTT would have been levied on May 1 this year, the maximum decline would be felt in gold (59 per cent), followed by crude, (57 per cent), chana (56 per cent), copper (53 per cent), and refined soybean oil (18 per cent) in just seven days.

Presently, traders on the exchange incur an average transaction cost of about Rs two per lakh. ''No country in the world levies transaction tax on commodities, and hence when it is implemented in India, there is a fear that it would render domestic futures market uncompetitive vis-a-vis the global markets,'' CII says.

Pointing out that the imposition of CTT would increase the transaction cost to the extent of more than eight times, the study forecasts a sharper fall in the volumes in the range of 93 per cent (chana) to 36 per cent (copper) in a longer term of two years.

The imposition of CTT would also lead to lowering of the trading activity which, in turn, would reduce the volume of transaction on the commodity exchanges and hence, increase the cost of hedging thereby adversely affecting the process of price discovery, CII said.

Thus, the reduced trading interest will also make the commodity markets more volatile, which is the risk a liquid futures market is supposed to eliminate by reducing volatility, the Chamber said, adding that increased volatility will lead to more speculative activities and will make the commodity exchanges to fail in their objectives of price discovery and resource allocation.

The study says the domestic commodity derivative markets, which are currently establishing their position on the global map to emerge as 'price setters' in Asian time zone, will eventually become uncompetitive thereby resulting in shifting of the commodities futures trade to the unorganised platforms or to the global exchange platforms as commodities are global asset classes.

''It will eliminate our chances of being 'price setters' and we would always remain 'price takers' much to the disadvantage of the Indian economy,'' the study highlights.

As the Indian economy opens up to currency transactions, the trades will have stronger potential to cross the borders than what has been estimated, leaving the prices of commodities that we consume to be largely determined by international markets, states the study.

Finally, if the increase in tax collection is the prime objective of the proposal, the study doubts whether imposition of CTT would facilitate the same.

On the contrary, it may prove to be counterproductive for revenue collection due to the decline in trading volumes as has been estimated above, said the CII.