Anjani Sinha

The National Stock Exchange (NSE) is the uncrowned king of the stock market, its rival, the Bombay Stock Exchange (BSE) trailing by a huge margin, with no other competitor visible on the horizon. But some recent data relating to Nifty volumes on NSE vis-a-vis SGX (Singapore Stock Exchange) are disturbing. In particular, the unprecedented growth of Nifty volumes on the SGX over last four months is sending alarm signals.

The comparative data of Nifty futures and options on both the Exchanges is given in Table 1. The NSE has always been the exchange of choice. It has captured more than 90 per cent of the business volumes of stock market operations and has considerable depth and liquidity in Nifty futures and options contracts. Therefore, prima facie there is no valid reason for the traders to shift their business to any other market.

But recent data clearly reveals that traders have taken a stance to shift business from the NSE to the SGX. Nifty futures and options volumes on the SGX during the last four months are almost equal to the total volume recorded at SGX during the last year (2007-08), which is disturbing. Even the open interest in Nifty futures contracts has seen a phenomenal increase in the last four months.

In fact, the recent shift of Nifty volumes from the NSE to the SGX is directly attributable to the impact of STT. The Finance Act, 2008 has changed the treatment of STT from tax rebate to business expenses, which makes jobbing unattractive.

After the change in treatment of STT, the cost of operations at both the Exchanges is shown in Table 2. Since the cost of operation is lower at the SGX, most of the international participants now prefer to trade on the SGX rather than the NSE. Although there are other significant reasons why the hedge funds prefer the SGX for trading in Nifty futures (such as trading in dollar terms and eliminating risks relating to exchange rate fluctuation), the STT does significantly influence the decision to shift business to the SGX.

Though this business shift holds good only for Nifty futures and options, it is still worrisome. Stocks as well as individual stock futures and options are traded only on the NSE, which has a virtual monopoly. But, as the Nifty F&Os alone constitute more than 25 per cent of the NSE turnover, shifting of Nifty volumes will severely impact the overall NSE turnover.

Moreover, it is detrimental to investors’ interests, as reduction in volume will make the market more vulnerable and volatile. In fact, if some basic market parameters are changed, there is a chain effect in the market structure, as detailed below:

The higher cost of operations and shifting of business to parallel exchanges decreases the depth in the market.

This makes alternative markets more lucrative, providing more depth, less impact cost and, that too, at lower transaction cost. Participants then start shifting to alternative market places.

As a result, any bulk transaction creates abnormal fluctuations in the market. This creates both-way price movements in the market on the same day and also leads to sudden spikes in the market.

Such spikes are hazardous for investors and traders. If the cost of transaction is less and there is no STT, there will be more depth in the market, which implies less volatility.

This is the scene when only one instrument traded on the NSE is listed on the SGX. If all instruments traded on the NSE are made available on the SGX or, for that matter, on any other international stock exchange, the results would be devastating.

The cost of trading Nifty futures was in any case higher compared to the same with respect to other index futures available elsewhere, but with the implementation of STT, it just goes beyond limit.

Now, imagine the case of commodity exchanges, where 80 per cent volume comes from those commodities listed on one or the other international commodity exchange. If the commodities transaction tax (CTT) is imposed on commodity derivatives in India, the entire Indian commodity derivatives market will naturally be exported to respective international commodity exchanges that provide similar products.

Empirical studies have been done on this subject in past. Almost every study concludes that the levy of transaction tax has negatively impacted the financial markets.

In May, 1997, the Chinese government increased the securities transaction tax from 0.3-0.5 per cent. Its impact on the behaviour of the Shanghai and the Shenzhen stock exchanges was studied to assess the impact of the trading volume and net tax realisation on the return volatility. The study concluded that the volatility increased significantly in both the Shanghai and the Shenzhen stock exchanges after increasing the transaction tax.

Studies also concluded that the tax revenue did not increase as much as the proponents of the tax expected. Investors reacted to the increased tax dramatically. Post transaction tax increase, in Shanghai, the volumes decreased 38.47 per cent, and in the Shenzhen stock exchange, it fell 32.79 per cent. The decrease in trading volume significantly offsets the increased tax rate.

The impact of a Swedish regulatory move to impose transaction tax was the migration of business from Stockholm to London. According to a study by Swedish researcher S. R. Umlauf in 1993: “Transaction taxes and the behaviour of the Swedish stock market,” published in Journal of Finance and Economics, following the doubling of the tax, 60 per cent of the volume of the 11 most actively traded Swedish stocks migrated to London.

The migrated volume represented over 30 per cent of all trading volume in Swedish equities. By 1990, that share increased to around 50 per cent. According to Campbell and Froot (1995), only 27 per cent of the trading volume in Ericsson, the most actively traded Swedish stock, took place in Stockholm in 1988.

In 2005, Robin K. Chou and George H. K. Wang carried out a study on “Transaction Tax and Market Quality of the Taiwan Stock Index Futures”. Their findings support the argument that transaction taxes have a negative impact on trading volumes and bid-ask spread. Analysis further finds no support for the argument that a transaction tax may have the benefit of reducing price volatility. The findings suggest that market participants changed their trading behaviour before and after the tax reduction.

Based on the above, the simple conclusion one can draw is that CTT should not be levied on commodity derivatives market. Rather than justifying CTT based on STT, it is desirable to withdraw STT. After all, repeating a wrong action does not make it right.

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