Indian Financial Markets Scenario

Report
June 2014
And then there’s the proposal for a Financial Transactions Tax... Even to
be considering this at a time when we are struggling to get our
economies growing is quite simply madness
-- David Cameroon, British Prime Minister

Average Daily Volumes across the Globe in May 2014:
Country
MCX, India
Shanghai, China
CME, USA / LME, UK
Gold (Rs.
Crore)
Copper (Rs.
Crore)
3,975
1,075
37,415
116,500
128,740
148,200

China is 9 times India and U.S. is 32 times India

We aspire to be among the world’s leading industrialized
nations but the volumes of Copper, the flagship industrial
metal, in China is 108 times India & in London 137 times
India

How much Gold can you buy at best available Sell Price & Vice
Versa without a change in Price?
SHFE China
CME U.S.
Country
MCX India

You Can Sell
You Can Buy
Kgs
Rs. Crore
Kgs Rs. Crore
China
155
40
391
99
U.S.
106
25
115
28
4
1
2
0.5
India
At a Single Price, you can buy just Rs. 0.5Cr worth in India while
you can buy Rs. 99 Cr in China & Rs. 28 Cr in U.S.
Cost of Hedging 1 Cr.
Gold
Future
Metal
Future
Gold
Future
Any Comm.
Future
Head
CME
LME
China
India
Exchange Fees
150
350
400
210
GST/ S. Tax
0
0
0
26
Stamp Duty
0
0
0
200
CTT
0
0
0
1000
150
350
400
1436
Cost per Cr.
Company
Commodity
Hindalco
Aluminium
Hindalco
Copper
Sterlite
Copper
90725 MT Buy & 90425 MT sell actual (Rs 8300 cr )
Sterlite
Gold
62478 ounces buy & 143779 sell actual (Rs 1580 cr)
Sterlite
Silver
603152 ounces buy & 2295815 sell actual (Rs 343 cr)
BPCL
Crude Oil
Rs 79612 cr import; hedge not disclosed
HPCL
Crude Oil
Rs 55934 cr import; hedge not disclosed
IOC
Crude Oil
Rs 184558 cr import; hedge not disclosed

Cost of Hedging is significantly high in
India as compared to globally

Large Corporate have massive hedging
requirements. Most Large Corporates
are hedging more than 90% of their
needs in International Markets

If large Companies can find hedging
attractive in India, it will save millions of
$ in foreign Exchange, increase
employment in Indian financial sector,
make our market vibrant and increase
Government service tax collections.

Vicious circle: CTT is reducing liquidity &
increasing hedging costs and hence
these companies are finding India too
expensive & shallow to hedge. Non
participation by these companies is
further reducing the liquidity.
Hedge Activity abroad
353350 MT actual hedged yr end (Rs. 4452 cr
approx)
72400 MT actual hedged yr end (Rs 3342 cr
approx)
If we can abolish CTT & make our exchanges attractive to these companies:

A huge amount of margin money in Foreign exchange can continue to be in
India and benefit the system

Liquidity in our markets will deepen and allow other industries like
extrusions , plastics and so many others to hedge their risks

Huge saving of Millions of Dollars paid out by these companies in foreign
exchange towards brokerage , commission , exchange charges

Increase in employment in Financial sector in India

Increase in service tax and other revenues to Govt.
Rank
Exchange
Notional
Value(bn USD)
1
USA
36000
2
CFFEX
12034
3
EUREX( euro stoxx 50)
9692
4
EUREX(DAX futures)
8223
5
Korea Exchange
7087
6
NYSE LIFFE(FTSE 100)
2481
7
JPX (OSAKA) NIKKEI FUTURES
2228
8
NYSE LIFFE(CAC 40)
1637
9
JPX( OSAKA)
1488
10
TAIFEX
1246
11
MOSCOW EXCHANGE(RTS INDEX FUTURES)
947
12
NYSE LIFFE(FUTURE AEX INDEX)
866
13
BM&FBOVESPA(BOVESPA INDEX FUTURE)
681
14
EUREX( SMI FUTURES)
603
15
NYSE LIFFE(FTSE 100)
495
16
NSE INDIA(CNX S&P NIFTY)
399
Source: WFE/IOMA Derivatives Market Survey 2012

India Benchmark Index ( Nifty
Futures) investments lowest in
the World .

Investors who want exposure
in any country can buy a
Benchmark Index Future.

It will give them exposure to
the Index without the expense
of purchasing all the underlying
assets on the Benchmark
Index.

India might be in one of the top
derivatives exchanges but only in
number of contracts. In notional
value, we are one of the lowest in
G20 and lowest in BRIC Countries

USA leads the table with 36000
bn USD, about 90 times that of
India. China is 30 times

To measure the health of a market, most economists recommend:
Turnover Ratio
for a year
Country
=
Total Trading value of all shares in that year
Average of (Opening Market Cap and Closing Market Cap)
2003
2012
% Growth
H. K.
48
123
156
Brazil
34
68
101
China
83
164
97
Russia
46
88
92
S. Africa
45
55
21
Japan
88
100
13
U.S.A.
123
125
2
France
95
66
-30
139
55
-61
India
Source: The World Bank,
http:// data.worldbank.org/indicator/CM.MKT.TRNR

Ratio is used by World Bank for comparing countries with
varied GDPs and Market Caps

Data for 9 years starting 2003, a year before STT

Brazil, Russia, China have grown 92% to 101% over 9 years
while India has shown 61% degrowth

In developed countries, France which introduced FTT is
showing degrowth as compared to a stable U.S. and
Japan

At 2012 end, India’s turnover ratio was 55 compared to
average of 94 for the sample with China’s ratio being 164
Low Turnover Ratio is affecting liquidity and
investment flows in Indian industry
Year
Value
(in Crore)
%age
Growth
2004
93432
2005
623575
2006
2025665
2007
2729821
34.76
2008
4284653
56.96
2009
5956656
39.02
2010
8696870
46.00
2011
14932852
71.70
2012
14890596
Jan to Jun 13
Jul to Dec 13
Jan to 6th Jun 14
% change in Impact cost
from pre CTT to post CTT
Gold
Copper
Crude Oil
10.30 am
16%
28%
33%
12.30 pm
123%
-
-1%
2.30 pm
-49%
16%
62%
4.30 pm
65%
-25%
109%
6.30 pm
37%
208%
-59%
-0.28
8.30 pm
80%
120%
159%
7356793
-1.19
10.30 pm
34%
87%
147%
3376412
-54.10
2344004
-68.14
Average
Increase in
Impact Cost
34%
55%
49%
The volumes have crashed by 60% post CTT regime
* Volumes above are those on MCX
Source: Working paper on Impact of Transaction Taxes on
Commodity Derivatives Trading in India by ICRIER
STT makes our trading
cost 5 times the cost of
trading in Singapore

Head
Singapore

35%
India
190
30%
Exchange
Fees
231
GST/ S. Tax
16
23
Stamp Duty
0
200
STT
0
1000
10%
SEBI TOT
0
20
5%
247
1433
0%
Cost per Cr.
Result: Singapore NIFTY Volumes as a %of total NIFTY
has breached 30%, directly affecting growth of our
financial markets and employment
25%
20%
15%
2006
2007
2008
2009
Source: Bloomberg
Volumes of SGX and NSE are normalized to equivalent quantity, Currency factor has been taken at 50
2010
2011
2012
2013
2014Q1
SGX volume as % of total volume
Because Derivatives are a form of insurance or risk management, the cost of
trading in them has to be low or investors will not find it economically sound to
purchase such "insurance" for their positions

It is shocking that open interest on
NIFTY Futures worth Rs. 32352 Cr sits on
foreign soil & is higher than that on NSE
with Singapore having 60% market share
If this trade is retained in India:

The margin Money of Rs. 2543 Cr
will be in India and benefit the
system

These volumes will be great add to
the market depth and reduce
impact cost

It will enhance employment in
financial sector

Increased Service Tax Collection on
brokerage coming to Indian Firms
instead of foreign counterparts
80%
70%
60%
50%
40%
30%
20%
10%
0%
2006 2007 2008 2009 2010 2011 2012 2013
SGX OI as % of total OI

Explicit Cost of Delivery Trades in Cash Market
Nature of Cost


Payee
Brokerage
Broker
TOT
Cost /
Cr. (Rs)
Cost Breakup
Weight (%)
Govt.
Broker
5000
29
Exchange
325
2
Exchange
Service Tax
Govt.
658
4
SEBI
Stamp Duty
Govt.
1000
6
STT
Govt.
10000
59
SEBI TOT
SEBI
20
0
Total Cost
17003
100
Add: Impact Cost
6000
Total Cost
23003
•Out of total explicit cost 68 % goes to the
government. How can any Industry
survive after paying 68% to the
government?
•STT Constitutes 58 % of total explicit cost
•Broker only get 29 % of the explicit Cost
To buy securities worth Rs 1 Cr, buyer incurs Rs 23000 which is very high
STT first directly increases cost itself and then increases cost indirectly as the impact
cost increases dramatically.

Live Mint: 22nd January 2014
 15,000 sub-brokers have gone out of business since April 2013: SEBI.
▪ 30,000 sub-brokers have closed down since April 2011
▪ Reason mainly due to dwindling interest from retail investors and
tighter regulations
▪ Brokers also out of business, number fell by 600, highest in 3 fiscal
years

Financial Express: 09th July 2013
 Stock Market: 14,000 sub-brokers shut shop
▪ Worst time for a sub-broker
▪ Cash Market volumes plummeting to record four year low
▪ Declining Retail Interest
▪ Surviving business has increasingly difficult

Mutual Funds saw net outflow
in Equity Schemes & cannot
fund long term equity needs of
midsize companies
50,000

65
46933
60
40,000
55
30,000
50
20,000
45
10,000
4024
2149
121
0
40
Retail Active Investor Participation
directly into markets is also down
hugely. FII Participation is most
desired but not their domination in
absence of a counter force
62.97
55.63
54.86
49.17
40.47
38.85
35
-10,000
30
-13138
-20,000
2007-08 2008-09 2009-10 2010-11 2011-12
MF Equity Mobilization (in Crore Rs.)
Source: SEBI Handbook
25
2007-08 2008-09 2009-10 2010-11 2011-12 2012-13
Retail Participation in Stock Market (%age of Total)
Active
retail
investors disallowed
88E tax rebate, face
double taxation &
have
stopped
providing liquidity
Rules do not allow
Institutions to invest
in Low Turnover and
High Impact Cost
Companies
Investor
putting idle
money into
non
productive
Gold
GROWTH

Against 42595 Cr raised in
2007–08. Average of next 4
years only, Rs. 25963 Crore
2007-08
42595
2008-09
2082
2009-10
35559
2011-12
41515
0
10,000
20,000
30,000
40,000
IPO Mobilization (in Rs. Crore)
Source: SEBI Handbook
New SME Market not even properly
born

NSE SME Market inaugurated in Sep
2012, in 2years:
•
Only 5 Cos Listed
•
Raised only 86 Crores
•
Total Turnover only 40 Crores
Issue Size
Rs Cr
Turnover
Thejo Engineering
19
1
Veto Switchgears
25
35
Opal Luxury Time
13
1
MITCON Consultancy
25
1
4
3
86
40
Company
24696
2010-11

50,000
Sanco Industries
Total
Average number
of Shares per day
No. of
Cos
< 10000
337
> 10000 & < 20000
139
> 20000 & <50000
201
> 50000 & <100000
145
> 100000 & < 200000
146
> 200000
523
Total No. of Cos
1491

More than 65% of Companies trade less than 2
Lakh shares a day

476 cos ( 31% ) trade less than 20,000 !!

As a result, Strong Fundamentals
of
companies Ignored due to low liquidity as
Investors avoid stocks with no exit, i.e. low
liquidity, high impact cost caused by STT

Data is for 15th May 2014 to 14th June 2014
when the Index and Market Cap was the
highest

Top 6% of the total listed companies
dominate 82% of the turnover




Earlier farmers, just after harvest, were selling their crop to the processors at distress prices
who were making super normal profits
Cynics say that farmers do not trade in India. But prices disseminated by NCDEX, FMC and
MCX help the farmers know the correct price and ensure that processors pay them the right
price
Also, efforts by NCDEX and MCX have ensured that an ecosystem of huge no. of modern
warehouses along with laboratories and assayers. This safe system has encouraged modern
financial players to deploy funds in cash and carry arbitrage with a return expectation of 15%.
This far lower than the traditional moneylenders who used to rip off farmers , growers.
Financiers are storing in warehouses and are selling in the market in a staggered manner
according to demand instead of all at harvest time
Jeera
Production
Castorseed
Oil Export
2006-07
185000
CASTOR
SEED MEALS
EXPORT
202175
2007-08
175000
339475
2008-09
152000
305000
203915
2009-10
176000
340000
240466
2010-11
190000
343254
209036
2011-12
218000
404489
341308
2012-13
275000
430752
383392
2013-14
375000

Earlier exporters could not take firm export orders
as they were not confident of getting confirmed
supplies at a fixed price. Now, exporters are buying
far month futures and are able to quote firm prices
and deliver schedules to overseas buyers . All this
has ensured that Castor Seed exports from India
have greatly grown in last 5 years along with the
exchange ecosystem.
Figures in Crores
F.Y.
CM
TO
CM-NON ND
STT
TO
STT
No of
Scripts
Traded
Index and Stock FUTURE
Market
Capitalisation
TO
STT
Index and Stock Options
TO
STT
2004-05
11,91,364
316
7,38,646
56
870
15,85,585
22,56,203
127
2,90,779
17
2005-06
18,89,667
1,738
11,71,594
127
956
28,13,201
43,05,452
573
5,18,722
69
2006-07
22,44,170
2,814
13,91,385
362
1,191
33,67,350
63,70,541
1,185
9,85,701
168
2007-08
40,29,072
5,178
24,98,025
626
1,264
48,58,122
113,69,230
1,974
17,21,247
293
2008-09
29,82,904
3,610
18,49,400
502
1,327
28,96,194
70,49,753
1,201
39,60,729
131
2009-10
44,49,216
4,871
27,58,514
758
1,968
60,09,173
91,29,635
1,552
85,34,029
121
2010-11
38,77,777
4,653
24,04,222
601
1,607
67,02,616
98,52,510
1,675
193,95,709
136
2011-12
29,89,141
3,587
18,53,267
463
1,807
60,96,518
76,52,668
1,301
236,97,062
166
2012-13
28,73,436
2,758
17,81,530
445
1,683
62,39,035
67,51,003
1,148
247,82,001
173
2013-14
29,88,601
2,869
18,52,933
463
1,768
65,17,421
80,34,577
803
301,91,011
211
Data Source Nse
2011-12 to 2013-14 are Approx figures

Post u/s 88e removal from 2009 onwards Turnover has fallen continuously
across all segments though Market Capitalization has increased.

When STT was bought in, official reason was in lieu of it, Capital
Gain Tax benefit is being given. But no such benefit was given in
lieu of CTT and hence there is no rationale for the birth of CTT.

People are paying indirect taxes:
 excise on Manufacturing,
 service tax on Services,
 and VAT on sale.
 And Direct Income Tax on Profits.

Then, what is the nomenclature of CTT ?
 Thus, CTT is an entry level regressive tax and an albatross around the neck
of market liquidity. It is a mindless collection of revenue lacking any basis.

STT was brought in with NIL Long Term Capital Gains Tax. However, people in Trade and
Commerce, who are assessed under “Business Income”, in any case, pay full 30% Tax and
Surcharge both for Equities and Commodities. They are not eligible for any benefits on
Capital Gains

So paying CTT & STT and direct Income Tax at 30% leads to effective taxation rates
upwards of 80%

Section 88E withdrawal from April 2008 led to huge fall in Market Volumes
and Government collection of STT

Till 31st March 2008, STT was treated as tax rebate under section 88E and the market was
somehow able to cushion the impact of STT slightly. However, the withdrawal of 88E and
consequent double taxation completely broke the back of the market and huge fall in
volume. STT Collection on delivery dropped from 5178 Cr in 2007-08 to 2869 Cr in 2013-14

Worldwide in any Business there are 2 types Taxes:- Manufacturing(Vat, Excise,etc) or
Service Tax. Derivative trading doesn’t come under Manufacturing and our Sector pays
service Tax. STT is nor a manufacturing tax or service tax so it should be removed.
Studies
Sample
Type of
reform
Measure
of Liquidity
Result for
liquidity
Hu (1998)
H.-K.,Japan,
Korea,1977-93
STT
Turnover
Inconclusive
Baltagi et al. (2006)
China 1997
STT
Volume
Negative
Chou & Wang
(2006)
Taiwan 1999-2001
STT
Volume,bid-ask
Negative
Liu (2007)
Japan 1989
STT
Autocorrelation
Negative
Foucault et al.(2011)
France
1998 to 2002
Cost of
forward
Auto covariance,
Amihud
Negative
Pomeranets &
Weaver 2012
U.S. 1932 to 81
STT
Holden spread
Negative

Among major nations across the world, there is no FTT/ STT except India and
Taiwan
Country
Futures
Options
Country
Futures
Options
Australia
na
na
Russia
na
na
Brazil
na
na
South Africa
na
na
Canada
na
na
South Korea
na
na
China
na
na
Hong Kong
na
na
France
na
Na
Singapore
na
na
Germany
na
na
Switzerland
na
na
Japan
na
na
Taiwan
6bps on Index
10-60 bps on
premiums
India
0.017% of
delivery Price
0.017% on
premium,
0.125% on strike



Welfare of India should be Government’s prime objective
Its decisions should not be influenced by revenue considerations alone
It needs to be a balance between market growth and revenue collection
Continue with STT/CTT
Collect Revenue
of Rs 4000 Cr.



Boost Growth
1. Increase market liquidity
2. Bring back exported markets
3. Kick start fundraising by
Industry
4. Increase Employment
People say Govt. will never abolish STT & CTT as it yields Rs 4000 Cr.
At National level, Rs 4000 Cr is not big. It is less than what TCS earns in 1 qtr
It is too small a price to pay for the prosperity of nation

The Government should abolish CTT & STT and treat this Rs.
4000Cr as a historic national investment to take our markets to
a much higher level.

Like any good investment, this investment will yield huge returns over time.

The removal of these regressive taxes will hugely reduce the impact cost in markets and
greatly increase the liquidity. There will be huge gains resulting from deepening of
National Markets & benefits to entire ecosystem due to linkages with the economy e.g.






Fund raising by industry ;
Channelizing of household savings in productive assets
Disinvestment by Govt.
Employment Generation
Taxes on profits of individuals and corporations due to buoyant economic conditions
Huge Increase in Service Tax because of Increase in Brokerage & Turnover.
Instrument
Current Rates
Request
Rationale
Equity
Futures
Rs 1000/Cr. on sell
Abolish or Rs50/Cr. for audit trail No tax on hedge instruments anywhere in the world;
Equity Options
Rs 1700/Cr. on sale on
premium
Abolish or Rs50/Cr. for audit trail No tax on hedge instruments anywhere in the world;
Revenue
Loss (Cr.)
800
200
Rs 12500/Cr. on
Equity Options
underlying value to
Exercise
buyer of option
Abolish or Rs5000/Cr. on
underlying value to buyer of
option
To Save tax partly , people square up open interest
Equity Cash
Delivery
Rs 10000/Cr.
on buy and sell
Abolish; or Rs 5000/Cr. only on
sell
Tremendous boost needed for shallow cash market
2100
Equity Cash
Non Delivery
Rs 2500/Cr.
only on sell
Abolish or Rs50/Cr. for audit trail
Enable liquidity provider to reduce impact cost by
providing tight bid ask
460
Commodity
Futures
Rs 1000/Cr. on sell
Abolish or Rs50/Cr. for audit trail
No tax on hedge instruments anywhere in the world;
Huge scope to build commodity eco system
600
For Indian taxpayers assessed under Business Income, paying
30% slab rates & not claiming Capital Gains, section 88 E tax
rebate should be restored

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