Short-sighted: Govt rewards traders over investors

Clearly, the government thinks of implementing market reform measures only when it has its back against the wall. And even then, it ends up helping the wrong segment of investors.

The latest proposal by the finance ministry to consider tax cuts on equities and foreign exchange trading to lower transaction costs and broaden investor participation in a market battered by dismal global sentiment is an example of just that.According to media reports , the ministry is mulling a cut in the securities transaction tax (STT) as well as a cut in stamp duty on futures and options trading in equities to 0.003 percent and on forex derivatives trading to 0.0001 percent.

[caption id=“attachment_93359” align=“alignleft” width=“380” caption=“The idea of the proposals is to spur more trading interest in the stock markets. Reuters”] [/caption]

Currently, STT ranges from 0.017 percent to 0.125 percent depending on whether the transaction is in the derivative or spot (cash) segment. The stamp duty on stock market transactions differs from state to state; the finance ministry has proposed that the rate be made uniform across states.

The idea of the proposals is to spur more trading interest in the stock markets, especially among foreigners at a time when persistently high inflation and the threat of a recession in developed markets has scared away investors. Foreign investors have pulled out a net $26 million since January from India’s equity markets, highlighting the fact they have been net sellers this year. That compares with $17 billion in investments in 2010.

There’s no doubt that these cuts have their benefits, because transaction costs of buying and selling shares in India are among the highest in the world. There’s just one problem though: these proposals are likely to benefit traders the most.

Is that the group of people the government really wants to encourage in the equity markets?

Long-term investors and retail investors don’t trade that often, so the securities tax was never a big issue with them in the first place. The attempt to pump up the markets with such a tax cut will, therefore, not attract buy-and-hold-stock investors, who are the target group the government should really be going after.

Even more problematic is the issue of frequent changes in the STT rate; it’s been changed quite a few times since it was first introduced in 2004-05. Again, not a good thing. Investors like stability in tax and regulatory regimes, and frequent changes, however good, can make investors adopt a wait-and-watch attitude to see what the government does next. The result? Inhibited investments.

Of course, the government being the government, is not always gifted with such foresight. Its reason for introducing these changes is more likely to lift short-term sentiment in the markets to help ensure its own divestment plans in state-run entities are received favourably. With a widening fiscal deficit (exacerbated by an increasing oil bill and subsidies because of the plunging rupee) and dwindling tax revenues, the government is desperately scrambling to collect some cash.

At the start of this financial year (April-March), it had nursed high hopes of raising Rs 40,000 crore from divesting its stake in various government-owned enterprises. But choppy markets have limited that fund-raising to a piddly Rs 1,144 crore.

Yet, left with no other recourse, the government looks set to plough on with its divestment plans. An Economic Times report said that initial public offers from companies such as Hindustan Aeronautics, India’s largest defence aviation company might be launched soon,while bulk sales of equity of cash-rich state-run firms to domestic financial institutions could also be considered. As an extreme step, cash-rich state-run firms could be directed to buy the government’s stake in other public-sector firms.“We have asked the disinvestment department to get back with a plan B,” a senior finance ministry official was reported as saying.

Well, given the dire situation, we might even have a Plan C soon. Such desperation rarely gives rise to long-term market reforms. Indeed, all the government wants is some cash from the markets, even if means making traders happy. Never mind these traders could be the same ones hammering stocks later when it suits them.

The government doesn’t care. It needs the money now.