About four years ago, around the time the Percy Mistry committee submitted its report on “Making Mumbai an international financial centre”, London-based think tank Z/Yen Group released its Global Financial Centres Index (GFCI) for the first time. Mumbai ranked low at number 39 among 46 financial centres. The index evaluates competitiveness of financial centres worldwide.
Last week, the ninth such list was announced. While only three Asian cities made it to the top 20 in the first list in 2007, as many as eight made it to the latest one. Mumbai, however, isn’t one of them. It still ranks a low 58 among 75 financial centres. Far from becoming an international financial centre, Mumbai is still a long way off from becoming even a regional financial centre. It ranks considerably lower than Shenzhen, Seoul, Taipei, Osaka and Kuala Lumpur.
A reason Asian cities did well in the latest GFCI study was that a majority of the respondents were from the region. That Mumbai ranked so low despite this advantage suggests a rather sorry state of affairs.
The Mistry report, of course, had a clear blueprint to transform Mumbai into an international financial centre. While some of its proposals, such as the establishment of a debt management office, introducing exchange-traded currency and interest-rate futures trading, and allowing algorithmic trading, have been implemented, a lot more needs to be done.
One of the recommendations that hasn’t seen the light of day is to eliminate securities transaction tax (STT) and stamp duties on financial transactions. It was recommended that as proposed in the Vijay Kelkar Task Force report, this needs to be done as part of the goods and services tax reform. The grand bargain proposed by the Kelkar Task Force envisaged that states should be willing to give up distortionary taxes such as the stamp duty, in exchange for tax revenues from all services.
In this backdrop, it’s interesting to note that last week the Maharashtra government decided to go in the opposite direction. It has increased the stamp duty on non-delivery transactions in the cash equities segment as well as for derivatives transactions by as much as 150%. For delivery-based transactions, stamp duty has been halved. Including the derivatives segment, non-delivery-based transactions account for over 90% of volumes, so essentially the markets have to grapple with a large increase in stamp duties.
Needless to say, STT continues to form the major portion of transaction costs. But stamp duty of 0.005% of transaction value isn’t negligible. For non-delivery trades in the cash equities segment, the exchange transaction fees is lower at 0.003%, and in the futures segment, it’s considerably lower at 0.00175%.
Excluding brokerage charges and service tax and related cess applicable on them, the total transaction stands increased by 17% in the case of non-delivery trades in cash equities and by 24% in the futures segment. Also, stamp duty charge will account for 24% and 36%, respectively, of transaction costs in the case of non-delivery cash trades and futures trades, respectively, compared with 11% and 16% earlier.
As pointed out earlier in this column, the outsized growth of the currency futures market and the index options market, where STT is zero and negligible, clearly shows market participants are sensitive to transaction taxes. When traders shift to segments of the market where transaction costs are lower, liquidity and discovery in other segments gets weaker.
Instead of building Mumbai as a financial centre by attracting various forms of market participants, policymakers are driving away certain segments of the market. Some brokers suggest at least proprietary trading operations may be shifted outside Maharashtra to benefit from lower stamp duty charges. This is clearly a case of going from bad to worse.
Policymakers need to wake up to the fact that transaction taxes create an unnecessary friction in the markets. This is not to say that there should be no tax whatsoever on financial transactions. But these should be applied on a uniform and non-arbitrary fashion.
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