Budget and Markets: Will the FM spook the F&O party by hiking securities transaction tax?

Budget 2024:

With indices at new highs, retail participation in derivatives increasing at breakneck speed and F&O volumes dwarfing cash volume by 400x, the grapevine has it that another hike in securities transaction tax (STT) could be on cards this interim Budget.

Market regulator Securities and Exchange Board of India (SEBI) has been reminding participants that 9 out of 10 traders lose money in F&O, thus a hike in STT could increase hurdle rate and keep volumes in check.

Furthermore, as the government looks to boost tax collections to manage its fiscal position, its gaze may turn towards the stock market to mop up resources.

STT was introduced in 2004. It is levied on transactions involving various types of securities. All stock market transactions that involve equity or equity derivatives, such as futures and options (F&O), are liable under STT, as are mutual fund transactions.

The government expects to collect Rs 27,625 crore from STT in FY24, which is 10.5 percent higher than the revised budget estimate of the preceding financial year. It will account for about 1.5 percent of the direct tax collection estimate of Rs 18.24 lakh crore.

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It might look like a small drop in a big ocean, but at an individual level, investors and traders pay several other taxes, including Goods and Services Tax (GST), stamp charges, exchange transaction fees, and so on. Rajesh Baheti, Managing Director at Crosseas Capital Services, believes any further hike in STT might not sit well with proprietary traders that make up 40-45 percent of F&O volumes.

Currently, the STT rate for equity delivery is 0.1 percent on both the buy and sell sides. For equity intraday, it is 0.025 percent on the sell side. For equity futures, it is 0.0125 percent on the sell side. For equity options, it is 0.0625 percent on the sell side and 0.125 percent on exercise.

What happened last year?
As per amendments to the Finance Bill 2023, the STT on the sale of options was hiked to Rs 6,250 on a turnover of Rs 1 crore against Rs 5,000, while on the sale of futures contracts, the STT was increased to Rs 1,250 on a turnover of Rs 1 crore compared to the earlier rate of Rs 1,000.

However, volumes were not greatly impacted. Take a gander: NSE’s average monthly cash turnover for December 2023 was Rs 1.03 lakh crore, and for F&O, it was a whopping Rs 379 lakh crore. This is despite the hike in STT last year.

Also Read: Budget 2024: Could consumption stocks come back in favour post the interim budget?

Baheti says, “It might not have impacted last time, but there is always a tipping point. Two consecutive years of STT hikes can be detrimental to volumes. Last time, soon after the STT hike was announced, NSE rolled back the increase in its exchange transaction charges to offset some of the impact. NSE’s transaction charges have been at the same level for years now, and it won’t be willing to reduce any further from these levels.”

Will they, won’t they?
As STT on F&O was hiked last year, Rajesh Palviya, Head - Technical Research at Axis Securities, believes the probability of any further rate hike in the current budget seems feeble.

Independent analyst Manish Shah also concurs. “I believe that the probability of an STT hike is low, as it was already hiked in March 2023,” he said. “The government expected to collect about Rs 27,000 crore for FY24, and most probably this expectation will be exceeded, given the huge trading volumes,” he added.

Also Read: Budget 2024: Defence stock valuations are stretched but may rally if budget allocation is stepped up

Shah added that any hike can hurt market sentiment as the increase in the cost of transactions will hit the profitability of traders.

“The economy is doing fine, and the revenue collection by the government is very good. Any more burden on the trader community is not fair to the trading and investment community,” Shah said.

Impact on HFTs and option sellers
According to Trivesh D, Chief Operating Officer of Tradejini, a broking firm, when STT is hiked, the move does not affect option buyers as much as it affects high-frequency traders and those selling options regularly. These groups are more sensitive to changes in market conditions and are likely to be impacted the most, he said.

As per Baheti’s calculations, 40-45 percent of F&O volumes are proprietary trades, 35 percent retail, and the rest are institutional clients.

“The real effect of the STT hike will be visible in case the bear market starts. Then, the pinch might be felt even more,” Trivesh D said.

“I firmly believe that for India to establish itself as a price influencer for its produced and consumed commodities, it is imperative to maintain low transaction costs,” he concluded.

The market is in wait-and-watch mode now. The mystery unravels on February 1, or, like last year, it may come out of the blue in an amendment to the Financial Bill at a later date.