Budget 2015-16: Expect commodity transaction tax to be removed, says MCX

MCX Joint Managing Director Singhal says commodity trading volumes have come down significantly since the imposition of CTT, and this is also leading to grey market transactions in which the government gets no revenue at all

MCX is hoping that the commodity transaction tax will be removed in the upcoming Union Budget, according to PK Singhal, Joint Managing Director . 

In an interview with CNBC-TV18, Singhal says Taiwan is the only other country which levies a CTT. He says commodity trading volumes have come down significantly since the imposition of CTT, and this is also leading to grey market transactions in which the government gets no revenue at all. Average daily turnover on MCX has fallen from Rs 50,000 crore to Rs 30,000 crore since CTT was introduced, Singhal says. MCX has regained the market share it lost in the aftermath of the scam at NSEL, Singhal says. He feels the shifting of the Forwards Market Commission to the Finance Ministry from the Consumer Affairs Ministry is a positive step.

Latha: The prime purpose of getting you is to ask you what you are expecting from the Budget for your trade. 

A: If you ask me about expectation then our first basic expectation from the Budget is finance bill - either the Commodities Transaction Tax (CTT) is removed or it is reduced. However, world over nowhere other than Taiwan there is any transaction tax on commodity futures and after the imposition of transaction tax on commodity futures the volumes have fallen down. It is not a question of volume because basically the hedging efficiency has lost and out of top five exchanges in the commodity futures markets in the world three are in China. 

The present vision of our government is to make ‘Make in India’ story successful and for that you need a good hedging platform and that hedging platform is not available for small and medium enterprises (SMEs). Government has rightly exempted agri commodities from CTT but somehow there is a necessity to revisit the CTT on bullion as well as base metal at least because before the imposition of CTT the impact cost in Indian MCX bullion contract was lower than CME. So after the imposition of CTT the cost of transaction has increased manifold. Exchanges are charging Rs 183 per crore as a transaction cost as against that CTT is Rs 1,000 per crore on the sales side which results into the increase in the impact cost from Rs 183 to Rs 683 per crore. 

I think nowhere there is a tax where more than what you are paying to the exchange as a transaction cost you are paying by way of tax and this tax is basically not necessary.

Sonia: Can you give us a sense of how much the volumes have fallen because of the imposition of CTT? 

A: Yes, I can give you a very clear sense. In financial year 2011-12 and 2012-13 and as well as prior to CTT imposition i.e. 2013-14 the volume in MCX – I can tell you about MCX because almost 100 percent volume in base metal bullion and energy takes place in MCX. It was in the range of 52,000 to 55,000 crore per day on single side which after imposition of CTT was reduced to about 30,000 crore. So you can understand how much volume fall has taken place and after that there was National Spot Exchange Limited (NSEL) problem and that is a different issue. So, those volumes fall which was due to NSEL issue has come back. Now we are again having same market share, but you see in agri commodities there is no CTT. Even then there is not much increase in agri commodity volume because you know there are lakh of SMEs and as far as our gold contract is concerned you ask anybody even a small jeweller to the biggest jeweller or exporter in jewellery they hedge on our exchange.

Latha: Any other expectations, have you had conversation with the ministry. You have seen the movement of FMC to the finance ministry from the consumer affairs ministry and now possibly the eventual merger into Securities and Exchange Board of India (SEBI) as well. Is the longer term terrain in which you fight much cleaner now. Are you expecting therefore better business?

A: There are two issues. One issue is very relevant which is most necessary. As per the Nelson report prior to CTT it says that the ‘dabba trading’ or bucket shops volume is three times of the official volume in the exchanges and this bucket shops or dabba trading is all illegal trades. It happens in cash with no audit trail. So it is one of the biggest damage the country has because it is all black money transaction and after imposition of CTT because the cost of transaction has increased as per the market sources it is now about 10 times of the exchange volume. 

So, FMC presently in the present avatar does not have any infrastructure, they don’t have manpower, they don’t have any raid and panel provisions to take action against the dabba traders. So the biggest benefit in case the merger of FMC with SEBI takes place then that power will come, but I have my own doubts about whether the merger will be helpful because commodity basically other than gold all the other commodities are consumable and it is not asset class. Base metal is consumable, energy is consumable.

So basically I don’t think SEBI has a bandwidth or the merger will be the right step but at least if nothing is happening, people make compromise. They think, if FCR is not passed at least it is better that the regulator will have a strong panel action. 

However, one thing I fully agree that shifting of FMC from the ministry of consumer affair to the Finance Minister was a very positive step and it was basically because finance ministry that way is more responsive and I am not saying that consumer affair ministry was not responsible but the point is finance ministry is more clear about what is happening abroad in the commodity futures trade or securities market, so they are more updated.

How can options trading gain ground in commodities ?

The commodities futures market underwent changes in 2003 with many policy reversals. But option-based derivatives are yet to gain ground in commodities. Though the Forward Contract (Regulation) Bill, 2010, has provisions for option trading, its execution requires considerable attention from the regulator, commodity exchanges and market participants.

The government can replace the price support scheme with minimum guaranteed price (MGP). Policy makers are passive on the adoption of option-based trading despite the benefits.

Modus operandi

Option can be over-the-counter and exchange-traded. Similar to the futures, option requires at least two parties to exercise the contract. Exchange-traded option can help to mitigate counter-party credit risk as the contract will be more standardised in nature. Farmers can avoid distress sales if they can opt for a longer put option, paying a put premium. Commodity processors, on the other hand, can hold a long call option, paying a call premium. Intermediaries between farmers and processors can act as option writers holding a short put and a short call position. They can be market agencies that procure from farmers and sell to consumers or civil supplies agencies such as FCI, STC, NAFED, HAFED and several private agencies. The payoff and profit structure are different. While farmers might delimit their potential loss, processors may have unlimited loss if the commodity price falls below the strike or exercise price of the contract. Farmers could wait for a better deal to exercise the contract. Thus, a minimum guaranteed price can be embedded in the long put option. On the other hand, processors can reduce their exposure through dynamic or “delta” hedging that implies that number of call option bought is relative to number of stocks sold. Based on financial aptitude, financial knowledge, and financial behaviour, agents can leverage their risks or increase their spread by formulating several option trading strategies. In addition, they can mix futures/forward and option contract (if offered in identical commodities) to protect them from unexpected losses, such as, “covered call” or “protective put”.

Option pricing

Option pricing (call and put) is important for an efficient commodities market. It depends on several variables known as Option Greek, which includes delta, gamma, vega, theta and rho. For example, one per cent increase/decrease or any absolute in underlying commodity price seeks to impact the relative change in option price or premium. Similarly, market volatility, time of the contract and rate of interest (asset borrowing and storage costs) seek to determine the magnitude of change in that option price.

If option market needs to be efficient, call-put parity should hold. Therefore, there should be a small deviation between market offered rate and an implied rate. Pricing exercise may be accomplished using binomial option pricing, Black-Scholes pricing, KMV-Merton pricing based on the model parsimony and robustness.

Boost for producers

Introduction of option in commodities calls for a careful concern of the regulator and market agencies. It should be implemented in a phased-manner. Fundamental analysis of commodities is required on two fronts: pricing of commodities and variables influencing the option price.

Option need to be introduced in those commodities which are having liquid contracts and significant trade volumes in futures/forward and spot markets. However, speculative asset should be avoided. First, exchange-traded option may be introduced in non-MSP; and then in MSP-based commodities. Commodity exchanges need to work on the contract specification and spread for assessing liquidity. Option contract implementation is critical to encourage commercial users. The coming Budget may shed light on the fate of this derivative instrument, given the possibility of SEBI-FMC merger. Second, since the underlying asset is commodity, a comprehensive study needs to be undertaken with respect to economic fundamentals, price and non-price factors, stock-to-use ratio or carryover stock, crop management practices.

Farmer Producer Companies (FPCs) can work out the prospect of option market as they procure the produce from farmers’ interest groups at MSP or market offered rate and then, distribute to the Small Farmers’ Agribusiness Consortium (SFAC). Instead of procuring at MSP, SFAC through FPCs should offer minimum guarantee price to producer-members which might improve farmers’ marketing decisions and their risk-return metrics.

FPCs need to create or lease in storage space for holding farmers’ produce until they deliver in exchange platform. NCDEX may offer customised contract to FPCs and NABARD might act as clearing agent of commodity exchanges or could train or handhold FPCs for account opening and daily and final settlement.

Service providers need to be empanelled by exchanges to safeguard farmers from any unexpected margin call or mark-to-market loss. In other words, exchanges need to depute some third party to resolve any unwarranted default in the option market.

Can be introduced in goods which have liquid contracts, significant volumes in futures & spot markets

Pre-Budget expectations for commodity markets: Religare Retail Research

According to Religare Retail Research, traders and investors from commodity derivatives market are expecting the government to announce steps to restruc-ture the Forward Contracts Regulation Act (FCRA). This would increase depth in the market and will help in efficient price discovery, says the report.

Pre- Budget Expectations for Commodity Markets: Religare Retail 

The market, like every time, has huge expectations and this time, hopes are revolving around lowering of subsidy burden, widening the tax net, supportive policies for the industry and rational allocation of funds. Also, some key points present in the agenda of the new government which should form part of the union budget should be to re-invigorate investment cycle and reviving Indian economy on a priority basis.

With lower crude prices, government is now in a better position in terms of its fiscal balances as oil imports occupies a major chunk in our im-port bill. Commodity futures trading also deserves attention this time, keeping in mind government’s agenda of Make in India. A large number of measures are required to bring back liquidity and to make market more efficient. 

Union Budget Expectations for Commodity Trading 

Amendment of FCRA: Traders and investors from commodity derivatives market are expecting the government to announce steps to restruc-ture the Forward Contracts Regulation Act (FCRA). This would increase depth in the market and will help in efficient price discovery. There is a need to increase market participation by allowing banks, MFs, FIIs which will also help in preventing price manipulation and help hedgers to efficiently hedge their exposure in physical markets. 

Abolition of CTT: Market participants are expecting the government to re-duce the Commodities Transaction Tax (CTT) which was levied in year 2013 on metals, bullion and a few processed agri commodities. 

Levy of CTT was strongly opposed by commodity exchanges, traders, bro-kers and investors. Commodity trading in India is just 10-year old and get-ting away with CTT may lure more participants, thereby increasing the over-all turnover. In India, more than 80% of the trade volumes take place in bul-lion, metals and energy and CTT has resulted in a significant drop in trading volumes in these segments. Unlike in stocks or agri commodities, daily movement in the above mentioned commodities are generally very low, re-sulting in most of the profits that a trader makes, being lost in the existing charges. FMC needs to take up with the Finance Minister on the need to reduce CTT to bring back liquidity and market depth in the commodity futures trading in the country. The CTT should be reduced to Rs. 1 per crore of trading to encourage the markets and the amount collected should be diverted to improve warehousing and infrastructure facilities. 

Union Budget Expectations for Base Metals Industry 

A reduction in excise duty on copper is widely expected this time, in order to improve the cost competitiveness of Indian capital goods companies. 

The government’s plan to turn India into a manufacturing hub will need a big budget boost. For this, a lot of metal will have to be imported into the country and hence import duty on ores and metals require a slash in import duty. This will likely boost metals’ market in India. 

Union Budget Expectations for Energy Industry 
Finance Minister Arun Jaitley may look at re-imposing five per cent customs duty on crude oil imports to shore up revenues by $3 billion and create a level-playing field for domestic producers. 

Presently, the government does not levy any import or customs duty on crude oil imports. On the other hand, domestically produced crude oil attracts two per cent central sales tax, something which imported oil is exempted from.

Union Budget Expectations for Agri Commodities 

Exemption of CTT for processed agricultural commodities to ensure a pickup in volumes in the futures market 

Passing on benefits of a fall in petrol/diesel prices to ensure reduction in freight charges 

Investment funds in warehousing sector to prevent wastage of food 

Bank accounts for farmers for each and every household for direct transfer of subsidies and loans 

Subsidized loans to farmers and safeguarding them from crop losses through crop insurance 

Availability of quality agri inputs like fertilizers, seeds and advanced technology inputs 

Providing irrigation facilities and electricity at cheap rates to farmers 

Upgrading weather forecasting system – IMD, for accurate monsoon forecasts which could enable farmer to take informed decisions. 

Investments in transportation and infrastructure like roads and railways to reduce transportation costs for farmers for their produce 

Custom Duty on Gold will be Reduced From 10% to 6% Likely on Budget Day.

The government is likely to announce a reduction in the customs duty on gold and the setting up of special notified zones for gems and jewelry in the budget.

The customs duty on gold is likely to be brought down to 6 per cent from 10 per cent in the wake of a significant decline in the import of the yellow metal.

The setting up of notified zones will boost the manufacturing of gems and jewellery, which is one of the sectors identified in the "Make in India" programme of the Narendra Modi-government.

"Gold imports are declining continuously. The gems and jewellery sector contributes significantly to the country's total exports. On account of this, we are expecting a cut in the import duty," commerce ministry officials said.

Gold imports in December declined to 39 tonnes from 152 tonnes in the previous month. The export of gems and jewellery has fallen 3.73 per cent year-on-year to $3 billion in January.

"The low duty will curb the smuggling of precious metals, increase affordability of gold jewellery in the domestic market and enhance the cost-competitiveness of gold jewellery manufacturers in the export market," analysts said.

The gems and jewellery sector, which employs about 3.5 million people, accounted for almost 13 per cent of exports in 2013-14.

The sector is one of the 25 areas identified under the "'Make in India" programme, which aims at attracting domestic and foreign investments to boost manufacturing and create jobs.

The notified zones would also import and trade in rough diamonds.

"The mining companies will be taxed to the extent of invoices raised to Indian companies, eliminating middlemen involved in the trade. This will help India to become a rough diamond trading hub, and especially help small diamond polishing units in India," CARE Ratings said in a research note.

Simultaneously, the government may hike the import duty on gold and silver jewellery to boost local manufacturing.

Officials indicated that the Centre could hike the duty on gold jewellery to 20 per cent and silver jewellery to 25 per cent from 15 per cent. The move will protect the interest of small artisans and provide an incentive to the local manufacturers of jewellery.

In the run-up to the elections, the BJP had promised to ease restrictions on gold imports as the curbs had led to smuggling. Modi had said any action on gold should take into account the interest of the public and traders and not just economics and policy.

Copper Technical Outlook

Copper got a bit of press attention recently with headlines of a plunge in price. This was in early January and I hadn't looked at the copper chart for a few days and I was gobsmacked when I did. A plunge they say?! What a load of baloney!! If that was a plunge then they are in for a big shock later this year if my analysis is correct.

But let's not get ahead of ourselves. Let's start with the small picture and then come back to the big picture which will reveal the likely shock in store.

Copper Daily Chart

The recent low was a "three strikes and you're out" low consisting of three consecutive lower lows. This low was also accompanied by triple bullish divergences on the Relative Strength Indicator (RSI) and Stochastic indicator. This generally leads to a significant rise and while price has risen from that low the nature of the rise is nothing to rave about.

Price has so far failed to take out the January 2015 high at US$2.65 which is denoted by the lowest horizontal line. Taking this into consideration, I believe price may be headed for a fourth lower low which is also accompanied by quadruple bullish divergences on the same lower indicators. That occurring really should lead to a substantial rally. Let's see.

The Bollinger Bands show price bouncing up to the upper band and perhaps one last move back to the lower band is in store before a decent rally takes place.

Other points of resistance are denoted by the higher horizontal lines which stem from the December 2014 low and December 2014 high and I favour any coming rally to take out these levels.

Now let's skip to the monthly chart to begin examining the bigger picture.

Copper Monthly Chart

The RSI and Stochastic indicator are both in oversold territory so a rally should be on the cards shortly. However, both these indicators have readings showing new lows so any rally from here is likely to be a bear market rally. I would like to see the final low be accompanied by bullish divergences on the lower indicators.

I have drawn an Andrew's Pitchfork which shows price trending down within the upper channel of this bearish pitchfork. If a rally is to take place soon then I am looking for price to test the upper channel line. And considering I expect a bear rally only then price should be rejected at this upper trend line.

So where is the final low likely to be?

I have drawn a green highlighted circle which shows where price exploded higher in a parabolic move. This area is at the 2008/09 lows of US$1.27. Price plunged into that low and them immediately launched higher in explosive style. Price often eventually corrects to these areas and I favour exactly that to play out here.

I have added Fibonacci retracement levels of the move up from 2001 low at US$0.60 to the all time high in 2011 at US$4.65. I am looking for a deep retracement that closes in on the 88.6% level at US$1.06 which would see price clipping the zone whereby price launched higher parabolic style.

Price putting in a low there around mid 2016 would also be at support from the middle trend line of the Andrew's Pitchfork.

Let's now look at the yearly chart to get another perspective.

Copper Yearly Chart

The recent high in 2011 showed a bearish divergence on the RSI and Stochastic indicator. These indicators now appear to be trending down and not looking particularly promising for the bulls.

I have added the same Fibonacci retracement levels from the monthly chart just to give a different perspective.

I have also added a Fibonacci Fan which shows the 2008/09 low was around support given from the 76.4% angle. I am looking for the next major low to clip the 88.6% angle. Time will tell.

If I am reading this correctly, then a massive 5 point broadening top is in play and price is now headed down to make a point 4 low. In this scenario, the 2006 high was point 1, the 2008/09 low point 2, the 2011 high point 3. If we do indeed get a point 4 low then I expect price to once again explode to new all time highs over the coming years as price eventually puts in the point 5 high.

And I'd like to see the final point 5 high be accompanied by triple bearish divergences in the lower indicators.

So while the move down in early January garnered some headlines, it really wasn't a major plunge. The real plunge is still to come. And expect much bigger headlines to come with it!

Author: Austin Galt

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