Markets await rollback

Govt paper down on transaction tax worries.

The government bond market was lifeless for the third consecutive trading day yesterday with the Budget proposal to levy a 0.15 per cent transaction tax on purchases of securities routed through stock exchanges playing havoc with the market.

Bankers said the biggest loser if the transaction tax came into force would be the government as it would find it difficult to push through its annual borrowing programme.

Moreover, the banks will run a huge systemic risk as the statutory liquidity ratio (SLR) holdings will lose relevance in an illiquid market where investors are staying on the sidelines.

"The SLR holdings are meant to be liquidated to generate cash in hours of crisis. In an illiquid market, banks cannot do that," said the chairman of a large bank.

The Reserve Bank of India is in talks with the finance ministry on the matter. If the government sticks to the proposal, 17 primary dealers will be forced to close shop. These primary dealers collectively made a pre-tax profit of Rs 1,470 crore in 2003-2004.

Had they been subjected to the transaction tax last year, they would have to cough up Rs 450 crore, based on the volume of trade in the gilts market.

The forthcoming auction of government paper will be a litmus test for the proposed tax. On Wednesday, the RBI will auction 4.83 per cent 2006 government stock to raise Rs 5,000 crore under the market stabilisation scheme.

Besides, there will be an auction of 91-day treasury bills for Rs 2,000 crore.

The 91-day treasury bill yield could shoot up as much as 60 basis points this week if the new tax was factored in, dealers said. The yield at last week's auction was 4.46 per cent.

"The imposition of this tax will affect the market, particularly when the interest rate is on the rise. The government may end up paying more than what it gets through the transaction tax as it will raise its borrowing cost," said another banker.

Unlike the stock market, where the price of a scrip can move by even hundreds of rupees, the price movement in government paper is normally 5-10 paise on a normal day.

"The brokerage and the Clearing Corporation of India charges work out to less than 2 paise (per Rs 100). If one factors in the proposed tax of 15 paise, the cost will go up to 17 paise. But traders do not make this much money," said a primary dealer.

On a Rs 5 crore government securities deal, the transaction tax works out Rs 75,000 while the trading profit on such a deal is normally Rs 5,000.

Banks yesterday tried to push deals through the RBI's negotiated dealing system to skirt the tax and the trading volume was about Rs 1,000 crore, roughly a fourth of the normal daily trading volume.

Insurance companies were reported to be buying high yielding gilts at rockbottom prices in direct deals done with market players.

While hardly any quotes were available for long-term papers, prices in the medium term gilts have fallen by 75 paise followed by a 50 paise dip in prices of short term papers.

The yield on the 10-year benchmark 7.37 per cent 2014 closed at 5.89 per cent, up from 5.87 per cent last week.