Part - I

The repeated history of financial crashes has demonstrated that shortcomings in macroeconomic policy can result in a failure to ensure orderly financial markets, sometimes with cataclysmic economic and social consequences. The Southern Cone (Latin American) capital flight crisis in the late 1970s, the 1994-95 Mexican currency crisis or "Tequila Effect", and the 1997-98 Asian financial crisis all have a common story to tell, which is that left to themselves financial markets do not behave in an orderly manner. They are prone to bouts of convulsions after even a slight change in "information processing", macroeconomic variables. But then introducing measures to supervise and regulate financial markets has not met with much success. There is a stiff resistance from financial participants with a conflict of interests between macroeconomic objectives and the immediate interests of financial market participants seeking to maximize their profits. A furore was raised recently in Asia's oldest stock exchange, the Bombay Stock Exchange (BSE) along with its offspring National Stock Exchange of India (NSE), as soon as it became known that the Indian 2004-05 Budget had mooted a proposal to wind back the "Turnover", or otherwise known as the "Transaction Tax".

This raises the question: how do we judge policy measures from a pure investor perspective or from a long-term financial stability point of view? Did the government introduce the turnover tax simply to ensue an orderly financial market in the longer term or was it a government gripped by "fiscal conservatism" with a "balancing act in mind" seeking to make revenue while attempting to keep everybody in good humour? If the objective is the former, can it be likened to the Tobin Tax which is intended to "throw sand in the wheels of the foreign exchange market" to reduce destabilizing speculation and gain traction so that the stock market will move in tandem with "macroeconomic fundamentals"? Such questions have larger implications with a wider resonance for emerging economies.

In India at the present time, a conservative investor is merely looking for a minimal return that provides insurance cover against a rising inflation rate of 6.5-7.0 per cent. For the small investor, the ability to earn money has come to an impasse. A foray into the stock market could be an option. Research has shown that investment made on the basis of sound fundamentals can give an annual average return of 10-14 per cent. Why then has a turnover tax as insignificant as 0.15 per cent generated such a furore, bringing stock market operations to a virtual halt? Why is a 15 paise tax on an investment of Rs.100 so hard to digest for the investment community?

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*Contributed by -
Prof. D. Tripati Rao and Varun Trivedi (PGP I),
Xavier Institute of Management,
Bhubaneswar.