The Union Budget 2026-27 raised the securities transaction tax or STT. Futures now face a levy of 0.05 per cent, up from 0.02 per cent; options face higher taxes on both the premium and the exercise. It is no surprise that market indices have fallen. This is a bad move for India’s financial development and growth.
A sound tax system is one based on the ability to pay or economic surplus. An example of a direct tax is an income tax, which is based on final income. A consumption tax, such as the Goods and Services Tax (GST), is also a proxy for the ability to pay. Even a GST taxes final use, and not intermediate transactions. For example, a GST system that allows input-tax credits ensures each good or service is taxed only once—at the point of final consumption.
An STT, on the other hand, is a tax on transactions, regardless of what the transaction is for and whether it is profit or loss–making. It is like paying tax each time a potato changes hands—from a wholesaler to a retailer, and from a retailer to your kitchen—regardless of profit or loss. The tax is not on consumption or profit, but on the transaction. In the context of financial markets, the STT implies that a market maker, a speculator, and a hedger merely rolling a position pay the same tax, and pay it repeatedly. The immediate response to an STT is that people will trade less, leading to lower liquidity and poorer price discovery. Research has shown that this is the case in India. An STT taxes the circulation of capital and not its returns, making it deeply distortionary.
An attack on derivatives markets is a mistake
A higher STT on derivatives markets is often justified because derivatives are viewed as speculative and socially unproductive. In fact, the government’s stated reason for the hike is that the move is likely to curb “excessive retail speculation” in F&O markets. This is a costly way to address the concern.
Derivatives carry out two important functions. First, they are useful for hedging risk. They allow you to lock in a price today so that you are immune to future price changes. This is useful to a farmer who wants to hedge price risk or a trader who wants to hedge currency risk. Derivatives are thus risk management tools in modern markets. An STT on derivatives is effectively taxing risk management.
Second, derivatives are useful for speculation. While speculation is also often considered a bad deed, it is an action based on a view of the future. By taking certain positions, a spectator bears price risk. As a result, prices adjust faster and incorporate information more efficiently. In fact, speculation makes markets less volatile through multiple market corrections instead of one big event.
Moreover, penalising derivatives trading often fails eliminate it, but moves it elsewhere. A higher STT may make transactions shift to offshore markets, beyond the reach of the Indian regulator. A clear instance of this is when restrictions on onshore currency derivatives pushed trading into offshore NDF markets instead of eliminating speculation or hedging demand. Price discovery in the rupee is now increasingly occurring outside India, reducing transparency and regulatory visibility.
One may argue that several jurisdictions around the world also have an STT or a similar tax. However, there are differences. First, many of these jurisdictions tax capital gains at a much lower rate, while others exempt certain investors or instruments. This is not true of India, where a long-term capital gains tax (LTCG) exists in addition to the STT, and the latter is stacked on top of derivatives trading. Further, the STT has to be seen in the context of the full range of taxes—stamp duty, GST, and capital gains—all of which make India an expensive destination for foreign portfolio investors in comparison to other Asian markets.
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Market impact
India aspires for high economic growth. This requires risk-taking. A modern economy requires instruments and markets to hedge risks on interest rates, currency, equity, and commodity prices. Derivatives markets play a crucial role in improving price discovery and transferring risk to those suited to bear it. By increasing taxes on derivatives transactions, India is damaging its ability to manage economic growth.
We must remember that in shallower markets such as ours, marginal trades matter far more, and hence a transaction tax is likely to affect more. What may be absorbed with little effect in deep markets can meaningfully impair market functioning in India.
It is also pertinent to evaluate how important the STT is to India’s tax revenues. In FY2024-25, STT collections were about Rs 53,095 crore, while total direct tax collections were about Rs 25.87 lakh crore—the STT made up about 2.1 per cent of total direct taxes. For a tax that can have such an outsized effect on market behaviour, it adds very little to total revenue. If the STT has been increased to meet revenue requirements, then there are other, cleaner taxes that could have been imposed. Better still, government expenditure could have been rationalised.
Renuka Sane is managing director at TrustBridge, which works on improving the rule of law for better economic outcomes for India. She tweets @resanering. Views are personal.
(Edited by Prasanna Bachchhav)