Dabba Trading Comes to a Halt

As an aftermath of the Demonetization of old Rs. 500 and 1000 notes from the Indian Economy, expected results of curbing the Black Economy to a major scale seem to be positive at least from the stock market point of view. The recent news have shown that the illegal “Dabba Trading” has completely come to a standstill as traders face liquidity crunch with the highest denomination of Indian currency notes been demonetized and no longer considered a legal tender in the fastest growing economy in the world presently.

What is Dabba Trading?

Dabba Trading is an Indian Terminology, which is an illegal form of trading and is considered equivalent to Black Economy in the stock markets.

In dabba trading, a client buys and sells shares or index futures, with a broker who offers the outlawed service. The only difference here is that the trades are based on official (market) rates, but are not entered in any trading terminal and no securities ever change hands; they happen outside the purview of stock exchanges and regulators. The broker with whom the trade has been placed is the counterparty, just like a cricket or horse racing bookie. If the client makes money on the trade, the broker loses an equivalent amount, and if the client loses money, the broker gains by an equivalent account.

Everything is settled in cash. The 'brokerage' is higher than that for a regular transaction, and is usually in the form of a spread; the client will have to pay slightly above the market price in a buy trade and will get slightly below the market rate in a sell trade. Still the savings on margins that have to be maintained with stock exchanges for regular trades and savings on income tax (in case of profitable trades) more than make up for the higher brokerage.

How is Dabba Trading linked to Black Money?

There are brokers who specialize in what can be called ‘unofficial official’ trades for high networth traders who want to avoid the taxman’s glare. The trades are perfectly legal and routed through the broker’s terminal, but the profits and losses are settled in cash. Also, there are no records of the clients who transact with these brokers.

This is contravention of the SEBI rule that insists on all dealings between the broker and client being done through cheques. The 'cash broker' will enter all his clients' orders in his own proprietary book. If the client makes money, the broker pays him in cash, and if the client loses money, the broker collects in cash from him. The benefits for the clients are that they do not have to put up margins, and do not have to pay taxes on the profits earned. The broker charges a higher commission on these trades in return for the ‘facilities’ he is providing.

For this business to be profitable for the broker, there should not be a huge profit on his books at the end of the year. Else, he will end up paying tax on that money, since all the trades are shown in his name. Also, having a good client base is important. It is the cash collected from the losing clients that is paid out to the winners..

Many of the high-volume traders on Dalal Street, and even some of the so-called investment gurus, are known to route a sizeable chunk of their trades through brokers who settle in cash, to avoid tax. And while the brokers manage to balance their accounts at the end of year, the Income Tax department is only too aware of the cash transactions in the stock market and of the tricks resorted to conceal them. Still, with help from skilled chartered accountants and some accommodative assessing officers, the game has been going on for a while.

Effect of Demonetization

The Rs. 500 and 1000 notes, which made up 86% of the cash in the Indian economy, have been scrapped as a legal tender in the country since November 8, 2016. With this, the black market cash economy, which is considered to be consisting money in these denominations, has taken a big hit. Some of the dabba brokers who accept big trades, hedge their bets by taking an opposite position in the official market. This adds to the liquidity in the market.

Black money holders who indulged in Dabba Trading are facing a severe liquidity crunch and the trades of this kind have come almost to a halt and are in turn putting pressure on the stock prices.

So… Finally there are some positive results showing up for the bold step of demonetization that the present Indian Government has taken to curb the Black Economy. A Great News indeed!! The present effects of this may seem to be negative (in terms of Stock Market Reactions), but however, its long term implications seem to be much more positive and are expected to outweigh the present negative impacts.

- Harsh Pathak

Student and Core-Committee Member of Finance Club, MISB Bocconi - Bocconi India