Budget 2026: STT Hike on Derivatives Triggers Sharp Market Correction

The Sunday Budget Shock

On Sunday, February 1, 2026, Finance Minister Nirmala Sitharaman presented the Union Budget 2026-27. While the speech touched upon various sectors, the most immediate and dramatic reaction came from the capital markets. The benchmark indices, BSE Sensex and NSE Nifty 50, experienced a sharp downturn shortly after the announcement of a hike in the Securities Transaction Tax (STT) on derivatives. The Sensex plunged over 2,300 points from its intraday high, while the Nifty 50 slipped below the 25,000 mark, reflecting investor anxiety over rising transaction costs.

The Core Announcement: STT Hike on Derivatives

The Finance Minister proposed a significant revision to the STT rates applicable to the derivatives segment. The government's announcement detailed a considerable increase in transaction costs for futures and options traders. The STT on futures contracts has been more than doubled, rising from 0.02 percent to 0.05 percent. Similarly, the tax on options premiums and the exercise of options has been raised to 0.15 percent from the previous rates of 0.1 percent and 0.125 percent, respectively. This move directly increases the cost of trading for all participants, from retail investors to institutional players.

Market Reaction: A Volatile Sunday Session

The reaction from the market was swift and decisive. The BSE Sensex plummeted by over 1,000 points in a matter of minutes, at one point touching a low of 81,218. The NSE Nifty 50 fell by around 348 points to 24,973. This sharp decline led to a significant erosion in investor wealth, with the total market capitalization of BSE-listed companies falling by approximately 6.58 lakh crore. The negative sentiment was broad-based, with over 2,100 stocks declining on the BSE and 200 stocks hitting their 52-week lows during the special trading session.

Impact on Brokerage and Exchange Stocks

Stocks of brokerage firms and stock exchanges were at the epicenter of the sell-off. Shares of BSE Ltd, Angel One, and Billionbrains Garage Ventures (Groww) tumbled by as much as 13.5 percent. Investors are concerned that higher transaction costs will deter active traders, particularly high-frequency traders and arbitrageurs, leading to a reduction in derivatives volumes. This could adversely impact the earnings of these companies, which have benefited from the recent surge in retail participation in the F&O segment.

Why the Government Targeted F&O Trading

The government's decision to raise STT appears to be a calculated policy move to curb excessive speculation. This follows repeated warnings from SEBI regarding the explosive growth in retail participation in the derivatives segment. SEBI had previously reported that nearly nine out of ten individual traders in the F&O market end up losing money. The STT hike is interpreted as a measure to disincentivize high-risk, short-term trading and nudge the market toward more stable, long-term investment.

Historical Context of Securities Transaction Tax

STT was first introduced in India on October 1, 2004, as a replacement for the long-term capital gains (LTCG) tax on equities. The objective was to simplify tax collection and curb evasion. However, the Union Budget 2018 reintroduced LTCG tax on listed equities while keeping STT in place. This created a dual tax burden for investors, which has been a long-standing concern for the broking industry. The latest hike further compounds this issue, increasing the overall cost of participating in Indian equity markets.

Industry Perspectives: A Divided House

Market experts offered varied perspectives on the move. Ace investor Shankar Sharma supported the hike, likening derivatives trading to a destructive force that adds zero value to the country. Conversely, Nithin Kamath, co-founder of Zerodha, expressed concerns that successive STT hikes could be counterproductive. He pointed out that while the government projected STT collections of 78,000 crore for FY26, actual collections were on track to be significantly lower, suggesting that higher tax rates might be shrinking the overall trading volume.

Broader Budget Highlights: Capex and Infrastructure

Despite the market volatility, the Budget reaffirmed the government's focus on growth through infrastructure spending. Capital expenditure was increased to 12.2 lakh crore for FY27, up from 11.2 lakh crore in the previous year. This continued emphasis on infrastructure and manufacturing formed the backbone of the Budget's growth narrative, with sectors like railways, semiconductors, and pharma standing to gain from targeted incentives.

Foreign Investment and Ownership Limit Revisions

To broaden market participation, the Budget proposed allowing individuals resident outside India to invest directly in Indian equities through the Portfolio Investment Scheme. Ownership limits were also revised, with individual limits raised from 5 percent to 10 percent and the combined cap increased to 24 percent. Additionally, the overall investment cap for Persons of Indian Origin (PIO) was increased to 24 percent, aiming to encourage deeper participation from the global Indian diaspora.

Personal Income Tax and Bond Market Reforms

On the personal taxation front, the Budget extended the deadline for revising income tax returns to March 31. However, there were no changes announced for capital gains tax, which disappointed some market participants who were hoping for relief. In the bond market, the government introduced a 100 crore incentive for large-scale municipal bond issuances and proposed the introduction of total return swaps on corporate bonds to improve liquidity.

Summary of STT Rate Changes

Market Impact on Key Entities

Analysis: Curbing Speculation vs. Market Liquidity

The hike in STT is a clear signal from the government and regulators to moderate the retail frenzy in the derivatives market. While this may lead to a healthier market environment in the long run by reducing speculative losses for retail investors, the short-term impact is likely to be a reduction in trading volumes and liquidity. For brokers, especially discount brokers heavily dependent on F&O revenue, this represents a significant challenge to their business models.

Conclusion

Budget 2026 has delivered a significant jolt to the Indian stock market, with the STT hike acting as the primary catalyst for a sharp correction. While the move aims to foster a more stable investment culture, it has raised immediate concerns about market depth and the profitability of the broking industry. As the market recalibrates to these higher transaction costs, the focus will shift to how trading volumes evolve and whether the government's fiscal prudence and capex push can eventually restore investor confidence.