ECONOMY-INDIA: Govt Mutual Fund Falls Victim to Liberalisation

By Ranjit Devraj Reprint | | Print |

Ranjit Devraj

NEW DELHI, Aug 6 2001 (IPS) - With a lifetime of savings safely stashed away in a tax-free government mutual fund over the last 37 years, M S Gupta had begun to look forward to a comfortable retirement.

But in early July, Gupta’s world crashed around him when the Unit Trust of India (UTI), by far the country’s largest mutual fund boasting of 20 million accounts, announced suspension of transactions of its flagship US-64 scheme for the next six months.

“I thought a government fund was safe and they said the units could be redeemed at any time — this is a fraud on ordinary people who put their trust in the government,” Gupta said.

If UTI has 20 million investors, it is mainly owing to the way in which some 60,000 agents went about marketing it as a safe government- backed scheme, which gave above-market, tax-free returns as well as liquidity. The freeze on transactions was obviously a rude shock.

It is small consolation for Gupta that the crisis in UTI, which had a proven track record of reliable investment for more than three decades, was the result of gross mismanagement by bureaucrats who were not accountable to any entiity, including the Finance Ministry.

India’s Finance Minister Yashwant Sinha fended off incessant demands for his resignation in Parliament through last week by claiming that the government, in keeping with the hands-off policy of liberalisation, had no role in recent bad investments made by UTI .

There were charges in Parliament that the investments were made at the instance of top-ranking bureaucrats and influential people close to Prime Minister Atal Bihari Vajpayee. The charges, made by key allies in his coalition government, were serious enough for Vajpayee to offer to resign.

Sinha claimed that the finance ministry was “deliberately kept in the dark” about the crisis brewing in the UTI by its chairman P S Subramanyam, who has since been sacked and arrested on charges of corruption.

Subramanyam’s arrest has not helped win the confidence of small investors like Gupta or that of the international community, which India has been assiduously wooing in the hope of attracting foreign direct investments to boost the economy.

In Parliament, leading economist Manmohan Singh who, as finance minister between 1991 and 1996 steered India’s economic reforms, charged Sinha with “sending out signals that the flagship of the Indian financial system is being run by crooks”.

While Sinha has pledged that the government would not let down the investors’ perception that UTI was backed by the government, he made it clear that it could not afford a bailout.

That is bad news for investors like Gupta, who are now busy trying to figure out the actual value of their units in the absence of any authorised net value assessment.

All that Gupta has to go on is the fact that in June 2000, investments in the US-64 scheme stood at more than five billion dollars, but a lot has happened over the last year and most of it was negative.

“Rating agencies tend to give high ratings to government-run institutions like the UTI, which should have shifted to realistic net-value assessment systems long ago,” said Narayan Vaghul a former member of the UTI board.

According to Monika Halan, analyst for ‘Intelligent Investor’ magazine, the government is unlikely to upset its international ratings by repeated big-ticket bailouts of incompetent institutions.

Three years ago, UTI had to be bailed out through a massive government dole totalling 800 million dollars, drawing criticism from economists that taxpayers’ money was being squandered at a time when the government desperately needed funds for social sectors like education and health.

“No longer is the government going to ensure that the UTI (or any other institution) gives a return higher that the market value of its financial products. These will have to be pegged to their market price resulting in a greater role for the market,” she said.

Halan said the government can no longer guarantee a fixed rate of return where no such promise has been made and where there is just a perception in the minds of the investor that a government-backed instrument is risk-free.

In Halan’s view, the UTI crisis is the first major cost of liberalisation that is being borne by the consumers of financial products. “We have got used to the benefits of liberalisation — more brands and models, lower prices, better customer serivice over the past decade — time to take a look at the costs as well.”

Following liberalisation, Indian investors have been encouraged to invest in the stock markets. In the last budget, Sinha lowered interest rates on provident fund and other fixed deposits that people have come to rely on.

Those who did transfer their hard-earned money from fixed deposits to put them in the stock markets were in for a big shock in April, when the markets crashed mainly because of massive insider-trading and manipulation, some of which was traced back to UTI and Subramanyam.

According to Arun Kumar, professor of economics at the Jawharlal Nehru University (JNU), ordinary Indian investors are now left with nothing to put their money into except traditional areas such as real estate and gold which reduce the savings and investment rates in the economy.

Kumar predicts that a bailout would be of little use because players in the stock market know that over the next six months, UTI will try to sell every time the market rises and the fund will be left holding assets that have lost a considerable part of the original value.

On top of that, with international trends unencouraging, the Indian economy suffering from a massive slowdown and difficulties in the financial markets, nobody is advising a bailout with taxpayers’ money — although that would ultimately be a political decision.

Says a recent World Bank report on the experience of government bailouts: “Increased politicisation of banking decisions, which is inevitable when government is involved, means that incentives for efficient intermediation are lost.”

“Governments that attempt to be both owner and regulator achieve success at neither,” the report warned.