| Yashwant Sinha | ||||||
Trust is a scarce commodity these days when it comes to Indian financial institutions. The Unit Trust of India, the country’s biggest mutual fund, could be in trouble once again. Last July the government bailed out UTI’s biggest fund, US 64, the second rescue in three years.
UTI’s new chairman, M Damodaran, says it could face a shortfall this year when it must pay investors guaranteed returns. An expert panel warned last year that in 16 out of 25 guaranteed-return funds managed by UTI the market value of assets was lower than the liability of the fund.
By one estimate UTI will have to pay investors up to Rs58 billion, or 11% of its Rs511 billion ($10.8 billion) assets, this year. Not much money is coming in from investors. UTI has suffered net outflows. Assets managed by UTI shrank by a fifth last year, partly because of a battered equity market.
The problems faced by flagship fund US 64 last year may also have infected the health of these funds. According to figures revealed by the UTI chairman, of the Rs69 billion borrowed by US 64 in May and June last year to meet huge redemptions from the fund, around Rs44 billion came from UTI’s “internal liquidity pool”, an opaque system of inter-scheme transfers.
Market analysts expect a huge sell-off by UTI. The fund is a large investor in several blue-chip stocks such as Reliance, India’s biggest listed company. As part of a move to restructure US 64 into a bond fund, UTI chairman Damodaran said in December that the equity investments of US 64 would be pared down from the present 61% to 55% this year and eventually to around 25%. Along with sluggish growth in the economy this year, the prospect of a rally in stock prices looks dim.
That should worry the government. The cost of US 64’s bailout is inextricably linked to hopes of a sharpish rally in the stock market over the next 18 months. In July last year, after the fund froze sales and repurchases, irate investors forced finance minister Yashwant Sinha to come up with a rescue plan. Under this, small unitholders are guaranteed a fixed price for their units, irrespective of their market value, until May 2003. The longer an investor puts off selling his units to UTI, the higher the price he will be paid for them. That forestalled an immediate rush for redemptions.
From January 1 the 37-year-old US 64 began declaring daily its net asset value. On New Year’s Day, 20 million investors were dismayed to discover that their units of face value of Rs10 were worth just Rs5.81. US 64 was buying units at Rs10.50 apiece under the special repurchase scheme in January. The difference between the market price and fixed price the fund pays out (Rs5 for each unit in January) is borne by the government. The greater the variance between the two prices in the coming months, the bigger the government’s tab will be.
The first bailout of US 64 three years back cost $702 million. This one will cost much more, particularly if other funds managed by UTI face problems. In the past the government has bailed out mutual funds run by state banks that had guaranteed returns. Last year it rescued IFCI, the third-biggest development bank, to avert a default on its foreign-currency bonds. Clearly, its ownership and control of India’s banks and investment institutions is proving to be a moral hazard. It is one that undermines its fiscal health.
For that reason, the government must fix the problems at UTI and urgently. At least three expert panels have looked into UTI’s problems in the past three years. They have suggested that the funds need to be run by professional managers and should open their books fully to investors and the market regulator. The government has promised changes in the law that will do away with UTI’s special status under an act of parliament, and to induct professional managers into UTI. US64 will, like all other mutual funds, be put under the scrutiny of the market regulator by the end of this year.
UTI’s problems stem from government control and the government seems reluctant to let go. In the past government-appointed chairmen have made disastrous investments, secure in the knowledge that they would be bailed out. In turn UTI was a faithful ally, and a big investor in the early sale of privatization shares.
The government is ambiguous about suggestions that a private strategic partner should be inducted to run UTI or that the government should not appoint top UTI managers. In early January, finance minister Yashwant Sinha said that the government was considering those suggestions, adding: “The ownership obligation is that if there is a problem, we should step in and solve the problem.”
Investors are voting with their feet. Those who stayed with US 64 after the first bailout lost money. More of them are now turning to privately managed funds that earn higher returns. UTI’s market share dropped from 64% to 50% last year while the share of privately managed funds is up at 41%. As the chief investment officer of one fund puts it: “Soon after the problems faced by US 64, investors were suspicious of all mutual funds. Private funds have a good track record now, and investors are ready to try them.” The government’s monopoly over India’s savings market, like that over the market for cars, telephones and airline travel, is fast disappearing.
The sooner India’s rulers face up to that reality, the better.
