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Macro dimensions of UTI fiasco

N. A. Mujumdar

THE FIASCO of the Unit Trust of India (UTI) raises the much broader question: Have financial crises of this nature become systemic? The individual small saver and investor has gone through a chain of such shocks in the 1990s when the financial sector ref orms were introduced.

There was the Non-banking finance companies (NBFCs) crisis; then the so-called green gold schemes on the lines of the teak plantations, and the Karad and Madhavapur Cooperative bank failures, and, now, the failure of the Unit Scheme 64 (US-64). In India, the household sector is the largest single contributor to the overall savings stream, and it has been responsible for raising the saving rate to a respectable 25 per cent of GDP.

Viewed against this background, the UTI fiasco assumes greater significance because the UTI's reach extends to even semi-urban and rural areas. In fact, the UTI should publish figures of resources mobilised from metropolitan, urban and rural areas. The p oint is such a series of shocks tend to erode the confidence of the individual saver in the financial system and may eventually even affect the overall saving rate.

There is another sense in which such crises can be categorised as systemic because many of these are related, directly or indirectly, to the happenings in the stock, or capital, market. The policy-makers, perhaps, inspired by the IMF/World Bank philosoph y, set out in the early 1990s to give boost to the capital market. In fact, they have been over-indulgent to the capital market and gone out of the way to support it with artificial props but also by discriminating against other segments of the financial sector -- commercial and development banks. But at the end of it all, what is the net result? The capital market has been practically stifled.

In the euphoric phase of the development of the capital market, in the early 1990s, the expectation was that it should be possible to raise, say, Rs 50,000 crore every year. Today, hardly Rs 7,000 crore is raised. While the current investigations into th e UTI operations focus, understandably, on its inept handling of its resources, and flawed investment decisions, the wider issue of the moribund capital market casting its shadow over most mutual funds is likely to be lost sight of.

Many of the mutual funds, set up with great fanfare during the euphoric phase, have had to be wound up. Many of those that are around are not exactly healthy. The policy package designed to boost the capital market has proved a double failure. One, it ha s not helped develop the capital market, but actually stifled it. The phenomenal growth of the private placement market in recent years is, by itself, an indictment of the policy package.

Two, it has crippled the other segments of the financial system -- commercial banks and development banks. Development of the capital market is, indeed, an eminently desirable objective. But it can be only an intermediate objective, for the ultimate obje ctive should be the promotion of industrial or corporate growth. It should also be recognised that there are alternative methods of achieving the ultimate objective, some of which are better suited to the Indian context. The policy package failed, to a l arge extent, because it did not take into account the essentially Indian milieu but sought to super-impose models borrowed from the IMF/World Bank. It is hoped that the UTI crisis would provoke Indian policy-makers to address these macro dimensions of th e broader issues, and introduce policy correctives.

As in the case of most of India's financial sector reforms, measures taken to develop the capital market were inspired by the IMF/World Bank mythology. De-emphasising development banks and throwing open portfolio investment to foreign institutional inves tors (FIIs) were the more important of these measures. Historically, the Industrial Development bank of India (IDBI) had played a critical role in promoting industrial growth.

In fact, many of the middle-level industrial houses of today owe their growth to the IDBI: Its performance was so impressive that many Asian and African countries sent their experts to study its functioning. The policy-makers, however, had no time to ref lect upon the essential Indianness of this experience, but were in a hurry to follow the IMF/World Bank mantra.

The Reserve Bank of India discontinued, since 1992-93, its concessional assistance to both the IDBI and the National Bank for Agriculture and Rural Development (Nabard) through its Long-term Operations (LTO) fund. Both these institutions were, thus, comp elled to raise resources through the market and since their cost of funds went up, their lending rates become very high. That triggered the deterioration of both the institutions; and in the case of the IDBI, its business shrank because highly rated corp orates could raise money abroad at cheaper rates of interest. Today, the IDBI's own shares are being quoted at below acceptable levels.

The World Bank may have had its own compulsions to de-emphasise the role of development banks which it used to support earlier through its subsidiary International Finance Corporation (IFC). Probably, the lobby of the fund managers of large finance compa nies in industrial countries was keen that the so-called emerging market in the underdeveloped world be opened up for investment of their funds and the World Bank, perhaps, succumbed to its pressure.

But there was no reason why India should have followed the World Bank lead. In fact, it should have taken a leaf from the recent experience of the Asian Tigers where development banks played a critical role in supporting industrial and corporate growth. Thus, there is no rationale for de-emphasising development banks.

Furthermore, even if portfolio investment is thrown open to FIIs, permitting them to operate in the secondary market does not make any sense. It only adds to the market volatility. There are many recent episodes in which FIIs with nominal capital have mo ved in funds on a massive scale for short periods and moved them out, after achieving their objective of a ``quick kill''. What good do such flows of hot money bring to the capital market?

Turning to the discrimination against commercial banks. At present, dividend income, including that from mutual funds is exempt from individual income-tax, whereas interest income from bank deposits attracts tax. To add to the discrimination, interest in come from banks is subject to TDS. The role of commercial banks in facilitating economic growth is as important as that of the capital market. In fact, some bigger banks such as the State Bank of India are keen on providing medium- and long-term credit t o the corporate sector. Wisdom seems to lie in providing a level-playing field to commercial banks by doing away with this discrimination.

What has been the result of all these props provided to the capital market? The props include throwing open both the primary and secondary markets to the FIIs, exempting dividend income from tax, raising the permissible level of banks' direct involvement in the capital market, and so on. In 1999-2000, the aggregate resources raised on the primary market through prospectus and rights issues was only Rs 7,700 crore. In sharp contrast, the resources mobilised by banks, financial institutional and public an d private sector companies through private placements added up to a staggering Rs 61,200 crore.

The proportion of resources raised in the capital market and of that through private placement are not an aberration of a particular year, but are part of an abiding trend. Private placements are neither transparent nor subject to public scrutiny. The ph enomenal growth of the private placement market is by itself an indictment of the policies designed to promote the capital market.

In large part, the sad mess in which the Indian capital market finds itself today is due to the amateurish understanding of the capital market's role. The policy-makers seem to believe that the capital market's development is an end in itself; in reality , it is only a means to promote industrial or corporate growth. Even in this task, capital market plays a relatively small role. In developed countries, such as the US and the UK, resources raised through the capital market account for only 20 per cent o f total capital formation of the corporate sector. The bulk of the capital formation comes from the internal generation of resources or ploughing back of profits.

Again, world over, the capital market has ceased to be the barometer of the economy; or the index of business confidence. Speculative forces have overwhelmed these text-book characteristics of what the capital market ought to be. This realistic perspecti ve should form the framework of policy formulation.

The policy correctives required are: Commercial banks, the IDBI and the capital market should regard industrial or corporate growth as a cooperative endeavour; let the RBI resume extending its concessional finance to the IDBI through LTO funds. When we c ry hoarse for a low interest rate regime, it makes little sense to ask the IDBI to raise its resources through the market. Discrimination against commercial banks must be stopped forthwith. Let them also play their part in promoting growth. The interest income from bank deposits should also be tax-exempt.

Let not the Government or the RBI prod, as they seem to be doing now, the public sector banks to involve themselves directly in the capital market. Japan's experience should sound a note of warning. Let the capital market grow on healthy lines autonomous ly and not on the crutches of artificial props, and not at the cost of other segments of the financial system.

Pic.: Are the series of financial shocks ballooning into capital market crisis?

(The author is former Principal Adviser to the RBI.)