[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
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REIMAGINING INDIA<br />
of the trust were imprudent and turned<br />
out to be in error.<br />
Apart from these investment inconsistencies,<br />
the stock scam in 2001 revealed<br />
the unhealthy nexus among the UTI (and<br />
possibly other mutual funds as well), local<br />
operators and promoters/corporates.<br />
It was believed the UTI mutual fund was<br />
the backbone of purchases in the infotech<br />
sector supported by the infamous operator<br />
Ketan Parikh. <strong>The</strong> tech meltdown of<br />
2001 resulted in sharp redemption for the<br />
scheme in early 2002. In mid 2002, the<br />
UTI decided to skip a dividend for its<br />
flagship US-64 scheme for the 2001-2002<br />
year. This was because the Net Asset<br />
Value (NAV) of the scheme has eroded<br />
sharply and was much lower than the face<br />
value of Rs.10. On 1st August 2002, the<br />
NAV of US-64 was only Rs.5.80. <strong>The</strong><br />
RBI was reported as contemplating a repurchase<br />
arrangement with UTI. This<br />
behavior of the RBI was an attempt to<br />
insulate the guilds market from the UTI<br />
crisis which was already having an impact<br />
on the equity market. Even some commercial<br />
banks such as the Bank of India,<br />
and State Bank of India started extending<br />
loans against UTI’s US-64 scheme<br />
at a steep discount. However, many<br />
other banks adopted a wait and<br />
watch policy.<br />
<strong>The</strong> Finance inister, Yashwant Sinha<br />
was initially reluctant to provide any sort<br />
of government support to UTI. In a press<br />
conference he was quoted as saying, “We<br />
cannot go on spending government money<br />
for bailouts. A budgetary support is<br />
not a desirable option at the moment.”<br />
However this policy could not be sustained.<br />
A majority of public sector banks<br />
rejected the proposal of buying stocks<br />
held under its flagship US-64 scheme.<br />
However, these banks were willing to extend<br />
clean loans to UTI for a short period,<br />
provided the central government gave<br />
a “comfort letter” ensuring timely payment<br />
of the interest and principal amount.<br />
However, the finance minister was not<br />
keen on providing a “sovereign guarantee”<br />
to public sector banks in lieu of loans<br />
extended to UTI. <strong>The</strong> chairman of UTI,<br />
Mr. M. Damodaran was quoted as saying<br />
that “<strong>The</strong>re were problems on two fronts<br />
- liquidity and solvency. <strong>The</strong> liquidity can<br />
be taken care of by the banks line of<br />
credit. But, to address the solvency issue,<br />
the government will have to step in at the<br />
second stage, if the market does not pick<br />
up by that time- That is, the government<br />
will have to bail out UTI.” M. Damodaran<br />
said that, in the wake of a problem<br />
regarding the solvency issue, if the government<br />
was not forthcoming with funding,<br />
UTI would dump its illiquid stocks<br />
in the market.<br />
A report by global consultancy firm<br />
Mckinsey declared that UTI may need<br />
$500 million to stay solvent. Mckinsey<br />
argued that, given the high fiscal deficit,<br />
recapitalization from government funds<br />
would not be easy. Also, funds raised<br />
from the capital market would not be sufficient.<br />
After a series of meetings between<br />
UTI chairman, M. Damodaran and Secretary<br />
of the Department of Economic<br />
Affairs and later with Finance Minister<br />
Y. Sinha, the government decided to provide<br />
cash assistance to UTI of Rs.5 billion.<br />
Officials said the liabilities to the<br />
center would be provided for either in the<br />
budget or the final supplementary demand<br />
for grants and will be in the nature<br />
of a contingent liability on the government.<br />
Financial analysts began suggesting<br />
the government would have to bail<br />
out the country’s largest mutual fund operator<br />
for another year. In the light of a<br />
negative reserve of about Rs.37 billion<br />
and payment obligation for about Rs.9<br />
billion for two of its MIP schemes maturing<br />
2002 UTI had demanded around<br />
Rs.50 billion. <strong>The</strong> Cabinet Committee<br />
on Economic Affairs chaired by the<br />
Prime minister, Mr. A. B. Vajpayee, approved<br />
a bailout package of over Rs.145<br />
billion for UTI to meet the liabilities on<br />
its flagship US-64 and assured return<br />
schemes. <strong>The</strong> government also considered<br />
some tax concessions for US-64 unit<br />
holders so as to create a market, reduce<br />
redemption and keep up investment in<br />
the scheme. <strong>The</strong> Finance Minister also<br />
asserted there would be no budgetary<br />
impact as a result of the package, although<br />
it would add to the fiscal burden<br />
and contribute to public debt. <strong>The</strong> UTI<br />
case provides an interesting and important<br />
example of policy reversal in the face<br />
of financial crisis.<br />
End Notes<br />
1<br />
“Under section 24 (b) of the Banking<br />
Regulation Act, 1949, every bank is<br />
required to maintain at the close of<br />
business every day, a minimum proportion<br />
of their Net Demand and Time<br />
Liabilities as liquid assets in the form<br />
of cash, gold and un-encumbered approved<br />
securities. <strong>The</strong> ratio of liquid<br />
assets to demand and time liabilities is<br />
known as Statutory Liquidity Ratio<br />
(SLR). Present SLR is 25 percent. <strong>The</strong><br />
RBI is empowered to increase the SLR<br />
up to 40 percent” (RBI Glossary).<br />
2<br />
In 1974, banks were required to direct<br />
33 percent of their net bank credit at<br />
concessional fixed interest rates to priority<br />
sectors. This was raised gradu-<br />
130 THE <strong>IIPM</strong> THINK TANK