[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...

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