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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
MORE MARKETS, LESS GOVERNMENT ally to 40 percent in 1980. 3 NPA have been defined as those loans for which interest has remained unpaid for four quarters in 1992-93. 4 For a detailed analysis on financial crisis see Joshi and Little (1996), Cerra and Saxena (2002), Kapila and Kapila (1996) and Rangrajan (1991) among others. 5 For example (Kohli, 2001) reports the dates of indirect intervention done by RBI as October 1995, January and July 1996, November 1997 and January, June and August 1998. 6 The 1998 committee on banking sector reforms recommended the minimum shareholding by the government or RBI equity in nationalized bank should be brought down to 33 percent. 7 In fact, few allies in the newly formed United Progressive Alliance (UPA) government are demanding a rise in the interest rates on various provident fund schemes. 8 To quote RBI Governor Y.V. Reddy:“The transaction costs are a drag on the economy and it is time to put emphasis on their reduction which can facilitate the growth of GDP by 2 to 3 percent. (November 3, 2003, http:// www.rediff.com/money/2003/nov/ 03cred10.htm) 9 Australian and New Zealand governments currently report such liabilities in their balance sheets. References • Bhattacharya, S. and U. R. Patel (2003). Reform Strategies in the Indian Financial Sector. In Conference on India’s and China’s Experience with Reform and Growth, New Delhi. International Monetary Fund and National Council of Applied Economic Research. • Bhide, M. G., A. Prasad, and S. Ghosh (2001). Emerging Challenges in Indian Banking. CREDPR Working Paper 103. • Cerra, V. and S. C. Saxena (2002). What Caused the 1991 Currency Crisis in India? IMF Staff Papers 49. • de Aghion, B. A. and C. Gollier (2000). Peer Group Formation in an Adverse Selection Model. Economic Journal 110, 632–43. • Demetriades, P. O. and K. B. Luintel (1996). Financial Development, Economic Growth and Banking Sector Controls: Evidence from India. The Economic Journal 106, 359–374. • Ghatak, M. (2000). Screening by the Company you Keep: Joint Liability Lending and the Peer Selection Effect. Economic Journal 110, 601–31. • ha, R. and A. Sharma (2004). Structural Breaks, Unit Roots and Cointegration: A Further • Test of the Sustainability of the Indian Fiscal Deficit. Public Finance Review 32. • Joshi, V. and I. M. D. Little (1996). India’s Economic Reforms: 1991-2001. Oxford: Claredon Press. • Kapila, R. and U. Kapila (1996). Understanding India’s Economic Reforms. New Delhi: Acedamic Foundation. • Kohli, R. (2001). Aspects of Exchange Rate Behavior and Management in India 1993-98. Economic and Political Weekly January 29. • Obstfeld, M. (1995). The Mirage of Fixed Exchange Rates. NBER Working Paper No. 5191. • Polackova, H. (1999). Contingent Government Liabilities: A Hidden Fiscal Risk. Finance and Development 36. • Puhazhendhi, V. (1995). Transaction Costs of Lending to the Rural Poor: Non-Governmental Organizations and Self-Help Groups of the Poor as Intermediaries for Banks in India. Banking with the Poor (BWTP) network. • Rangrajan, C. (1991). Recent Monetary Policy Measures and the Balance of Payments. Reserve Bank of India Bulletin July. • RBI (1990-2003b). Report on Currency and Finance. • RBI (1993-2003a). Trend and Progress in Banking in India. • RBI (1993-2003c). Reserve Bank of India Bulletin. • RBI (1997). Report on Currency and Finance. • RBI (2003d). Reserve Bank of India Annual Report. • Saez, L. (2001). Banking Reform in India and China. International Journal of Finance and Economics 6, 235–44. • Saggar, M. (1999). Some Issues Relating to Exchange Rate Policy in India in the Post Liberalization Period. Ph. D. Dissertation, Indira Gandhi Institute of Development Research (IGIDR), Mumbai, India. • Sharma, A. (2004) Fiscal Deficits, Banking Crises And Adjustment Policy In A Semi-Open Economy Ph. D Dissertation, Australian National University, Canberra, Australia • Shirai, S. (2002). Banking Sector Reforms in India and China: Does India’s Experience Offer Lessons for China’s Future Reform Agenda. JBIC Discussion Paper No.2. THE INDIA ECONOMY REVIEW 131
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Lawrence Surendra, Planning Commiss
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Anandajit Goswami, Associate Fellow
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Amal Sanyal, Associate Professor, L
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REIMAGINING INDIA then the resource
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Nilanjan Banik, Associate Professor
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Shripad Dharmadikary Manthan Adhyay
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D.M.Diwakar, Professor of Economics
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Anu Singh, Professor of Economics,
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Anindo Banerjee, Head, Programme In
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Anjani Sinha Managing Director & CE
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P LANMAN TECHNOLOGIES KNOWLEDGE . I
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