Trust betrayed

It is futile to pretend that the Finance Ministry was unaware of the UTI's disastrous funds investment; it must accept responsibility for this big blow to public confidence.

THE Unit Trust of India (UTI) has stopped trading in its US-64 scheme, long considered its "safest" savings avenue. Of all the recent encounters that the public has had with the much-celebrated forces of the market, the US-64 debacle is surely the most painful. Its gravity far exceeds the powerful downswing of the mid-1990s in the artificially bloated stock market, which the middle class had just discovered as an investment avenue amidst euphoria over "market forces". This wiped out its savings to the tune of Rs. 20,000 crores. Then came the property market bust-up, which reduced real estate values by 40 to 60 per cent in most cities. Meanwhile, the creeping post-1997 economic slowdown - which may now be turning into a full-fledged recession - has eliminated about one million jobs, many of them in the white-collar segment.

Equally traumatic has been the bursting of the information technology (IT) "revolution" bubble, which had raised dizzy hopes through 50-per cent-a-year increases in software exports, and promises of a cornucopia of e-commerce and IT-related services. India, it was said, would be the "natural leader" of the ICE (information, communications and entertainment) Age. Imitating the West, Indian financial dailies - most of them dutifully and unoriginally pink - tomtommed the "New Economy's" triumph, although the IT sector constitutes less than 2 per cent of India's GDP. They even constructed a "Mindex" and declared "e-governance" as the future trend - as if that could be a substitute for rugged democracy.

Today, after the dot.com bust, all talk of "IT Superpower" India sounds embarrassingly hollow. (It always was hyperbolic; India's share of the world software market never crossed even one per cent). Once-coveted IT professionals are being unceremoniously given the "pink slip". Termination notice periods are shorter than 24 hours. The "Mindex" has crashed. The middle class's experience of the raw end of "fast-track capitalism" has hardly been a pleasant one - despite the unprecedented increase in the range of availability of consumer durables, and now, even perishables such as processed food. The post-Budget market decapitalisation (one is almost tempted to say "decapitation") has meant the disappearance of over Rs.70,000 crores in share values in their precipitous fall - despite the Budget's strenuous effort to boost them by diverting savings from other avenues. This has led to a spate of suicides of the affluent, not the poor - the traditional victims of India's capitalism. And now comes the news on US-64.

Dejection is writ large on the faces of unit-holders over the sinking of this "super-safe" instrument floated by the public sector giant, which has delivered a steady and regular return for 27 years. But try telling small investors that private funds and asset management companies (AMCs) are reliable and they will laugh at you. After their experience with fly-by-night operators like Lucknow's Century Consultants alias Cyberspace Infosys, which promised the earth but vanished, they no longer trust any. There is a larger lesson in the US-64 collapse for the management of public savings, including pensions, and also public sector undertakings (PSUs).

THE causes of the US-64 crisis lie in the (mis)management of the Scheme's investment portfolio. US-64 was launched as a steady income fund to channel small savings into the capital market. Logically, it should have invested in debt, especially low-risk fixed-income government bonds. Instead, over the years, its managers increasingly invested in equities, which promise big but high-risk returns largely through speculative appreciation in value.

This tendency can be traced back to the late 1980s when the UTI was "politicised" along with other financial institutions (FIs) such as the Life Insurance Corporation and the General Insurance Corporation, and made to invest in certain favoured scrips. By the mid-1990s, equities exceeded debt in the UTI's portfolio. Another function thrust upon the FIs was to "boost the market" artificially in order to provide an "endorsement" to the government's highly controversial economic policies.

In the past couple of years, the UTI's funds management had become even more imprudent with heavy investment in a handful of fast-moving stocks from the so-called K-10 list of Ketan Parekh's favourite portfolio, such as Himachal Futuristic, Zee Telefilms, Global Tele and DSQ. Most of these "technology stock" investments took place amidst indications that the "technology boom" had ended. The Trust saw its Rs.30,000-crore portfolio lose half its value within a year since February 2000. And yet it continued to buy recklessly into these stocks despite the fact that certain well-known corporates, which kept themselves closely informed of the trends, sold off their US-64 holdings worth Rs.4,000 crores in April and May.

According to available figures, the UTI invested Rs.3,400 crores in just six out of a total portfolio of 44 scrips. This was eroded by 60 per cent. It also sank Rs.1,300 crores in another five scrips, whose value has dropped to a miserable Rs.300 crores (by 77 per cent). By March/April this year, US-64's net asset value (NAV) had probably plunged below par (Rs.10). But the UTI continued to sell and re-purchase US-64 above Rs.14. Today, its NAV is estimated at Rs.8.30 - a massive loss for the Scheme's 13 million investors.

It is inconceivable that UTI made these fateful (mis)investment decisions entirely on its own. According to insiders, the Finance Ministry substantially influenced them. Indeed, active collusion among FIs, and shady operators like Harshad Mehta, were central to the securities scam of 1992. The entire institutional involvement in the capital market had been corrupted by unscrupulous corporations and brokers. To start with, the FIs were only too happy to make windfall profits through such collusion. But this was not going to last. Soon, the scam broke. The Joint Parliamentary Committee's report amply documents all this. We would have learned more about the UTI, had its chairman M.J. Pherwani - who had earlier rigged prices as a top GIC manager - not died soon after the scam became public.

Over the past decade, the Finance Ministry has coerced the UTI into rigging the market to show "positive" trends. Such manoeuvres arise from a growing obsession with securing endorsements of official policies through the economy's "ultimate arbiter", the market. In more recent months, the Finance Ministry became desperate to reverse the market downtrend following the presentation of the Budget. The UTI's misinvestment now coincided with the now-famous global "technology stocks" meltdown. The result was disastrous.

UTI chairman P.S. Subramanyam resigned, accepting responsibility for the debacle. But, although culpable, he could well have been partly a scapegoat too. According to senior finance officials, he had kept Finance Secretary Ajit Kumar informed of the UTI's dealings. The Ministry kept a close watch on the UTI's transactions, especially after the Rs.3,300-crore bailout of 1999. Its level of surveillance presumably increased after the government recently agreed to a JPC probe into the stock market scam linked to Ketan Parekh. According to one official, "no big decision or really large investment by any FI is possible without political approval, which sometimes even comes right from the Prime Minister's Office."

THE US-64 debacle, then, is not just a UTI scam. It is a governance scam which speaks of a larger malaise: deliberate mismanagement of public financial institutions at the behest of a Finance Ministry frustrated by the failure of its own gambles. That word precisely describes its macroeconomic assumptions and calculations about various steps taken to boost markets at the expense of the small-saver. The magnitude of its miscalculation should automatically ensure the exit of the Finance Minister, no less, in any accountable democracy which respects parliamentary norms. But Yashwant Sinha obviously does not believe in such norms although he in the abstract says he is "constitutionally... responsible to Parliament and the people..."

There are larger lessons in the UTI debacle. If a well-established and until recently well-managed institution like the UTI (which used to plough back 80 per cent of its earnings) can no longer be trusted to safeguard public savings, then there is a doubly powerful reason why we should not allow the most precious of such savings - pensions and provident funds - to be put at risk in the stock market. In a number of self-avowedly capitalist economies in western Europe, such funds cannot be invested in equities. In India the argument acquires even greater force given the poorly regulated stock market - a veritable beehive of dubious practices, including insider trading, where only a dozen brokers control 90 per cent of trade - its extreme volatility, limited depth, and vulnerability to powerful businessmen and unscrupulous politicians. Besides, opportunities for saving are extremely limited in this hierarchical and job-poor economy. Nor is there old-age social security.

Yet, Finance Secretary Ajit Kumar has, at the PMO's goading, formulated a proposal to privatise pensions. If it goes through, pensions and the Employees' Provident Fund will be diverted to the market through private managers. The rationale of the proposal has less to do with sound economics than with the government's deplorable desire to be rid of its pension obligations of Rs.22,000 crores a year (about a tenth of the Central government's expenditure). The government is unwilling to reduce its yawning fiscal deficit by slashing unproductive spending or taxing the rich. Shedding the pension obligation is a lazy, easy option.

This must be stiffly resisted. The state must be made to respect its public obligations and cut unproductive expenditure, especially in the military.

It has no business to play around with the people's savings. To allow it to do so is to write a charter of ruin for the 19 million households dependent on it - and to legitimise the government's profligacy.

Equally important, the government must not proceed with PSU disinvestment.

Its record in this regard is appalling. In the early 1990s, ill-conceived disinvestment cost the public exchequer over Rs.3,000 crores in losses through underpricing, according to the Comptroller and Auditor General. But the government learnt no lessons. Recently, it fully privatised Modern Foods with disastrous effect. The unit, sold to the biggest private corporation in a similar line of business - against anti-monopolistic practices - is going under and has been notified to the Bureau of Industrial Finance and Restructuring (BIFR). Even worse is the case of Bharat Aluminium Co (Balco) being sold at a fraction of its true market worth - again a fact confirmed by the CAG - to Sterlite Industries, a company with a dubious financial and environmental record, and which stands indicted by the Securities and Exchange Board of India (SEBI) and has been debarred from accessing the market.

The official argument for PSU privatisation is purely ideological and has little to do with their management record which is no worse than the private sector's. In any case, practically, it is ludicrous to sell off PSUs just when their shares have been hammered down by foreign portfolio investors by a staggering Rs. 200,000 crores. Yet the government is itching to sell Indian Airlines and Air India although all bidders for IA stand disqualified and Air India has only one suitor - Tata-Singapore Airlines. (This is the result of the blacklisting of Videocon and the Hindujas for serious charges of malfeasance.) That is also why it mindlessly wants to lease out four profitable airports to private companies. Nothing could be more irrational than the Rs. 16,000 crores-a-year disinvestment target of the 10th Plan Approach Paper - to finance the fiscal deficit.

However, as the economy slows down to 5 per cent or less, as agriculture stagnates, industrial investment declines (by a third), exports grind to a poor 5 per cent (against a 20 per cent target), and as income and regional disparities widen further, the government's obsession with privatisation and cutbacks in public spending will grow. This must be countered.

If India is not to go down the road of the failing states of Africa, Latin America, large parts of Asia, and Russia, it must wisely husband public savings. That is the key to responsible governance and to the maintenance of the state's capacity to act in the public interest. Let us be clear: the scams we are witnessing are not signs of learning-by-doing in a democratic, healthy economy, but acts of criminality and marauding of the state by private entrepreneurs - Russian-style. This is wholly incompatible not just with sound economics and ethics, but with democracy itself. A hollowed-out, corrupt, irresponsible state presiding over an unequal, discontented and divided society is a recipe for social and political collapse.