Economic Highlights

New Delhi, 16 October 2008

Mutual Funds Take Brunt

DELINK ECONOMY FROM STOCK MARKET

By Shivaji Sarkar

The Reserve Bank-injected liquidity of Rs 1,00,000 crore through cash reserve ratio (CRR) cut is a tacit admission that the Indian financial sector is not as secure as it is claimed to be. It also bursts the myth that the stock market is the mirror of the economy.

Importantly, it raises a basic question whether the RBI is correct in its decision on CRR. The economy and not just the market need relief from the high interest rates. That is what the RBI should have done instead.

The financial instrument linked to the stock market – mutual funds (MF) – has once again taken the brunt of the hit. It is not the first time that the stock market has burnt the Indian economy. It has done so many times during the past 15 years in scams such as Harshad Mehta’s (Rs 90,000 crore), Ketan Parekh’s (Rs 30,000 crore) and the UTI, a mutual fund in reality (Rs 64,000 crore).  

Mutual funds, mostly floated by banks or financial institutions, play on the small investors’ money. The losses of 35 MFs at the stock market are being computed and some estimates suggest that these are likely to suck in all the liquidity that the CRR cut has induced. In fact, the high-level committee set up by the Central government was engrossed with the problem in its very first meeting and soon after arranged Rs 20,000 crore to bail the MFs on a short-term basis. Dhirendra Kumar, CEO of Value Research, and an expert on mutual funds, says investors are pulling out their money from MFs and warns that the latter may need Rs 1,00,000 crore to resuscitate.

Besides, the market is agog that the banks have taken out 80 per cent of their investment from mutual funds. The pull out of the giants is clearly shaking the confidence of smaller investors, who too have started taking out their money, lest they lose the principal amount as well. In one month alone, the MFs asset value has been reduced by over Rs 15,000 crore – from Rs 544,000 crore to Rs 529,000 crore. This indicates the exit of investment and does not take into account the actual losses.

The way the Union government is trying to bail out the MFs – an extension of the US bail out package – strengthens the belief of privatization of profits and socialization of losses. It is no wonder that French President Nicolai Sarkozi, in his comment on the global meltdown, says, “The idea that market was always right was a mad idea.” He goes on to add that “The crisis marked the end of a world that was built on the fall of Berlin Wall and the end of Cold war – big dream of liberty and prosperity”.

The scrip at the stock market is as unreal as the sub-prime real estate prices. Both have far over-rated their intrinsic prices, leading to an inflated credit market. In reality, high credit is given on low value instruments. It adds to artificial money circulation, while actually there is no money.

The speculative prices and linked-up credit do not add to either the national or global wealth but to the bubble of speculative prices. No wonder the bubble bursts repeatedly but the financial sector, which is based on greed, quick profits and not so ethical practices, refuses to learn its lessons.

Sarkozi’s remark is a grim warning for all economies. It should be taken as a call to delink the world economy from the stock market led “boom”. At least, India needs to take the remark seriously. The financial regulator, RBI, needs to issue strong instructions to the financial sector that they should keep off from the stock market.

Stocks or equities are company properties, held by private interests profiting on large public investments. It is for this reason that when the stock market burns, the companies rarely shed tears as their intrinsic basic investment is always safe. The losses are accrued to the public, who are sold the scrips on dreams of, as Sarkozy says, “prosperity”. It may be recalled that the Great Depression of 1929 also started from the New York Stock Exchange.

The silver lining, however is that despite problems, the IMF hopes to see both India and China do better than the western countries. It does expect a thaw. And, this should be utilised for reworking the financial policies linked to the market so that the losses are not socialized. The knee-jerk reaction to bail out MFs -- indirectly the stock market - seems to belie that hope.

Since 1991, all the so-called reforms have been addressed to the stock market. This has skewed the bank-financing pattern. The entire financial market’s obsession for quick profits through stock market investments has not only added to huge losses, but has kept the investments away from sectors that need the money, such as infrastructure and industrial growth.

The impact is being seen as in low growth in every sector – manufacturing, core sector, industry, services and finance. Industrial indices like IIP were fine tools when they projected 10 per cent growth, but are being maligned and termed incorrect by the top bosses, when these fall to a low of one per cent. This is clearly an ostrich-like policy—a refusal to accept the reality, possibly under the pressure of stock players and corporate lobbies. Importantly, this is where policy correction is required.

A law should be enacted to prevent the government from giving such bail-out packages. It only means rewarding the bad players, if not criminals, and penalizing the good and honest investors. It also calls for a review of regulators such as the Securities and Exchange Board of India (SEBI), which has repeatedly failed. The present step, CRR cut, does not address the real issues. The nation has to debate and look for the corrective path – away from the stock market. ---INFA

(Copyright, India News and Feature Alliance)