Beyond the fiasco in Unit Trust of India

Confidence in our financial system is at stake

D N Ghosh

A dark cloud hovers over the financial markets. The fiasco in the Unit Trust of India (UTI), nervousness in the capital market, doubts on the solvency of key financial institutions, integrity of market participants, dithering over policy initiatives, all of these have rudely shaken the trust and confidence, which it has taken years to nurse. In the early 1990’s, we started with high expectations on the reform agenda, but today we seem to have lost our sense of direction and are uncertain about the future.

The fiasco in UTI is the most recent manifestation of a deep-seated canker in our financial system. Development of the mutual fund industry by opening it up for the players in the private and foreign sector was a commendable policy initiative; so also the supporting structure of regulation by Securities and Exchange Board of India (SEBI) for the benefit of the investing community. Public memory is proverbially short, but many may still recall the interesting duel between the then respective chiefs of SEBI and UTI on their jurisdiction. UTI refused to come within that regulatory ambit, claiming that its governance mechanism under a separate statute was in no way inferior to any kind of external regulatory surveillance. Significantly, the government stood by as a mute spectator.

That studied silence had a pregnant message for the regulator: Keep your hands off UTI. Those tracking the investment market and the mutual fund industry knew well enough that UTI, the largest investment outfit of the country, had always been available, as a handy and convenient tool for the political executive and several business houses. It made eminent sense therefore that the machinations of this triple alliance, these mutually accommodating interest groups, of which the political executive has always been an integral part, are sheltered from public gaze. The discipline of an external regulatory agency could on occasions prove too embarrassing: none of the interest groups could afford to take that kind of risk. UTI got away in the bargain with a reprieve from the regulatory discipline; what was sacrificed in the process is transparency and accountability for the millions of the investing community.

Assuming that such speculations are unfounded and government had no undisclosed agenda, a question remains - one that worries the investors. If the government wanted to keep UTI on a special pedestal, why is it that it did not move to enforce on UTI a structure of corporate governance that incorporated the best of international practices in the mutual fund industry. The veil was partially lifted much later, that too, only partially, by the Deepak Parekh committee, thanks to the crisis of 1998. To quote: “The dominance of nominees appointed by the initial contributors to the capital, which were all public sector financial institutions/banks may have resulted in direct/indirect interference by the government in the investment policies of the scheme,... the Trust, at the suggestion of the Government, has from time to time utilised the large corpus of US-64 to support the market, and the fund managers could have invested on various occasions due to factors other than prudent investment management, and without consideration of the return to unit holders.”

Note the few instances highlighted by the committee: supporting the disinvestment programme of government, propping up the stock market, whenever required by government, giving an impression of solvency by drawing upon reserves to pay dividend - all these in utter disregard of the interests of the investors. Clearly, perhaps too brazenly, the trustees, notwithstanding the explicit and unequivocal responsibility cast on them by the statute, to act on business principles in the interests of investors, acquiesced passively in what was going on. The true and fair picture of business was getting distorted to an extraordinary degree but the men of eminence selected to be independent trustees chose to remain silent; that was virtual subservience. Could they have been so naive? That seeming naivete must have had its roots in the implicit belief that, when the day of reckoning arrives, the government would come to its rescue.

Fidgeting in a trap set by the different interest groups, government is unable to cut the knot. The party in power and the opposition know the truth; but their slanging match will take us nowhere. Not only in UTI but also in all other premier institutions in the system the game goes on. The government and the opposition, all together, must own their share of responsibility in failing to adapt our institutions to the new requirements; worse still, having made themselves captive to the short-termism of their political horizon, they are knowingly allowing some of the finest institutions to disintegrate. UTI is the mirror in which they should see their own reflection.

A financial system derives its strength and character from its institutions and organisations that comprises it. That is the foundation on which any reform process can be built and developed. The policymakers have to create conditions for the preservation of the integrity of these key institutions. In a market system where the state does not get hollowed out, the responsibility of guiding and supervising the financial system becomes much more onerous. This is not subsidiary to their ownership responsibilities; if this comes in conflict with the broader responsibility, which the state has, for reforming and strengthening the financial system, they have to find ways of resolving that conflict. That is the litmus test for judging the leadership role of the political executive.

The behavioural pattern, of those in power and in opposition, does not give the citizens of the country any confidence. The sacrifice made by the investing community will have gone in vain if the political leaders, the government and opposition, do not look beyond their narrow political interests. Sometimes a crisis may be a blessing in disguise; it may make our political class wake up. Our financial system stands on the brink of a precipice; this cannot be wished away by optimistic posturing, which, to use an expression from Voltaire’s Candide, is nothing more than “alas ... the obstinacy of maintaining that everything is best when it is the worst”.

The author is a former chairman of State Bank of India.