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| June 12, 2006 | Monday | Jumadi-ul-Awwal 15, 1427 |
India grappling with pension fund rules
INDIA’S financial services sector has traditionally been dominated by the state-owned companies, many of which in the past acted not on the basis of prudential norms – or for the benefit of their shareholders – but at the dictates of their political bosses.
Nationalised banks in India piled up hefty bad debts during the 1980s, especially after a particularly unscrupulous minister ordered them to organise ‘loan melas,’ where managers had to dole out thousands of rupees to the lackeys of politicians and party favourites.
The borrowers did not have to provide any documents, or even commit themselves to clearing off the loans. The state-owned banks took more than a decade to clear their books of these bad loans.
The last few years have seen the government relinquish its control over (or dilute its stake in) several firms in the industry, including banks, mutual funds and insurance companies. Reforms in the financial services industry, with the opening up of sectors like mutual funds and insurance, have boosted its fortunes and brought up dramatic improvements on the technological and client services front.
But the Indian government continues to wield tremendous influence over the industry, and certain crucial segments – like pensions, for instance – are still dominated by it. International consultancy, McKinsey & Company, last week noted that further reforms in the sector, with the government diluting its role in the financial system, could free nearly $50 billion of capital.
McKinsey’s report – Accelerating India’s Growth through Financial Sector Reform – points out that reforms could raise the real GDP growth to 9.5 per cent a year (up by more than a per cent), besides increasing household incomes by a third above current projections in less than a decade.
The government, emphasises the report, has to drastically reduce its role in financial sector, to boost the GDP. The state’s control over financial institutions has resulted in less than 45 per cent of the total credit going to the private sector. The rest goes to state-owned firms, the agriculture sector, and unorganised businesses.
The public sector, though a major beneficiary of state-sponsored credit, has labour productivity levels that are half of those in the private sector. Worse, in the agriculture and unorganised sectors, productivity is a tenth of those in the private sector.
The government has a tight control over credit, which virtually starves the private sector of funds. Banks have to invest a quarter of their assets in the government bonds - a third of it has to be allotted to ‘priority’ sectors, including agriculture and small businesses. But these loans often turn bad, have high default rates, and because of the small quantum, cost more for banks.
Reforms in the banking sector have seen the entry of several new players, and international banks have also been able to go in for limited expansion. But yet, private banks account for less than 10 per cent of market share, while international ones have around five per cent of the market share.
Similarly, a massive 90 per cent of pension funds and half of life insurance assets are being held in government bonds, depriving crucial sectors – such as infrastructure – of funds. If the government deepens the reforms in financial sector, it could release billions of rupees to fund mega projects that are being planned in power, roads, ports and airports sectors, consequently boosting the GDP growth.
One sector where the government’s role has reduced drastically is in the mutual funds business. For almost 35 years since the mid-1960s, the government-controlled Unit Trust of India (UTI) had a dominating presence in the mutual funds industry.
But following a major crisis – caused by the government’s foolhardy policy of assuring guaranteed returns to unit-holders – the mutual fund sector went in for major restructuring. The UTI itself underwent significant changes and became answerable to the capital market regulator, the Securities and Exchange Board of India (SEBI).
The UTI Mutual Fund, the new avatar of Unit Trust, is today a dynamic company that has managed to face the stiff competition posed by nearly 30 other funds, including international ones. But last week, for the first time in the country’s mutual fund history, the UTI lost its top position (in terms of assets).
The Prudential ICICI Mutual Fund – a joint venture between the Prudential Plc, UK’s leading insurance company, and the ICICI Bank, India’s top financial institution – toppled the UTI from top position. According to the Association of Mutual Funds of India (AMFI), the Prudential ICICI had assets under management (AUMs) of Rs321.51 billion, overtaking the UTI (Rs305.51 billion) in mid-May.
The mutual fund industry’s investor-base expanded by six per cent to 23.51 million, while assets grew by 7.3 per cent, adding up to Rs2.763 trillion. The AUMs have shot up by over 60 per cent over the past one year.
But with the stock markets taking a stiff beating in May and June – foreign institutional investors (FIIs) have slashed their exposure to the Indian bourses by $2.5 billion since the middle of May, when the Sensex reached its all-time high of 12,671 – equity funds also suffered. Assets of equity schemes fell by up to 13 per cent.
Mutual funds have also been selling stocks following the over 20 per cent fall in the indices over the past month. Their liquid assets grew by over 10 per cent in April, and are expected to account for a substantial chunk of total assets now.
Industry observers note that many mutual funds have started dumping equity, in preparation for the expected redemption by nervous retail investors. Generally, mutual funds keep less than five per cent of their assets in cash, but with redemption pressures expected, they are likely to raise their cash component significantly, by selling off shares.
For the first time in several weeks, mutual funds have emerged as net sellers in the stock markets.
But despite the recent setback, many other international majors are planning to enter the Indian mutual fund sector. According to AP Kurian, the AMFI chairman, at least four top asset companies – the American International Group, the JP Morgan, the UK-based Dawnay Day and the Temasek of Singapore – will set up shop in India over the next six months.
THE United Progressive Alliance (UPA) government is keen to open up the pension funds sector, but strong opposition from the leftist allies has prevented it from pushing through the Pension Funds Regulatory and Development Authority (PFRDA) bill in Parliament.
The steep fall in stock markets, and the consequent outflow of funds as the FIIs and the NRIs make a quick getaway with their profits, could make things easier for the government to convince its critics about the need for the FDI (foreign direct investment) in the pensions sector.
India’s foreign exchange reserves are at a record high of $163 billion, but a significant chunk of it constitutes ‘hot money’ (the FII and the NRI funds in stock markets). The FDI in sectors like infrastructure, insurance and pensions represents long-term funding, which is unlikely to evaporate in times of a market meltdown.
The government is now trying to convince its left allies on the need for foreign investments in pension funds. There is talk of a 26 per cent ceiling – which could be raised at a later stage. However, the left is loathing allowing the government to set such ‘arbitrary’ ceilings, as it fears that these can be raised later. An alternative being suggested is that Parliament should decide whether to raise these limits, and not the government.
About half a dozen pension funds – including five private ones – are expected to start operations. The left parties, which control trade unions, are insisting on assured returns – state-controlled Provident Fund, which provides such returns, has to dip into its reserves to make payments – but the international funds don’t provide such guarantees.
The government is toying with four schemes: safe, balanced, growth and guaranteed, which would invest only in government securities. Some mutual funds and insurance companies have launched pension schemes in India, but the absence of the PFRDA law has held back many other players.
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