View: Another self-righteous half-measure by the RBI

What is that solipsistic little kid, who did nothing remarkable by any yardstick that an objective observer would bring to bear on his conduct but was wholly satisfied with his own little feat, doing in a comment on the Reserve Bank of India? He deserves, true, not to be in a comment on the august institution, but in a mirror held up to it.

The RBI has made available yet another chunk of money to the banks, this time for the purpose of providing credit to mutual funds, suddenly scrounging around for funds to pay out to investors who want to cash out. Never mind that the single biggest impact of the RBI’s long-term repos that showered the banks with liquidity has been to nearly treble the amount of money the banks put back into the RBI every day, as compared to before the Covid19 crisis began.

The banks are flush with funds, but are not lending to industry, but simply kicking it back to the RBI under the reverse repo arrangement. So what if the banks lose some money on the transaction? No one is going to jail for putting money into the RBI. This is more than can be said about what would happen if you lend to troubled industry and some of that lending turns out to be a dud loan.

Why are mutual funds under redemption pressure? Why has Franklin Templeton closed its debt funds? There is a long answer and a short answer. The short answer is that fund managers had made very risky loans with the mutual fund investors’ money, such as to the promoters’ holding companies for Yes Bank and Diwan Housing Finance Ltd, and others like it.

Now, there is scope for high-risk bets, because the rewards can be steep, too. But such bets should be part of a portfolio of high- and low-risk bets, so that the risk is properly diversified. If someone is very confident of his or her ability to pull off high-risk bets, they should invest their own money, not that of ordinary investors who do not really understand the kind of risks they take on when they invest in a bland category called fixed income instruments.

In part, of course, investors are to blame for investing in funds going simply by the brand name of the fund house. But there are systemic issues at stake. Should mutual funds that invest in such high-risk debt instruments be offered to retail investors? Should there be financial penalties on fund houses in proportion to the imprudent losses they make? Should the fund house’s return be linked to the return on the assets it manages, rather than to the amount of money managed?

Of course, it is not just the fixed-income funds that made risky loans of the Franklin type that are under redemption pressure. A lot of mutual funds are. These are related to the economy’s malperformance and grim prospects forecast for economic growth. Companies’ profitability is slated to take a huge beating, and their ability to service debt or pay dividends is suspect. This is the underlying problem that needs to be tackled.

The RBI’s liquidity move does little to address the challenge faced by the economy. The government has not offered companies and succour by way of a relief or stimulus package. Knowing this, how will a bank lend money to a mutual fund to pay off investors who want to redeem their units, when the chances of the fund making good on its investments are low?

If the RBI were to buy bonds issued by companies directly, as the US Fed, the Bank of England and the European Central Bank are, these companies would have ready access to liquidity and hope to tide over the current bad patch and hope to do better in the days ahead. The RBI is not willing to do that.

We have moved into the territory of the long answer. India does not have much of a market for corporate bonds. Companies borrow from banks, instead of issuing bonds that are subscribed to by a large swathe of investors directly or, more viably, indirectly through investment pools such as pension funds, mutual funds, insurance premia. A vibrant corporate bond market would bring out the inherent risk of different kinds of bonds issued by different companies. Absence of such a market, complete with risk mitigation instruments that hedge against the risk of default — credit default swaps — and interest rate and currency swings — appropriate interest rate and currency derivatives — is what makes mutual fund investment in some corporate bonds more risky than they ought to be.

The RBI and the government need to act to create that bond market, and to give companies direct access to credit — via credit guarantee and interest subsidies from the government and direct purchase of bonds issued by companies and Non-Banking Finance Companies by the RBI — to survive the current period of zero revenue for a large number of companies, during the lockdown, and to overcome the problem of banks lacking the confidence to lend to companies. And the government needs to spend extra to stimulate the economy, to revive demand and give companies a chance to recover.

In the absence of any such thinking, merely giving banks access to additional liquidity, in the hope that bankers would risk their shirts by lending to the mutual fund industry whose underlying assets promise to turn duds , amounts to the pretense that something is being done to alleviate the problems besetting the economy. If that smug self-righteousness does not bring Little Jack Horner to mind, what would?

These are independent views of the author