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OPINION 9
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Volume XXII Number 234

ILLUSTRATION BY AJAY MOHANTY
MUMBAI | MONDAY, 9 JULY 2018

Gaining heft
Few red marks in pvt mutual funds’ 25-year scorecard

T
wenty-five years after mutual funds were opened up to the private sec-
tor, the asset class has emerged as an important investment avenue,
providing Indians an alternative to direct equities. Today, the indus-
try manages assets of more than ~23 trillion, accounting for a fifth of
all bank deposits. A decade ago, mutual funds took up barely a tenth of bank ished in a few days was dragged out for a few months.
deposits. The net asset value of the oldest equity mutual fund scheme today — In the end, this was ineffectual, as the overall
UTI Mastershare — has grown at a compound annual growth rate (CAGR) of INR depreciation which took place in India was in
line with what happened in other emerging mar-
18 per cent since its launch in 1986, compared to the 14 per cent CAGR for the kets. The only thing that was different about India
Sensex and gold prices rising 6 per cent every year over the period. Franklin was that we harmed our local economy more by try-
Bluechip Fund, one of the oldest private sector mutual funds, launched in 1993 ing to fight the depreciation (https://goo.gl/KJq9na).
as Kothari Pioneer Bluechip, has earned its unit holders an impressive 21 per cent This time, the sharp rise in interest rates harmed the
a year since its launch, twice that of the Sensex. Unlike Unit Trust of India’s Unit over-leveraged corporations (which had been creat-
Scheme-1964 (US-64), which had huge problems in terms of disclosure, private ed in the previous episode of volatility management)
and exacerbated the banking crisis.
sector funds brought in transparency.
A similar story has shaped up on the long-dated
The industry though has a long way to go, as it has not always demonstrated government bond. Fundamental factors point to an
that the interest of its unit holders comes first. Nor has it done enough for increase in the Indian long rate. The best thing is to

Prices, fast and slow

investor education. The industry is guilty of proliferating schemes through new allow the market to work and let the long rate go up
fund offerings (NFOs), which were easier to sell than existing funds, to garner (i.e. have a decline in the price of the long bond). We
assets. Investors who bought the flavour-of-the-season story, be it tech funds are doing many things to prevent the long bond
in the late nineties or infrastructure funds in 2007, were left holding lemons. price from going down.
This has presented a one-way bet for market par-
Many say the fund industry has also been opportunistic in creating a culture
of churn where gullible investors were told by distributors to not hold funds
The job of the government in finance is not to influence the price ticipants: You are better off selling the long bond,
waiting out its price decline, and then profitably
longer than a year as they made commission every time a fund was sold. but to create open access systems through which everyone can buying it back. Each actor who does this tends to
Distributors were also paid higher fees to sell NFOs over existing funds. The reg- push down the price of the long bond, making things
ulator has had to routinely clamp down on the malpractices of the industry, the
express views on the market harder for the authorities.
main one being mis-selling. On their part, mutual funds have complained that A financial market should have some people who
e often think that there is a problem currency appreciation. think the price is low and worth buying, and some

W
there isn’t a level playing field between them and the insurance industry’s unit-
when asset prices move sharply in a
linked investment plan. short time. There is a clamour for a gov-
However, the last five years have been a distinct improvement for both ernment that will prevent these move-
investors and asset management companies. The industry’s assets have ments and “manage the volatility”. However, a slow,
tripled in size on new inflows and rise in stock prices, and investors too are in predictable price move is often destabilising. The
the money, although lower than three-four months ago. The pooling of secu- one thing worse than a fast price move is the same
rities with clear product definition, adequate disclosures, professional man- move spread out through time.
Large price movements of
agement with appropriate asset allocation, diversification across securities and
financial assets worry many peo-
low ticket size have all made mutual funds appealing. Plus, the falling inter- ple. We would all like to live in a
est rate cycle made a lot of fixed-income products unattractive and with low volatility world, where noth-
equities delivering robust returns, the investor lapped up mutual funds, espe- ing much changes from yesterday
cially systematic investment plans of equity funds. The regulator has brought to today. People are even more sus-
more discipline in terms of how many schemes a fund can have in each cat- picious about large price moves
egory, and forced fund houses to merge schemes. that happen within the day. When
a price changes by a lot in a few
During this bull run, mutual funds have been conscious to alert investors reg-
seconds, we think: “How could
ularly on inflated valuations, especially in the small- and mid-cap segments. Even things change so fast?”
as a large part of the market is in the midst of a correction, mutual fund investors This leads to calls for govern- SNAKES & LADDERS
have kept the faith. If the industry has managed to convey the message that wealth ment intervention. We want the
creation requires patience and happens only over the long term, then the indus- government to get into the act, and AJAY SHAH
try’s campaign “Mutual funds sahi hai” may be working. somehow force the price to not
move so fast, and thus make everyone happy. These
days, we are all more sophisticated and we no longer
The authorities decided to manage the volatility.
A rapid currency appreciation was replaced by a
long slow predictable appreciation.
Every rational person thought: “Ah, the rupee is
going to appreciate!” People started looking for
ways to profit from this coming move. This meant
you should bring foreign capital
into India for six months, in which
time you get about 4 per cent as
interest and about 2 per cent as INR
appreciation, giving a low-risk 6 per
cent return in dollars within six
months. This was very attractive
and we got a flood of capital coming
in, which made life more difficult
for the authorities.
Capital flooded into India, the
RBI bought dollars and flooded the
local market with rupees, which
gave a growth rate of 35 per cent a
year in bank credit. But banks in
India are poorly regulated, so they
took this additional capital and lent it out badly. A
few years later, we realised there is a banking crisis.
people who think the price is high and worth selling.
If prices were allowed to adjust, there would always
be some people who are willing to lend to the gov-
ernment at the prevailing market price, thus giving
stability to the borrowing programme of the gov-
ernment. Artificial interference in the working of
the market creates conditions where there is only one
side to the market. This creates greater harm than the
problem that we set out to solve.
It is attractive to think that in normal times the
market will work, and occasionally the authorities
will prevent volatility. This does not work out owing
to moral hazard. If private persons are told that they
are protected from large price movements, they will
take larger risks. For example, too many Indian com-
panies have borrowed abroad after 2013 as the Indian
state is likely to fight large rupee depreciation. This
increases the harm when large price movements do
come about (as they will), and creates new kinds of
political lobbying.
As with the price of cement or steel or wheat, we
are better off with prices that come out of markets.
There was a time when the newspapers in India pon-
dered whether the price of cement or steel should be

Distant neighbours say that we want the government to control the price.
We just want the government to reduce the volatili-
ty. Government interference in the volatility is con-
Modi govt’s foreign policy falters sidered acceptable while government interference in
the price is no longer kosher.
A similar story was repeated in 2013. Conditions
changed in the US and a large INR depreciation was
required. The authorities tried to manage the volatil-
ity. A rapid large move was replaced by a long, slow
predictable depreciation.
allowed to fluctuate, whether the government should
get involved in controlling this volatility.
Deregulation came, and everyone learned to live
with a steel price that is no longer in the zone of
public policy. The job of the government in finance

W
hen it took charge, the National Democratic Alliance government Suppose the world changes and a large move in Every rational person looked for ways to sell is not to influence the price but to create open access
seemed to have picked up its foreign policy mantra from what for- the exchange rate is called for. Look back at the assets in India, take the money out, wait out the systems through which everyone can express views
mer prime minister Atal Bihari Vajpayee once said: “You can early 2000s, when there was new buoyancy in depreciation, and then bring the money back. The on the market.
change friends but not neighbours.” As such, the Modi govern- Indian services exports, coupled with a new level RBI tried to fight it by doing numerous things that
ment seemed to follow a “neighbourhood first” policy. Prime Minister Narendra of capital flows into India. If the market had been harmed the economy, e.g. by raising the short rate by The writer is a professor at National Institute of Public
Modi took an active and keen interest in making this happen. The government allowed to work, there would have been a rapid 440 basis points. A drama that should have been fin- Finance and Policy, New Delhi
made an early and much overdue reorientation of India’s foreign policy towards
its neighbours, seeking to inject substance into the oft-repeated rhetoric of

Project Sashakt: Several steps backward

attaching the highest priority to neighbouring countries. There was a flurry of
high-level visits, a readiness to deal with negative legacy issues and contribute
to development in the neighbourhood through better connectivity and infra-
structure development. There was an effort to look more seriously at regional
ndia has probably lost count of the number of
and sub-regional cooperation under the South Asian Association for Regional
Cooperation (Saarc) and the Bangladesh, Bhutan, India, Nepal Initiative (BBIN)
respectively. But as has happened repeatedly in the past, the initial momentum
I government committees set up to address cor-
porate bankruptcy issues. We have had nine
major government committees between 1964 and
has flagged. As the PM enters the last lap of his term, it is an open question 2013, apart from several minor committees from time
whether India’s relations with any of its neighbours have decidedly improved. to time. One more committee headed by Sunil Mehta,
Indeed, there is evidence that India might have allowed its sphere of influence chairman of Punjab National Bank, submitted its
to shrink considerably, last week’s bitter political standoff with the Maldives report last week to the energetic interim Finance
being the latest example. Minister Piyush Goel, who labelled it Project Sashakt.
Anyone who has some understanding of the bad loan
Minor issues, unaddressed, have become festering irritants in our relations situation and the pervasive government control over
with several neighbours and the record on delivering on project commitments the financial system will see that the committee rec-
remains dismal. Perhaps the biggest setback under the Modi regime is that with ommendations alone will do little
each passing year, India has lost ground to China, its biggest competitor in the to either reduce the stock of bad
region, in Nepal, Sri Lanka and the Maldives. For instance, India’s unofficial loans or prevent the creation of fresh
blockade of Nepal in 2015 gave rise to a massive wave of anti-Indian sentiment bad loans. Indeed, by creating con-
fusion over existing processes, most
in the country, leading to the pro-China leader, K P Oli, taking over premiership.
of the ideas will actually hinder bad
Over the years, Sino-Nepal economic ties have intensified rapidly — China is loan resolutions.
Nepal’s biggest foreign investor, making double the foreign direct investment than Under the plan, for bad loans of
India — even as India has faltered in keeping its promises. China is offering Nepal ~500 million or less, banks will for-
a credible alternative to being “India-locked”, and Nepal looks set to act on it. The mulate a resolution plan within 90
positive developments in Indo-Bangladesh relations have been soured by domes- days of their detection. There is no
clarity on to how and why this will be
tic politics driven by communal sentiments. The stand taken on the Rohingya
issue is a case in point.
different from the futile efforts of the IRRATIONAL CHOICE
last four decades in handling bad DEBASHIS BASU
And on Pakistan, as long as the temptation to make it a factor in domestic loans by government banks.
politics is not resisted, it is difficult to see how relations can be improved even mar- However, there is plenty of clarity on
ginally. The imposition of Governor’s rule in Jammu and Kashmir and the stat- how this undermines a circular issued by the Reserve
ed intent to intensify security operations in the state will only make foreign pol- Bank of India (RBI) issued last February, asking banks
icy decisions more complex and difficult. The UN report on human rights to report a bad loan to the RBI by the 91st day of it turn-
situation in the state is a pointer to greater international focus on this issue and ing bad. If banks are going to resolve bad loans over
another 90 days under Project Sashakt, just informing
the prospect for a re-hyphenation of India-Pakistan relations and an unwel-
the RBI on the 91st day has no meaning. Indeed,
come external intrusion, once again, in these relations. India's neighbourhood pol- according to some media reports, the committee has
icy needs a thorough review and a new and sustained focus. It remains true that even suggested that the banks should give additional
India can play a meaningful regional and global role only if it manages its own loans to the defaulter. Since most cases of bad loans in
periphery well. At present, it is falling short on this count. public sector banks are a result of either inefficiency or
corruption, you wonder what the real objective here is.
For assets between ~500 million and ~5 billion, “the
lead lender should take charge and devise a resolution
plan within 180 days”, recommends the committee, for
which banks will enter into an inter-creditor agree-
ment. All this is hope, not strategy. While resolution has
slowed due to disagreements among lenders, allowing
the lead lender to take charge will not achieve anything
substantially different. Worse, the committee’s rec-
ommendation will simply vitiate and delay the reso-
lution process. After all, under the Insolvency and
Bankruptcy Code (IBC), banks are already supposed to
act immediately after a loan goes bad and then vote
through a committee of creditors.
Why give another 180 days to banks
and defaulters? How does this rec-
ommendation square with that of
the statutes of the IBC? And where do
the RBI’s various directives on bad
loans stand in all this?
The committee says bad loans
assets worth over ~5 billion will be
handled by asset management com-
panies (AMCs), which will suppos-
edly be funded by banks, foreign
funds, infrastructure investment
funds, etc. This is wishful thinking.
Guess how many asset reconstruc-
tion companies (ARCs) set up by the
private sector already exist. There are as many as 24
ARCs specialising in bad loans, already registered with
the RBI. Some of them are joint ventures with foreign
firms. Why would India need more of AMCs/ARCs?
Just because netas and babus want to show the coun-
try some fresh action? Where is the money for this?
Since the government wants it, new ones would be
set up mainly with public money from Life Insurance
Corporation and public sector banks, no matter how
wasteful and impractical the idea may be. Given this
government’s approach, we may even see cash-rich
government companies like Hindustan Petroleum
being asked to contribute to the AMCs — all in the
national interest.
The fourth idea is another pipedream: Alternative
investment funds (AIFs) that supposedly will be cre-
ated by institutional investors. Who are these institu-
tional investors, if not government-owned insurance
companies and banks, who have an interest in AIFs
focused on bad loans? If private-sector AIFs and ARCs
with a far greater focus and abilities have not seen
much of an opportunity in this, what can public-sec-
tor AMCs and AIFs do? All this is a throwback to the glo-
rious 1980s, the days of development finance institu-
tions, Unit Trust of India and government-funded
mutual fund and venture capital funds.
The deeper you look, the clearer it becomes that the
committee’s recommendations undermine existing
resolution processes and ignore the market realities of
private initiatives such as ARCs, which would have
flowered if they did not have to deal with a thicket of
arduous rules, unaccountable bankers and unreliable
corporate accounts. The best that can happen to Project
Sashakt is that AMC and AIF ideas will remain dead in
the water. If the recommendations are indeed imple-
mented even a little bit, we will have turned the clock
back on bad loan resolution. Surely, the bankers who
sat in the committee and thought up these confusing
and impractical recommendations knew what they
were doing. I wonder what the real intention was here,
since it mainly helps bankers and promoters who are
responsible for the bad loans. Meanwhile, despite
many visible initiatives by this government, we are
yet to get one single idea that would break the corrupt
nexus between the promoters and bankers of public
sector banks (PSBs), which account for more than 90
per cent of bad loans.
The writer is the editor of www.moneylife.in
Twitter: @Moneylifers

Putin vs the US ‘reset’ comes in late 2011, when relations between

BOOK REVIEW
DANIEL BEER
In May 2012, the American ambassador to
Russia, Michael McFaul, accompanied a
senior White House official to a meeting
with Vladimir V Putin at the then-presi-
dent-elect’s country estate. Midway
through the discussion, Putin turned
directly to McFaul and berated him for try-
ing to ruin United States-Russia relations. In
From Cold War to Hot Peace, McFaul recalls
wondering, “Why was one of the most pow-
erful men on the planet so obsessed with an
American diplomat?”
McFaul answers his own question in
these pages. In 2008, he joined Barack
Obama’s presidential campaign and was
later appointed senior director for Russian
affairs at the National Security Council
before serving as ambassador in Moscow
from 2012 to 2014. McFaul combines both
analytical and personal perspectives to
offer a fascinating and timely account of the
current crisis in the relationship between
Russia and the United States.
In the wake of Russia’s 2008 war with
Georgia, the Obama administration
attempted to reboot relations with the
Kremlin. McFaul was the author of what
became known as the “Reset,” and so his
narrative pitches the reader deep into the
flurry of briefing documents, negotiations,
handshakes and treaties that were calcu-
lated to draw Russia closer to the orbit of
Western agendas and values. He empha-
sises that the personal chemistry between
the two new presidents, Obama and Dmitri
A Medvedev, drove forward a range of poli-
cies, from nuclear disarmament to efforts to
deny Iran the bomb, with tangible success.
The dramatic pivot in McFaul’s story
Russia and the United States quickly soured.
The primary cause was, McFaul maintains,
Russian domestic politics. Putin’s earlier
terms as president had been underpinned
by a social compact in which the Kremlin
offered rising living standards in exchange
for political support or at least acquiescence.
By 2011 under Medvedev, as the fallout from
the financial crisis hit Russia hard, that deal
was beginning to unravel.
In September, many educated Russians
became indignant at the news of a “castling
move,” in which Medvedev and Putin
announced they would swap positions of
president and prime minister. Mass
demonstrations against voter fraud in the
December parliamentary elections
thronged Russian cities and spooked the
Kremlin. With the presidential vote loom-
ing in March 2012, Putin cast around for
enemies at home and abroad to revalidate
himself as defender of the Russian people.
The newly minted American ambas-
sador was the perfect fall guy for the
Kremlin — manna from heaven for Putin’s
election effort, as one senior Russian offi-
cial put it. Here was a diplomat with a
long history of personally supporting
democratic movements in Russia and the
author, no less, of a book entitled “Russia’s
Unfinished Revolution.”
The Kremlin subjected McFaul and his
embassy staff to harassment and vitriol
that tore up the conventions of interna-
tional diplomacy. A fake Twitter account
purporting to belong to the ambassador
tweeted out criticisms of the Russian elec-
tions; videos circulated on YouTube sug-
gesting he was a pedophile; agents of the
pro-Kremlin youth organisation Nashi
repeatedly ambushed McFaul in the street
with accusations and innuendo; even his
children were obtrusively tailed by the
Russian security services.
McFaul did his best to swim against this
tide of official hostility. He took to Twitter
and Facebook in an attempt to communi-
cate directly with the Russian people, an
unorthodox approach that enjoyed, he
claims, some success, but ruffled feathers in
Moscow. He hosted receptions, concerts
and lectures designed to champion not just
American culture but also wider respect
for democratic values. “Our tweets and jazz
concerts were no match,” McFaul acknowl-
edges, for Putin’s “media empire.”
McFaul believed that this flagrant
breach of international norms was proof
that his own lifelong endeavour to promote
democracy in Russia and secure integration
with the West had emphatically failed. His
personal tragedy was capped by the fact
that he is now persona non grata in Russia,
the first American ambassador to have
been banned from the country since
George Kennan in 1952.
Putin is clearly the villain in this story.
He makes his case with energy and con-
viction. Yet his relentless focus on Putin’s
individual role tends to obscure the broad-
er evolution of attitudes toward the West
within the Russian political establish-
ment. There are, for instance, only passing
references to the siloviki — hard-liners
with a background in the security servic-
es who were all along uneasy about
Medvedev’s embrace of the Reset. In fact,
Putin is far from alone in his hostility to
what he sees as aggressive NATO expan-
sionism and the threat of American mis-
sile defence programs.
And what of wider public opinion?
McFaul concedes that Putin’s popularity
“suggests a deep societal demand for this
kind of autocratic leader, and this kind of
antagonistic relationship with the United
States and the West.” But instead of devel-
oping this insight, McFaul leaves it hanging.
Placing responsibility for the rapid dete-
rioration in United States-Russian relations
squarely on the shoulders of the Russian
president has its appeal. It holds out the
promise that Kremlin policy toward the
West might pivot once again when Putin
finally retires or is pushed out. Maybe so,
but the more pessimistic view is that Putin
represents a now-entrenched revanchist
nationalism that sees the liberal interna-
tional order as a mere smokescreen for the
advancement of Western political agendas.
As McFaul himself laments, “the hot peace,
tragically but perhaps necessarily, seems
here to stay.”
© 2018 The New York Times News Service
FROM COLD WAR TO HOT PEACE
An American Ambassador in Putin’s Russia
Michael McFaul
Houghton Mifflin Harcourt
506 pages; $30