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Suresh Krishnamurthy

THE Finance Ministry appears determined to contain the fallout of the US-64 crisis on the equity market. If large-scale redemptions from US-64 happen as expected in May and June 2003, it could have an adverse impact on the stock market. This may take equity prices down to levels lower than those prevailing now. That is not all.

Intermittent and subsequent sell-offs of equity holdings in monthly income plans of the UTI can keep valuations down for longer periods.

Markets have known this all along and the recent trends in the market may even have been influenced by concerns in this regard. For example, FII inflows have hit the lowest levels since liberalisation in the 1990s. The Finance Ministry's efforts need to be seen in this backdrop.

`Holding-up' operation: The Finance Ministry has put in place serious measures to ensure that the UTI does not resort to distress sales of equities. It has asked it not to sell equities which it thinks are not priced properly. The Government will provide the UTI with bonds to meet the shortfall that arises to pay investors because it refrains from equity sales.

If the idea of `no distress sales' pleases the markets and stock prices rise, the problem for Government may be mitigated.

The UTI will then no longer need to hold on to its equity investments. In addition, if the value of equity investments rises in future, the Government will even benefit. That could reduce the costs of the bailout too.

However, if markets remain range-bound then the nitty-gritty of this plan might prove not so encouraging. Importantly, if the value of the portfolio declines, the cost of the bailout can increase for the Government.

Side effects: The impact of withholding equity sales will also be felt in other areas, such as rising market borrowings. For one, the plan requires enhanced budgetary support to provide funds upfront to the UTI. The plan could enhance the funds required by at least a few thousand crore rupees, pegging the costs of all the bailouts at Rs 20,000-25,000 crore. Even if the Government makes it a cash-less exercise, this will increase the total amount of money pulled out from the market in the next fiscal.

Its impact on interest rate movement can only be negative. It will be even more negative if the trend of rising borrowings by the Central and State governments continues unchecked next year too. If there are expectations of a sharp rise in interest rates, its impact on stock prices will be negative.

In other words, what the plan to withhold sales seeks to achieve may be offset by the prospect of rising interest rates. As such, the plan may not provide enough of a fillip to equity prices.

Valuing stocks: In addition, implementing the plan may also prove difficult. For example, deciding what is the appropriate price for the UTI to sell a stock may not be easy. That will keep changing with time. Therefore, holding on to stocks in the hope of an improvement in price in future may not be a sound idea in all stocks. Besides, a relatively better investment opportunity may exist in the market. What will the UTI do in such cases?

In addition, as long as the UTI holds on to these stocks the price trends may remain weak. Investors will not be willing to buy at higher prices fearing sales by the UTI if prices rise.

Smart market operators will also take prices to lower levels the moment they know the UTI is in the market to sell — whether it is now or 12 months down the line.

Is the plan then poorly conceived? That is not so. What is important is how it fits in with the overall scheme of things, such as interest rates, fiscal deficit, economic growth and general investment interest.

If these relevant factors turn positive then the value of the plan to all concerned — UTI, Government, investors and taxpayers — will get enhanced. Overall, this does seem a positive development on paper for the equity markets. Whether it pans out as the Government hopes remains to be seen.

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