Provident fund trustees are forced to buy suspect bonds

Provident fund trustees today are forced to invest in the bonds of public sector undertakings (PSUs), which are of 'suspect quality'.

This is because such PSUs "" whose underlying exposure is junk "" offer the highest rate of interest in the market today. Trustees however, invest in these bonds only on the back of government guarantees.

Their contention is to ensure that they are able to come as close to the 9.5 per cent stipulated assured rate of return directed by the government.

PSUs like HMT Ltd for instance, have defaulted in meeting interest payments on unguaranteed bonds earlier, and yet have been able to mop up funds through its bond issues.

This has been solely on the back of the central government guarantee. This is possible since ratings agencies rate the bonds based on the "unconditional and irrevocable guarantee from the Government of India (GoI), supported by a structured payment mechanism to ensure timely servicing", stated Care Ratings.

At the same time even if PF trustees know that their investment is of poor grade, they are unable to sell since the regulations state that they can exit from an instrument only if two rating agencies downgrade an entity's bond issue to below investment grade.

Instrumentation Ltd was downgraded to default category by Crisil on December 31, after the entity defaulted in meeting the interest due and after the trustees invoked the government guarantee.

"Our investment in PSU papers is made on the assumption that the central government will not default, and is the best choice within the specific category of investments," said Amit Gopal, vice president India Life, which manages over 150 PFs.

Central government guaranteed papers offer coupon rate of 8.5 to 9 per cent. HMT bonds offers 8.5 per cent, and that of Instrumentation over 9 per cent.

Majority of prescribed investment instruments yield much lower returns in the region of 6 to 7 per cent, even as PF trustees are under pressure to deliver the stipulated 9.5 per cent.

"There are little opportunities these days to generate higher returns. The good PSUs are no longer coming to the market as they can meet their capital requirements through internal accruals, as in the case of oil companies," said G V Nageshwara Rao, managing director IDBI Bank. Further due to the government divestment, the number of strong PSUs drawing funds have further reduced as in the case of VSNL.

Incremental investments are thus being made in the high-risk categories of state government guaranteed and central government guaranteed bonds, in the hope that governments will not default.

However, many state government corporations despite state government guarantees backing their instruments, have defaulted in payment of interests.

These include Madhya Pradesh Electrical Board, the Maharashtra Jeevan Pradhikaran and the Mahararstra Krishna Valley Dam Corporation. Now the next trend is default by the Centre.