Cut your losses

BS OPINION

The question no longer is whether the government should take a hit, but what is the size of the hit, and whether the government will be able to cut its losses by foreclosing these schemes. In the bail-out culture that has been made acceptable, the answer is in the affirmative.

Consider that just one of UTI-I's children's plans, CGGF 86, faces a shortfall of over Rs 3,000 crore and will mature some 15 years from now, when the last investor in the scheme will get his dues.

For all these years to come, investors in the scheme will keep bleeding UTI-I (read government) as they would continue to earn substantially higher returns "" around 12-14 per cent assured "" than the going market rate, which is barely half as much.

Clearly, foreclosing these schemes makes financial sense. Based on the latest estimates, foreclosure of seven problematic schemes will cost about Rs 4,700 crore.

The government has two choices: shell out the entire amount, or adopt the modus operandi it chose in the case of US-64. It may be recalled that the US-64 bonds met with phenomenal success "" nearly three-fourth of the investors in the scheme opted for government bonds instead of taking cash.

This was primarily because the bonds were priced 25 basis points higher than other government bonds of similar tenure. Retail investors grabbed the offer for obvious reasons, and the instrument was a big hit with institutional investors as well.

While investors in high-coupon, assured-return funds of UTI will be unwilling to settle for bonds with lower interest rates, most investors will have to accept the bonds because alternative instruments will be even less attractive.

The conversion of US-64 into bonds must have cost the government about Rs 20 crore in terms of incremental interest cost. If one were to assume that half of UTI-I's corpus will be foreclosed by issuing similar bonds to unit holders (with a 25 basis point premium), the incremental interest cost will be not more than Rs 40 crore.

This is a small penalty for the government, because it thus avoids a big hole in its finances this year. It will also make it easier for the government to manage its liquidity.

Indeed, with an economic recovery under way, UTI may even be able to recover the money from its defaulters. And the rally in the stock market will help portfolios appreciate in value as most of these schemes have equity exposure to the extent of 20-25 per cent.

The entire corpus of UTI can then be managed as one whole, to optimise returns to the government over the life of these bonds. But while all this will mean a smaller hole in the government's wallet, it will be a hole nevertheless.