September 7, 2002
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Money > Special September 7, 2002 |
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UTI bailout: Common man feels the pinchTamal Bandyopadhyay When Finance Secretary S Narayan was unveiling the historic split of the Unit Trust of India in North Block, the trust's Chairman M Damodaran was not in his Mumbai office. He was out for lunch and his mobile phone was switched off. When he switched on the phone after the lunch was over, more than a dozen messages flashed on his mobile phone screen in succession and the voice mail box was full. By the time he reached the UTI headquarters in New Marine Lines, it was almost possible to hear a collective sigh of relief from 20 million investors of the Unit-64 scheme across India. The government had finally accepted ownership of the country's biggest mutual fund and their money was safe. Every last investor would be paid. When the UTI goes to its grave it will take with it the era of assured return schemes in the Indian financial system. Its epitaph may read: "Here lies the leviathan which promised returns to investors without risks. It had to die." "There is no free lunch for investors. They must realise that they must take risks if they want high returns," says Abhay Aima, country head, equities & private banking, HDFC Bank. Aima, like many other bankers and financial consultants, does not believe there is a crisis roiling the Indian middle class, who are trying to figure out where to put their money. "What we are witnessing today is a bit of a turmoil because everything is happening at the same time. It's more of a psychological phenomena than a financial crisis," he says. Whatever the reasons, the fact is that people who want to squirrel away their money for a rainy day have never had it so bad. Consider the facts:
There's no question that individuals are feeling the pinch. "One year ago, the average interest earning on my savings was over 12 per cent. In one year, the earning has come down by one-third as today I don't earn even 8 per cent," says Suresh Shastri (name changed), a former tobacco company official who retired five years ago. After retirement Shastri put his money in fixed income instruments. Today, he is worrying about the future. "I've heard people talking about low inflation rates. Have you ever taken into account the cost of medical expenses at my age? Last week when I came out of a private hospital after an angioplasty, my son did not let me have a look at the bill as that would have given me another heart attack," he says indignantly. One man's meat is, of course, another corporation's poison - and vice versa. While Shastri is grumbling about falling interest rates, it is a cause for jubilation in the Indian corporate sector. And the biggest winner is the government because the cost of borrowing is falling sharply. Top-rated companies can now raise three-year money through the placement of commercial papers at a rate as low as 6.05 per cent - 45 basis points (one basis points is one hundredth of a per cent) lower than the bank rate (6.5 per cent): the rate at which commercial banks get re-finance from the Reserve Bank of India. For longer term bank loans, the good companies are paying 9 per cent to 10 per cent. They are raising money from the market at an even lower rate through flotation of non-convertible debentures. For the government, the cost of money is even cheaper. It is now paying a little over 7 per cent for 10-year money and a little less than 8 per cent for 30-year money. Things could get worse for people who are hoping to see their nest eggs grow. "Our asset-liability committee (Alco) will meet soon to take a look at the cost of the deposit structure. It needs to be brought down by at least half a percentage point," says Bank of Baroda Chairman P S Shenoy. But hasn't he cut the deposit rates by about three percentage points over the last one year? "Yes, we did. But the bank is only an intermediary: everything depends on the demand and supply of money. When companies are not willing to pay much for loans, how can we pay depositors? We have no choice but to cut deposit rates," says Shenoy. Jaspal Bindra, Standard Chartered bank's chief executive officer, India region, also feels the deposit rates will have to fall further. But he argues that consumers shouldn't be grumbling. "One should not complain about the lower returns on deposits. Aren't we paying less today for TVs and fridges and other white goods than what we were paying three years back? Hasn't the cost of telephony come down? When the cost of other things come down, yield on our savings is bound to come down," says Bindra. StanChart is disbursing all new loans at rates far below the prime lending rate, which was unthinkable just about a year ago. Certainly, US-64 and the other assured return schemes (some of the schemes assure the principal amount while others assure principal plus a fixed rate of interest) are an anachronism. They promise high fixed returns to investors while the yields on investments are not fixed. Inevitably these schemes are going down and they probably have no right to survive. The insurance companies have realised that. Take a look at what they have done:
IRDA Chairman N Rangachary is one of many who feel that with interest rates moving south, the players cannot support the level of assured rate of returns as in the past. "We asked the industry to revise the rates as we feel they are not sustainable," he points out. This is the crux of the situation: high rates are not sustainable and savers will have to accept this new reality. "If they want high returns, they must tap the equity market. But the chances are that one may burn fingers there. If you don't want to take risks, stay put in bank deposits or post office instruments and earn a little after paying tax. Put money in tax-free instruments like Relief Bonds and the proxy relief bonds. Without taking risk just forget about high returns," says an investment advisor. Risk-averse savers may have even worse days ahead. With no signs of an economic revival in sight, the rates could fall further. In fact, the market believes that the Reserve Bank of India will signal a further softening of interest rates in its October credit policy. That will only make matters worse for middle-class savers. "I will not be surprised even if the savings deposit rate is cut from the present level of 4 per cent. And mind you, the depositors don't get even this 4 per cent as the interest is given to the minimum balance kept in the deposit between the 10th and the last day of the month. The effective rate works out to around 3.5 per cent which the post office savings deposits offer," says a senior banker. Milind Barve, managing director, HDFC Mutual Fund, feels that debt funds are now an ideal vehicle for investment. "In a declining interest rate scenario, one should put money in debt funds. With rising prices of securities, old money (that you have already put) will always earn more than the new money you put in making the average return reasonable," he says. Both he and Aima are proponents of asset diversification: put in a portion of your savings in equity which can earn you more but is laced with risk. Then, park money (up to Rs 2 lakh) in the 8 per cent Relief Bonds and the 7 per cent proxy relief bond. You can get loans against relief bonds but the new instrument - to be launched on October 1 - cannot be used as collateral to get loans. Also, keep some money in fixed deposits. Post-tax returns (up to Rs 12,000 interest income is not taxable under 80L of Income Tax Act) are much lower but in terms of liquidity and convenience, bank deposits are a must. "For the time being you must look for four things: post-tax good returns, convenience, flexibility and liquidity," Barve says. Between mutual funds and bank deposits, the performing funds may be more attractive for two reasons: first, by staying put one year in the funds, it is possible to avoid dividend tax and pay long-term capital gains tax which is only 10 per cent. By contrast, dividend tax could be as high as 31.5 per cent depending on which income bracket you are in. Secondly, the funds disclose their investment portfolio quarterly. "There is a lot of transparency. You can always walk out if you find the investment portfolio is not sound. If one wants to stay invested at least for a year, income funds can be an ideal vehicle," says an SBI MF executive. Then there are post office instruments - for safety and reasonably good returns. A five-year recurring deposit account offers roughly 9 per cent. There is no cap on investment and any number of accounts can be opened. The post-tax yield works out to 6.17 per cent for the maximum tax bracket of 31.50 per cent. The monthly income schemes too offer 9 per cent payable monthly but the post-tax return is 6.17 per cent. The more popular instruments are the six-year National Savings Certificate (VIII issue), 15-year Public Provident Fund Account and National Savings Scheme Account 1992. The current interest rate for NSS works out to 8.75 per cent (Rs 1,000 becomes Rs 1,695.90 at maturity) while PPF offers 9 per cent per compounded annually and NSS gives 8.5 per cent annually. In the case of PPF, the interest is tax free the pre-tax yield works out to 13.14 per cent for the highest tax bracket. Tarun Modi, chartered accountant, Tarun Modi and Associates, says the Post Office monthly income scheme is good because of the interest rate it offers and the bonus it gives on maturity. "I tell my clients to take care of four things while investing: safety of capital, regularity of returns, liquidity and tax benefits. All factors can be standardised into a model for everybody as the priorities for each individual are different. I recommend PPF, Infrastructure Bonds, RBI Relief Bonds and even MediClaim," he says. The Relief Bonds continue to be the hot favourite. In fiscal 2002, the government mopped up Rs 4,500 crore (Rs 45 billion) through this instrument. This year's target has been kept at Rs 6,500 crore (Rs 65 billion) and it will be met even though the return has been brought down to 8 per cent from 9 per cent. "If a person is in the high tax bracket I would highly recommend RBI Relief Bonds to them up to the Rs 2 lakh limit. Nothing can be better than a 8 per cent tax-free return," says Deepak Pandit, chartered accountant, Blue Chip Investments and Finance. For non-tax payers or those who fall in lower tax brackets, Pandit recommends the postal monthly income schemes and time deposits where the rates are compounded quarterly. "No longer are assured return schemes the norm and the interest rates are going down. The investor today must consider all avenues including riskier instruments like equities for getting high returns," he says. One consultant also recommends taking out bank loans to buy flats as a way of savings. "Even if one buys a flat to rent it out, economically it is justified considering the tax breaks given for this sector," he points out. One lesson to be learnt from the UTI fiasco is that there is no risk-free return in the financial world. It is possible to play Lotto to make a fortune, provided you are ready to accept the fact that you may lose your money too. If you don't, then play safe and build a mixed bag of investments. But there is always a silver lining in every cloud. The cost of money has never been so cheap, so perhaps that is an argument for spending more. Take bank loans to buy flats, cars and consumer goods. But if you want to build financial assets it is time to figure out a new strategy for growth. (With inputs from Arti Sharma, B G Shirsat and Freny Patel) Powered by
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