Opinion | Bond market woes and RBI’s debt mutual fund rescue

On Monday, the Reserve Bank of India (RBI) opened a special window of ₹50,000 crore for mutual funds (MFs) to tide over a liquidity crisis that has shaken investor confidence in one of India’s most popular modes of retail investment. The market had been anticipating it. Mint made a case for RBI aid in a Saturday Quick Edit on Livemint.com. Also, calls arose over the weekend asking for the central bank to do what was done in a similar situation back in 2009. The crisis that erupted late last week involved only debt funds, which had ₹11 trillion in assets under management (half of the MF total); even within the debt segment, the crisis was restricted to schemes with money in bonds that were investment grade but not rated triple-A (supersafe, that is), nor issued by the government (the safest kind). Unusually high redemptions were seen in this sub-category, the result of a mix of events that can be traced to India’s lockdown. There was a surge in demand among MF holders for cash, not just among firms and individuals to make year-end tax payments, but also in response to squeezed inflows. So badly strapped did this leave Franklin Templeton AMC for payout funds, that despite borrowing ₹4,000 crore from banks, this asset management company froze six of its schemes last week and six more after that, trapping the money of its investors.

Investors in MFs that were fully functional also grew nervous, and some of them sought to withdraw their money from whichever schemes they saw at threat. Funds with riskier debt that promise higher returns, like those that shut down, were hit first. But it exposed others to the contagion of panic. When too many people rush to redeem investments together, such a run on MFs needs to be stopped before other fund houses also fall short of cash. For 15 days starting 27 April, RBI has allowed banks to borrow money from it at its repo rate of 4.4%, so that MFs can take loans of up to a fifth of their assets, as permitted by the securities market regulator. Whether or not banks avail of this temporary facility, the very access of fund houses to such a credit line should give the market confidence.

Should MFs, though, not have managed their risks better? Why did they need a rescue? RBI, it seems, is both a problem and its solution here. Debt MFs would do better if India had a thriving market for corporate bonds—of varied risk grades, priced accordingly. But India lacks one. Low-rated paper is traded way too thinly, if at all. The recent trouble was caused not by credit quality downgrades, as in past instances, but by buyers gone missing for anything but safe bonds. This gap is often attributed to RBI’s dual role as a bank regulator and public debt manager. If it did not expend so much energy on ensuring ready demand for government securities, goes this allegation, privately issued bonds might be traded along a wider spectrum of risk and return profiles, letting a diverse market flourish. Each crisis is a time to ponder flaws in the way things work, and perhaps this time, the government, regulators and other stakeholders should pay attention to the need for market depth. Ironically, to keep debt MFs secure, we need to ensure that money can be made even on paper that isn’t fully safe.