Don’t invest PF money in equities

It will lead to market manipulation by businessmen in league with politicians, warns Swaminathan S Anklesaria Aiyar.

SHOULD the government-run Employee’s Provident Fund invest part of its money in the stock market? This suggestion, made repeatedly at budget time, has special force this year since President Clinton has proposed placing part of his country’s Social security Funds in equities.

The argument in the United States of America is that stocks have consistently outperformed government securities, so pensioners will gain. This argument carries much less conviction in India: now that government securities bear market-determined interest rates and not controlled ones (as in the past), it is not obvious that stocks perform better in the long run. Indeed, the Bombay Sensex has yielded less than government securities in the last few years.

So the idea is being sold to the Finance minister for a different reason: that investing a small percentage of PF contributions in the stock market will boost prices and confidence, on a sustained basis. This, it is hoped, will revive the capital market, and enable businessmen to raise money in new issues.

In fact it is a terrible idea. I fear it will become a misused form of backdoor government manipulation of the corporate sector and markets.

In the US, Clinton’s proposal win result in the government owning perhaps 4 per cent of the gigantic equity of the country, making it the biggest shareholder by far in the world. The percentage in India could be much larger, given our small equity markets. So the Employee’s Provident Fund could soon overtake the Unit Trust of India as the country’s biggest shareholder. That should ring alarm bells.

To assuage critics, the government may promise to convert the Employees Provident Fund into an autonomous body free from political pressures to invest in this or that company. If you believe that, you will also believe that pigs have wings. In practice it will become a political football.

Even in the US, where political interference in the market is limited, Clinton’s proposal claim that the controlling body will be autonomous has few takers. Fed Chairman Alan Greenspan has declared “I do not believe it is politically feasible to insulate such huge funds from government direction”. If that is so in the US, will it not be far worse in India?

Former US presidential candidate, Jesse Jackson, has already declared that the proposed equity purchases by Social Security should avoid certain sectors he regards as undesirable, such as liquor, tobacco and gun manufacturing. And in Texas last July, the state department of education was pressured by the supposedly market-friendly ruling party, the Republicans, to sell $1.2 billion worth of stock it held in Disney to protest the “anti-family” content of Disney films like Pulp Fiction and Chasing Amy. If not even the Republicans can resist the politicisation of equity investments of the government, can you imagine any Indian party doing so?

I can just see the Marxists demanding the sale of all Reliance holdings whenever the Ambanis get embroiled in a controversy. The RSS will want a ban on purchases of shares of foreign-majority companies, or at least preference for fully-Indian companies, Jayalalitha win demand a special quota for Tamil Nadu companies, the Asom Gana Parishad will bring down any government that dares withdraw investments from Assam, the Akali Dal wffl demand special privileges for Sikh-owned companies.

In an era of coalition politics, how far can the government resist such pressures?

The current travails of UTI are due in some measure to the fact that it has, despite its veneer of autonomy, been used as a government instrument to manipulate the market up or down. Even businessmen have often urged the finance minister to instruct the UTI to support a falling market (so much for their supposed belief in the market).

Politicians have long made phone calls to UTI to pressure it to buy or sell shares of some favoured company. Arguably, UTI has stood up to such pressures much better than other government-controlled outfits, but nobody believes for a minute that it is truly autonomous.

If we now have the Employee’s Provident Fund buying shares, over and above Unit Trust of India, that will truly mean a huge chunk of equity in government hands. I do not think this will result in backdoor nationalisation, as some critics claim. The greater danger by far is that the government’s clout will be converted into market manipulation by businessmen in league politicians.

This is not only bad in itself, it will also endanger the common man’s savings invested in provident funds. While equities may indeed outperform government securities if fund managers are given a free hand, nobody can possibly claim such a happy outcome if the managers are under constant political pressure.

In any case it is simply not true that shifting PF money from government securities to equities is automatically good for the market

Diverting PF money from government bonds to equity will mean either higher interest rates or more crowding out of the private sector from the loan market Indeed, the consequent rise in interest rates could induce private fund managers to sell equity to buy bonds, frustrating the whole aim of boosting the stock market.

Market prices must ultimately reflect corporate performance, not attempted manipulation of the supply of funds. Mr. Yeshwant Sinha must resist the urgings of myopic businessmen and expert manipulators. If he really believes that equities will help pensioners, he should expand existing tax-saving schemes for long-term investment in equities. But the government itself must steer clear of the stock market.

What do you think?