India’s debt mutual funds are facing a liquidity crisis presently. Last week, Franklin Templeton shut six of its funds, which froze INR 30,000 crores of investor money. And if matters get worse, this will just be the first chapter of the story. Because the underlying bond markets are almost frozen, mutual funds will only freeze more, which will make the money inaccessible to investors.
The biggest problem presently is that the investors of debt funds are mostly businesses who had parked their money with these funds for quick access. Therefore, when the market freezes, businesses will also have their money locked away, and that too at such crucial times.
Investors here are not really those rich individuals who can easily postpone their expenses in the mutual fund market. Instead, these are all businesses that need their money on demand in order to pay salaries, buy their raw material to keep operations running, and then ship goods. All in all, these businesses need money when they need it. The ongoing pandemic and lockdown is the biggest crisis that these businesses have perhaps ever faced. If access to their own money is delayed even by a month, the damage would already have been done.
And like any financial market, this is a crisis of belief. When people start to believe that a market is shaky, they then trigger actions that further make the market shaky. Luckily, the opposite is also true. When such beliefs are countered quickly, some assurance can help to tackle the crisis.
What is important to note here is how Franklin Templeton had to block their investors’ access to money. This was not because the investments had turned bad, but because a wave of panicked redemptions was going on. Was there a public assurance that redemptions will be met, things would have calmed down.
And for those who think that this will be a governmental rescue of private individuals, this is not true either. Similar events had taken place in the case of the UTI crisis re US64 when investments were rescued. Eventually, the government made very good returns. Even in 2008-2009 and in 2013, RBI had opened a special channel to provide liquidity to mutual funds. Even these episodes had ended well.
It is a great misfortunate that such reassurances did not come before these funds had to be frozen. Perhaps then could the crisis have been stopped before it had started. Hopefully, that can still be done. Let us just hope that the right choice will be made.