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Cash funds unfazed from proposed debarment

The RBI is likely to debar mutual funds from investing in overnight call market. However, AMCs are unfazed by the proposed move.

Asset management companies are undeterred by RBI's proposed move for a time-bound phasing out of non-banking entities from the call market. Most fund managers see an active development of very short-term investment products as a substitute to call loans. It may be recalled that the issue of stopping non-bank institutions from participating in call market has been hanging fire for over a year now. Yet, no further dilly-dallying is expected on this occasion with the three-step phase out, expected to commence from June 30. "The Reserve Bank is dead serious about it. All the scams involving co-operative banks will also strengthen the case for banning non-bank and primary dealers from the call money market,'' says Nilesh Shah, CIO, Templeton.

The call market is the lifeline of short-term debt funds, which invest a significant part of their assets in overnight call lending operations due to the very short nature of their investments. For instance, cash funds shepherded an estimated Rs 1400 crore in call markets, nearly 32% of their total asset base of Rs 4300 crore on February 28. They especially make a killing when call rates shoot up. Further, call money markets are also an ideal parking ground for bond funds in times of interest rate volatility. Equity and balanced funds also keep a certain part of their corpus in cash to meet redemption pressure or for making investments at a later date.

Once the RBI diktat comes into effect, cash funds are expected to start actively utilising the repo route for making investments. "There is not going to be much impact of this ban and cash funds will move to the repo market,'' says Dhawal Dalal, fund manager, DSPML Bond Fund. Adds Shah, "We will go to repo market in liquid fund if not allowed to operate in call money market.''

In fact, repo market is safer since unlike "naked" call, lending here is backed by collateral in the form of government security. "In normal call loans, we give a cheque and get a slip from the counter-party, which promises to repay the next day. However, repo is securitised,'' says Dalal. "Apart from repo, we see a market evolving for very short-term instruments like very short-term CPs, CDs with increased investment in treasury bills, which will push up the maturity of cash funds,'' adds Rajiv Anand at Standard Chartered Mutual Fund. So far, most cash funds have refrained from investing T-bills since it leads to price risk in the portfolio. Further, the evolvement of short-term alternatives will depend on the structure of stamp duty. Currently, the stamp duty is same across-the-board for both short-term and long-dated bonds, which impacts the yield on the former.

However, the movement to the repo market could be fraught with some impediments. To start with, there is hardly any activity in longer-dated repos in the 2-3 day bracket. Add to it, repo transactions will depend on the counter party's holding in gilts beyond the stipulated SLR requirement. Further, the central bank's ability to handle the sudden surge in repo volumes will be tested. This is one of the reasons why the non-bank institutions will be debarred in a gradual manner.

"Broadly, returns will remain the same but the flexibility of cash funds may be impacted. Unlike US, where settlement issues are very simple and take place in real time, the pressure is going to be immense on the system with primary dealers, mutual funds and other institutions entering into buy and sell transactions on a daily basis,'' says Anand. However, some fund managers feel that it will be a smooth transition with RBI planning to set up a clearing corporation (CC) and introduce real time gross settlement or RTGS, which will pump up volumes. "Once CC is set up, the operational hazards will be overcome. RBI will soon have the necessary infrastructure to take care of the volumes. In fact, if CC becomes the counter party for every transaction, it will further secure the system,'' says Dalal at DSPML AMC.

While there are a number of issues, the impact will be known once the phase out starts. Till then, fund managers can breathe easy.