In two articles on Indian financial markets, (Where have all the profits gone? and Gone to markets, everyone, Economic Times, Feb. 1 and 15) I fervently hoped that there would not be an occasion to write an article entitled “When will they ever learn?” I spoke too soon. The recent Income-Tax - Foreign Institutional Investors (ITFII) fiasco shows how everyone is learning except the policy makers. Indeed, what appears likely is that the Ministry of Finance (Mof), and its 1999 report on “How to save UTI and mess up the financial system” are the main culprits behind the ITFII drama of last week. A drama not at all different than the illegal betting match-fixing affair a la the South African cricket team captain, Hansie Cronje.

The batsmen are the FII's, mutual funds and individual investors competing with each other to score the maximum amount of runs (profits). The bowlers are the IT officials looking to bowl the batsmen out i.e. catching them undertaking illegal activities. The umpire, appointed by the BCCI - oops, the government - is the MoF.

Until early 1999, the game was being played according to well established rules. For seven long Boycott years - March 1992 to 1999 - not much happened; indeed, Indian batsmen achieved a world record for scoring the least amount of runs as the market (Sensex) stayed in the 3000-4000 range. In a world of exploding stock markets, and first-generation reforms, all that the Indian policy makers could take pride in was in scoring ducks or zero returns. There was one star batsman, however, who continued to increase the money under management even with zero returns-Unit Trust of India, a government owned gorilla mutual fund with more than 80 percent of all mutual fund assets. How did UTI achieve success? By guaranteeing its equity investors (with tax- payers money) a fixed annual return of 12 to 15 percent.

The other batsmen also scored ducks, but did not increase assets under management. The foreigners came, set up mutual funds, but did not conquer - mostly because their own civilized structures prohibited guaranteeing returns on equity investments. And savvy as they think they are, the FII's were unable to beat a zero return market.

The match was fixed. UTI was actually Hansie Cronje in drag and able to succeed without really trying because it had the umpire (MoF) as a partner in the return fixing. However, the government fixers were not efficient; it does not take a bookie to find out that fixing matches and yet losing money was a recipe for disaster. The equity market was flat for seven years and the government through its public-sector mutual "in the name of the poor" UTI-64 fund was paying out 12-15 percent each year. Late September 1998, bad light stopped play - UTI was close to bankruptcy.

The government decided to stop illegal betting. It set up a committee to investigate the affair (not dissimilar to a committee set up by the Board of Cricket Control of India and decreed that henceforth, no more guaranteed returns. After this bold initiative, it was back to business. As any Cronje will tell you, the rush of match fixing is high, especially for the influential and the powerful.

In a rush to fix the zero-growth stock market, the MoF decided to play batsman, bowler and umpire. It proclaimed (in the name of institution building, in the name of the small investor etc) that equity oriented Indian mutual funds would not pay any capital gains tax for three years! Now many countries give tax benefits to equity investments and indeed it can be argued that it is a good policy. But precious few (try none) of the countries ever discriminate among investors in this blatant, nay stupid, fashion. What the new policy meant was that the fielders (individual investors using their own brains to calculate probabilities of winning and paying a 33 % tax) would never get a chance to bat against the legal zero-tax Cronje's of the world. Just think about it - the government states that if you give money for investments to high-fees mutual funds you pay a zero tax but if you use your own brains to invest, and save on high mutual fund fees, you face a 33 percent tax rate! 

Did the new match-fixing rules win matches? No. Even the fixed six - a booming stock market - was caught at the boundary. Excluding the two software stocks - Infosys and NIIT - the Sensex stayed in the seven (now eight) year range of 3000-4000 plus/minus 500 points during 1999-2000, the year of the Great Mutual Fund Robbery.

But the Indian ICE market did explode, and returns of 100 percent in 1999-2000 became common place. What did the non-institutional Indian investor do? She obviously decided that if the umpire was a fixer, then why shouldn't she provide weather information to the bookies ? She achieved a level-playing field by taking money out and bringing it back into India via a zero-tax FII sub-account in Mauritius.

The gentle-woman's game came to an end when some honest income-tax officials saw Indian origin FII (an oxymoron or a brilliant stroke?) accounts in Mauritius and said it was not cricket. But the IT officials did not care to notice that the rot led to the top and it was their very own Ministry that had fixed the match! Thus, we had the unfortunate reality that all players played by the rules - and the umpire was always the fixer.

How do we get back to the past? By reinstating fair rules. Legalize betting; let the players be compensated for their abilities; let the players be paid more, and cricket bureaucrats less. Let all players (domestic/foreign and institution/individuals) have an equal chance to bat. Let there be no artificial distinction between short-term and long- term. Let the tax rate be 10 percent. Setting up a Mauritius account, increased expenses etc. amount to at least 5 percent. So equal incentive to come via Mauritius or Ludhiana.

How much tax revenue would the government have obtained in 1999-2000 with neutral umpires and no match-fixing and a flat 10 percent rate? About 15,000 crores. How much will the government collect from its mis-guided attempts at match-fixing ? Less than a 1000 crores. When will they ever learn? You wanna bet?