The mutual fund (MF) industry sells a category of funds called money market funds (MMFs). As they are a subset of debt funds, they are considered to be safe and liquid, just like ‘cash’. In terms of tax benefits, they have an edge over fixed deposits in a bank. Why park your cash in a bank when you can get better and equally-safe returns from an MMF? Such funds are an example and part of a steady pipeline of ‘innovations’ that keep popping up in financial services. In this case, liquid-fund instruments offer an advantage not just to investors/savers, but also to borrowers, for whom accessing these funds is easier than getting bank loans. This particular innovation is decades old, and a further innovative tweak was to consider issuing a cheque book or an ATM card against an MMF. Everything seemed hunky dory, until it received a big jolt one day in September 2008. Just a day after Lehman crashed in the US, redemption pressure on a renowned MMF called Reserve Primary Fund sank its net asset value (NAV) below $1. If a liquid fund is as good as cash, how can its unit value go below $1? This is called ‘breaking the buck’, and for the first time in history, a retail money market fund ended up with an asset value less than a buck. It was a wake-up call on the inherent risks embedded in MFs even as safe as MMFs. That incident led to heavier regulatory oversight, with more fine print and risk disclosure requirements for MFs. Notably, however, we did not ban MMFs. The MF industry has gone to great lengths to improve financial literacy and a surge in retail investments since then would testify to increasing retail interest and confidence. Innovations like these tend to highlight risks, which when addressed often improve the product. There’s constant race between innovation and regulation. Bans are mostly unthinkable.
Yet, in the past 15 years, we have merrily banned (and unbanned) another financial instrument off and on: commodity futures, specifically agri-futures. Futures trading facilitates price discovery, provides farmers and buyers with useful signals, and leads to better planning and perhaps lower volatility. But policymakers, in knee-jerk fashion, have periodically banned futures trading in some agri commodities on fears of inflation and reckless speculation. These mandarins forget that for every reckless buyer, there is a seller, without whom a transaction cannot take place. The market’s price mechanism should be seen as a collective expression of opinions. Banning trading, thus, is like suppressing free speech. And almost all studies have confirmed that banning futures has had no impact on curbing inflation. In fact, the much discussed Minimum Support Price (MSP) is nothing but a pricing option, a derivative that farmers are offered free. If our futures markets were operative and stable, without the fear of frequent bans hovering over them, the need for MSPs might be mitigated.
Why, then, are we considering a ban on private cryptocurrencies? The proposed Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, seeks to “prohibit all private cryptocurrencies in India”, as this item listed for parlia-mentary business says; “however, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses,” adds the notice. What are policymakers fearful of? If they are apprehensive about mis-selling, then their target should be crypto advertisements, an issue remarked upon by the Prime Minister. During the recent T20 World Cup tournament, crypto exchanges spent an estimated ₹50 crore on such ads, which were splashed all around. Big money is in play. No authentic numbers are available, but about $6.6 billion are said to be invested in crypto assets by around 20 million investors. It is still a tiny fraction of the global pie of nearly $3 trillion. After the PM’s statement, these ads have reduced and the language of “doubling your money” has been muted. But the fear of an impending ban caused a crash in crypto values. And then there was a statement from the government clarifying that no outright ban was being contemplated. Such equivocation over a policy stance is more detrimental than the inherent risk in trading these assets.
If crypto tokens are being used as a store of value, as another asset class, they qualify as an ‘innovation’, as discussed above. Since these assets are based on blockchain technology, which enables electronic records kept by distributed and immutable ledgers, they can provide a big boost to our digital economy. Blockchains are being used to authenticate contracts and for applications in fields as diverse as global trade and cross-border payments. They serve as a basis for central bank digital currencies too. India can and will play a leading role in the adoption and evolution of these, and a ban on cryptocurrencies will deter talent. Just as people hold gold as a substitute for sovereign currencies, or as a hedge against inflation, they are using crypto assets to diversify their portfolio risks.
A confident, transparent and accountable sovereign should try to have its fiat currency and sovereign instruments (like government bonds) match the stability and reliability of gold and crypto assets. Not ban the latter. Despite the unfortunate terminology, cryptocurrencies are not about to replace fiat currencies, nor will they serve as legal tender. So, in the absence of such dangers or any clear harm to public welfare, the proposed ban on private crypto assets is ill advised. On one hand, India is thinking of opening up its capital account fully and floating dollar sovereign bonds. A ban of private crypto assets, on the other, will only signal an under-confident and confused sovereign.
Ajit Ranade is a senior fellow, Takshashila Institution
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