The Unit Trust of India's (UTI's) decision to price its repurchases at Rs 14.25 has left market players surprised as they expected that there would be an attempt by the fund to be a bit realistic now that the worst suspicions of the market vis-a-vis UTI's flagship scheme have been confirmed and the repercussions would now be felt in the market. The fate of the entire mutual fund industry is also at stake.

But the view within market circles is that individual investors may not react immediately by redeeming the units irrespective of the repurchase price, but at the same time new inflows will not be forthcoming. However, the retail investors should take advantage of the higher repurchase price and exit from the fund.

But more importantly, a big chunk of the US 64 is with a few of thelarge domestic private-sector companies, public-sector enterprises and large nationalised banks. Their reaction to this will be absolutely crucial to the immediate future of the fund and the market. The private-sector companies would be the most likely of the lot to liquidate rather than hold onto these assets, especially now that the repurchase price is above what the perceived fair value is.

Leading market analysts like Nikesh Shah of Triumph Securities agree that any mispricing or attempted cover-up from UTI could result in an outflow owing to redemptions, while a more realistic pricing would have been better appreciated.

Now there is a growing feeling within market circles that given the situation that UTI is in, the development financial institutions (DFIs) will also have no choice but to eventually come clean with their true NPAs sooner or later, and those figures will be much higher than what is being put forward for ICICI, IDBI and IFCI now.

The DFIs themselves have given an indication to thiseffect by announcing a halt to further advances to some of the sectors in recession like steel. Market worries have now gone beyond agonising over the fate of the US 64.

There is now a question on the very soundness of the Indian financial system. The financial markets have doubted the rapid growth of the development financial institutions, and have been suspicious of the sudden spurt in advance and disbursements being made.

Critics have pointed out that advances have been made to cover up bad loans by using the funds to show some repayment of principal. These suspicions have included the banking system as well. The DFI stocks have already faced a brutal revaluation, which is still continuing and the bank stocks are also beginning to see some renewed selling pressure.

Market experts like Ramesh Jagtiani of Supreme Financial Services point out that it is inconceivable the US 64 scheme could not have been in trouble, since out of its top 25 holdings, there is not a single software, pharmaceutical or FMCGstock, which are the only market outperformers, and under the present market conditions, such an underweightage would ensure a depreciating portfolio.

Expert views such as his have long warned that the US 64 scheme was overpriced in relation to its NAV. The suspicions only grew when two years ago the fund indicated that it would overweight its equity holdings to two-thirds of its corpus. Since then the market has been in a decline, and to keep up its cash flows, the fund was forced to liquidate its blue-chip holdings after liquidating some of its debt holdings. The cumulative effect of having to sell off its debt holdings and subsequently its blue chips is being felt now.

There is a consensus within the stock market fraternity that this was the right time for UTI to come clean and link the repurchase price with its NAV. Such a move would have caused short-term jitters, but would have had a long-term effect of eventually improving sentiment, and gradually inflows would have begun again.