India Country Risks in 2012

Indian organizations are in for a rocky ride in 2012 as darkening clouds hang over India growth story. In some ways it is a make or break year for India’s continuing successful journey for economic growth and power. The world is watching and India cannot afford to flounder. However, the risks in the economic environment are acting as tsunamis and volcanoes, wiping out past efforts swiftly. This year Indian organizations need to watch out for external risks and triggers carefully, as they can have huge impact on the bottom line of the company.

The prophets of gloom and doom predict that India’s GDP in 2012-2013 financial year will be between 6-7%. In light of prevailing political and economic environment this statement is a conservative realistic assessment. Hence, organizations to sustain and grow in 2012 need to conduct strategic risk assessment of India country risks. I am giving below my top four.

1. Political Paralysis

In 2011, Prime Minster Manmohan Singh’s reputation has nose-dived as the country was engulfed in corruption scandals. His continuance as Prime Minster till the end of term is widely debated in political circles. The Congress party is facing another crises due to Sonia Gandhi’s ill-health. Public is speculating that she has undergone surgery to treat cancer in USA. Hence, rumors are rife about Rahul Gandhi  taking over the reigns of the party. Moreover, senior Congress party leaders are having spats in public.

Last but not the least, Anna Hazare’s fight against corruption has awakened the middle class. Finally, they have lost their apathy and are demanding better governance.

Considering all aspects, there is little likelihood of a strong national party leading India in 2012. Moreover, political commentators are hinting about mid-term polls due to fishers in Congress party and it’s deteriorating credibility. Therefore, large organizations must manage political risks at national and local state level. Keep in mind sensitivities of various political parties otherwise their is a probability of getting caught in a tug of war. Also, adjust the growth plans for government ineffectiveness.

2. Financial Market Turmoil

Indian markets in 2011 have done badly on financial indicators. There is slowdown in growth and in October 2011 industrial output contracted by 5.1%. Fiscal and current deficit are expected to cross 3% and 5% of the GDP respectively in 2011-2012. The GDP growth forecast for the year was reduced to 7.5% on 10 Dec 2011.

Sensex on 16 December 2011 closed at 15,491, a 25 month low. Stock brokers predict that the market is not going to rise in a hurry.

Business Standard reported in its weekly report on 16 December that “The WPI inflation for the month of November came in at 9.11 per cent compared to 9.73 per cent in October. The market was looking at an inflation of below 9 per cent for November. Inflation for November 2010 stood at 8.2%. India’s food inflation eased to 4.35% in the year to December 3 — its lowest reading since late February 2008 — from an annual 6.60% rise in the previous week, government data showed today.

Further, On Thursday, the Indian rupee touched a record low of 54.30 to the US dollar on the back of sustained foreign fund capital outflows in view of the fall in the equity markets, coupled with a stronger dollar in global markets.”

The Finance Minister Pranab Mukherjee recently commented in a meeting – “The present indicators show that both private consumption and investment sentiments have weakened and it is this weakening of sentiments that makes it necessary to shift our focus back to near term issues.

Moreover, Moody’s in November 2011, “downgraded the entire Indian banking system’s rating outlook from “stable” to “negative,” citing the likely deterioration in asset quality in the months ahead.” Additionally, aviation, telecom, commercial real estate and power utilities industries collectively owe banks Rs 5 lakh crore. These industries are most affected by the slow down.

The financial market situation is unlikely to improve in the short run. India will most probably not see a double-digit growth in GDP in 2012-2013. Companies need to risk adjust the financial growth numbers keeping in mind the prevailing situation. . Conservative estimates and cost control will steer the organizations in safe waters. Maintain good liquidity throughout the year as banks are not going to save organizations in a crunch.

3. Future Regulatory Reforms

The regulatory reforms came to a standstill in 2011. The business leaders came out strongly criticizing the political parties for hampering economic growth. The unhappiness of corporate world is evident that investments – domestic and foreign – are at an all time low.

The government in December 2011 parliament session had a list of 50 Bills for approval. Some of the Bills presented were Companies Bill 2011, Banking Laws Amendment Bill 2011,Prevention of Money Laundering (Amendment) Bill,  Direct Taxes Code Bill, 2010, Forward Contracts (Regulation) Amendment Bill, 2010; Pension Fund Regulatory and Development Authority Bill, 2011, Securities and Exchange Board of India (Amendment) Bill 2009; Insurance Laws (Amendment) Bill, 2008 and Regulation of Factor (Assignment of Receivables) Bill, 2011, among others.

This shows the pending backlog of bills requiring approval in the parliament. Business leaders are likely to lobby for approval of these bills in 2012. Hence, risk managers need to be geared to manage numerous regulatory changes in 2012.

4. Skyrocketing Corruption & Bribery

In light of various scams – telecom, mining, land, etc, – the corruption perception index in 2011 has fallen to 3.1 from 2010’s 3.3. India’s world ranking in corruption has gone lower to 95 from a total of 183 countries assessed. This is not surprising as Indian’s in 2011 saw well known politicians and business owners implicated in scam cases.

The recently released report of Global Financial Integrity – Illicit Financial Flows from Developing Countries Over the Decade Ending 2009 – states that trade mis-pricing accounts over 80% of the illicit financial flows in Asia. India in the last decade lost US $104 billions in illicit flows and is ranked 15th highest among developing countries with China topping at US $ 2467 billion. Though in comparison to China, India doesn’t appear to be doing badly, but that is distorted reality. A couple of activists and whistle blowers lost their lives during the year for uncovering corruption cases.

In 2011, Anna Hazare initiated public rallies to force government to pass Lok Pal Bill. Although, parliament is expected to pass it in December 2011 winter session, the implementation will take some time. The government’s sincerity in eradicating corruption is questionable as the various anti-graft bills are being used to play political football. The UPA government to counteract Hazare’s war cry has presented three additional anti-graft namely –  Judicial Accountability Bill,  Public Interest Disclosure Bill (Protection to Whistleblowers Bill) and the Citizens’ Charter – in the parliament in December 2011. A step in the right direction but the road ahead is tough. Passing bills and implementing them are different ball games.

In light of the fraud cases, high-level prosecutions and political games, the Indian corporate world has become vary. In 2012, organizations must focus on implementing a code of conduct for employees and provide training to them on business ethics. The legal and reputation risks will be extremely high if these aspects are ignored.  The situation becomes more tricky for US and UK multinationals as they are governed by FCPA of their respective countries.

Closing Thoughts

Political deadlock, inflation and corruption have taken the air out of India’s growth story. 2012 will be the decisive year in assessing whether India can surmount these obstacles and accelerate economic growth or  go on a downward spiral. Organizations must maintain a balance between growth and risks. The downside risks can cost heavily and there may be no quick ways to turn around numbers. Hence, doing proper planning, implementation and cost effective operational execution are key for success.

References:

  1. Illicit Financial Flows from Developing Countries Over the Decade Ending 2009 – By Global Financial Integrity
  2. Corruption Perception Index
  3. Weekly Report: Sensex, Nifty hit 2-yr lows on growth woes – Business Standard
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CAG Audit Report on Air India and Indian Airlines

“Man must rise above the Earth — to the top of the atmosphere and beyond — for only thus will he fully understand the world in which he lives.” — Socrates

I was waiting for the Comptroller and Auditor General (CAG) performance audit report on the Civil Aviation Ministry, which includes operations of Air India Limited (AIL) and Indian Airlines Limited (IAL). Both the airlines, AIL on international routes and IAL on domestic routes have lost market share in the last few years. The liberalization of civil aviation sector by allowing private airlines to operate ended the monopoly of the government airlines. The market perception was that this resulted in huge operating losses. However, there is much more dirt. Give below some of the highlights of the report.

1.    Purchase of Aircrafts

The report questions the Boeing aircraft purchasing decisions made in 2004-2005 by the Civil Aviation Ministry. In December 2005, decision was made to purchase 50 aircrafts at a price of Rs.33,197 crore (USD 6871 million). The initial plan in 2004 was to purchase a lesser number of aircrafts and over the period, the order increased. CAG has questioned the decision, that the market demand was not sufficient to place such a large order. As per the report –

“The increase in numbers does not withstand audit scrutiny, considering the market requirements obtaining then or forecast for the future as also the commercial viability projected to justify the acquisition. The acquisition appears to be supply-driven.”

It further questions the sudden speed shown by the ministry in purchase decisions. It also categorically refutes the assumptions made for the project and states the costing analysis was improperly conducted. Most of the purchase money was to be funded from debt. In the report it states-

“This was a recipe for disaster ab initio and should have raised alarm signals in MoCA, PIB and the Planning Commission.”

It has concluded that Ministry of Corporate Affairs (MoCA) influenced this decision.

Lessons for private sector

From a private sector perspective, the observations apply to the purchase department. Purchase decisions made without considering organizational requirements as a favor to the supplier implies that purchase department is receiving kickbacks. Overlooking so many aspects of internal controls means collision between employees and departments (buyer, purchase and finance departments). Employees may process fake purchase orders for personal expenses. Periodic supply chain audit including purchase function and inventory management reduces probability of purchasing frauds.

2.   Merger of AIL and IAL into NACIL

The second mind-blowing statement made is about the merger of the airlines. Here is an extract-

“Based on the records, we are unable to ascertain the detailed justification for, or the background to the “in principle” approval of GOI for working towards the merger of AIL and IAL.”

The report further states that the merger made little sense after such massive aircraft acquisition plans. Besides the timing of the merger, the report mentions that financial analysis of the proposed merger was insufficient, without considering ground level realities. Human resources, maintenance of aircrafts, operations, system integration etc. were not delved into deeply for decision-making. The auditors are of the opinion, that the decision was made at the top without due consideration.

Lessons for private sector

Experience has shown that in India most of the mergers and expansion plans are ill thought. For example, some senior managers propose a location for an office, and the decision is made. A detailed analysis at operational, financial and market is not available. I had mentioned in fraud symptoms series that mergers without organizational integration and extensive geographical distribution increases fraud risks. Hence, organizations must conduct detailed reviews of business strategies while making decisions having long-term impact.

3.   Role of Ministry of Corporate Affairs

It hasn’t spared the MoCA at all. The ministry will have some answering to do. Here is a line about the Memorandum of Understandings (MOU) signed by the airlines.

“This skewed the MOU ratings of IAL and AIL to unduly represent a rosy picture of performance. The overall combination of financial and non-financial parameters devised for the MOUs were such as to ensure that the MOUs become a meaningless exercise, rarely (if ever) reflecting poor performance, and ensuring lack of accountability for all parties concerned.”

These are strong statements questioning the validity of key performance indicators, measurement criteria and performance reporting.

Lessons for private sector

The phrase “what cannot be counted, cannot be measured” holds well in respect to performance management. Private sector suffers from the same malaise. Instead of select few performance indicators management is bombarded with trivial many. With the information overload, massaging of data occurs simultaneously. Hence, the timely and accurate information about company performance is not available. Management decisions are flawed and reactive in nature. Investing in good business intelligence systems helps to surmount this problem.

Closing thoughts

The report is excellent and as usual, I am impressed with the independence of CAG reports. The one shortcoming is that the losses were not quantified as in the previous 2G Telecom and Common Wealth Games Report. CAGs viewpoint is that it was outside the scope of the current audit. I disagree with the statement. If the observation is part of the report, the impact of loss is inclusive. Nonetheless, I recommend fellow risk managers to read the report. They can learn a few good lessons.