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***SNS*** Special Letter: The Indian Economy: Suffering from Terrorism, the American Financial Crisis, and the Satyam Scandal
By Rafiq Dossani
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Publisher’s Note: Rafiq Dossani is by now a well-known figure to all SNS members, both through his contributions to our Future in Review Conference and in his ongoing series of Special Letters on India. As perhaps the leading U.S. expert on outsourcing and the Indian economy, we are indeed fortunate to have Rafiq’s on-the-ground views and interpretations of India’s challenges and successes.
The recent events in Mumbai, the overt tensions with Pakistan, and the question of how global declines play in India’s balance of services, all make Rafiq’s comments and ideas yet more timely, and, I think, useful, to SNS members. As always, Rafiq has done a masterful job of uniting the large with the small, the anecdotal with the academic, and the technical with the economic. – mra.
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» The Indian Economy: Suffering from Terrorism, the American Financial Crisis, and the Satyam Scandal
By Rafiq Dossani
November’s terror attacks in Mumbai, India’s commercial capital, which killed 183 persons and injured 293 in locations as widespread as India’s best hotels, a train station, and a hospital, were not the country’s worst in recent times. That record is also, tragically, held by Mumbai, where 209 were killed and 700 injured by bombs placed in suburban trains in July 2006.
The media uproar over the terror attacks was unusual this time around, with calls for attacking Pakistan and for resignations of the home minister and other key officials. (See my op-ed on the unusual media reaction in the Mercury News of December 19, 2008: http://www.mercurynews.com/opinion/ci_11266509.) A prominent set of ex-government officials called for war on Pakistan. The Indian government, after initially keeping its calm, also accused Pakistan. Pakistani government officials were predictably angry in response, denying even that the terrorists came from Pakistan (it has since back-tracked on this claim) and taking the offensive by moving troops to the border even as India did the same. The United States has since played a key role in preventing the escalation of the situation into a war, and matters have calmed down.
The hyper-response bespeaks a nation in pain and feeling vulnerable to outside forces. Globalization, Indians are realizing, can be a double-edged sword. They are also realizing how difficult it is to do too much about terrorist attacks from across its borders (or even within its borders, as a spate of incidents in the eastern belt in 2008 indicated). The real problem may be Pakistan, a conclusion hotly disputed by that country, but corruption at home is also a real problem.
Having a large armed force is no match for corruption, which is endemic to the Indian environment. During the Mumbai incident, the ineptitude of the army was only too visible on TV cameras. At one point, an apparent terrorist was televised falling out of a first-floor window; the cameras then showed the commando member rapidly removing himself from the scene rather than confronting the terrorist.
After the November incident, a reporter wrote about a navy gunboat that was supposed to be patrolling the borders. The gunboat, which the reporter boarded quite openly, was parked on a civilian pier and had no guns and no engine. It turned out that it had not been used as a patrol boat for three years, and was being used by its crew as a place to stay. Corruption had long ago taken its toll on this boat.
The police are so ill-equipped that, in a high-security area near the Pakistan border, force mobility for patrolling a group of 19 border villages consists of three camels, two bicycles, and one Jeep (the Willys 1943 Jeep, for old-timers)!
How can such an economy, putatively along with China, lead the world out of a recession, as the decoupling theorists would have us believe? To the contrary, the economy of India has slowed considerably as a result of the American financial crisis. Sectors that once were booming – such as property markets, financial services, and manufacturing – are in crisis. The industrial production index in October declined for the first time in this decade, before recovering slightly in November. Output at one of India’s largest truck makers was down 80% in October from the year earlier. The banks are in serious trouble for similar reasons as in the U.S. – i.e., due to bad property loans and rising defaults on consumer credit.
There was a time early in 2008, which now seems distant, when fans of “decoupling” assumed that China and India would keep growing even as the West slowed down, thanks to domestic demand, and this would help stabilize the global situation. There is, it turns out, some truth to the assumption but not to the conclusion. India’s domestic-driven economy has always grown, and continues to grow, at 5.5%, based on population growth of 1.6%, high savings rates of 23%, and rural-to-urban migration of 1.5 million persons per year. This story is unchanged since 1980. It is the “old economy” of India, which still accounts for 80% of GDP and includes all of agriculture and most services and manufacturing.
The “new economy,” which has been growing at 25% a year over the past decade, includes exported services, such as software and tourism; professional services, such as finance and consulting; and the related construction, utilities, and services that were built around the sizzling parts, such as industrial parks (many funded by American hedge funds), airlines, and telecommunications. With the slowdown, the growth rate of the new economy has collapsed, bringing overall growth rates down from 9% last year to at best 5% in 2009. [Pub. Note: – therefore suggesting a small hit taken by the “old economy” as well. – mra.]
India’s economy is, in other words, no more immune from poor regulation and global forces than that of any other country. Add in domestic corruption, and things can be worse than elsewhere. This is exemplified by the scandal that broke out in January 2009 around Satyam Computers. The firm, founded in Hyderabad in 1987 by Ramalinga Raju, had become one of India’s largest outsourcing firms by 2008, employing 53,000 persons, with a revenue of $2 billion. In January 2009, Raju confessed to cooking the books for several years in amounts over $1 billion, by padding expenses while still reporting high profits to look good to investors.
Satyam did not hit the top leagues of the IT industry in India until the year 2000, when it marketed its services aggressively for fixing the Y2K problem. Its task was made easier because the top Indian IT firms turned away such business, as it was considered low-end. This gave Satyam entry into the best firms and, by 2008, it counted 185 of the Fortune 500 companies as its clients, as well as 600 others in the Western world and Japan.
To residents of Hyderabad, the capital of Andhra Pradesh, Raju became a star, courted by politicians and respected by the common man. He showed the world that Hyderabad could compete with Bangalore, and, at the government’s behest, played a key role in marketing Hyderabad to multinationals; firms such as Microsoft and Motorola chose Hyderabad as the base for their Indian operations.
I did not meet Raju until 2000, when I was advising the Indian government on sequencing its telecommunications reforms. The Chief Minister of Andhra Pradesh was a key driver of national telecom reforms, and Raju was often at his side during meetings in Hyderabad and in Silicon Valley. When the Chief Minister traveled overseas, Raju organized local meetings, hospitality, and similar privileges. In return, he was respected in his home state and, over time, was able to obtain privileges in return, particularly to set up a multibillion-dollar construction business for his son.
During my career as a stock market analyst in the 1990s in Mumbai, and earlier as the editor of Business India magazine in the late 1980s, my professions of those times did not take Satyam seriously. It was in the genre of “just another family firm,” one of the thousands that were constantly emerging in newly growing India, not regarded seriously as long as its operations were tightly controlled by family and close associates. Given the endemic nature of corruption in India, it was assumed that a firm that chose to be so closely controlled by just a few must be corrupt.
However, as noted above, Raju used his one break (Y2K) to prosper, and then used his prosperity to become part of his state’s patronage network. As India Inc.’s reputation grew in IT, Raju’s grew with it. He employed all the trappings of trustworthiness other than family control: a world-class auditing firm, Pricewaterhouse Coopers; and independent board members that included a prominent Indian from Silicon Valley – Vinod Dham, known for co-inventing the Pentium chip – and Krishna Palepu, a chaired professor at Harvard Business School who specializes, ironically, in corporate governance. Once Satyam hit the ranks of the top 10 Indian IT firms early in this decade, Raju had arrived, escaping the stigma of his family-controlled peers in other industries.
During our several meetings during this decade, I noticed that Raju always commanded the respect of Silicon Valley techies of Indian origin, as, I confess, he did mine. In addition to their admiration for Satyam, they respected Raju’s social work, such as setting up the equivalent of a 911 service in Hyderabad, and providing back-office work in rural areas of Andhra Pradesh.
So, how did PwC and Messrs. Dham and Palepu go along with all this? One point of view is that a culture of obsequiousness surrounds family-controlled firms in India, making it impossible for anyone – vendor or employee – to challenge the boss. There is some truth to this, which is why reputable family-founded firms, such as the Tatas, go to such great lengths to create professional management structures that run their companies. Another is just that corruption is so endemic to India that one mostly looks the other way when corruption occurs rather than challenge it. Do that often enough and it becomes entrenched, applicable equally to a Satyam as to the smallest corner shop. Whatever the cause, as the almost unbelievable facts of the Satyam case come to light, the culprit most exposed is the standard of Indian corporate governance – not in terms of its norms, which are world-class, but in their implementation.
Consider these facts (and I must qualify my statements below by noting that they are based on news reports from credible news media, but not on official reports by the company or the government): PwC was paid $800,000 a year for auditing Satyam – twice the average audit fee paid by the three largest IT firms: TCS, Infosys, and Wipro. Could this have made it “look the other way”?
At a crucial December 16, 2008, board meeting, Raju proposed that Satyam acquire his son’s property company for $1.5 billion. All the directors, including the independent directors, approved the deal, which had been revealed to them only at that meeting. How could they do this? One of the independent directors, Professor Palepu, not only received director’s fees of $25,000 last year (the same as the other directors), but was, in addition, paid more than $150,000 for providing training to Satyam employees. How could an independent director also be a vendor?
An analyst at the company’s investor briefing in October 2008 pointed out that the exact sum of $550 million had been lying idle in a non–interest-bearing account for the past five quarters. He asked how this could be. The firm’s CFO promised to get back to him on it. The amount, it turns out now, never existed. How is it that investment bankers at the analyst’s briefing, which was attended by analysts from Bank of America and Goldman Sachs, among others, never took this up?
Does all of this mean that India is just another “bull market” story and that, when times go bad, the real mess is exposed? Or is there hope?
In an earlier posting, I have argued that education is finally setting India free. Although this is a factor with more long-term implications, it matters. Thanks to good policies, one in three Indian children who complete high school now go on to college, compared with fewer than one in four in China. At the level of higher education, private provision has engendered a quiet revolution in quality and access. On average, one new engineering college, with enrollment of 1,500 students, opens its doors every day.
The second factor, notwithstanding Satyam, is the unusual, perhaps unique, role of the software services sector. Now operating manpower at a scale and level of sophistication that match the best Western firms, the software services sector is sparking a rise up the value-chain for industry as a whole.
Consider the impact of semiconductor chip design, a field that was earlier the preserve of a few Western firms. Indian software exporters have, since the 2001 Internet bubble, pushed their way into the field of semiconductor design, converting what was the preserve of product firms with small teams into a scalable design-services business. For instance, the largest design firm, Wipro, has more than 2,000 persons in its semiconductor design division, working with the most sophisticated platforms and with 45 nm. pitch sizes. By comparison, the Chinese semiconductor design industry mostly works with .18 microns circuitry; even Taiwan’s semiconductor design industry does not have the capacity for 45 nm. semiconductor design, and does mainly simple chip testing and verification at that level.
With such capability, Indian semiconductor design firms have clients in sophisticated industries such as aerospace, the automotive industry, and consumer electronics, and are developing project management and domain expertise that is being tapped by industry at large.
Chroniclers of pre-reform India attributed its low growth rate – 3.5% up to the 1970s – to the culture of its people. The so-called Hindu Rate of Growth of 3.5% was, it was said, the pace at which Indians worked. This myth was shattered in the 1980s, when modest liberalizations led to a 5.5% growth rate, and was laid to dust when the growth rate jumped thereafter, reaching its highest trajectory of 9% in the current decade. India is not about to return to the Hindu Rate of Growth; in the short run, the growth rate will probably return to the rate of the 1980s.
Most of that growth will benefit India alone, as pointed out above. Once its educated manpower comes on stream, this will change and India will play a more global role. Of importance, though, is the implication that India can already look after itself even as it begins, however tentatively, to look outward. That, for India, is a good place to be.
Copyright 2009 Strategic News Service and Rafiq Dossani. Redistribution prohibited without written permission.
Rafiq Dossani, Ph.D., is a senior research scholar at the Shorenstein Asia-Pacific Research Center of Stanford University and is responsible for directing its South Asia Initiative. He teaches courses in the development, religion, and politics of South Asia. A specialist on sectoral policy reform, he has advised the Indian government on telecommunications, venture capital, energy, and rural access to information technology.
Rafiq’s research interests include South Asian security and financial, technology, and energy-sector reform in India. He is currently undertaking projects on political reform, business process outsourcing, innovation, and entrepreneurship in information technology in India, and security in the Indian subcontinent. His most recent books are India Arriving, published in 2007 by AMACOM Books/American Management Association; Prospects for Peace in South Asia (co-edited with Henry Rowen), published in 2005 by Stanford University Press; and Telecommunications Reform in India, published in 2002 by Greenwood Press.
Prior to joining Stanford University, Rafiq worked for the Robert Fleming investment banking group, first as CEO of its Indian operations and later as head of its San Francisco operations. He has also been the chair and CEO of a stockbroking firm on the OTCEI exchange in India; the deputy editor of Business India, India’s largest circulating business magazine; and a professor of Finance at Pennsylvania State University.
Rafiq holds a BA in Economics from St. Stephen’s College, New Delhi, India; an MBA from the Indian Institute of Management, Calcutta, India; and a Ph.D. in Finance from Northwestern University.
I would like to thank Rafiq for taking time from his harried travel schedule, and during a period of demanding personal duties, to write this Special Letter for us. As matters unfolded during the Mumbai attacks and intergovernmental exchanges, he cheerfully and quickly created updates for us, so that our members would have current information. We are all indebted to him for this continuing picture of India and its growth paths.
Your comments are always welcome.
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SNS: Special Letter: The Indian Economy: Suffering from Terrorism, the American Financial Crisis, and the Satyam Scandal
