Just-in-Time Budgeting for a Volatile Economy

Please click on this link to read an interesting article form McKinsey Quarterly.
http://www.mckinseyquarterly.com/Just-in-time_budgeting_for_a_volatile_economy_2351

ECONOMIC RECESSION IN INDIA- OPPORTUNITIES AND CHALLENGES

The global economic recession played havoc in India also. The worst affected was the capital market. The SENSEX and NIFTY , the two major stock indices in India fell by more than half from its position at the beginning of last year. However, Indian banking system was saved from the attack of global recession thanks to the timely intervention by Reserve Bank of India. Many times the liquidity in the banking system was under pressure resulting into withholding of credit expansion. But the timely intervention by Reserve Bank of India by pumping additional liquidity into the system enabled the banks to survive the liquidity crunch. In order to ease the liquidity crisis, RBI released funds by reducing reserve ratios (SLR &CRR) and Repo rates. These steps helped the banks to continue their lending activities which were a great boon to the corporate entities in India when their counterparts elsewhere in the world were crying for more funds. Within a short gap of 3 months our stock indices picked up and started upward journey. The worst affected sector in India is the IT which had to downsize their employees to meet the decline in business. Though construction industry received a temporary setback, it is now slowly picking up. However, exports have declined due to the slump in demand abroad. Consequently, the rupee declined substantially making the imports costly. The inflation in India is all-time low and at one time people were wondering whether we would be moving to deflation. Given the present condition, India can grow by 6 to 6.5%. A good monsoon can bring better crops and if this happens, India can hope for a better growth. The Indian economy is poised to rebound and reach its full glory by mid-2010. FIIs have already become active in the capital market. One biggest problem we may have face is the return of expatriates on account of job-loss abroad and giving them a position in India. Let us hope that the industrial and business expansion during the coming days can absorb them also. The Indian experiences are excellent lessons for countries across the world.

A Conversation With Rober Shiller-Video from McKinsey

http://www.mckinseyquarterly.com/Surveying_the_economic_horizon_A_conversation_with_Robert_Shiller_2345

AUDIT PROFESSION INDIA: CERTAIN ISSUES

The Satyam imbroglio has made several fingers pointed at the sanctity of audit reports in India. Sections 224 to 233 of Companies Act 1956 clearly set out the qualifications, appointment and certain statutory requirements to be complied with auditors of a limited company. The Act thrust upon the responsibility of professionalizing the auditing by stipulating that only a registered member of the Institute of Chartered Accountants of India is eligible to become auditors of companies. The Institute of Chartered Accountant of India (ICAI) is a statutory body incorporated under the Chartered Accountants Act, 1949. The website of ICAI shows the names of the Council who governs the Institute, takes policy decisions, controls, regulates and supervises the auditing operations in India. According to Section 224, the auditor of a company is appointed by the General Body Meeting. Hence the auditors are accountable to the shareholders of the company who constitutes the General Body.

Today’s Economic Times carried a report stating that Price Waterhouse Coopers, statutory auditors of the Satyam Computers pointed out that the audit reports of the company were not signed by their partners (See page 5 of ET). Now the following question arises:

(1) Is it not the responsibility of the auditor appointed by the General Body of a Company as per the provisions of Companies Act 1956 to inform the appointing authority about who all were authorized to conduct the audit and who all were authorized to sign the reports?

(2) The General Body appointed PwC as the statutory auditor and how can they delegate the power of audit to Lovelock and Lewes (Remember the famous maxim “Delgatus Non Protest Delgare” which a delegate cannot delegate his powers to another person).

(3) ICAI who has been empowered as the statutory body as far as accounting and auditing is concerned and Mr. S.Gopalakrishnan one among the disputed signatories of Satyam’s audit report and member of Lovelock and Lewes is a member of the ICAI’s Council. Then how this fact did not come to the notice of ICAI?

(4) In an interview with Mr. Patrick de Cambourg of Mazars (See page 11 of ET), it is stated that though the cash and bank balances are to be independently verified by auditors, often this did not happen and shortcuts were adopted due to complexity of procedures. In this era of technologically enabled banking system, the auditor can even get the username and password of all bank accounts of the company and download the latest account statements directly from the respective banks. Later on the company could change the password. Another statement was that the checking of bank accounts was typically given to the junior accountants. Does this mean that the senior auditors are not responsible for what the juniors do? Is it not the duty of the senior auditors to teach right practices to the auditors?

(5) Another critical issue is that Mr. S.Gopalakrishnan who signed the audit reports of Satyam continues to be a member of the council of ICAI who has to enquire about the audit practices at Satyam. Is it not a conflict of interest? One has to naturally doubt whether ICAI is having a soft approach to the issue because a few days back there was a remark by ICAI President that the auditors could be misled by the company management. Is ICAI trying to protect PwC or Mr.Gopalakrishnan?

(6) Given this conditions how a shareholder can trust the audit reports? The valuations of companies are done based on the audited financial statements and the latest revelation indicates that around hundred odd reports may also face this problem. We are investing in shares looking at the valuation of the company and if the valuation goes wrong our investment decisions also will go wrong. Another important aspect is that the rating agencies also depends heavily on audited financial results and in the above context the rating of instruments and institutions also can go wrong. What would be the solution for this contagious problem?

(7) Now Satyam’s officials are facing prosecution. Why the auditors also are not being booked under the law and subjected to prosecution process. Was there any unholy relationship between the audit staff and the Satyam management?

(8) A few years back in the case of Tata Finance, A.F. Fegusson withdrew its report and the senior partner of Fergusson Mr. Kaley resigned from the position. At that time ICAI had indicated that a review committee would be reviewing the audit reports on a random basis. Did this take place? If so why the Satyam’s report missed from their review process?

(9) The Minister in charge of Corporate Affairs has stated that the company officials could not escape from financial misappropriations by simply remitting the penalty. What about the auditors? Are they also not accountable?

(10) Now the capital market is dwindling and bears dominate the market. A year back, the booming market prompted many investors to put their hard earned money in equity and derivative securities as also mutual funds. Now under the current market condition, many of these investments are considerably below the preliminary investments. The two stimulus packages announced by the government could not instill confidence among investors and many of them are still shy in investing in stock market and related instruments. The confidence in corporate accounting and the audit reports have been lost. It is not that the companies are strong that the investors shy away, but it is the sentiments play high now in the stock market. What would be the measures by the government to bring back the investor confidence?

SATYAM FIASCO: IS IT A FAILURE OF CORPORTE GOVERNANCE?

Satyam Fiasco has raised several eyebrows against the credibility of corporate governance in Indian corporate entities. This is not the first time that companies promoted by family groups defraud the investors. But Satyam has a different face because the Chairman himself admitted the fraud and wrote to the Board of Directors and the Capital Market Regulator about the manipulations which have made all regulatory frameworks a mockery. The first corporate governance issue came up on account of the ‘conflict of interest’ in the case of AF Fegusson who acted as auditor and consultant to the Tata Finance Limited in which case the TFL Managing Director had committed financial manipulations which the auditor had failed to bring out. In the case of Satyam, the financial manipulations amounted to about Rs.7000 crores. These manipulations were in the form of understatement of liabilities and inflated cash balance. Satyam reported a net profit of Rs. 649 crores whereas the real profit was only Rs.61 crores. The website of the company shows that the revenue for Q2 of 2008 had gone up by 38.8 per cent and Net Profit had gone up by 42 per cent on a YoY basis. The quarterly results had been filed with stock exchanges, SEBI, and the other stakeholders in compliance with the statutory requirements. It is also stated that the audited financial statements had been prepared in compliance with the Indian GAAP, US GAAP and IFRS guidelines. While the standalone financial statement under Indian GAAP is audited by Price Waterhouse Coopers (PWC), one among world’s four leading audit firms, the other statements are unaudited. This reminds me the role of Arthur Anderson in the case of Enron where, Anderson became a party to hiding the real financial position of Enron. Consequently, the audit wing of Anderson had to be closed down.

Another interesting aspect of Styam story is that two academicians were on the Board of Satyam. They were not mere academicians, but were from two leading business schools. While Prof. Rammohan Rao was from the Hyderabad based Indian Business School, which is the leading business school in India, Prof. Krishna Paleppu was from the famous Harvard Business School. Prof. Rao also held various important positions in various bodies in India where as Prof. Paleppu is professor in Harvard and corporate governance happens to be one of his primary areas of interest. Now I am wondering how these eminent personalities failed in ensuring the implementation of the declared corporate governance practices of the company? They were considered to be independent directors, but their actions raise doubts about their independent functioning. The company’s corporate governance statement for 2007 shows that an audit committee was functioning overseeing the financial reporting and disclosure process as also the ensuring the sufficiency, correctness and credibility of the financial statements. It is also seen that Prof. Rammohan Rao was a member of the audit committee. How far the audit committee was committed to the responsibilities thrust upon them?

The statutory auditors of Satyam were PWC. With my two years experience as internal auditor of a leading commercial bank in the private sector, I fail to understand the principles of audit followed by the auditors of PWC. Normally auditors insist on a certificate of balance from the company’s bankers and the banks balance as per the balance sheet should tally with the balance as revealed by this certificate. Wherever the balance does not tally, the company has to prepare a reconciliation statement and produce before the satisfaction of the auditors. Similarly the liabilities were understated. Now the question is how the auditors were satisfied with the company’s statements. Did they blindly believe the company? Or did they physically verify documentary evidences in support of company’s claims. Mr. Ramalinga Raju’s letter to the Board reveals that the practice of inflating the profit was vogue in the company for the last several years. If this is true, how the auditors’ failed to find out this manipulation and bring this in their report? PWC owes answer to the investors because they have certified the company’s financial statements.

Satyam episode pulled down the stock market indices heavily. Sensex lost 7.25 per cent and NSE lost 6.18 per cent on a single day consequent to the revelation of financial manipulation and Ramalinga Raju’s resignation from the Board. Satyam lost over 70 per cent in the market. Now the fate of over 50,000 employees of Satyam is in doldrums. The investors who had great faith in Satyam lost heavily in this game. The clients have already expressed their reactions by blacklisting the company. Now how will compensate the investors?

I have great appreciation towards Mr. Ramalinga Raju because he was bold enough to openly admit which otherwise would have remained in the dark corridors resulting into damages at a much higher scale. I feel that Mr. Raju is not as much guilty as the independent directors and the auditors. It is unbelievable that the financial manipulations of this much magnitude went unnoticed by the colleagues of Mr. Raju. Probably, Mr. Raju may be trying to save all his colleagues by owning up the whole responsibility. By this action he has exhibited the qualities of a true leader. However, these actions do not dilute the gravity of the offence he committed and the law has to take its own course. It is high time that we should redefine the punishments to financial offences by enhancing the value of punishments so as to make it costlier to pay the penalty than compliance of rules and regulations (now it is the other way).

Incidentally, Satyam is the winner of Golden Peacock Global Award for Excellence in Corporate Governance. They had also won award for best learning centre from American Society for Training and Development and another award for Corporate Social Responsibility. I am wondering weather this is the type of corporate governance and corporate social responsibility for which awards and recognitions are being given?

While concluding, the following questions still remain in my mind:

(1) What is the value of corporate governance principles declared by the companies? As an investor how much can I believe them?
(2) What is the role of independent directors on the board of companies? How much they are accountable?
(3) What is the function of the audit committee of the Board constituted as per the corporate governance guidelines? How much they are statutorily accountable to the regulator, investors and the stakeholders?
(4) How far investors can rely on audit reports? What is the sanctity of audited financial statements?
(5) What is the role of academicians in the boards of companies? How do they justify their actions to their students whom they teach good governance and corporate ethics? Are they using their expertise for the benefit of the company?
(6) What is the role of market regulator? How are they going to protect the investors? How are they going to fix accountability with the auditors and company directors?
(7) As an investor whom can I trust now? Is it the company? Is it the independent directors? Is it the market regulator? How far my investments in equity and equity related investments are safe?
(8) What would be the penal action against Mr. Ramalinga Raju? Will it be the usual peanuts or some thing larger which would make him lose a fortune?
(9) What would be the regulatory initiative to prevent spread of this decease to other corporate entities and protect the interest of the investors?
(10) What would be the action against the auditors? Will ICAI show the courage to blacklist PWC from undertaking audit work of any corporate entities India?

MONEY SUPPLY

Money supply can be defined as the aggregate supply of money in circulation, which comprises of currency with the public and demand deposits with the banks. It is the liquid assets held by individuals and banks. Some economists consider time and savings deposits to be part of the money supply because such deposits can be managed by governmental action and are involved in aggregate economic activity. These deposits are nearly as liquid as currency and demand deposits. Other economists believe that deposits in mutual savings banks, savings and loan associations, and credit unions should be counted as part of the money supply. Money supply is also known as money stock or monetary aggregates

There are several measures for the money supply, such as M1, M2, and M3. The money supply is considered an important instrument for controlling inflation .The Reserve bank of India has adopted four concepts of measuring money supply. They are M1, M2, M3, &M4.
The measure of money stock designated by M1 is usually described as the money supply. The components of money supply are currency with the public ie notes in circulation and deposits. It is the narrow measure of money, which is used for everyday expenditure.
Another measure of the money supply is M2, which is the total of M1, savings and small time deposits, overnight repos at commercial banks, and non-institutional money market accounts. M2 is a key economic indicator used to forecast inflation. M2 is also a broad money concept.
M2, plus large time deposits, repos of maturity greater than one day at commercial banks, and institutional money market accounts constitute M3 is also known as broad money concept. This includes net time deposits (fixed deposits), savings deposits with post office savings banks and all the components of M1.

The monetary policy and credit policy addresses the control of money supply. These policies are aimed at increasing or decreasing the money supply. The Reserve Bank of India announces these policies on a half yearly basis, at the commencement of each half-year. The major tools use by the RBI to control the money supply are the bank rate, variation of reserve ratios, open market operation and moral suasion.

When RBI increases or reduces the bank rate, the funds become dearer or cheaper to banks. This either eases the market with more money supply or tightens the market by withdrawing the excess liquidity in the market. The change in the reserve ratios such as Statutory Liquidity Ratio or Cash Reserve Ratio also reduces or increases the funds availability. Statutory Liquidity Ratio represents the investments made by the banks in unencumbered securities approved by the RBI. Under open market operations, the Reserve Bank auctions the treasury bills or buys the bills back so that the excess liquidity in the market would be absorbed. Similarly the buying back of the securities will enable the banks to get funds from the market. The moral suasion is a non-monetary measure. It is psychological pressure applied on the activities of the banks, which ultimately would either withdraw or supply money to the market.

GLOBAL FINANCIAL REGULATORY AUTHORITY- WILL IT BE A SOLUTION FOR FUTURE FINANCIAL CRISIS?

History tells us about the existence of financial system in the world enabling the countries to exchange their currencies. The Bimetallism prevalent prior to 1875 gave way to the Classical Gold Standard. The World War I brought an end to the age old British dominance in the World money management. The Great Depression in 1931 called for a central regulatory system to ensure economic stability in the countries across the world. Thus the move started in 1944 by 44 countries in Brettonwoods in UK brought two Institutions to manage the global financial word. While International Monetary Fund (IMF) was expected to provide assistance to come out of Balance of Payment crisis, the sister institution International Bank for Reconstruction and Development (IBRD), popularly known as World Bank, took the responsibility of extending financial aid to build up ruined economies across the world. The lack of confidence in the British Raj in management of International Monetary System consequent to the failure of the Classical Gold Standard led to replacement of Great Britain by United States on the control. The dominance of US can be witnessed visibly in the Brettonwoods System which had thrust upon the responsibility of conversion of Dollar into Gold at a specified rate which was revised thrice. The failure of US to meet their commitment was the reason fro the failure of Brettonwoods System.

 

The 1922 Geneva Economic Conference provided the platform for giving birth to an International Banking Institution to bring co-operation among the Central Banks across he world. Thus the Bank for International Settlement (BIS) was established in 1931 with its Head Quarters in Geneva to promote central bank co-operation.

 

The Latin American Crisis and the East Asian Currency Crisis in the 1990s were ample evidence for the failure of all the above institutions in managing the International Financial System. If we closely examine the administration of these bodies, we can clearly see the US dominance everywhere. Thus the US has grown to the level of a major economic power capable of deciding the fate of the economies in the world because they are the custodian of the wealth of these economies. Though European Monetary System emerged as an alternate mechanism and Euro was positioned against US Dollars, so long as US Dollar remains as the intervention currency and the foreign exchange reserves of countries are maintained US Dollars, the economic power of US is difficult to be controlled. After dwindling for quite a long time since its inception, Euro is getting stabilized only now.

 

The current financial crisis also was triggered by the US economy. The US subprime crisis was the root cause for the meltdowns of banking institutions and loss of jobs, homes and security for millions in the world. Still they continue to be the custodian of the wealth of economies in the world. Now a new demand has emerged out of the discussion among the world economists for constitution of a Global Financial Regulatory Authority. Prof. Joseph Stiglz while delivering the Lakdwala Speech in New Delhi had put forward this suggestion as a solution to check future meltdowns. At the same time he had criticized the economic policies of US administration and had squarely blamed them for the present crisis.

 

If we examine the role of IMF, World Bank and BIS in preventing a meltdown as that happened in the previous years, we have to accept the fact that these institutions have miserably failed in preventing a crisis. I feel that they were silent spectators of the crashing of markets. The reasons, I feel, could be the US dominance.

 

Now it is not clear what would be the shape of a new regulatory authority. Can the US hands be kept out of this agency? If US dominates this one also will it not be another institution like IMF or World Bank? Being the holder of the major portion of the wealth of nations how can one keep away US from the proposed authority? In my opinion, the countries have to shift their reserve currency from US Dollars to Euro and use Euro as the intervention currency in order to prevent future financial crisis. With weak banking system and lack of control mechanism US can create more havocs in the world financial markets. Unless US is kept out of the scene no new authority can effectively prevent future meltdowns.