The Satyam Scandal: The Past and Future of India's Economy

The heated wave of criticism against Bernie Madoff has barely came to a conclusion when, as the global media reported, another round of scandal emerged. The “Indian Madoff”, Ramalingam Raju (see left), the chairman of India’s fourth-largest IT company Satyam Computer Services, shocked investors with a letter that admitted his culpability of compiling fraudulent financial statements. This announcement to the public not only caused investors to scramble to retrieve their investments, but also put a red light over the worldwide confidence on India’s vast economic growth and success in its niche IT market. Ironic enough, the Obama administration issued a budget letter for fiscal year 2010 last week, stressing that the economic blueprint should be as much about morality as fiscal policy. Maybe this serves as a wake up call for Indian regulatory bodies; a time for Indian corporations to shed their outdated and controversial methods of doing business and learn from the success of respectable corporations around the world. In the subsequent analysis, instead of laying out the logistics of the Satyam scandal from beginning to end and the public criticisms against the company’s management team, I wish to embark on a road less traveled and examine some issues that are worth our attention. In particular, I believe there are creditable lessons to be learned from the scandal. While there are certainly external factors which hinder the economic growth of India such as the poor market environment and power of suppliers that governs the production rate of the country, I believe India should take steps in strengthening its internal operations and culture for the sake of a better future. Through the discussion, I hope to suggest ways that India, in its vibrant stage of economic growth, can potentially rise to a powerful position like the United States and contribute to the global economic realm.

In Raju’s startling four-and-a-half page letter to his board of directors as well as the Bombay stock exchange, he uncovered the fact of inflating the amount of cash on financial statements by nearly one billion and incurred a liability of $253 million on funds arranged by him personally. In Satyam’s quarterly report for September 2008, he overstated revenues by 76% and profits by 97%. Upon submitting his resignation, Raju confessed personal inability to close a small discrepancy that grew beyond control. “What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly,” he wrote. “It was like riding a tiger, not knowing how to get off without being eaten.” The question is: how did Raju get away with all this fraud? I suggest we trace the cause back to the legacy of License Raj, a period of heavy government intervention and bureaucratic control of the economy from 1947 to 1991. During that era, India's GDP growth rate was as low as 5%, lowest among developing countries and more than half of China's. Businessmen were forced to work with politicians and pay bribes to regulators and government. Companies often run separate accounts to avoid taxation. Wharton management professor Jitendra Singh said in an interview, “In the bad old days, particularly pre-1991, when the License Raj held sway, and by design, all kinds of free market mechanisms were hobbled or stymied, and corruption emerged almost as an illegitimate price mechanism, a shadowy quasi-market.” All in all, corruption was prevalent and the level of ethical standards was very low in India. Yet, corruption was not the sole reason for India’s economic failure. Corruption led to the emergence of a trend, whereby people lost incentive on product development and focused instead, their energy on cultivating people in positions of power. In the years following 1991, although India engaged itself in an economic reform, such distorted cultural norms remained in existence in society. Even though government control loosened up over the years, and significant economic growth occurred in India, corruption was not seen to have decreased. Faster growth gave regulators and governmental bodies new grounds to extract payments, such as land regulation, spectrum allocation or college admissions. In order to be competitive in the international market, companies need efficient approval from the government. This also gave regulators much more leverage over private institutions. In a survey by Transparency International in 2005, India was ranked 89th in the Corruption Perception Index, with a CPI Score of 2.9 over 10 when the average is 4.1.

Corruption could be a significant brake on India’s economic rise. CLSA India analyst Bhavtosh Vajpayee called the scandal “an accounting fraud beyond imagination and an embarrassing and shocking episode in Indian corporate governance.” The Satyam scandal undoubtedly shook India to the core. It pulled out many issues that the Indian government and corporations are facing. It brought to the attention of the public that their investments and trust are not safe in the hands of Indian corporations. It raised one prominent question: Is the Indian economy doomed under such vicious state of economic environment? Possibly, and if so my suggestions to rectify the situation would be: first, to reform the economic system in the country; and second, to learn from the United States. To begin with, a thorough reform is definitely necessary. Propositions should be made to govern the relationship between institutions and regulatory bodies. Detailed codes of conduct should be established and firmly adhered to. Regulatory bodies should be set up to make sure fairness is upheld. Simply take a well-developed country as an example, the mentioned criteria are inherent in success of those countries. Such reform is necessary if India hopes to gain significant growth and a solid position in the international economic realm.

The next aspect is to learn from the United States. I am not suggesting that the United States is free from corruption and unethical practices. In fact, from a recent research conducted by the Marist College Institute for Public Opinion in New York, nearly 60% gave the worst grades to Wall Street executives for honesty and ethical practices. Yet, my point is, despite the economic downturn and financial instability, the Obama administration signaled a candid call to return to ethics and responsibility in his 2010 budget titled A New Era of Responsibility - Renewing America's Promise. Obama's message in the budget says, "The time has come to usher in a new era— a new era of responsibility in which we act not only to save and create new jobs, but also to lay a new foundation of growth upon which we can renew the promise of America." In a website documenting Obama’s campaign, it laid out Obama’s ethics rules which included the creation of a centralized internet database for lobbying reports and ethics records; establishment of an independent watchdog agency to oversee the investigation of congressional ethics violations, and; restrict political appointees on their participation of regulations or contracts directly relating to their prior employer for two years. The Obama administration took solid steps to address the issue of ethics in his political regime. This is crucial in setting an example for institutions in their establishment of corporate governance. It also lays a foundation for the Indian government and corporations on the approach necessary to succeed and rise to power. Drawing from the United States’ biggest accounting fraud, the Enron fiesco, the country swiftly acted on and corrected its accounting systems to avoid similar issues happening again. India should respond to its problem of corruption with the same attitude. All in all, it definitely will be a tough process to bring India out of its corruption practices and into the international business realm. However, with persistence, India will one day come out of its shell and become a butterfly.