The Rs 7000-crore accounting fraud at Satyam Computer Services raises concerns of corporate governance in Indian companies

Just as it was recovering, IT major Satyam Computer Services’s explosiverevelations send the market on a southward spiral. Satyam’s shares plunged 77.69% in a single trading session on 7 January 2009, as chairman Ramalinga Raju resigned after announcing during trading hours that the company’s accounts were inflated. The shocking revelation of the accounting fraud, estimated at about Rs 7000 crore, sent theBSE 30-share Sensex tumbling 7.25% on that day.

Satyam’s disclosures raised concerns of corporate governance and accounting integrity of Indian companies. Realty and infrastructure shares tumbled on market perception that a number of firms in these sectors do not strictly follow good corporate governance practices. The BSE Realty index tanked 30.2% in the fortnight.

Two days after the Satyam scandal, the Securities and Exchange Board of India (Sebi)said the certification of corporate results from the December 2008 quarter by auditors would be subject to peer review to assure investors that the fraud at Satyam was unique.

Weak economic data in the US, Europe and Japan, and a deepening banking crisis in theUS also cast their shadow on the domestic bourses. Nevertheless, stronger-than-expected Q3December 2008 results by IT bellwether Infosys Technologies on 13 January 2009 and a USgovernment bailout of the largest US bank by assets, Bank of America, on 15 January 2009triggered a bounceback from the lower levels. The Sensex rose 3% on 16 January 2009.

Earlier, recovery in the global markets and coordinated policy actions by the Indiangovernment and the Reserve Bank of India (RBI) to boost the economy had cheered thedomestic bourses. Just before the Satyam scandal, the Sensex rose nearly 11% to 10,335.93on 6 January 2009 from a low of 9,328.92 on 26 December 2008.

The RBI has substantially eased the monetary policy over the past few months and thegovernment has announced two fiscal stimulus packages and taken steps to boost creditavailability to the industry to soften the impact of the global financial crisis andeconomic recession in key world economies on the Indian economy. The global financialcrisis that began last year with the collapse of the US housing market has spread roundthe world, brining several top financial institutions to their knees and pushing the US,Japan and Europe into recession or to the brink of it.

Infosys rose 12.1% to Rs 1268.25 in the fortnight. A decent addition of clients andemployees in Q3 December 2008 despite the global financial crisis cheered investors.Infosys derives substantial business from the financial sector vertical and there havebeen concerns of the impact of the global financial sector crisis on Infosys’revenue.

After a steep 20.9% slide to Rs 1080.90 on 13 January 2009 from Rs 1368.05 on 6 January2009 on fears of weak Q3 results, shares of India’s biggest private sector firm bymarket capitalisation and oil refiner Reliance Industries (RIL) rose almost 9% to Rs1178.15 on 14 January 2009 on speculation the two warring Ambani brothers will reach anout-of-court settlement over the supply of gas from RIL’s Krishna-Godavari (KG)basin. After trading hours, RIL denied rumour of the settlement of the dispute. The stocklost 5.1% in the fortnight.

India’s biggest engineering and construction firm by revenue L&T slumped 12.7%to Rs 717.60 on fears that it is likely to register huge losses on its exposure to SatyamComputer taken just before the accounting fraud at the IT firm was unearthed. L&Tchairman A M Naik said on 9 January 2009 that the company holds a 3.95% stake in Satyam.L&T, which has a small outsourcing unit, had made the investment in Satyam in the hopeof forming a strategic alliance.

Global News

* The US Treasury will provide Bank of America, the largest US bank by assets, withUS$ 20 billion in fresh capital from a government bailout fund in exchange for preferredstock. The government also agreed to share in losses on the troubled assets, which Bank ofAmerica took on when it paid an estimated US$ 19.4 billion for Merrill Lynch on 1 January2009.

* Democratic leaders in the US House of Representatives on 15 January 2009 unveileda US$ 825-billion tax cut and spending bill. After the closing bell, the US Senaterejected an attempt to block the release of the remaining US$ 350 billion from thefinancial bailout fund.

* On 9 January 2009, the US non-farm payrolls printed a loss of 5,24,000 inDecember 2008. Unemployment in the world’s largest economy rose to a whopping 7.2% inDecember 2008. This is the highest rate not seen since 1993.

* The Commerce Department reported on 15 January 2009 that, stung by weak demandand falling prices, US retail sales plunged a seasonally adjusted 2.7% in December 2008from November 2008.

* China’s exports dropped 2.8% in December 2008 over December 2007, afterfalling 2.2% in November 2008, while imports dropped to 21.3% in December 2008 overDecember 2007, after having fallen 17.9% in November 2008.

* Core Japanese machinery orders fell a record 16.2% in November 2008 to atwo-decade low.

* The European Central Bank (ECB) cut its benchmark interest rate by 50 basispoints (bps) to 2% on 15 January 2009, matching its lowest ever rate.

* The Bank of England cut interest rates by half a percentage point on 8 January2009 to a record low of 1.5%.

* Taiwan’s central bank cut its benchmark interest rate by 0.50% to 1.50% on 8January 2009 on a record plunge in the island’s exports in December 2008.

* The Bank of Korea on 9 January 2009 joined the central bank of Indonesia andTaiwan by slashing interest rates by half a percentage point, bringing its key rate torecord low 2.5%.

* Nortel Networks Corporation, North America’s biggest maker of telephoneequipment, filed for bankruptcy protection on 14 January 2009, a day before theToronto-based company was due to make an interest payment of about US$ 107 million.

Policy

* The Union government on 2 January 2009 restored the countervailing duty (CVD) andspecial CVD on imported cement, which was removed 19 months ago to contain inflation. Themeasures were part of the second stimulus package to give a much-needed boost to theIndian economy.

Economy

* Inflation based on the whole price index rose 5.24% in the year through 3 January2009 — lower than previous week’s 5.91% rise.

* India’s infrastructure sector output grew 2.2% in November 2008 overNovember 2007. The figure was below the 3.4% annual growth in October 2008 over October2007. Output had risen an annual 5.1% in November 2007, and 5.6% in 2007-08 over 2006-07.The infrastructure sector accounts for 26.68% of India’s industrial output.

* India’s industrial output rose 2.4% in November 2008 over November 2007. Thefigure rebounded from the previous month’s revised decline of 0.3%. Manufacturingproduction rose 2.4% in November 2008 over November 2007. Industrial output rose 8.1% inthe 2007-08 fiscal year compared with 11.6% in 2006-07.

Industry

* India’s GSM telecom companies (excluding Reliance Telecom) added over 8.1million mobile customers in December 2008.

* The Indian automobile industry’s overall domestic sales declined 18.2 % inDecember 2008 as commercial vehicles and two-wheelers sales crashed heavily. The totalvehicle sales in the domestic market stood at 5,97,622 units in December 2008 as against7,30,603 units in December 2007. Car sales in India fell 7% to 82,105 units in December2008 over December 2007 — the fifth drop in six months as high borrowing costs, tightcredit and a slowing economy weighed on demand.

* Cargo handling at the country’s 12 major ports a marginally increased 2% to130 million tonnes in Q3 December 2008 over Q3 December 2007. The rise was mainly due to a52% growth in handling of iron ore in the quarter.

* Revenue of the Railways increased 13.87% to Rs 57863.90 crore in April-December2008. Total revenue earning from goods went up 14.53% to Rs 39085.22 crore.

* Domestic passenger traffic for calendar year (CY) 2008 showed a decline of 5 %compared with CY 2007. Total air traffic carried in 2008 stood at 40.8 million, comparedwith 42.9 million in the previous year.

* Venture capital firms clocked over 125 deals worth US$ 740 million in calendaryear 2008 — down 15.53% compared with 2007, as per data compiled by VentureIntelligence.

Corporate action

Fraud: Satyam Computer Services chairman Ramalinga Raju admitted on 7 January 2009that Satyam’s balance sheet as on 30 September 2008 had inflated cash and bankbalances of Rs 5040 crore, inflated debtors of Rs 490 crore and non-existent accruedinterest of Rs 376 crore. Against this, the liability was understated by Rs 1230 crore.

The Q2 September 2008 results had overstated operating revenue by Rs 588 crore, therebyoverstating the operating profit and cash to that extent. The gap in the balance sheet hadarisen purely on account of inflated profit over the period of last several years, Rajuconfessed, adding that every attempt made to eliminate the gap failed. As the promotersheld a small percentage (around 8%) of equity, the concern was the poor performance wouldresult in a takeover, thereby exposing the gap.

Raju said in the last two years a net amount of Rs 1230 crore was arranged to keepoperations going. This was done by pledging all the promoters’ shares and raisingfunds from known sources by giving all kinds of assurances. Significant dividend payments,acquisitions, and capital expenditure to provide for growth did not help matters. The laststraw was the selling of most of the pledged share by the lenders on account of margintriggers. The aborted acquisition of two Mayatas companies was the last attempt to fillthe fictitious assets with real ones.

Ban: Wipro said on 12 January 2009 it was barred from bidding for contracts fromthe World Bank until 2011 after it offered employees of the institution shares in itsinitial public offering. The company in a release to exchanges said it had offered acommonly utilised and Securities and Exchange Commission (SEC)-approved direct shareprogramme in 2000 that allowed employees and clients to purchase American depositoryshares at the IPO market price. Under the programme, Wipro representatives offered theWorld Bank, through its chief information officer and a senior staff, participation in theprogramme and they directed this offer to members of their family and friends. Theaggregate number of shares purchased by them was 1,750 for approximately US$ 72,000 at theIPO price. All participants in the programme signed a conflict of interest statement thattheir purchase did not violate any ethics or conflict of interest of their company. Theprogramme’s objective was to involve employees and customers with the public offeringto expand the company’s recognition and brand. Wipro’s revenue from World Bankwas insignificant and the decision would not affect its business and results. It said theannouncement was being made now under revised disclosure policies.

Sales: Ashok Leyland’s sales fell 63% to 2,321 units in December 2008 overDecember 2007.

Interest rates: State Bank of Travancore reduced the benchmark prime lending rateby 50 bps from 13.25 % to 12.75 % effective 1 January 2009.

* India’s largest private sector mortgage financer HDFC slashed its home loanrates by 50 bps following a deposit rate cut by 50-75 bps on 16 January 2009. HDFC willnow disburse floating rate home loans up to Rs 30 lakh at 9.75% and loans above Rs 30 lakhat 10.75% to new borrowers. In December 2008, it had announced a 50-bp cut in lending anddeposit rates for its existing and new customers.

M&As: Infotech Enterprises acquired a 10% stake in Kalyani Net Ventures, Pune.

* Future Capital Holdings acquired a non-banking financial services firm BlackDiamond Finance.

Production: Tata Steel’s overall production grew 23% in Q3 December 2008 overQ3 December 2007. Crude steel output rose 17% to Rs 1.5 million tonnes, and hot metaloutput 23% to 1.7 million tonnes in Q3 December 2008 over Q3 December 2007. Volume ofsteel products, used by infrastructure and automobile industries, grew 24% to 0.48 milliontonnes in Q3 December 2008 over Q3 December 2007.

* Bangalore-based auto parts maker Bosch is to temporarily suspend operations atits three manufacturing units to avoid inventory build-up. It will suspend manufacturingof starters and generators at its Naganathapura plant between 10-31 January 2009, some ofits manufacturing operations at its Bangalore plant from 15-17 January 2009 and adopt afive-day week at the plant from 19 January till end February 2009, and would also observeblock closure at its Nashik plant from 19-24 January 2009.

* The Mumbai-based cement maker Ambuja Cements’s shipments rose 11.8% to 16.62million tonnes in December 2008 from 14.86 million in December 2007.

Prices: Hindustan Zinc raised zinc prices by 11% to Rs 70.100 after the governmenton 2 January 2009 restored the 5% basic customs duty on zinc.

* India’s largest cigarette maker by sales ITC is reported to have hikedprices of its brand, Gold Flake Premium, in Maharashtra by Rs 1 to Rs 28 per pack of 10cigarettes. The brand contributes around 14%-15% to ITC’s volume sales. By value, itis around 20%.

December 2008 quarter: Net profit of IT bellwether Infosys Technologies rose 14.59%to Rs 1641 crore in Q3 December 2008 over Q2 September 2008 on depreciation of the rupeeagainst the dollar and vastly above-market-expectation growth in net profit. Revenue rose6.8% to Rs 5786 crore in Q3 December 2008 over Q2 September 2008.

* Net profit of HDFC Bank rose 44.77% to Rs 621.74 crore on total income rising58.78% to Rs 5407.89 crore in Q3 December 2008 over Q3 December 2007. The results includedoperations of Centurion Bank of Punjab, merged with the bank. Hence, the results for Q3December 2008 are not comparable with Q3 December 2007. HDFC Bank’s gross netperforming assets (NPA) rose 120.47% to Rs 1911.41 crore end December 2008 from Rs 866.97crore end December 2007.

* Tata Consultancy Services’s (TCS) standalone net profit as per Indian GAAProse 3.31% to Rs 1211.89 crore on sales rising 3.07% to Rs 5875.48 crore in Q3 December2008 over Q2 September 2007. Foreign exchange loss was Rs 250 crore, of which Rs 45 crorewas a mark-to-market loss and the rest hedging losses.

Fund-raising: The Chennai-based state-run coal miner and power generator NeyveliLignite Corporation is to raise at least Rs 500 crore through bonds. The 10-year bondscarry a coupon rate of 8.83% and are rated ‘AAA’ by rating agencies Fitch,Crisil and Icra. The issue has a greenshoe option to retain oversubscription of up to Rs100 crore. Earlier this month, the board of the Neyveli Lignite Corporation approvedraising up to Rs 1850 crore worth capital through various means.

* The Bangalore-based state-run lender Canara Bank to raise Rs 325 crore from bondsto augment capital resources. The bonds, with a 120-month maturity, will have a couponrate of 8.08% and listed on the National Stock Exchange.

Market

* The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) haveannounced the index-based, market-wide circuit breaker for the quarter January-March 2009.The circuit breaker system is applicable at three stages of the index movement either wayat 10 %, 15% and 20%. Accordingly the percentages are calculated on the closing indexvalue of the quarter.

As the NSE Nifty closed at 2959.15 on 31 December 2008, the last trading day of theprevious quarter, the market-wide circuit breaker for any day in the quarter betweenJanuary and March 2009 would be triggered only if the index moves by 300 points (10%), 440points (15%) and 590 points (20%).

Similarly, the BSE would suspend trading only if the Sensex moves by 970 points (10%),1,450 points (15%) and 1,925 points (20%). The BSE Sensex had closed at 9647.31 on 31December 2008.

* The BSE revised the circuit filter, the maximum permissible limit up to which anyparticular scrip can move either on the upper or lower side, for 18 stocks from 13 January2009. The move is part of surveillance measures taken from time to time to check anyabnormal movements (rise or fall) in shares. The list includes Avantel Softech, CHIIn-vestments, Birla Ericsson Optical, DCM Financial Services, Asahi Infrastruc-ture andProjects, JBF Industries, Lumax Industries, JMC Projects, Jenson & Nicholson, RishiLaser, Nila Infrastructures, Nandan Exim, Lumax Auto Technologies, Jhagadia Copper,Suryalata Spinning Mills, Veejay Lakshmi Engineering Works, Lumax Automotive Systems, andNiraj Cement Struc-turals. The circuit filter for the first 13 scrips has been revised to10%, which is lower than the 20% applicable earlier in most of the cases. The remainingfive will now attract 5% circuit filter compared with 10% earlier.

* The BSE has listed 1,829 stocks as illiquid and has asked investors to becautious while investing in such stocks. The NSE’s list comprises 397 stocks. Thelist has been compiled based on trading activity in December 2008 and would be reviewed ona monthly basis. Sebi had directed the exchanges to draw up a list of illiquid securitiesbased on criteria jointly agreed between the BSE, the NSE and the Sebi. Such a list wouldbe made available to the trading members on a monthly basis.

The BSE’s list includes Bajaj Electricals, Force Motors, Bannari Amman Suars,Godfrey Philips, Goodyear India, IFSL, Kakatiya Cements, Kinetic Engneering, KSB Pumps,Mafatlal Industries, Maharashtra Scooters, Centrum Capital, Empower Industries, BajajHindustan Sugar & Industries, Keynote Corporate Services, and Sundaram Finance.

Almondz Global Securities, Advani Hotels & Resorts, Archidply Industries, BangOverseas, Blue Dart Express, Can Fin Homes, Chettinad Cements, IMP Powers, KhandwalaSecurities, Mahindra Forgings, Maxwell Industries, Nissan Copper, Pritish NandyCommunications and Siyaram Silk Mills have been included in the NSE’s list ofilliquid stocks.

* The BSE and the NSE excluded Satyam Computer Services from their respective keybenchmark indices from 12 January 2009. Sun Pharmaceuticals Industries has taken place ofSatyam on the Sensex, while Reliance Capital has replaced Satyam on the Nifty.

Mutual Fund

* The mutual fund industry’s assets under management increased over Rs 21800crore in December 2008, with total AUM rising 4.6% over that of November 2008.

Index Movements

Benchmark indices: The BSE Sensex fell 634.63 points, or 6.37%, to 9,323.59 in thefortnight ended 16 January 2009. The benchmark index touched a high 10,469.72 on 7 January2009 and a low of 8,946.62 on 15 January 2009.

The S&P CNX Nifty slipped 218.30 points, or 7.16%, to 2,828.45 in the fortnight.The benchmark index climbed up to a high of 3,147.20 on 7 January 2009 and declined to alow of 2,701.75 on 15 January 2009.

Niche Indices: The BSE Mid-Cap index fell 364.35 points, or 10.74%, to 3,026.83 inthe fortnight. It closed at a high of 3,494.85 on 6 January 2009 and a low of 2,981.88 on15 January 2009. The BSE Small-Cp index slumped 457.68 points, or 11.82%, to 3,412.77. Itscaled up to a high of 3,965.41 on 6 January 2009 and dropped to a low of 3,398.18 on 15January 2009.

Institutional Activity

FIIs: Foreign institutional investors (FIIs) sold Rs 1855.70 crore more shares thanthey bought from 5 to 15 January 2009. Foreign funds bought Rs 1750.10 crore more sharesthan they had sold in December 2008. FIIs had sold Rs 52987.10 crore more shares than theyhad bought in calendar 2008 to raise resources amid a global financial sector crisis.

DIIs: As per the provisional figures released by the stock exchanges, domesticinstitutional investors (DIIs) including insurance firms, bought 647.50 crore more sharesthat they sold from 5 to 16 January 2009. Within DIIs, as per Sebi data, mutual funds soldRs 2236.20 crore more shares than they bought during the period from 5 to 15 January 2009.

Market Outlook

Forced FII selling has been a key factor in pulling the market sharply lower in thelast few months. Foreign funds pressed sales to raise cash to meet resources amid theglobal financial sector crisis. Reflecting the depths of the problems in the US bankingsector, two of the nation’s largest financial-services companies — Bank ofAmerica and Citigroup — reported on 16 January 2009 substantial losses for Q4December 2008. The deterioration in credit markets, which had seen signs of recovery, mayagain see sell-off from foreign funds. FIIs pulled out a record Rs 52098.10 crore from theIndia in calendar 2008.

The current gloom notwithstanding, India’s long-term growth story remains intact.Growing urbanisation and rising disposable incomes are factors in favour of a stronglong-term growth of the economy. A May 2007 McKinsey Global Institute study estimatedthat, between 2005 and 2025, the average real household disposable income in India willnearly triple, the Indian middle class will swell from roughly 50 million people to around583 million, and the country’s consumer market will grow from the 12th largest in theworld to the fifth largest.

It is estimated that by 2051 half the population of India would reside in urbansettlements and the number of metropolitan (million plus) cities would be 75 and the totalnumber of the urban centers would be more than 6,000. Further, the contribution of urbansettlements to the GDP may be around 75%-80% and they would play a key role in the overalleconomic development. Economic reforms, which have stagnated over the past five years orso, hold the key.

A big positive for Indian manufacturing companies is the sharp meltdown in commodityprices which will result in lower input costs. The prices of almost all non-ferrous metalshave declined to their multi-year lows due to recession in major global economies.

The Indian government and the RBI have taken a series of steps including sharp duty andrate cuts to shore up the economy, which has been slowing faster than expected due to highinterest rates and the global financial crisis. Inflation, based on the wholesale priceindex, peaked at 12.91% in August 2008 and has more than halved since then to 5.2% inearly January 2009. The combination of monetary and fiscal measures are likely to help theeconomy recover. However, a recovery of the world economy holds key as Indian firms needlarge sums of money to fund their capital expenditure plan.

Investment growth, i.e., surge in capital expenditure by Indian firms, has been a keydriver of the robust growth of the Indian economy over the past three years till the yearended March 2008. As per one report, 77% of an estimated Rs 600000-crore capitalexpenditure plan of India Inc is still on, with 23% of the projects either deferred orshelved due to global credit crush and the world economic recession. Large funding is alsorequired to build the infrastructure required to sustain economic growth at around 8% andhelp reduce poverty, for which foreign investment is crucial.

Meanwhile, mutual funds are reportedly sitting on a large cash pile, estimated at 30%of assets under management, so as to take advantage of any opportunities that may arise.The combined cash pile is projected at over Rs 13000 crore, reports suggest. In fact,inflows to mutual funds, particularly to equity-linked savings schemes, may rise in thecoming months as investors typically start tax planning towards the end of the financialyear in March every year. Further, insurance firms also get substantial first premiumincome towards the end of the financial year for the same reason: tax planning.

source: Capital Market

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