End of Story, Morning Glory?

The United Arab Emirates (UAE) is experiencing the antithesis of the “Dubai Chalo” mantra of the ’60s and ’70s.  Dubai is likely the shed 10% of its population over the next two years, as a result of unmanageable debt, failing businesses and shrinkage of property values.   This is only to be expected —  unsound economics have driven Dubai’s growth in recent years.  Unlike other states in the Arabian Peninsula, Dubai has no oil of its own.  Indeed, from the emirati pearl merchants of the early 1900s to the establishment of the Jebel Ali Port in the 1970s, its historic strength has been trade.

However, the single minded pursuit of turning this free-trade town into a megacity rivaling New York or Los Angeles is as bad an idea today as it was when it was conceived.  And now, conservative but oil-rich Abu Dhabi, who many said was slow off the mark in this maddening real estate circus, is having the last laugh.  The Maktoums of Dubai have had to had to swallow their pride and approach Abu Dhabi to bail them out.  But even Abu Dhabi’s bailout of Dubai comes with strings attached:

[T]he rapid deceleration had given rise to speculation that Abu Dhabi, the richest member of the UAE, might have to bail out its flashier neighbour. Rumours spread that Abu Dhabi would only stump up the cash if Dubai ceded control of its successful airline, Emirates.

Federal support has come through folding Dubai’s troubled mortgage companies into well-capitalised Abu Dhabi banks. There have been other direct discussions between Dubai and Abu Dhabi state companies, although none has reached agreement.

Sheikh Mohammed’s Dubai International Capital fund, whose assets have shrunk sharply, briefly courted investment from Mubadala, the Abu Dhabi investment arm. No substantive discussions ensued, people close to the matter say, but the incident fuelled rumours of a bail-out. Well before the credit crisis raised questions about Dubai’s solvency, Mubadala and Dubai Aluminium had been discussing equity restructuring of their joint venture, Emirates Aluminium, a vast smelter on the Abu Dhabi/Dubai border.

What Dubai needs to do now is to rightsize.  New York City was not built overnight.  Even if NYC’s economy relies heavily on financial markets, these markets trade against tangible products — from the pharmaceuticals of New Jersey, to the automobiles of Detroit.  Dubai’s financial markets trade in recycled financial instruments, which have a tendency to flourish during the good times, and falter during the bad.  This blogger also feels that Dubai (and the UAE as a whole) needs to address debt insolvency.  Given that foreigners and foreign owned entities form the majority of Dubai’s demographic and economic footprint, a credit history check system such as the one in the United States would be ineffective.  Yet, there is an urgent need to address the frequency with which expatriates and foreign-owned companies run up substantial debt and abscond from the country.  The current economic crisis in Dubai is as much a result of a nonexistent debt reconciliation system, as it is due to building artificial islands, skyscrapers and magical kingdoms that no one could afford.

The one benefit of an Abu Dhabi bailout might be that the UAE would start functioning more like a federation with a visible nucleus (Abu Dhabi) than the disagreegated collection of city-states that it now is.

Filed under: Abu Dhabi, Dubai, economics, Financial Crisis, Middle East, Politics, UAE, United Arab Emirates, World, Abu Dhabi, bailout, burj dubai, Dubai, emirates airlines, jebel ali, recession, United Arab Emirates

Satyam IT Scandal

If the global economic downturn wasn’t bad enough, incidents such as the Bernard Madoff issue, and now the Satyam scandal can’t have helped matters much in providing confidence to the already skeptical investor. India’s fourth-largest IT company admitted to “irregularities” in its books, thanks to the imaginative accounting practices of its Chairman Ramalinga Raju.

The company, which ironically received the Global Peacock Award for Excellence in Corporate Governance, first raised investors’ concerns with the apparent bid to acquire Maytas Infra, a construction company owned by Raju’s son. Once word of the proposed acquisition got out, shareholders rebelled, forcing the deal to fall through. The attempted unilateral acquisition, though, opened up a whole host of issues at Satyam with regard to systemic corporate mismanagement, which culminated in Ramalinga’s shameful admission on Wednesday.

Some people have put the whole episode down to poor corporate governance. Unfortunately, the issue is much deeper. Like everything else in India, the larger issue is archaic laws; the dilapidated securities and internal control legislation of the country is not congruent with the current business environment of India. The issue is compounded further when you consider countries like the United States, where despite the attempts to heavily regulate internal control, dramatic failures such as the Madoff scandal, or even the sub-prime mortgage scandal come to light.

In the United States, the Sarbanes-Oxley Act (“SOX”) was passed in response to the Enron and Worldcom drama of 2001. The Act’s Section-404 requires both management and an independent external auditor to assess the adequacy of the company’s internal controls over financial reporting (ICFR). In addition, a public accounting oversight body, the Public Company Accounting Oversight Board (PCAOB) was constituted. However, as of 2009, SOX has effectively run its course in terms of its usefulness.

Companies have had a few good years to understand the scope and approach of SOX audits and have taken comfort in the fact that the demands of the Act, despite the design, merely result in scratching the surface of ICFR. Despite the design, there is a fundamentally flawed bottom-up approach to ICFR that all SOX audits assume. For example, more hours are spent reviewing mundane transactional detail than investing in a robust review of the “bigger picture” and asking why company executives are doing the things that they are doing.

Most “white collar” crime is committed by corporate executives, and not, for example, by staff accountants or system administrators. Corporate fraud uncovered by the United States Department of Justice (DoJ) indicted 214 CEOs and Presidents, 53 CFOs, 23 Corporate Councils and Attorneys and 129 VPs, in 1,236 cases registered since 2002. Fraud can occur with the marriage of — (a) Opportunity, (b) Motive, and (c) Means. Usually, these three elements fall either directly or indirectly within the purview of corporate executives. Corporate executives didn’t get where they got by boiling potatoes; they’re sharp, know their businesses inside out, and are driven to excel. The intrinsic flaw in public auditing is the relationship between the auditor’s independence in assuring the accuracy of their client’s books, and the dependence on the client for revenue. An imbalance in this relationship creates scenarios such as Arthur Andersen’s willful connivance in cooking up Enron’s books in 2001.

So where does India proceed from here? Clearly, investor confidence will be down, both at home and abroad (Satyam trades on the New York Stock Exchange). Lack of investor confidence may very well translate into reluctance to invest in India’s growth — negatively impacting Foreign Direct Investment (FDI) and an already slowing economy. Despite the drawbacks of legislation like SOX (as described above), regulation of internal control must be standardized in India. If the 2008 financial crisis has proved one thing conclusively, it is that companies and people operating in a capitalist and/or entrepreneurship friendly environment will look out for their own interests; the capitalist system, by design, is anti-self regulation. India needs to look into the following areas:

• Developing robust legislation to regulate publicly traded companies in India, including the regulation of internal control, corporate governance, independence and financial disclosure requirements;

• The creation of a federal body, separate from, but reporting to the Securities and Exchange Board of India (SEBI), that will enforce the legislation described above;
• Auditor independence (I find it hard to believe that PricewaterhouseCoopers genuinely had no idea that Satyam was cooking its books); public auditors should not be allowed to provide consulting or advisory services to companies on whose books they issue opinions;
• The constitution of an independent Audit Committee to review the company’s state of affairs; the requirement of having an independent Internal Audit department that reports only and directly to the Audit Committee;
• A national whistle-blower program to report instances of possible corporate fraud to the newly constituted federal body;
• A requirement of full disclosure of any business interests held by executives’, their spouses, and immediate family;
• A comprehensive review of the company’s corporate governance as part of audits and investigations, assessing the reasonableness of significant corporate decisions (asking the question “why” instead of regular checklist auditing);
• Stringent penalties for committing corporate fraud (e.g., holding executives personally liable), and a body to investigate and adjudicate over fraud cases.

At the end of the day, the Satyam saga is a tragic multi-point failure of a government that doesn’t sufficiently regulate publicly traded companies, of an Executive Board that didn’t probe suspicious transactions (why does an IT firm need to acquire a construction company?), of lower level management and staff who wouldn’t notify authorities of irregular accounting practices, and of auditors who chose to turn a blind eye to obvious accounting irregularities.

Adopting the recommendations above will not completely solve India’s problems (indeed the pressure to report significant revenue increases in a rapidly developing economy such as India’s will remain and will bare fruit to more ingenious accounting practices), but should be looked at as a good starting point. The central government, in trying to ensure investor confidence and tackle other cases of corporate fraud, must show that it is serious about providing a clean and transparent business environment and that it still upholds that timeless credo of the Nation — Satyam eva jayate — Truth alone Triumphs.

Filed under: Business, corporate fraud, corporate governance, economics, India, information technology, internal control, Politics, sarbanes oxley, satyam, sebi, securities and exchange board of india, Technology, World, arthur andersen, audit committee, auditing, bernard madoff, corporate governance, enron, executive board, fraud, hyderabad, independence, India, internal audit, internal control, it scandal, maytas infra, new york stock exchange, nyse, pcaob, pricewaterhousecoopers, public company accounting oversight board, pwc, ramalinga raju, sarbanes oxley, satyam, sebi, sec, section 404, securities, securities and exchange board of india, sox, whistle blower, worldcom

12 Easy Steps to Destroy India: A Handguide

Well really, there’s just 1 easy step to destroy India: have the UPA government hire R Vaidyanathan as chief strategist in the fight against terrorism. He will swiftly ensure that the anarchy in Afghanistan and NW Pakistan will spread like cancer to eastern Pakistan, and then eventually to all of India as well. Vaidyanathan wrote “8 things India Inc, govt must do against Pakistan“, a masterfully crafted economic and strategic treatise, and followed that up with “12 steps to shock-and-awe Pakistan’s economy” the very next day, apparently in response to overwhelming feedback to the first article. Nothing will ensure India’s discombobulation faster than the implementation of some of his plans.
Vaidyanathan’s proposed assaults on Pakistan’s economy include the following gems:

Identify the major export items of Pakistan (like Basmati rice, carpets, etc) and provide zero export tax or even subsidise them for export from India. Hurt Pakistan on the export front.

Create assets to print/distribute their currency widely inside their country. To some extent, Telgi types can be used to outsource this activity. Or just drop their notes in remote areas.

I fail to see how this is going to make matters better. In fact, there is a very distinct possibility that things could get much worse. It is a fact that terrorist organizations like LeT and Al Qaeda prey on frustrated, impoverished, disenfranchised youth for recruitment. By his own admission, Ajmal Amir, the lone surviving terrorist from the Mumbai attacks, was a laborer and a petty thief before being recruited by the Lashkar. There is a history of young men living under conditions of unemployment, poverty and helplessness turning to terrorism. It’s no surprise that most of the 9/11 hijackers came from Saudi Arabia (one of the world’s fastest growing unemployment rates, at 12%) and Yemen (unemployment rate of 35%). I bring this up because India’s economic muscle is very real, and can inflict substantial damage on Pakistan’s economy. Nothing will please the Lashkar more, since hordes of Ajmal Amirs will be lining up outside their recruitment offices in Muridke, in much the same way that Indians line up to work for Infosys or Wipro.

But wait, it gets better. Vaidyanathan continues…

We should realise that a united Pakistan is a grave threat to the existence of India. Hence, we should do everything possible to break up Pakistan into several units. This is required to be done not only for our interest, but for world peace.

Not only for our interest, but for world peace? How very benignant of him. Pakistan as a federation is already teetering on the brink of collapse. There is already a struggle going on in Baluchistan. In Swat, Pakistani forces are fighting the Taliban against the imposition of a parallel Sharia law. South Waziristan has unilaterally declared independence, which the government in Islamabad has tacitly accepted. The “real” Pakistan now exists only in Sindh and Punjab, and even in Sindh there are several secessionist movements.

If Pakistan as a federation falls, the whole area from Helmand province in Afghanistan to Wagah will be in a state of anarchy. This is a humanitarian disaster waiting to happen, and India will be ill equipped to handle the influx of refugees from this region. Worse, once in India and bereft of any viable employment opportunities, many of these refugees may turn to theft and militancy. One only has to look at the Afghan refugee crisis in Pakistan to get a sense of what to expect, if it were to occur in India. Secondly, and more importantly, Pakistan is a nuclear weapons state. The threat of rouge Army officers, and/or ISI agents in cahoots with their Al Qaeda, LeT and JeM buddies launching attacks on India with those weapons is very real. To ward off such a possibility, Indian troops, along with US and NATO forces will be forced to enter into mainland Pakistan in search of the weapons, where our troops will get summarily slaughtered in close combat situations à la the US in Iraq. It takes only five minutes for a nuke from Pakistan to hit India. How soon can India’s forces track down and decommission Pakistan’s warheads?

India has already shown, post-Kargil, that it does not have the appetite to go after Pakistan unilaterally.  Indeed, off-late, India’s strategy vis-a-vis Pakistan appears to be to make the United States do its bidding in Pakistan — a bungling miscalculation, since the US itself is tied down by its own compulsions in the Afghan-Pakistan border.  India has not articulated a credible strategy towards Pakistan.  Relying on the US somewhat to use its influence on Pakistan is fine, as long as it is only part of a coherent, multidimensional strategy that India, as a soverign, independent nation adapts, taking into consideration its own national interests.  Flexing India’s economic muscle is also fine, as a means to an end — the end being the ultimate termination of anti-India militant forces in Paksitan, and not the capitulation of the state of Pakistan itself, as proposed by Vaidyanathan.

India must make it clear to Pakistan that it has multiple non-military arsenal in its inventory that it can use to bleed Pakistan, in the same way that Pakistan, implicitly or explicitly, aims to hurt India.  For example, India should make it clear that it is willing to violate the Indus Water Treaty, and severely or completely choke the westward flow of the Chenab, dealing a blow to Pakistan’s agricultural output for domestic consumption and external trade.  Similarly, India should be able to affect a de facto deep water import blockade of the port of Karachi, ostensibly with an intent to ward off pirate activity from the Horn of Africa. A substantial volume of import trade with Pakistan, will then need to originate from or be routed to the Arabian Penninsula, from smaller ports in Muscat or Sharjah; smaller trade volumes means increased per-unit costs of imports.

If in the future, India is to be the global force that many are predicting it to be, then Pakistan’s stability will be vital to the fulfillment of that prophecy. An unstable Pakistan will mean an unstable India. Rather than seeking to destroy and disintegrate Pakistan, India must work to ensure that its voice is heard in Pakistan.  India’s sphere of infleuence must effectively include, not exclude Pakistan.  Any carrot-and-stick policy that India adopts with regards to Pakistan must show our neighbor that its interest lie in working with, rather than against India.  The benefits in working with India must be conspicious and very apparent, as must the consequences of attempts to destablize India.  To this end, where necessary, India should be willing and able to unilaterally use non-military tools at its disposal to punish Pakistan.  However, a constant, ineffectual, quasi-military, adversarial posturing with Pakistan, such as the one currently in favor in New Delhi, will leave India muddled in the internal quagmires of South Asia, and unable to break free from its shackles to project power and influence beyond this impoverished and chaotic region.

Filed under: 11/25/2008, 9/11, Afghanistan, Al Qaeda, Congress I, economics, helmand, India, Indian Army, isi, Lashkar-e-Taiba, Laskhar-e-Toiba, let, Mumbai, Mumbai Terrorist Attack, november 25, nuclear weapons, nukes, Pakistan, pakistan army, Saudi Arabia, Terrorism, Wagah, Yemen, 9/11, Afghanistan, ajmal amir kasav, ajman amir, Al Qaeda, balochistan, baluchistan, bomb blasts, commandos, Congress I, economics, helmand, India, isi, Lashkar-e-Taiba, lashkar-e-toiba, let, Mumbai, november 25 terrorist attack, nuclear weapon, nuke, NWFP, Pakistan, punjab, Saudi Arabia, september 11, sindh, South Asia, Swat, taliban, Terrorism, unemployment, Wagah, waziristan, Yemen