India moves to contain Satyam fraud fallout

The $1 billion fraud unearthed last week at a leading Indian outsourcing firm has spawned fears it could tarnish the image of India overseas as an outsourcing powerhouse, thus impeding business prospects.

Two days after B. Ramalinga Raju and his brother Rama Raju were taken into judicial custody for orchestrating the fraud, labeled widely as "India's Enron," the Indian government, in damage-control mode, swooped in to take control of Satyam, the beleaguered outsourcing company they cofounded. On Sunday, it appointed three leading businessmen to the board of Satyam Computer Services Ltd.

Last week, Mr. Ramalinga Raju admitted to concocting key financial results of Satyam Computer Services Ltd. "for years," while vastly overstating revenues and bank balances.

The magnitude of this fraud – the worst ever witnessed by corporate India – has sent shock waves across the country. Particularly unpalatable is the fact that Mr. Raju was no fly-by-night cash embezzler, but the chairman of India's fourth-largest outsourcing company. Satyam boasts of being the back office of more than 185 Fortune 500 companies, with a network spanning 66 countries. Many analysts fret this scam could impede the growth of the country's $40 billion outsourcing industry, long hailed as the engine of India's economic resurgence.

"For years, Raju was lionized as one of the whiz-kids of the IT [information technology] sector," says Paranjoy Guha Thakurta, a New Delhi-based commentator. "There is no doubt this is a heavy blow to India Inc.'s [squeaky-clean] reputation overseas."

It isn't clear if the Satyam scam will deter multinational companies from outsourcing business to India or entrusting Indian outsourcing firms – attractive for their cheap labor and efficiency – with sensitive confidential data.

The National Association of Software Services Companies, India's IT watchdog, emphasizes that Satyam's case is an exception.

"This is a stand-alone case of the failure of corporate governance, and it is critical that it be viewed in this light," it said in a statement.

But it is a blow to the outsourcing industry, reeling under a slowdown. "The timing could not have been worse," the Indian Express, a national daily, editorialized Thursday. "We are less than a fortnight away from the inauguration of the least globalization-friendly American president in decades. At the cusp of a possible attitudinal shift in US policy towards offshoring, the collapse of one of the biggest Indian outsourcing companies amid allegations of ethical breaches is simply catastrophic."

"This incident is a black eye," Nandan Nilekani, co-chairman of Infosys, India's second-largest software firm, told the media last week. "We have been promoting Indian entrepreneurs, [the] Indian [corporate sector] as the flagship of 'brand India.' When one of the lot has deplorable behavior, then obviously it affects us all."

Before he fell from grace, Ramalinga Raju was hailed by investors as a visionary who shepherded his company to post profit margins exceeding 20 percent every year. Buoyantly declaring a 28 percent year-over-year revenue growth in the second quarter last year, he said: "We achieved this despite a challenging global macroeconomic environment."

But last week, Raju conceded that Satyam's revenues had been overstated by 76 percent and profits by some 97 percent. The stated operating margin of 24 percent was actually 3 percent.

The chase of huge profits and the pressure to meet investor expectations may have been behind his actions, some analysts say.

That pressure affects every major outsourcing player, Mr. Nilekani emphasizes.

"All of us who run companies must really put ethics, corporate governance, and running a transparent company in the front," he says. "If results are bad we should declare that, if profits are low we should declare that, but we should not do anything which impairs the trust of our stakeholders."

Analysts say poor accounting standards that allow manipulation of figures without being detected by Indian regulators are a key problem.

"We were disappointed but not surprised by Satyam's revelations," says Saurabh Mukherjea, head of Indian Equities, at Noble, a London-based investment bank. "Our daily encounters with listed Indian companies suggest that there are more Satyams in the pipeline thanks to enfeebled regulation, weak accounting discipline, and aggressive promoter behavior."

In his regular encounters with Indian companies listed at the Bombay Stock Exchange (BSE 500 index), he has discovered several fraudulent and unethical corporate practices.

In recent years, he has found at least 10 companies in the BSE 500 that have manipulated finances, he says, by "shifting expenses away from the current period by significantly reducing depreciation rates." At least 15 companies have "disbursed the bulk of their loans and advances to companies in which directors have an interest."

But while investor confidence in the very near term might take a knock, Mr. Mukherjea is optimistic that India Inc. will emerge from the crisis.

"In the country where accounting scandals have been exposed most frequently – the US – such scandals do not appear to have a bearing on the overall direction of the market," he says.

A year after accounting irregularities in Cendant and Sunbeam (two of the biggest such cases before Enron) were discovered in April 1998, he notes, the S&P 500 rose 17 percent.

"With the Indian market almost unprecedentedly cheap, this [might be] a good time to look for attractively valued companies," he says, "provided investors are willing to use forensic accounting analysis and primary data checks to avoid the next Satyam."