My column for Wealth Insight Dec issue - here.The unedited version is below:
The scourge of
corruption
N Vittal, former Central Vigilance Commissioner, in a recent
book titled “Ending Corruption: How to Clean up India”, defines corruption as
“the lack of integrity – whether intellectual, moral or financial”. International
studies indicate that India falls among the bottom half of countries in the
world in corruption rankings. Corruption
reduces competitiveness of industry, leads to lower investments, misallocates
capital, and increases income disparity – among other effects.
Measuring corruption
– usually based on surveys
One of the key challenges to empirical research in the area
of corruption is an appropriate measure of corruption. During the nineties,
three different groups of measures appeared – indices like the International
Country Risk Guide (ICRG), and Business International (BI) that were based on
assessments of country experts. The next group were based on surveys of
business people or the local public – these included indicators tracked by World Economic Forum
(WEF), or the World Development Report (WDR). The last group was a set of “poll
of polls” – the “Graft Index” of World Bank or Corruption Perception Index
(CPI) of Transparency International.
Given its amorphous nature, corruption measures tend to rely on surveys.
Survey of attitudes
of Indian corporations
Between March and May 2013, E&Y along with FICCI conducted
a survey among Indian businesses, and foreign companies operating in India.
This survey was supplemented by inputs from private equity investors. The
target companies surveyed had incomes between Rs5000crs, and Rs10,000crs. The report estimates that between October
2011, and September 2012, corruption related cases reported in the press
(excluding large scams like 2G, commonwealth games and mining) led to potential
loss to the Indian economy to the tune of Rs36,000crs.
Some of the report’s conclusions bear repeating:
-
“Strain
on ethical behaviour: Alarmingly, a large number of respondents appeared to be
comfortable with (or were aware of) unethical business conduct, including
irregular accounting to hide bribery and corruption, gifts being given to given to
seek favours and third parties being used to pay bribes.
-
Taking the easy way out: More
than half of the respondents agreed that it is the lack of will to obtain
licenses and approvals the “right way,” which leads to bribery and corruption.
-
Need for greater enforcement of laws: Around
89% of the respondents felt that there should be greater enforcement of laws to
curb the proliferation of bribery and corruption.”
The survey further goes
on to point out that 44% of the respondents were in favour of legalizing
“facilitation payments”.
The other end of society
Centre for Media Studies
(CMS) – a not-for-profit think tank, has been studying corruption in India over
years. In 2012, CMS revealed its 8th study in the series - focused
on slums and basic services availed by residents of slums – and the amount of
bribes to be paid to receive such services.
The figures speak for
themselves. The incidence of corruption is high, but more disturbingly has
doubled over the period 2008-2012.
A lack of
accountability
Vittal, in his book, identifies a lack of accountability as
a key factor behind poor governance in India. He gives an example of
dysfunctional governance – where policies, while existing, are not implemented.
He states - “An example .. is the Benami Transactions (Prohibition) Act,
enacted in Sep 1988. Section 5 of the Act says that benami property will be
confiscated by the government. Section 8 says that the government will
prescribe the rules under which the confiscation will take place. … Over 20
years have passed, and the government has still not issued such instructions.”
He goes on to add that when he was CVC, he wrote to the Secretary of the
revenue department requesting that the rules be framed. He received no
response.
The most corrupt
sectors
Chart: Sector wise corruption heat map
The E&Y survey referred to earlier, asked respondents to
rank sectors based on perceived level of corruption. It is no surprise that
sectors rated as most corrupt were those where government interface was the
highest. Lowering government touch-points is definitely a way to reduce
corruption.
Investment take-away
While making investment decisions, investors are forced to
rely on financial statements as a source of information of how a company is
performing. What happens when that document itself is not reliable? In the case
of corrupt sectors, businesses, by their own admission tend to distort
financial reporting. If a management is willing to color the accounts to adjust
for bribes paid, is it likely that they will represent a true and fair picture
in the account books for minority share-holders.
The irony is that even institutional investors who should
know better are all too often prone to look the other way. The survey notes that “Around 93% of the
respondents representing PE firms indicated that accounting fraud is the most
common fraudulent practice observed in India.” Despite this, “73% of PE
respondents’ organizations do not conduct anti-bribery and corruption
due-diligence before investing in enterprises.”
As investors, it is important to realise that “audited”
statements do not necessarily mean a true picture of a company’s health.
Investing in real estate companies is, for example, more a macro call on the
sector – rather than a careful analysis of the financial statements. The
financial statements reveal nothing of importance – only a carefully crafted story
that the management wants investors to see.
Correction has to
start from the top
As India enters into another set of elections – first for
state legislatures, and then for Parliament, it is important to realise that
each one of us is impacted by corruption, and in most cases, negatively. If
leaders we chose are honest, the system will start to correct itself. Each one
of us has a stake in a corruption free country.
When voting, as in investing, choose carefully and avoid the rotten
apples.
