second generation economic reforms in india

8/4/2019 Second Generation Economic Reforms in India

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SECOND GENERATION

ECONOMIC REFORMS ININDIA


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BACKGROUND FOR 2NDGENERATION REFORMS

First Attempt made in 1966 by Indira Gandhi

Second Attempt under Rajiv Gandhi in 1985-87

But in 1991 India launch Its Market-Oriented Economic Reforms

Since 1991, economic reform has been based on Market Liberalization & a LargeRole of Private Enterprise

PRESSURE OF ECONOMIC CRISES BALANCE OF PAYMENT & HIGH RATEOF INFLATION- MAJOR REASON FOR 2ND GENERATION ECONOMICREFORMS.

2ND GENERATION ECONOMIC REFORMS CATEGORIZED UNDER TWO BROADAREA

> Major macro-economic management reforms

> Structural sector-specific economic reforms.


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Action Plane


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Change

Progress report


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Objectives of Economicreforms

Increase in the rate of Economic growth

Increase in competitiveness of industrial sector

Reduction in Poverty and Inequality Increase in Efficiency of public sector

Control over Fiscal deficit

Promoting FDI

Decline in Deficit of BOPs


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CORPORATE GOVERNANCE

Brief history

Mandated CGGuidelines and

Disclosures How does India

measure up withSarbanes-Oxley

New corporate

governance moves thatare expected


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CGBrief History Unlike South-East and East Asia, the corporate governance initiative in India was not

triggered by any serious nationwide financial, banking and economic collapse Also, unlike most OECD countries, the initiative in India was initially driven by an

industry association, the Confederation of Indian Industry In December 1995, CII set up a task force to design a voluntary code of

corporate governance The final draft of this code was widely circulated in 1997 In April 1998, the code was released. It was called Desirable Corporate

Governance: A Code

Between 1998 and 2000, over 25 leading companies voluntarily followed thecode: Bajaj Auto, Hindalco, Infosys, Dr. Reddys Laboratories, Nicholas Piramal,Bharat Forge, BSES, HDFC, ICICI and many others

Following CIIs initiative, the Securities and Exchange Board of India (SEBI) set up a

committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies The Birla Committee Report was approved by SEBI in December 2000


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Cont Became mandatory for listed companies through the listing agreement, and

implemented according to a rollout plan: 2000-01: All Group A companies of the BSE or those in the S&P CNX Nifty

index 80% of market cap 2001-02: All companies with paid-up capital of Rs.100 million or more or net

worth of Rs.250 million or more 2002-03: All companies with paid-up capital of Rs.30 million or more

Following CII and SEBI, the Department of Company Affairs (DCA) modified theCompanies Act, 1956 to incorporate specific corporate governance provisionsregarding independent directors and audit committees

In 2001-02, certain accounting standards were modified to further improve financialdisclosures. These were: Disclosure of related party transactions

Disclosure of segment income: revenues, profits and capital employed Deferred tax liabilities or assets Consolidation of accounts

Initiatives are being taken to (i) account for ESOPs, (ii) further increase disclosures,and (iii) put in place systems that can further strengthen auditors independence


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CGMandated Guidelines &Disclosures

Board of Directors: frequency of meetings and composition Board must meet at least at least four times a year, with a maximum time gap of four

months between two successive meetings If the chairman of the Company is a non-executive then one-third of the board should

consist of independent directors, and 50% otherwise

Independent defined as those directors who, apart from receiving directorsremuneration do not have any other material pecuniary relationship or transactionswith the company, its promoters, management or subsidiaries, which in the view of theboard may affect independence of judgments. This definition may be soon strengthened

The frequency of board meetings and board committee meetings, with their dates,must be fully disclosed to shareholders in the annual report of the company

The attendance record of all directors in board meetings and board committeemeetings must be fully disclosed to shareholders in the annual report of the company

Full and detailed remuneration of each director (salary, sitting fees, commissions,stock options and perquisites) must be fully disclosed to shareholders in the annualreport of the company

Loans given to executive directors are capped (no loans permitted to non-executives),and must be fully disclosed to shareholders in the annual report of the company


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Cont

Board of Directors: information that must be supplied Annual, quarter, half year operating plans, budgets and updates Quarterly results of company and its business segments Minutes of the audit committee and other board committees Recruitment and remuneration of senior officers Materially important legal notices and claims, as well as any accidents, hazards,

pollution issues and labor problems Any actual or expected default in financial obligations Details of joint ventures and collaborations Transactions involving payment towards goodwill, brand equity and intellectual

property Any materially significant sale of business and investments Foreign currency and other risks and risk management Any regulatory non-compliance


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Cont

Board of Directors: Audit Committee Audit Committee is mandatory Must have minimum of three members, all non-executive directors, the majority of

whom are independent Chairman must be an independent director, and must be present at the annual

shareholders meeting to answer audit or finance related questions At least one member must be an expert in finance/accounts Must have at least three meetings per year, including one before finalizations of

annual accounts Must meet with statutory auditors and internal auditors; have the powers to seek any

financial, legal or operational information from the management; obtain outside legalor professional advice

Board of Directors: Audit Committee functions Oversight of the companys financial reporting process to ensure that the

financial statement is correct, sufficient and credible Appointment / removal of external auditor and fixing of audit fees


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Cont Reviewing with management the annual financial statements before submission to

the board, focusing on: Changes in accounting policies and practices Major accounting entries Qualifications in draft audit report

Significant adjustments arising out of audit The going concern assumption Compliance with accounting standards, with stock exchange and legal

requirements Any related party transactions

Adequacy of internal audit and internal control systems, through discussion withinternal and statutory auditors as well as management

Significant findings, follow-up and action taken reports Discussion with internal and statutory auditors about scope and design of audits Reviewing financial and legal risks and companys risk management policies Examining reasons behind any materially significant default to creditors, bond-

holders, suppliers and shareholders


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Cont

Disclosures to shareholders in addition to balance sheet,P&L and cash flow statement

Board composition (executive, non-exec, independent) Qualifications and experience of directors Number of outside directorships held by each director (capped at director not being a

member of more than 10 board-level committees, and Chairman of not more than 5) Attendance record of directors Remuneration of directors Relationship (familial or pecuniary) with other directors Warning against insider trading, with procedures to prevent such acts Details of grievances of shareholders, and how quickly these were addressed Date, time and venue of annual general meeting of shareholders Dates of book closure and dividend payment Details of shareholding pattern Name, address and contact details of registrars and/or share transfer agents Details about the share transfer system Stock price data over the reporting year, and how the companys stock measured up

to the index


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Cont Financial effects of stock options Financial effects of any share buyback Financial effects of any warrants that are to be exercised Chapter reporting corporate governance practices Detailed chapter on Management Discussion and Analysis focusing on markets,

operations, finances, accounts, risks, opportunities and threats, internal controlsystems

Consolidated financial statement, incorporating accounts of all subsidiaries (over50% shares held by reporting company)

Details of all significant related party transactions Detailed segment reporting (revenues, costs, operating profits and capital employed) Deferred tax liabilities and assets and debit/credit in the P&L for the reporting year


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Corporate GovernanceHow does India measure up with

Sarbanes-Oxley

The Sarbanes-Oxley Act came into force in July 2002 andintroduced major changes to the regulation of corporategovernance and financial practice.

It is named after Senator Paul Sarbanes and RepresentativeMichael Oxley, who were its main architects, and it set a number ofnon-negotiable deadlines for compliance.


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Sarbanes-Oxley ActThe Sarbanes-Oxley Act is arranged into eleven 'titles'. As far as compliance

is concerned, the most important sections within these eleven titles are usuallyconsidered to be 302, 401, 404, 409, 802 and 906.

Section 302 Under title III of the act, and pertains to 'Corporate Responsibility for Financial Reports'.

Section 401 Under Title IV of the act (Enhanced Financial Disclosures), and pertains to 'Disclosures in Periodic

Reports'.

Section 404 Under title IV of the act (Enhanced Financial Disclosures), and pertains to 'Management

Assessment of Internal Controls

Section 409 Under title IV of the act (Enhanced Financial Disclosures), and pertains to 'Real Time Issuer

Disclosures'.

Section 802 Within Title VIII of the act (Corporate and Criminal Fraud Accountability), and pertains to 'Criminal

Penalties for Altering Documents'
http://second%20generation%20economic%20reforms%20in%20india.ppt/http://second%20generation%20economic%20reforms%20in%20india.ppt/


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Sarbanes-Oxley Act.

Section 302 - This section is of course listed under Title III of the act,and pertains to 'Corporate Responsibility for Financial Reports.Periodic statutory financial reports are to include certifications that:

The signing officers have reviewed the report

The report does not contain any material untrue statements or materialomission or be considered misleading The financial statements and related information fairly present the financial

condition and the results in all material respects The signing officers are responsible for internal controls and have evaluated

these internal controls within the previous ninety days and have reported ontheir findings

A list of all deficiencies in the internal controls and information on any fraudthat involves employees who are involved with internal activities Any significant changes in internal controls or related factors that could have a

negative impact on the internal controls


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CONT

Section 401 :

This section is of course listed under Title IV of the act (EnhancedFinancial Disclosures), and pertains to 'Disclosures in PeriodicReports'.

Financial statements are published by issuers are required to be accurateand presented in a manner that does not contain incorrect statements oradmit to state material information.

These financial statements shall also include all material off-balance sheetliabilities, obligations or transactions.

The Commission was required to study and report on the extent of off-

balance transactions resulting transparent reporting. The Commission is also required to determine whether generally accepted

accounting principals or other regulations result in open and meaningfulreporting by issuers


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CONT

Section 404This section is listed under Title IV of the act (Enhanced FinancialDisclosures), and pertains to 'Management Assessment of InternalControls'.

Issuers are required to publish information in their annual reportsconcerning the scope and adequacy of the internal control structure andprocedures for financial reporting. This statement shall also assess theeffectiveness of such internal controls and procedures.

The registered accounting firm shall, in the same report, attest to andreport on the assessment on the effectiveness of the internal control

structure and procedures for financial reporting.


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Section 409This section is listed within Title IV of the act (Enhanced FinancialDisclosures), and pertains to 'Real Time Issuer Disclosures'.

Issuers are required to disclose to the public, on an urgent basis,

information on material changes in their financial condition or operations. These disclosures are to be presented in terms that are easy to

understand supported by trend and qualitative information of graphicpresentations as appropriate.

CONT


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Section 802This section is listed within Title VIII of the act (Corporate andCriminal Fraud Accountability), and pertains to 'Criminal Penaltiesfor Altering Documents

This section imposes penalties of fines and/or up to 20 years imprisonmentfor altering, destroying, mutilating, concealing, falsifying records, documentsor tangible objects with the intent to obstruct, impede or influence a legalinvestigation.

This section also imposes penalties of fines and/or imprisonment up to 10years on any accountant who knowingly and willfully violates the

requirements of maintenance of all audit or review papers for a period of 5years

CONT


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CGHow does India measure upwith Sarbanes-Oxley

Sarbanes-Oxley Indian situation What might be needed

Certification of annualaccounts by CEO, CFO

At least two directors mustsign, of whom one must be theManaging Director

Need to change to haveMD/CEO plus FinanceDirector/CFO to sign

Fully independent audit

committees

Fully non-executive, majority

independent audit committees

Need to consider (i) fully

independent (ii) tighterdefinition of independence

Disgorgement ofCEO/CFOcompensation in eventof restatement

Accounts and profits oncepublished cannot be re-stated

Need to see if ESOPpayments need to bedisgorged if there is arestatement

Prohibition of insidertrading

Prohibits insider trading Nothing is needed

Prohibition of insiderloans to directors

Strict cap on insider loans todirectors; requires priorgovernment approval

Caps are stringent enoughto prevent insider abuse


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Sarbanes-Oxley Indian situation What might be needed

Real time disclosureconcerning changes infinancials and operations

Listing agreement mandatescompanies to report quarterlyresults and material changes

Nothing is needed

Mandatory periodicreview of companys

filings once every threeyears

No such provision Need to consider how thiscan be done without creatingadministrative hassles

Auditors prohibited fromnine types of non-auditservices to audit clients

These services are alreadyprohibited in India

Nothing is needed

Auditors to report toAudit Committee oncritical accountingpolicies

Mandated by the listingagreement and theCompanies Act amendments

Nothing is needed

Rotation of auditpartners every five years No such provision exists A committee is consideringsuch a change

Up to 20 years in prisonfor fraud and destructionof records

No such provision Need to consider tougherpenalties, including longerimprisonment


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CG - New corporate governancemoves that are expected

There are five reasons why one doesnt expect thecorporate sector in India to exhibit the excesses thatoccurred in the US

1. The amount of stock options to be granted to employees is strictlylimited. Expensing options (if adopted) will create a further natural limit

2. In general, companies are controlled by a sizeable shareholder,typically owning over 35% of stocks. This tends to limit agency costs ofdispersed ownership

3. The variable compensation package is much more linked to profitsand/or EVA, than stock prices or P/E

4. Much greater importance is given to accumulating cash. Profit is an

opinion; cash is fact5. For better or for worse, most Indian companies still dont have to give

forward looking earnings estimates


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CONT ESOP: Employee stock ownership plans can be used to keep plan

participants focused on company performance and share price appreciation. Bygiving plan participants an interest in seeing that the company's stock performs well,these plans are believed to encourage participants to do what's best forshareholders, since the participants themselves are shareholders

Read more: http://www.investopedia.com/terms/e/esop.asp#ixzz1XRVI7lbW

EVA: Economic Value Added is an estimate of the amount by which earningsexceeds or falls short of the required rate of return for shareholders or lenders atcomparable rates.
http://www.investopedia.com/terms/e/esop.asphttp://www.investopedia.com/terms/e/esop.asp


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CG - New corporate governancemoves that are expected

After the US crises, there have been some initiatives:1. A committee has been set up to examine stock options, including

expensing them

2. Another committee has been set up to recommend tighter enforcement

by DCA and stiffer penalties, including longer prison terms

3. A third committee has been set up to examine auditor-companyrelationships and the role of independent audit committees

4. A fourth committee is examining what additional disclosures andaccounting standards are needed to have even better corporate

governance


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CORPORATE SOCIALRESPONSIBILITIES


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CSR focus - People, Planet andProfit (Triple Bottom-line )

Stakeholders in a business - customers, employees, shareholders,communities and environment

Sustainable development and profits are inter-related

Corporate profits need to be analyzed in conjunction with social prosperity


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CSR IN INDIATHE INITIALSTEPS

Evolved through the concept of giving an integral part of Indian culturePhilanthropyReligious donations

Modern connotationGandhian concept of Trusteeship

Bombay Plan (1944-45) First initiative byleading business houses (Tata, Bajaj, Birla group through FICCI)

Individual initiatives by individual corporate


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CSR IN INDIAFOCUS AREAS

Traditional

Education

Health

ContemporaryCapacity Building skill development, training

Sustainable Development environmental protection

Community Development education, health,poverty

alleviationSocial Challengeswomen's empowerment, girl

child


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CSR - INTERNAL vs. EXTERNAL

Internal (carried out within the organisation) viz.o Energy and water conservationo Employee welfare training, healthcareo Affirmative action employment of backward sections

o Corporate governance External (within vicinity or for society at large), viz.

o Community developmento Capacity buildingo Environmental protectiono Healthcareo Creating awareness - education, health, social issueso E-initiatives Online Information, education, etc.


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CSR - Benefits Positive public image Retaining staff, enhancing employee morale Higher productivity, reduction in costs and increase in profitability Positive engagement with government

In-house CSR activities treated as a business expense Contributions to registered Non Profit Organizations eligible for

benefits under Indian Income tax laws (Sections 80G, 35AC) Contributions to NGOs

100% deduction if NGO promotes social and economic welfare125% deduction if NGO engaged in research in sciences/social

sciences and statistical research


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EXTERNAL SECTORS After 1991, the liberalization of the external sector was gradual, in consideration of the domestic

and external situation. The strategy in 1991 shifted from import substitution to export promotionand the reach of export incentives was broadened to cover numerous non-traditional items. Thestrategy for external sector reforms had the following key elements:

(a) sufficiency of reserves

(b) stability in the foreign exchange market

(c) prudent external debt management

The share of Indias imports in world trade increased from 0.6 per cent in 1993 to 0.9 per cent in

2003, while that of the exports increased from 0.6 per cent to 0.8 per cent.


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CONT BALANCE OF PAYMENTS AND EXTERNAL DEBT - A number of measures have been

initiated since 1991 to liberalize capital inflows. Foreign investment policy also underwent aradical change to encourage foreign direct investment to India Convertibility of foreign directinvestment was extended to portfolio investments by foreign institutional investors in Indian stockexchanges. Indian corporations were allowed access to overseas financial markets in the form ofGlobal/American Depository Receipts and Foreign Currency Convertible Bonds

FOREIGN EXCHANGE RESERVES - India's foreign exchange reserves, as a result ofmeasures initiated since 1991, have continued to record a healthy growth due to moderation inthe trade deficit and strong capital and other inflows India's foreign exchange reserves, as aresult of measures initiated since 1991, have continued to record a healthy growth due tomoderation in the trade deficit and strong capital and other inflows. The increase in reserves hasbeen facilitated by Foreign Direct investment ($129 million in 1991-92 to $ 4.5 billion in 2003-04)and net invisibles ($1.6 billion in 1991-92 to $25.4 billion in 2003-04). Inward workers

remittances have increased from $2.1 billion in 1990-91 to $19.2 billion in 2003-04 while softwareexports have increased from $0.7 billion in 1995-96 to 12.2 billion in 2003-04.

EXCHANGE RATE - Despite these regular adjustments, the exchange rate was overvalued andresulted in erosion of international competitiveness by 1990-91.Therefore, it was adjusteddownward in two stages on July 01 and 03, 1991 to effect about 18 percent reduction in theexternal value of the rupee


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External Sectors Reforms

OUTCOME OF REFORMS Merchandise Imports and Exports :There was a healthy growth in the U.S.

dollar value of both merchandise exports and imports other than petroleum, oil andlubricants (POL) for three years 1993-94 to 1995-96 before a subsequent slowdown.

India's Exports in Asian Perspective :Indian export performance incomparison with that of three rapidly growing East Asian economies (China, SouthKorea and Taiwan), three South East Asian economies (Indonesia, Thailand andMalaysia) and two of Indias South Asian neighbors (Bangladesh and Pakistan). It is

clear that although trade liberalization during the post-1991 period has improvedIndias export performance, it is still lagging behind other rapidly growing Asian

countries


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Cont

Export Shares in Gross Output :When the incentive structure is changedaway from import-substitutes and toward exports as a result of trade liberalization,the consequences are reflected in the increased international competitiveness of thedomestic production structure.

Growth in Factory Manufacturing Output and Employment :All the

components of reforms, namely, removal of entry barriers, import tariff reductions,removal of quantitative restrictions on imports of most of the intermediate and capitalgoods, not only introduced competition both internal and external but alsocontributed toward more efficient allocation of resources by reducing distortionsintroduced by the earlier policies. The impact is reflected in a higher growth in realmanufacturing output and a faster employment growth in the higher productivity

factory segment


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Cont

Trends in Total Factor Productivity (TFP) :Prior to reforms of 1991,given the strait-jacket in which producers were placed through controls oninvestment, location, technology and input choice, imports of inputs, and foreigninvestment, and the absence of competitive pressures, it should surprise no one thatthere was no growth in TFP except in the eighties when the rigors of some of the

controls were relaxed.

External Capital Inflows :Until the eighties the two major sources forexternal capital for India were bilateral government-to-government foreign aid andborrowing (largely concessional) from international financial institutions. Only in theeighties, when fiscal prudence of the previous three decades gave way to profligacy,the government borrowed from private sources on commercial terms.


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Capital Account Convertibility

There is no specific definition of CAPITAL ACCOUNT CONVERTIBILITY. ButTaraPore committee defines CAC as the freedom to convert local financial assets

into Foreign Financial Assets and Vice-versa at market determined rates ofexchange.

TaraPore suggestions:

Reduction in Gross Fiscal Deficits Mandated rate of Inflation

Fully deregulated Interest Rates

Reduction of non-Performing Assets

But Non of these has been met in its specified time period.

There are Limit s to Indian companies borrowing from abroad. Restrictions onIndians sending money abroad that does not have to do with importing goods orservices.


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Cont

Restrictions on Foreigners investing in India

Restriction on foreigners buying shares of Indian companies as only FIIs can holdshares in Indian companies individuals cannot. Restriction on amount that FIIs canhold. Global diversification is practically nonexistent.

Components : Merchandise Exports & Imports

Invisible Exports & Imports

Short Term & Long Term Capital transactions

No restriction for Indians (company or individual) talking rupee out or bringing foreignexchange for doing global diversification


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CONT Capital A/C Convertibility desirable

o Reduction in cost of capital Foreigners Investing more in India meansmore money available for Development.

o Diversify Portfolios internationally If Indian Household are globallydiversified in their portfolios this reduce risk and stabilises the economy

o Induces Competition against Indian FinanceWith convertibility Indiansaving will have the choice of moving offshore venues and firms will havechoice of Financing Projects offshore. This will have repercussions forIndian GDP growth, since Finance is the BRAIN of the economy

o Reduce size of Black Economy If India tries to control on the capitalaccounts , these are rather easy to evade through various unscrupulous.

Pushing for convertibility is about reducing the size of the black market.