India's heirs of corruption

India and Russia are accustomed to being bracketed together as two of the world's most promising high growth markets. But is there more to it than just being adjacent initials in the fabled Brics acronym? Foreign investors are not alone in worrying this might be the case.

Even as the country becomes one of the great economic growth stories of the 21st century, significant members of the Indian elite fear it may be following Russia in developing a kind of crony capitalism dominated by powerful insiders. A slew of recent corruption scandals – notably in telecommunications – has nourished anxieties that the combination of fantastic wealth creation and weak governance threatens to undermine India's long-term success.

Not for nothing has Joseph Stiglitz's Globalisation and its Discontents emerged as a favourite read among India's supreme court judges and policy-making classes. Attention has focused on the insights of the former World Bank chief economist on how Russia mismanaged the transition from communism to the free market: while a handful of people became very wealthy, conditions for most worsened as national income declined.

Tony Jesudasan, an aide to Anil Ambani, one of India's most powerful industrialists, says "judicial activists” in India are gripped with the notion that Asia's third-largest economy is following Russia's example in creating a generation of oligarchs. Stiglitz's bestseller of almost a decade ago serves, he observes wryly, as a handbook for judges eager to take on India's large business families.

Twenty years on from reforms that prised open India's economy, the system still favours the insider. Cronyism harms India's growth story and frustrates multinationals from abroad, which consider India a formidable place for those who do not know the "right people” on the inside. Accusations of influence-peddling by powerful entrepreneurs, combined with a colluding state bureaucracy, have led commentators such as Arun Poorie, editor-in-chief of India Today Group, to identify corruption as the "biggest issue” confronting the country.

Fantastic wealth creation amid weak governance is deepening anxieties about long-term economic success. Regulation that can be trampled over, alongside a widening gap between the rich and a largely poor population, invite unflattering global comparisons. Also, Prime Minister Manmohan Singh says, the developments have dangerously sapped Indians' confidence in themselves.

International investor sentiment has picked up on the mood and turned sharply for the worse. Foreign capital flows have fallen. "Nine out of 10 clients are not positive on India in the near future,” says Suresh Mahadevan, head of research at UBS Securities in Mumbai. "Most of the bad news is already in the [market] price.”

"We met with about 50 investors in Singapore and Hong Kong last week,” says Rohini Malkani, a Citigroup economist in Mumbai. "About 70 per cent remain bearish on India, with investments, inflation, and politics topping the list of worries.”

The most potent allegations surround telecoms – a sector in which India had aspirations of global eminence. An official audit claimed that the national exchequer had lost as much as $39 billion in potential revenues from irregularities in the awarding of mobile licences in 2008. Many of India's leading businesses – Tata, Reliance, Vodafone Essar and Bharti Airtel – were bidders in a bitter contest for more spectrum.

The fallout from the scandal – now the subject of a supreme court investigation – is considerable. Opposition protests have vilified Singh as a weak leader presiding over a corrupt administration. Andimuthu Raja quit as telecoms minister in November. Chief executives are being hauled in for questioning by the Central Bureau of Investigation. The supreme court has struck down Singh's choice of anti-corruption chief.

Natarajan Chandrasekaran, the chief executive of Tata Consultancy Services, India's largest information technology outsourcing company, calls corruption a huge "distraction” from improving the lives of tens of millions of people. He warns, too, of its damaging effect on India's image. The advantages of a quick recovery from the global financial crisis and an economy growing at 8.5 per cent have been thrown into doubt by graft in telecoms, the military and the hosting of last year's Commonwealth Games.

Once a poster boy of India's new economy, rolling out 640 million mobile connections and this financial year attracting $40 billion of new investment, the telecoms sector is now viewed as toxic. It was a market fought over by the country's tycoons, also attracting the participation of Vodafone, Etisalat, SingTel, Virgin and NTT DoCoMo from abroad. Behind the scenes, according to senior business people, wars were waged over a decade to manipulate regulators. Now, if charged and convicted, former officials and executives face the possibility of jail sentences.

Yet research by KPMG, shows that property and construction are even more prone to graft than telecoms. "The rising level of bribery and corruption cases have cast a dark cloud over the success earned by the country over the last two decades,” says Subir Moitra, associate director at the auditing firm. The scams "are now threatening to derail the country's credibility, especially in the international arena”.

Last year, India slipped down Transparency International's index of 178 nations based on the level of corruption, to 87th place (the higher the ranking, the cleaner a country). China is ranked 78th. National surveys have shown overwhelmingly that urban Indians view corruption as much worse than ever before.

The travails have precipitated public introspection. Sonia Gandhi, president of the ruling Congress party, remarked bleakly that India's "moral universe was shrinking” with faster economic growth. Rivals speak of a "malignant nexus” of corporate and political interests at the heart of modern India. Manish Tiwari, a Congress MP from Punjab state, invokes Winston Churchill to warn that India is in danger of throwing away its economic opportunity and could suffer "locust years” similar to the early 1930s in the UK, which were characterised by economic decline.

But it is the comparison with Russia that sticks. India's corporate landscape is dominated by a handful of family-led companies. Some of the biggest are household names, such as Tata and the Reliance companies led by brothers Mukesh and Anil Ambani. Other clans include the Birlas, Godrejs, Bajajs and Mahindras. Among newcomers are Anil Agarwal with Vedanta; Bharti Airtel, led by Sunil Bharti Mittal; and Hero Honda's Munjals. Economic growth is making these families richer.

The reforms of 20 years ago were the initiative of Singh, then finance minister. A study on their impact, by Laura Alfaro and Anusha Chari at the Harvard Business School and University of North Carolina respectively, showed that companies present before the liberalisation phase continued to control a far larger portion of the economy than newcomers.

"Corruption has clearly increased since the economy opened up in 1991. Economic reforms were supposed to usher in liberalisation but liberalisation has actually meant big bucks for corrupt politicians,” says Brahma Chellaney, professor of strategic studies at the Delhi-based Centre for Policy Research. "The capability of big business to influence policy now is much greater than it was prior to 1991,” he adds. "There is a growing relationship between oligarchic business structure and its impacting and shaping of Indian politics. This is a trend which has been in the making for a long time now.”

Ajay Shah, a professor at the National Institute for Public Finance and Policy, says: "India's nascent capitalism is characterised by firms vigorously pursuing profits. Under normal notions of competition in the market economy, the most efficient firms [would] get to the top. [But] in parts of the economy afflicted with corruption, the most rotten firms get to the top.”

Some industry leaders acknowledge that India is becoming an increasingly tough place to do business. Ratan Tata, the chairman of Tata Group, complains that business ethics are on the slide. Industrialists Jamshyd Godrej and Keshub Mahindra, banker Deepak Parekh and Bangalore-based IT magnate Azim Premji have likewise bemoaned India's operating environment. "We are alarmed at the widespread governance deficit in almost every sphere of national activity covering government, business and institutions. Widespread discretionary decision-making has been routinely subjected to extraneous influences,” they wrote in an open letter.

Volatile fortunes among some leading groups, for instance Anil Am­bani's Reliance Adag, are evidence of a bruising market. Ambani recently agreed to a year-long ban on trading equities as part of a settlement with the stock market regulator over charges that two of his companies misrepresented their financial statements. Last month, shares in his empire tumbled by as much as 25 per cent in what executives said was a campaign to short the stock. The industrialist was then questioned by anti-corruption investigators amid claims that his group breached rules in the allocation of mobile licences. The company denies any wrongdoing.

Some think Reliance is being roughed up by rivals prepared to use an arsenal of dirty tricks. "There's a real sense that [rivals] are trying to bring him down... It's a miracle he has resisted this long,” says a Mumbai fund manager.

One or two see a silver lining, saying the telecoms furore will bring improvements in governance and is a mere blot on one of the world's best investment opportunities. "Right now we are definitely not the flavour of the month,” Anand Mahindra, chief executive of Mahindra & Mahindra, says of the country. But that doesn't mean we won't be flavour of the year.”

K.P. Singh, the chairman of DLF, India's largest property company, says reforms need to speed up to keep pace with the country's entrepreneurs. "Where reforms have not taken place is where corruption is worst,” he says. "[Real estate] is plagued with archaic laws. No reforms have taken place since independence.”

Although judicial activism and stronger regulatory enforcement are persuading some to sell assets in India and expand abroad, many New Delhi policymakers are confident that Russia's example will be bettered. Indeed, while the debate rages within India, some outsiders are not deterred. They regard volatility surrounding India's leading business figures and political establishment as business as usual. "It's the norm,” says Jeffrey Immelt, chief executive of General Electric of the US, "We do learn to operate inside a certain context. This [country] still has the green light.”

Local politicians differ. Praful Patel, a former civil aviation minister, insists the shamed telecoms sector is "an aberration”. But Mani Shankar Aiyar, a Congress party representative in the upper house, says liberalisation has unleashed strengthening corporate interests that have transformed the economy into one dominated by "black money”.

"The corporate sector, the corporate honchos, are utterly avaricious and utterly corrupt elements in our society. It takes two hands to clap.”

Copyright The Financial Times Limited 2011.