India economic update
Milind S. KothariManaging Partner
M & A tracker
Rajesh ThakkarPartner & Leader/ Transaction Tax
Vishal DivadkarAudit Partner and International Liaison Partner
Pramod NairFinancial Controller and Head – Corporate Accounting
Sony Pictures Networks India Pvt. Ltd.
The aftermath of the maiden Union Budget presented by Finance Minister(‘FM’), Ms Nirmala Sitharaman in July 2019 has been tumultuous with all the economic indicators raising alarm-bells. The Indian economy expanded at its slowest pace in six years in the first quarter of this fiscal year(April-June) @ 5% against the projected 5.79%, on the back of slowing investment growth and weak consumption demand..
The sectors that led to a decline in growth are manufacturing, agriculture and construction. Automobile sales, domestic air traffic, demand for consumer durables seem to be on a continuous downturn, with the middle class not spending enough, indicating a slowdown in private consumption. The uncertainty in trade & investment arising out of the US-China tariff war and the geopolitical issues threatening a stable oil supply, further weigh down the growth sentiments and business confidence in India.
On a positive note amidst this gloom, key factors that remain buoyant are that India’s macro-economic fundamentals are strong, current account deficit is low and the country is one of the least externally indebted countries in the world. The extant US-China trade war could also be to the advantage of India.
To pull up the economy, the FM announced a series of measures - credit support, tax rebates, support to the MSME sector and FDI reforms with easing norms to revive economic growth. A few days later, the FM announced further measures, mostly focusing on export and housing sectors, including offering credit support in priority sector lending etc. The economic stimulus package also includes measures for consolidation and recapitalisation of public sector banks and consolidation of state-run banks to bring in efficiency that would augment ability to fund bigger projects and spur private investment.
The biggest of all recent measures was announced on 20 September 2019, where the base tax rate for the corporate sector was reduced to 22% from a maximum of 30%. This move brings the effective tax rate between 25.17 - 34.94%, amongst the lowest in comparison to other Asian countries and is anticipated to give a lot of relief to companies affected by lack of demand. Further, domestic firms incorporated on or after 01 October 2019, will pay income tax at only 15% base rate, that is likely to give huge fillip to investment.
The FM reiterated that no country has a 15% tax-rate in South-East Asia and India has become an attractive destination for companies to relocate supply chains from China. After the US-China trade war many companies are relocating from China owing to factors like the rule of law, an English-speaking work force and more importantly, lower tax. Overnight, India’s tax regime has become comparable to most countries in Asia.
With deep tax cuts, it is likely that India will miss the fiscal target for this year, but it may be justified if growth kicks back in, strongly. Everyone is in agreement to one thing: rapid economic growth is a necessity.
All these measures to pump in liquidity and boost private investment along with FDI reforms to turn around the Indian economy in the short-term, is an acknowledgement by the government, of the intensity of the problem. The sentiments have turned positive in an expectation of more reforms from the government, to bring about sustainable growth in the medium term. In the given circumstances, it is a big achievement to turn the mood positive, that would pave way for economic recovery.
M&A in India
Between July 2019 to September 2019, around 131 M&A deals were announced / completed aggregating to approx. USD 4,620.37mn; dominated by domestic deals (77) followed by cross border deals (54)
In terms of sectors, Materials sector saw the maximum deal value, with deals worth USD 2,789.51mn followed by Financial sector with deals worth USD 479.73mn and Industrials sector with deals worth USD 464.35mn
(Deals mentioned in the M&A Tracker do not include those with undisclosed deal values as well as those which have been announced but not closed)
Target Company: Mad Pow Media Solutions LLC
Acquiring Company: Tech Mahindra (Americas) Inc
Deal Value (in mn USD): 70
- In July 2019, Tech Mahindra Limited, through its wholly owned subsidiary Tech Mahindra (America) Inc (Tech Mahindra) acquired Mad Pow Media Solutions LLC (Mad Pow) for USD 70mn (INR 4.83bn).
- As a part of the transaction, Tech Mahindra first acquired a 65% stake in Mad Pow and may buy the remaining stake over the next three years, depending on the firm’s financial performance.
- Mad Pow is engaged in providing strategic design consulting services. It offers research and testing, experience strategy and service design, experience design, behaviour change design, content strategy, mobile app and web development and design transformation services.
- The acquisition will help Tech Mahindra to boost its capabilities in customer experience and digital transformation such as research and testing, content strategy, data science and analytics.
Target Company: Dhunseri Tea and Industries Limited
Acquiring Company: Tata Global Beverages Limited
Deal Value (in mn USD): 14.68
- Tata Global Beverages Limited (TGBL) acquired the Branded Packet Tea Business of Dhunseri Tea and Industries Limited for a total consideration of USD 14.68mn (INR 1.01bn).
- The packet tea business is located in Kolkata, West Bengal and includes Lal Ghora and Kala Ghora brands.
- The transaction is in line with TGBL’s strategy to grow its branded tea business in India and to expand the footprint in Rajasthan.
Target Company: DT Associates Research and Consulting Services Limited
Acquiring Company: Indegene Private Limited
Deal Value (in mn USD): 10
- Indegene Private Limited (Indegene) acquired a majority stake in DT Associates Research and Consulting Services Limited for USD 10mn (INR 0.715bn).
- DT Associates Research and Consulting Services Limited is engaged in providing information technology service and offers solutions for digital organisation assessment, digital excellence maturity assessment, digital factory assessment, customer engagement plan review, etc.
- The acquisition would help Indegene's clients in objectively measuring the current maturity of digital and customer excellence, designing commercial models that suit them best and further supporting clients with change management throughout their transformation journey.
- Post transaction, DT Associates Research and Consulting Services Limited would operate as ‘DT Consulting’, as a separate entity and as a subsidiary of Indegene.
Target Company: Gamma Pizzakraft Overseas Private Limited
Acquiring Company: Sapphire Foods India Private Limited
Deal Value (in mn USD): 8.50
- In August 2019, Sapphire Foods India Private Limited acquired an additional 26% stake in Gamma Pizzakraft Overseas Private Limited for a total consideration of USD 8.5mn (INR 0.609bn).
- Gamma Pizzakraft Overseas Private Limited is a commission agent dealing in agricultural raw material, live animals, food, beverages, intoxicants and textiles.
- Post transaction, Gamma Pizzakraft Overseas Private Limited operates as a subsidiary of Sapphire Foods India Private Limited.
The changing audit landscape, a gateway to better governance and global relevance
In the midst of governance lapses and exposes of negligence at some large corporates, the Audit landscape in India is again under the spotlight. With increased scrutiny from regulators, the 2019 AGM season has not been a ‘sleepy affair’. A slew of corporate woes has forced stakeholders to revisit the effectiveness of their governance mechanisms, including challenging the underlying role and responsibilities of auditors. Fairly serious questions are being raised in the on-going IL&FS probe against some of the largest global audit firms - Is there sufficient independence and objectivity for firms to discharge their roles effectively? Has there been collusion with management on part of the auditors? and so on..
Audit regulation isn’t a new phenomenon. The International Forum of Independent Audit Regulators (IFIAR), a global regulatory body comprising of independent accounting institutions had recently published in their yearly inspection report that approximately 37% of audits carried out by the six largest accounting networks had a deficient finding. Although the study illustrates a marginal drop from the previous year (40% in 2017), realising that over a third of audits fail the quality check is alarming. In the aftermath of Enron, the US enacted the Sarbanes Oxley Act which paved the way for setting up of the Public Company Accounting Oversight Board (PCAOB). Similarly, the UK, also has a two-tier structure, where the Financial Reporting Council (FRC) is the independent regulator for the audit profession. The Asian financial crisis of 1997-98 and the Satyam scam in 2009 shaped the need for a substantial revamp of the erstwhile corporate law in India, the Companies Act of 1956. The subsequent enactment of the Companies Act, 2013 (‘Act’) was a groundbreaking development for corporate governance practices in India – it was more contemporary and relevant to corporates, regulators and other stakeholders. It paved the way for India embracing ‘regulator regime’ with the constitution of the National Financial Reporting Authority (‘NFRA’). While not yet a member of the IFIAR, the NFRA has far reaching investigating powers akin to a civil court. Unlike other countries where the jurisdiction for audit regulators is fairly well established and defined, in India there appears to be a trend emerging where other statutory authorities such as the Capital markets regulator (SEBI), Banking regulator (RBI) and Serious Fraud Investigation Office (SFIO), are also proposing severe actions against firms. Hitherto, the provision under the law to ban firms has never been invoked in India and perhaps globally too, but such unprecedented action is currently being proposed.
Auditing standards are being standardised globally to ensure the profession remains relevant and the expectations of various stakeholders are recognised; similar to practices prevalent in Europe, India introduced ‘Key Audit Matters’ (KAM) within audit reports. This new auditing standard opens the door for the auditor to give users more insight into the audit process and improve transparency. Timely communication of KAM is likely to encourage management and those charged with governance to enhance or make new disclosures in the financial statements or other reports, in light of the fact that the matter will be communicated in the auditor’s report. However, what is also needed is continuous technological advancements in the audit process i.e. moving from the traditional ‘audit sampling method’ to data analytics and artificial intelligence tools to make the audit process more robust and effective. The new Companies Act also paved the way for India adopting globally aligned financial reporting standards (akin to IFRS) and mandatory audit rotation, to name a few far-reaching changes.
The auditing profession is under great scrutiny and has been a subject of much debate. With increased focus on the role of auditors and their importance in the corporate governance framework, restoring any lost public trust is paramount. However, this requires considerable effort and uplift by the entire ecosystem - legislators, regulators, standard‐setting bodies and the business community. Could this be India Inc.’s ‘watershed moment’?
Brace for change, as technology facelifts the auditing function
The audit profession has been in the limelight in recent months, unfortunately, for the wrong reasons. The auditors, both past and present, have been under intense regulatory scrutiny almost in every case where a company has declared bankruptcy or admitted to serious financial difficulties and even otherwise. The big names involved lead to attention grabbing headlines causing serious reputational damage to the audit firm, in addition to penal charges and prosecution proceedings. The risk perception of the profession in India (both within and outside the industry) has suddenly increased manifold.
Whilst this trial by fire will cause upheavals in the short run, it would ultimately lead to stronger processes, review mechanisms, adoption of technology as well as quality training and knowledge management within audit firms. This will ensure the strongest survive and therefore lead to a more robust and healthier industry. Companies would prefer to have auditors who are reputed, since credibility is increasingly becoming a key element for survival in the competitive world.
Companies would also need to gear up their operations to meet this new reality. The need for strong financial processes, investment in technology for such processes and training staff is of utmost importance. The frequency of engagement between auditors and clients is and needs to be more regular through the year so that potential issues and process gaps are identified well in advance rather than post facto, at the end of year. Hence, I believe, auditors and clients are partners on a journey of constant improvement rather than being on ‘opposite sides of the table’.
The adoption of cutting-edge technology, especially as tools become more robust and cheaper, will happen faster and on a larger scale as compared to what we have seen in the past. Data analytics will play an important role and therefore, needs to be adopted by both clients and auditors. The emphasis should be to find outliers in the population rather than drawing conclusions from selected samples of transactions. I would expect auditors to employ machine learning tools to improve analysis of data and trends. Implementation of cognitive tools and natural language processing which for e.g. could read contracts and other documents would further add to the quality of data gathered. Artificial Intelligence could be added for forecasting. We at SPN have been steadily transforming the finance function, largely through adoption of appropriate technology, with an aim of achieving leaner and faster processes (purchase to payables, order to cash, record to report and planning/ budgeting/ forecasting), more automated controls and best-in-class standards.
Whilst technology will play a key role in providing greater assurance levels, ultimately it would be the people involved in this partnership (between auditors and clients) that are of paramount importance. Hence, to state the obvious, acquiring and retaining the right talent, regular training and improving skill sets and establishing a culture of transparency and compliance would be imperative for success in the current environment. Next-gen technology can only provide better quality information on which the auditor will have to exercise professional judgement and expertise to draw conclusions and express views. Hence technology will remain a tool, albeit a very important one, for the audit professional. Robots running the world will hopefully remain within the realm of sci-fi movies.