Friday, 23 January 2009

Icarus Is In The Air!

A little while ago we posted a piece on The Icarus Effect, speculating that as the BRIC economies have soared the greatest in the past few years, so they will fall the furthest and hardest during the present downturn (see post). The Economist recently presented two cases that support this contention.

The first article was about a company called Smart Union in China (see article). During the upswing, Smart Union was something of a success story. It included a tale of rags to riches for Tony Wu, who built a toy manufacturing empire from nothing in 1995 to a HK$53mn IPO in 2006. In 2007, sales topped HK$1bn. However, it appears that the company overtraded. Rising costs - particularly labour costs - squeezed profit margins, the weakness of the balance sheet pushed the company into costly credit arrangements for working capital, and a flood led to HK$65mn stock being written off. This led the company to cease trading.

The second case is about Satyam Computer Services (see article). Satyam, India's fourth largest software and services firm, seems to be a victim of crony capitalism. It is a company that is tightly controlled by a small number of family members. One of the family members has confessed that the company balance sheet is more of a work of fiction than fact. A reported cash pile of US$1bn on the balance sheet does not, in fact, exist. This story has a little way to run, but it does highlight the downside and how it is likely to play out.

Operating in the BRIC economies has a number of difficulties for western companies. BRIC companies are often inexperienced and under-capitalised, as in the case of Smart Union. They also operate in an environment where internal financial controls, transparency, accountability, and audit independence are weak or non-existent, as in the case of Satyan. It is a small wonder that capital is flying back from the BRIC nations to a more safe haven - Europe and North America.

If globalisation is to proceed as fast as it has in the past, then there needs to be a harmonisation in the development and implementation of the rules surrounding accounting practice, corporate governance, and audit reporting. If not, the BRIC economies will always be junior players.

© The European Futures Observatory 2009

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