CONVERGENCE WITH IFRS IN INDIA - CHALLENGES AND PROSPECTS

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1 CONVERGENCE WITH IFRS IN INDIA - CHALLENGES AND PROSPECTS Ramesh K.V, Assistant Professor, Dept. of PG Studies in Commerce, Govt. First Grade College, Kunigal. During early days all multinational and global companies were required to prepare separate financial statements for each country in which they did business, in accordance with each country s GAAP. This GAAP was evolved from International Accounting Standards (IAS) issued by International Accounting Standards Committee (IASC) from 1973 to During this period, a series of accounting standards (IAS) were released which were numbered numerically starting from IAS 1 and concluded with IAS 41 in December International Accounting Standards Board (IASB) formed after a span of 27 years through restructuring the International Accounting Standards Committee (IASC). In 2002, European Union implemented the legislation that makes the listed companies in Europe to adopt IFRS in their consolidated financial statements with effective from This applied to more than 8000 companies in 30 countries. Many other countries outside the Europe have also been adopting IFRS. In Africa, Asia and Latin America it has become mandatory. Additionally, countries like Australia, Hongkong, New Zealand, Phillipines and Singapore have applied national accounting standards that reflect IFRS. The following table provides the IFRS acceptability across the globe. Table No. 1 The table showing the IFRS Acceptability across the Globe Sl. No. Domestic Listed Entities 1 IFRS required for all domestic listed companies 85 2 IFRS permitted for all domestic listed companies 24 3 IFRS required for some domestic listed companies 04 TOTAL 113 No. of Countries Globalization of economic activities has laid down a new way for all the countries to develop and adopt a single set of accounting standards. International Financial Reporting Standards (IFRS) provide a single source of such standards, which could be used globally so as to provide financial information in the same language in view of the borderless economies. Reliable, consistent and uniform financial reporting is an important part of good corporate governance practices worldwide in order to enhance the credibility of businesses in the eyes of ISBN :

2 the investors and other stakeholders and to enable them to take well informed decisions leading to a healthy growth of the capital markets. IFRS IN INDIAN CONTEXT: At present, Accounting Standard Board (ASB) formulates and issues accounting standards in India which are in line with IFRS except for certain areas. Council of the institute of Chartered Accountants of India (ICAI) opined in May 2006 that adopting IFRS was considered and supported by the ASB. It was decided to converge for all listed, public interest and large sized entities from accounting periods beginning on or after 1 April 2011 with IFRS and the task force was set up to decide the journey process. But it has not notified the date of implementation in India. In India, National Advisory Committee of Accounting Standards (NACAS) recommends the Indian Accounting Standards (Ind- AS) to the Ministry of Corporate Affairs (MCA) on 25 th February MCA carried out the process of convergence of Indian Accounting Standards with IFRS and as a result 35 Indian Accounting Standards converged with International Financial Reporting Standards (henceforth called Ind- AS). There is a difference between adoption and convergence to IFRS. Adoption means using IFRS as issued by IASB. Convergence means that the Indian Accounting Standard Board and IASB would continue working together hand in hand to develop high quality, compatible accounting standard over a period of time. For the smooth transition to happen ICAI has taken up the matter with NACAS, MCA, Govt. of India, IRDA and SEBI. The following are the regulatory framework of India with respect to enforcement of accounting and reporting standards: Accounting Standards issued by the ICAI under The Companies Act (1956): The basic requirements for financial reporting of all the companies in India are provided by the Companies Act (1956). The act requires the preparation, presentation, publication and disclosure of financial statements, as well as an audit of all companies by a member-in-practice certified by the Institute of Chartered Accountants of India (ICAI). Under the Act, the Central Government has the power, by notification in the Official Gazette, to constitute the National Advisory Committee on Accounting Standards to advise the Central Government on the formulation and lying down of the accounting standards for adoption by companies or class of companies. For this purpose, the Act requires the committee to consider accounting standards issued by ICAI when recommending accounting standards to the Government. While, as stated earlier, ICAI bases its accounting standards on the corresponding IAS / IFRS, the committee also specifically considers any deviations from and reasons, if any, for them the corresponding IAS / IFRS when reviewing ICAI accounting standards. When the committee is not satisfied by any ISBN :

3 deviation, it requests ICAI to amend the standard to comply with IFRS. ICAI generally deviates from corresponding IAS /AIFRS because of the following factors: Economic environment within the country; Legal and regulatory environment prevailing in the country; Alternatives permitted in IFRS would lead to incomparable financial information; Level of preparedness of the industry. Accounting Standards by other Regulators: i) Securities and Exchange Board of India (SEBI): The Securities and Exchange Board of India acts as a regulator of the securities market and the listed companies of India are required comply with the requirements prescribed in the 1992 Act of the Board and the Securities Contracts (Regulation) Act of To protect investor interests, the board has issued a listing agreement, which specifies disclosures applicable to listed companies, in addition to other applicable auditing and accounting requirements, it requires compliance with the accounting standards issued by ICAI. ii) Reserve Bank of India: The Reserve Bank of India (RBI) is empowered by the Banking Regulation Act (1949) to regulate financial reporting of the financial sector, including banks and financial institutions. One of the schedules to the Banking Regulation Act prescribes formats for general-purpose financial statements (e.g. balance sheets and profit and loss accounts) and other disclosure requirements. Banks are also required to comply with the requirements of the Companies Act (1956), provided that they are consistent with the Banking Regulation Act. The Reserve Bank has issued circulars requiring banks to comply with the accounting standards issued by ICAI. iii) Insurance Regulatory Development Authority: The Insurance Regulatory and Development Authority regulate the financial reporting practices of insurance companies under the Insurance Regulatory and Development Authority Act (1999). The authority s regulations require compliance with the accounting standards issued by ICAI. iv) The Institute of Chartered Accountants of India as a Regulator: ICAI requires its members to ensure compliance with all the accounting standards that it issues while discharging their attesting function. Recently, extensive charges have been introduced into the Act through the Chartered Accountants (Amendment) Act (2006), which has made the ICAI s disciplinary mechanism more stringent. ICAI, with a view to further improve and strengthen the financial reporting practices in India, has also constituted the Financial Reporting Review Board. The board reviews general purpose financial statements of certain selected enterprises, with a view to ensuring compliance with, inter alia, the accounting standards. In case where noncompliance is observed, appropriate action is taken by ICAI and/or the case is referred to an ISBN :

4 appropriate authority for the action. This step definitely helps to improve the quality of financial reporting in the country. IFRS Meaning: IFRS are a set of international accounting standards stating how particular types of transaction and other events should be reported in financial statements. Other events should be reported in financial statements. They are guidelines and rules set by IASB the companies and organizations can follow when compiling financial statements. The creation of international standards allows investors, organizations and governments to compare the IFRS supported financial statements with greater case. The term IFRS has two varieties of meaning viz., 1) Broader and 2) Narrow. Broadly, IFRS refers to the entire body of IASB pronouncements, including standards and interpretations approved by IASB, IFRIC, IASC and SIC. Narrowly, IFRS refers to the new numbered series of pronouncements that IASB is issuing as distinct from the IAS series issued by its predecessor IASC. IFRS is principle based, drafted lucidly and is easy to understand and apply. However, the application of IFRS requires an increased use of fair values for measurement of assets and liabilities. The focus of IFRS is on getting the balance sheet right and hence can bring significant volatility to the income statement. A single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world s capital markets and other users make economic decisions IFRS aims for serving the public by fostering trust, growth and long-term financial stability in the global economy. IFRS ADOPTION PROCEDURE IN INDIA: To rationalize accounting practices in the country, the Indian Government in 1949, established Institute of Chartered Accountants of India by passing ICAI Act, Accounting Standard Board was constituted by ICAI in 1977 in order to create harmony among the diversified accounting policies and practices in India. Three steps process was laid down by the accounting professionals in India which are summarized as follows: Step 1: IFRS Impact Assessment: In this step the firm will assess the impact of IFRS adoption on Accounting and Reporting issues on procedures and systems and on core business of the entities. Then the firm will find the key conversion dates according to IFRS training plan has laid down. As and when the training plan is in place, the firm will have to identify the important Financial Reporting Standards which will apply to the firm and also the variations among the present financial reporting standards being ISBN :

5 followed by the firm and IFRS both. The firm will also ensure the loopholes in the current systems and process. Step 2: Preparation for IFRS Implementation: This step refers to the activities required for IFRS implementation process. The firm will reform the internal reporting systems and processes. IFRS first deals with the adoption and implementation of first time adoption process. To make this process smooth, few exemptions are mentioned under IFRS one. These exemptions can be identified and applied. The control systems are developed and put in implementation to ensure the correct application and consistency of IFRS. Step 3: Implementation: This is the final step of the process which deals with the actual implementation of IFRS. THE initial phase of this step is to prepare an opening Balance Sheet at the date of transition to IFRS. To understand the actual impact of the transition from the Indian Accounting Standards to IFRS is to be developed. This will follow the full application of IFRS as and when it is required. At the initial stage of implementation of IFRS requires lot of training and various technical difficulties may be experienced. The smooth implementation of the transition from Indian Accounting Standards to IFRS, regular training to personals and identify the problems while carrying out the implementation. BENEFITS OF IFRS IMPLEMENTATION: Globalization: most of the countries of the European Union have switched over to IFRS. If companies in India also switched over to IFRS, it would make transaction and dealings with companies of other countries who operate under IFRS much easier. It would also give stock holders and other interested parties a common basis of comparability. Adopting a global financial reporting basis will enable the company to be understood in the global market place. It allows company to be perceived as an international player. Clarity and Productivity: Under IFRS, makers of financial statements use their own professional judgment as to how to handle a specific transaction. This will lead to less time being spent trying to follow all rules/ complications that are coupled with rule based accounting. It will also allow prepares of financial information to keep statement on a simplistic and understandable form for investors and other companies interested in the said company s financial statements. Consistent Financial Reporting Basis: A consistent financial reporting basis would allow a multinational company to apply common accounting standards with its subsidiaries worldwide, which would transform internal communications, quality of reporting and group decision making. Improved access to International Capital Markets: many Indian entities are expanding and making significant acquisition in the global arena, for which large amount of capital is required. The majority of the stock exchanges require financial information prepared under IFRS. ISBN :

6 Convergence to IFRS will enable Indian entities to have access to international capital markets, reducing the risk premium that is added to those reporting under Indian GAAP. Lower Cost of Capital: Migration to IFRS will lower the cost of raising funds, as it will eliminate the need for preparing dual sets of financial statements. It will also reduce accountant s fees, abolish rfisk premiums and will enable access to all major capital markets as IFRS is globally acceptable. Escape Multiple Reporting: Convergence of IFRS by all group entities will enable company managements to view all components of the group on one financial reporting platform. This will eliminate the need for multiple reports and significant adjustments for preparing consolidated financial statements or filing financial statements in different stock exchange. Reflect True Value of Acquisition: In Indian GAAP, business combinations (with few exceptions) are recorded at carrying values rather than fair value of net assets. In the acquirer s book, it is usually not reflected separately in the financial statements, instead, the amount gets added to the goodwill. Hence, the true value of the business combination is not reflected in the financial statements. IFRS will overcome this flow as it mandates accounting for net assets taken over in a business combination fair value. It also requires recognition of intangible assets, even if they have not been recorded in the acquirer s financial statements. Benchmarking with Global Peers: Adoption of IFRS will enable companies to gain a broader and deeper understanding of the entity s relative standing by looking beyond country and regional milestones. Further, adoption of IFRS will facilitate companies to set targets and milestones based on global based or global business environment, rather than merely local ones. Comparability: IFRS enhances the comparability of entities among the various sectors, companies and countries. The statements prepared in accordance with IFRS cut across borders, thereby helping in increased comparability of performance and the comparability among the financial statements of Indian companies with their global counterparts. It also improves investors confidence and initiates new relationships with customers and suppliers across the globe. Proximity to Economic Value: IFRS replaces historical cost with fair values for the various balance sheet items, thereby, helping the firm to know its true worth. For ex: all the investment properties and financial instruments will be shown at their fair values, which will reflect a more accurate measure of the current value of the net assets of the company. Better Access to Global Markets and Reduction in Cost: Companies that desire to raise capital from global exchanges, such as the London Stock Exchange are required to convert their statements to IFRS for meeting the regulatory requirements. In such a case, a previously adopted IFRS would help a company to cut the costs arising out of delays and due to a dual set of financial statements. ISBN :

7 Improves International Mergers and Acquisitions: IFRS provides comparable and transparent financial information, thus enabling cross-border partnerships and aliances and reducing postacquisition financial integration efforts and costs. Avoids Multiple Reporting and Improves Consistency of Information: Currently, a dual set of financial statements may be prepared by different entities residing in different jurisdictions for the purpose of external reporting. In such a case, group wise adoption of IFRS will eliminate the need for dual reporting. Economic Growth and Employment Opportunities: Convergence to IFRS will result in improved international trade, capital flows and economic growth. Indian professionals with IFRS skills will be benefitted in the global marketplace. CHALLENGES: Institutional Challenges: when IFRS are introduced in a given jurisdiction, they form a part of the pre existing laws and regulations in the country guiding the governance of business entities. Often, the laws and regulations overlap or become inconsistent with each other, especially when the roles and responsibilities of different institutions are not clearly defined, and coordination mechanisms are not in place. Lack of coherence in the regulatory system becomes a cost for serious misunderstanding and inefficiency in the implementation of IFRS. Most of the laws and regulations pertaining to corporate reporting where enacted several decades before the introduction of IFRS. For ex: the Indian Companies Act pass into a law in It requires the relevant laws to be amended including the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA) before IFRS can be implemented successfully. ICAI may restrict the available Accounting alternatives because the alternative accounting choices that are permitted in IFRS may be incompatible with the local requirements within specific sectors or industries, for ex: when the ICAI issued an accounting standard on leasing, based on the equivalent IAS, the association of leasing companies approached the court to seek relief from the standard, arguing that it was onerous for the leasing companies. Enforcement Challenges: a rigorous and systematic enforcement of the IFRS standards is of paramount importance for its successful implementation. The responsibility of enforcing IFRS rests with a number of parties. Institutions such as SEBI, RBI and IRDA play important roles in enforcing financial reporting requirements like IFRS. The lack of clarity on the status of authoritative and non-authoritative accounting guidance, for example, the guidance notes issued by ICAI, subsequent to the stated convergence is another enforcement challenge. In cases where the Indian Accounting Standard are in full conformity with the equivalent IFRS, the interpretive guidance provided in India may be inconsistent with the interpretive guidance in other countries that are fully compliant with IFRS. ISBN :

8 Technical Challenges: Practical implementation of IFRS necessitates adequate capacity among preparers, users, auditors and regulatory bodies. Companies in UK, Ireland and Italy that have already converted to IFRS, faced the biggest challenge in understanding IFRS, in training, in assimilating requirements, and also faced major challenges in IT (Brown & Pike, 2011). A variety of capacity challenges are faced by the countries that implement IFRS, which are as follows: Shortage of accountants and auditors, who are technically competent in implementing IFRS. Limited availability of training materials and experts on IFRS at an affordable cost. Difficulty in coping with the rapid frequency and volume of changes made by the IASB to existing IFRS, as well as keeping pace with new standards. For ex: In India, IASB decided to amend 13 standards, as part of its improvement project, and as a result, more than 20 standards were affected because of the consequential amendments that were made. Repeated amendments on IFRS place a strain on available technical capacity, which in many cases was already insufficient. Fair-value measurement requirements in IFRS pose yet another significant technical implementation challenge. For Ex: In India, where trading volume is low and capital markets are not sufficiently liquid, obtaining reliable fair value for IFRS measurement purposes becomes difficult. Legal and Regulatory Considerations: The lack of clarity on issues such as whether the financial statements have to be prepared as per the IFRS model or Schedule VI of the Companies Act, FICCI had raised questions on the ability of Indian companies to incur substantial IT and manpower training cost required to initiate the change to the present IFRS (FICCI Press Release, December 2010). A more rational approach, for this issue raised by FICCI, was already answered in the roadmap as with effect from April 1, 2011; only the large entities are required for the compliance with complete convergence, which would provide guidance and direction for the other companies. Difference between Indian GAAP and IFRS: There are differences between Indian GAAP and IFRS. It means the entire set of financial statements will be required to undergo a drastic change. The differences are wide and very deep routed, to say a few- financial instruments accounting, business combinations, employee benefits and effects of changes in foreign exchange rates, are being not dealt under the Indian GAAP. Economic Environment: The economic environment and trade customs and practices existing in India, in a few cases, may not be conducive for adoption of an approach prescribed in an IFRS. For Ex: in a country whose markets do not have adequate depth and breadth for reliable determination of fair values, such as India, it may not be advisable to follow a fair value-based approach prescribed in certain IFRS. Certain IAS / IFRS assume an economic environment with mature markets. ISBN :

9 Level of Preparedness: Adopting IFRS, in certain cases, may cause hardship to certain industries. There are also a few conceptual differences between Indian Accounting Standards and IFRS, for ex: IAS 37 deals with constructive obligation in the context of creation of a provision. The effect of recognizing the provision on the basis of constructive obligation is that, in some cases, the provision will need to be recognized at an early stage. Majority of the companies rely heavily on their auditors to advise them, but even the audit firms should agree on the treatment of certain items to ease out the complications. Capacity and Training Issues: Convergence to IFRS requires India to be equipped with adequate technical capacity in terms of training of employees, trained professionals and chartered accountants, number of actuaries available, and modification of the IT system. The impact of IFRS on IT and financial systems can vary depending on the firm s size complexity, capabilities, internal control structure and other attributes (Brown & Pike, 2011). Increased Responsibility: The change to IFRS opens up certain choices a company will have to account for some items. This also caries with it the responsibility of explaining to investors the reasons for the choices and the impact on financial statements. A communication strategy should be developed to prepare the market and stakeholders for potential impacts of IFRS on key performance measures. Tax Implications: IFRS convergence will have a significant impact on the financial statements and consequently tax liabilities. Tax authorities would ensure that there is clarity on the tax treatment of items arising from convergence to IFRS. Ex: the govt. authorities tax unrealized gains arising out of the accounting as required by the standard on financial instruments. From an entity s point view, a thorough review of the existing tax planning strategies is essential to test their alignment with changes created by IFRS. Distributable Profits: IFRS is fair value driven, which often often results in unrealized gains and losses. Whether this can be considered for the purpose of computing distributable profit is still to be debated, in order to ensure that, distribution of unrealized profits will not eventually lead to reduction of share capital. Fair Value Measurement: IFRS uses Fair Value as a measurement base for valuing most of the items of financial statements. The use of fair value accounting can bring a lot of volatility and subjectivity to the financial statements. It also involves a lot of hard work in arriving at the fair value and valuation experts have to be used. Re-negotiation of Contract: The contracts would have to be re-negotiated which is also a big challenge. This is because the financial results under IFRS are likely to be very different from those under the Indian GAAP. Reporting Systems: Companies would have to ensure that the existing business reporting model is amended to suit the reporting requirements of IFRS. The information systems should be designed to capture new requirements related to fixed assets, segment disclosures, related party transactions etc. ISBN :

10 Issue of GAAP Reconciliation: The Securities Exchange Commission (SEC) laid out with two options in its proposal. Firstly, calling for the traditional IFRS first time adoption process. Secondly, requiring that step plus an on-going unaudited reconciliation of the financial statements from IFRS to US GAAP. Clearly the second one is a more costly approach for firms and its users. PROSPECTS / OPPORTUNITIES FOR INDUSTRIES IN INDIA: International Collaborations becomes easier: IFRS gives Indian companies a major opportunity to global and makes the process of international collaborations easier. They can source out raw material or manufacturing bases in other countries with a greater degree of local acceptance. Access to international capital markets will strengthen the financial fabric of corporate India. Inter firm comparisons will be rendered more meaningful giving investor choices greater clarity. On the same logic, attracting FDI can also be facilitated. Opportunities in Financial Consultancy Services: Service Industry plays its prominent role in economic growth of India. IFRS augurs well to open up a slew of opportunities in financial consultancy, financial auditing and financial bookkeeping of India CAs, ICWAs, Actuarial Service and financial experts. This talent need not be confined to the country but seek openings in IFRS compliant countries that are already more than 100 in number. In fact, IFRS may well herald the next big outsourcing opportunity to India and its financial professionals. The USA is going to transit from US GAAP to IFRS commencing 2012 and completing in They have a shortage of Public Accountants and are bound to outsource from a talent abundant country like India. Some experts reckon this opportunity to be worth around US$ 1 Billion. More visible Brand Management: On account of the fair value evaluation of IFRS, the financial visibility of a brand has to be recognized. Brand Management will be more tangible in terms of its financial impact and financial contribution to a business. Premium charged on branded products and services can be rationalized and brand valuation would be integrated will be the overall corporate strategy of a company. Branded companies especially in FMCG industry charge a premium to their brands to local subsidiaries under a licensing agreement. The local subsidiaries have been treating this value as intangible and have no financial notion of brand value. Thereby, development of a brands thus making its value transparent and attract higher stakeholder confidence. OPPORTUNITIES FOR BANKING SECTOR IN INDIA: Bank can take this opportunity to redefine and reconfigure their conglomerate groupings in accordance with IFRS. Business may be assessed on shareholding and non-shareholding ISBN :

11 ownership of related entities for the consolidation. Accounting practices can be standardized across the group and norms set for inter group transactions. Capital adequacy ratios and requirements can be embedded in the business strategy of the banks. Redeployment of technology and human resources are vital factors in the transition to IFRS affords an opportunity for banks to reorient their resources. Identification of gaps in strategy is crucial to the future health of banks. IFRS provides an opportunity to relook at their existing mix of products and services. Securitization is one activity which creates grave problems in describing the tradeoff between risk and reward. Hedging and derivative trading is generally considered an obvious method of immunization of a bank s balance sheet. Such a strategy is based on subjective judgmental assessment rather than a quantities measurement of risk and return. Hence, IFRS is indeed an opportunity to understand the highly important derivative business in better light. Fair value assessment on derivatives could have saved many financial institutions from going bust as was evidenced in the recent past. This is also a good opportunity to upgrade the IT infrastructure and put systems and networks in place as the new accounting regime demands seamless flow of high value information. Data has to be strengthened, developed, captured and transmitted in time for managing credit risk among others. Adherence to Basel II norms will also undergo changes as the components of income and expenses will alter. In such a scenario, upgrade3d technology is indispensable. India has been earnestly trying a make a mark on global business and global economic platforms. For India to become a economic super power, it is mandatory to have an Indian bank which is truly international and global in nature. Difference in internal reporting standards was an important hindrance in achieving transparency that will attract the confidence of investors in Indian banks. This hurdle can now be overcome under IFRS and the decks cleared for the emergence of an Indian multinational bank. Let this fact not be understood as it has an explosive potential to give impetus to India emerging as a major economic power. MEASURES TAKEN TO ADDRESS THE CHALLENGES: Measures for Institutional Challenges: a) For changes required on IRDA rules and regulations, draft recommendations have been placed before Accounting Standard Board (ASB). b) For changes required in The Companies Act 1956, draft recommendations had been sent to the Ministry in May c) For changes required in RBI / Banking Regulations Act, draft recommendations have been placed before the ASB. ISBN :

12 Measures for Enforcement Challenges: The following are the steps taken by ICAI which is proactive to ensure effective implementation of the process of convergence: The ICAI issued 30 interpretations of accounting standards, with a view to resolve various intricate interpretational issues arising in the implementation of new accounting standards that have already been issued. Guidance notes have been issued by ICAI for providing immediate guidance on new accounting issues arising as a result of the issuance of new accounting standards and to provide immediate guidance on new accounting issues arising because of changes in legal or economic environment and / other developments. To facilitate discussions at seminars, workshops, etc., ICAI has issued background material on newly issued accounting standards. ICAI is often presented with certain delicate situations while performing attesting functions, where an authentic view is required. for the purpose of assisting its members, the ICAI council has formed an expert advisory committee to answer queries from its members. The initiative has to be taken to provide proper education and training of employees about IFRS. The government of India needs to format a separate committee for IFRS process and feedback purpose. It is to identify the effects on the existing contracts and agreements before implementing IFRS. Conclusion: The long-term volatility of the global capital markets demands a revolution in corporate reporting. It is to encourage the sphere of corporate reporting by implementing IFRS which provides benefits and opportunities like never before. Convergence with IFRS in India leads to many challenges. Several measures taken to address the challenges. The convergence with IFRS is well equipped as the steps taken by ICAI and other statutory authorities and bodies to facilitate the smooth convergence to IFRS are in creditable and give the positive opinion that the country is ready for convergence. ISBN :