Mahabharata in Polyester

by McDonald, Hamish

  Dhirubhai and his sons astutely portrayed themselves as part of the new India, raw-spirited capitalists champing to have the bridles of failed Nehruvian socialism removed. The investment fund managers who flocked to Bombay from Hong Kong, Singapore and London from the end of 1991 were also inclined to overlook the ‘colourful’ past. ‘Someone who can smuggle in a whole factory clearly has something going for him,’ one Kleinwort Benson researcher remarked at the time.3 Imbued with the notion of ‘emerging markets’ – forgetting that Bombay’s stock exchange, set up in 1875, was among the world’s oldest – the fund managers had reached India after selling their clients on the business ventures of Thai and Indonesian generals, Chinese People’s Liberation Army units and East Asian dynasties newly listed on new stock exchanges. India was a cinch by comparison. Soon research reports were piling up, pointing to India’s large middle class and its hidden savings, the basic soundness of its British-style legal and corporate institutions, the skill of its top administrators and managers, and the political safety valves in its complex but democratic political system.

  Dhirubhai had actually fared rather better under V.P. Singh’s prime ministership and its aftermath than he had under Singh’s earlier tenure in the Finance portfolio. Reliance’s results for 1990–91 (April–March) showed a tough year, but sales had grown 13 per cent to Rs 21.05 billion and net profit 39 per cent to Rs 1.25 billion. The new year, 1991–92, had started out with little growth in sales or profit, given the brakes on the economy. But Dhirubhai asked his shareholders, at their annual meeting in October 1991, to look at Reliance’s massive projected expansion now that licensing had been removed on nearly all the company’s products.

  This meant that the existing Patalganga plant would be further expanded to ‘international size’, and its supplies of naphtha and kerosene would soon come by pipeline from the Bharat Petrochemicals refinery at Chembur, whose own plans for downstream expansion had been virtually pre-empted by Reliance. The new petrochemicals complex was rising by the Tapti River at Hazira, on the former tidal flat reclaimed by use of a massive Dutch dredger and extensive piling. Its monoethylene glycol plant came into production late in 1991, and its polyvinyl chloride and high-density polyethylene plants were expected on stream during 1992. But the cost had blown out 70 per cent from the original Rs 10 billion because of the rupee’s devaluation and the failure of government authorities to chip in their share of the power plant and jetties. Financially the subsidiary Reliance Petrochemicals was struggling.

  At this point, Dhirubhai decided to merge the petrochemicals arm back into the parent company. The shareholders of Reliance Petrochemicals approved the move at a meeting in August 1991, held at Hazira where not too many of the 2.4 million stock-holders could have turned up. The meeting also allowed the early conversion of the remaining portions of the company’s big debenture issue and the issue of fresh shares to the Reliance parent company at par in payment of a loan from it. The merger was announced as a decision by both boards on 28 February 1992 and made effective from 1 March.

  Three of Bombay’s leading chartered accountancy firms recommended a swap of ten Reliance Petrochemicals shares for one Reliance share. It meant that Reliance acquired the massive assets of the subsidiary at a discounted price and from 1992–93 was able to add its growing production stream to its own sales or keep them in-house at cost for use at Patalganga. The depreciation benefits of the subsidiary’s investment were transferred to Reliance, where they were a shield against corporate income tax for several years. Reliance’s profits indeed showed a strong leap the next year. Reliance shares had risen high again, so few of the subsidiary’s old shareholders were complaining.

  • • •

  Even before the first foreign portfolio funds were authorised to invest from mid-1992, the Indian sharemarkets had enjoyed a spectacular boom on the euphoria generated by the reforms. The 1991–92 boom helped Dhirubhai quickly overcome his Larsen & Toubro disappointment. A new debenture issue in December 1991 raked in Rs 9.87 billion, a new record for corporate issues in India, and four months later it rolled over one of its big debenture issues from 1985 for another seven years.

  The source of the subscription money puzzled Finance minister Singh and many of his officials, given that the central bank was still applying a tight liquidity squeeze, with interest rates around 20 per cent, as part of its attack on the external payments crisis. Then it was discovered that bank reserves were being turned into speculative cash. To help finance the huge government deficit, commercial banks were obliged at that time to keep a total 54.5 per cent of their deposits in government securities and cash. To make more profit from this compulsory investment, the banks traded and swapped their holdings of bonds issued by the treasury or government corporations in search of higher yields. Changes in interest rates would raise or lower the market value of bonds carrying rates fixed at earlier times. The deregulation of interest rates on bonds early in 1991 allowed public-sector enterprises to offer much higher rates on new issues, so the market value of their existing bonds fell sharply.

  At the end of 1991 banks were more keenly trading their securities in search of higher yields. Banks were the only parties authorised by the Reserve Bank of India (RBI) to trade in ‘gilts’ (government securities), but several brokers had established themselves as trusted middlemen for particular bank treasury departments. The RBI was ill-equipped to control this growing market. Its register of who owned which gilts at any time was through handwritten entries in Dickensian ledger books at its old building in Bombay, and new ownership notes were sent by post out to banks. To speed up their transactions, the banks and brokers developed their own informal system outside the central bank’s aegis, through the use of chits called ‘banker’s receipts’ or BRs, which were simply certificates issued by the banks themselves indicating that they owned the securities being sold.

  According to brokers and bankers involved, the practice began in 1984–85 when the bond portfolios of several public-sector banks were churned over on behalf of Congress Party fund-raisers for Rajiv Gandhi’s election, raising Rs 4 billion.4 The Reserve Bank was aware that bankers’ receipts were being issued without the backing of actual securities, but did little about it. For ten years until 1992, the RBI’s deputy Governor supervising banking operations was Amitava Ghosh, later criticised in a Joint Parliamentary Committee report on the scam as having taken a ‘casual’ approach to his role. Dhirubhai is widely credited with having swung Ghosh’s unusual second term as deputy Governor.

  The entry of public-sector enterprises (PSEs) in the late 1980s stepped up the unofficial market’s tempo with a new ‘portfolio management scheme’, whereby the enterprises (and private-sector companies) would lend their spare cash to the banks, which would make high-yield investments on their behalf. The transfer was not a deposit (in which case the banks would have had to put 54.5 per cent into their reserves) and no return could be guaranteed. The risk would be on the enterprise, not the bank.

  That was the theory anyway. In practice, the banks competed for PSE funds by giving an ‘indicative’ return. The PSEs wrote the placement down as a ‘deposit’ in their own books. If the banks made more than the indicated return, they kept it. The risk stayed with the owner of the money. In practice, the banks were not equipped to make high-return speculative investments, usually in the share markets and developed informal relationships with brokers. But because the banks were not allowed to lend money to brokers, a subterfuge was needed. The cover was a fake securities transaction, whereby the broker obtained an unbacked BR from a compliant bank to give in return for the funds. The transaction would usually take the form of a ‘ready-forward’ or ‘repurchase option (repo)’ deal, whereby there would be an agreement to sell back the security after a certain time.

  • • •

  Dhirubhai, according to the brokers, became interested in the money market in the late 1980s and played it to recover some of the funds lost in the desperate 1986–87 defence of the Relia
nce share price. He had built Reliance’s fund-raising operations to such a level that one analyst likened them to a virtual banking business parallel to and almost as important as the polyester business.5

  The best known figures in the 1992 repo boom, broker Harshad Mehta and his brothers, had been caught in the crushing of bear brokers engineered by Dhirubhai’s ‘third son’ Anand Jain at the end of 1986. They had escaped lightly after pulling a family connection: one of the brothers was married to a daughter of the vice-chairman of the Industrial Credit and Investment Corporation of India, a major lender to Reliance. The father-in-law had interceded with Reliance auditor D.N. Chaturvedi. Chastened, the Mehtas stayed clear of Reliance and turned to the money market.

  Around November 1991 the Mehtas put in a call to Anil Ambani to break the ice. Their first meeting discussed the 1986 affair; it was agreed to let bygones be bygones. They started meeting frequently. The Ambanis were concerned about their share price, which was languishing despite the efforts of their brokers. They wanted to be first in India with a Euro-issue (i.e. securities priced in foreign currencies and issued in markets such as London) and to sell it at a high price.

  The Mehtas found that Reliance was still seen in the market as a seller of its own shares. Every time the price rose Rs 20 or so, its brokers would start booking profits. The Mehtas agreed to start pushing up the share price, on condition that Reliance itself stopped selling. The intervention worked. It was against a background of wild bullishness in the market, but the ramping of Reliance was a substantial cause in itself.

  Harshad Mehta became ‘the Big Bull’ – a title once given to Manohar Pherwani in his days heading the Unit Trust of India. Mehta’s fellow Gujaratis came to regard him as a second Dhirubhai. It caused some pique at Reliance that a mere broker was achieving such glory and even presuming to correct Dhirubhai on his investment strategy. The Mehtas were buying up debentures that Reliance was selling, particularly those of the struggling Reliance Petrochemicals and Larsen & Toubro.

  A small incident might have helped to persuade the Ambanis that Harshad Mehta was getting too big for his boots. Harshad and Anil Ambani had descended together in the elevator at Maker Chambers IV, the building housing Reliance’s head office in Nariman Point, and stood together on the steps while their cars were hailed. Harshad’s arrived first, a gleaming new Toyota Lexus, at that time the only one in India. Anil looked at it in admiration and made some complimentary remark. Harshad promptly handed over the keys and told Anil: ‘Take it, it’s yours.’ Anil refused, but the gesture might have left him feeling patronised.

  A net was closing in on the Mehtas in any case. The central bank’s Governor, S. Venkitaramanan, had been trying again to goad his deputy Governor, Ghosh, into cracking down on the BR trading between banks. He was also intrigued by Harshad Mehta’s apparently inexhaustible source of funds. An income tax raid on Mehta in February 1992 had failed to crack the secret because the Mehtas kept their data on encoded computer disks. Venkitaramanan had not quite put his suspicions together and made the mental link, but he was getting closer. In March he asked the State Bank of India to look at Harshad Mehta’s account. The bank reported huge inward and outward flows of money. During April the State Bank began pressing Mehta to reconcile the huge shortage, Rs 6.2 billion, in his business with it. He sought to roll over the obligation and on 24 April brought in cheques to settle his dues.

  But by then the scam was out. On 23 April a young business reporter, Sucheta Dalal, on the Times of India had reported a Rs 5 billion shortfall in the State Bank’s treasury on account of transactions with a broker called ‘the Big Bull’. The music stopped, and ten leading banks were left with a Rs 40 billion gap in their books.

  It soon emerged that Harshad Mehta had paid his dues with funds provided by a fully owned subsidiary of the central bank itself, the National Housing Bank. Venkitaramanan, after his own appointment by the Chandrashekhar government, had brought back the former Unit Trust of India chairman Pherwani as the Housing Bank’s chairman and managing director. Still wildly ambitious, Pherwani had thrown the bank into the thick of the repo-based securities trades. When Harshad Mehta was squeezed by the State Bank, the Housing Bank had obliged him with cheques made out to ANZ Grindlays Bank. Mehta had deposited these into his own account with ANZ Grindlays, then paid the State Bank of India.

  According to sources close to the Mehtas, Dhirubhai had been the first person Harshad Mehta had contacted when put on the spot by the State Bank. Dhirubhai had told him: ‘Don’t call anybody. I’ll look after the matter.’ According to an account by the financial journalist R.C. Murthy, at a meeting with Harshad Mehta and ‘an industrial tycoon’, Pherwani had agreed to bail out Mehta.6 One acquaintance confirms that Pherwani said Dhirubhai had been the person who interceded for Mehta. ‘I was forced to do,’ Pherwani told this person. However, the Mehta-linked sources deny that a joint meeting took place between Pherwani, Dhirubhai and Mehta.

  Pherwani had been the fall guy for Dhirubhai once before, losing his Unit Trust of India job over the Larsen & Toubro affair. Now he faced complete disgrace. Harshad was unable to pull off the big securities deal he promised Pherwani, whereby a government corporation would have parked the funds through him with the Housing Bank. Pherwani resigned on 9 May. In the early hours of 21 May family members found him dead at his Bombay home. The journalist Murthy got a phone call and rushed to the house about 8am. Pherwani’s body looked ‘blue’, he remembers. It was cremated at 11.30am the same day with the face covered instead of left open in the normal Hindu way. The death was ascribed vaguely to a ‘heart attack’. Murthy and many others believe Pherwani committed suicide.

  • • •

  The opening up of the securities scam led to investigations by the Reserve Bank of India, the Central Bureau of Investigation and finally a Joint Parliamentary Committee. Senior bankers were sacked; several brokers and bankers arrested (including Harshad Mehta) and a special court set up to try those charged. Three ministers ultimately lost their posts for improper financial dealings. The blame was widely spread among financial system regulators, including the Reserve Bank Governor, Venkitaramanan.

  The links between Reliance and Harshad Mehta or other brokers were never made explicit throughout the entire investigation, although the favours shown to Reliance by several banks were criticised in the parliamentary committee’s report. It noted how funds placed by the Oil and Natural Gas Corporation (ONGC) in portfolio management schemes with two banks had been channelled through brokers into Reliance shares; how Reliance had recruited the ONGC chairman immediately on his retirement; and how some banks had given large amounts of credit to Reliance and its associated ‘front companies’ through bill discounting. In a general note on the overall scam, it said: ‘There is some evidence of collusion of big industrial houses playing an important role.’

  The Congress majority in the committee, who included Dhirubhai’s old friend Murli Deora, prevented the probe going any further than that. A note by the opposition minority pointed out that there were still gaps in the investigation and that the CBI had made many lapses (its chief investigator, K. Madhavan, had resigned in protest during the inquiries). A second note by three Left MPs pointed out that the Reliance name had surfaced more often that those of other industrial houses, but this must still be only ‘the tip of the iceberg’. One MP who was on the committee recalls: ‘There was always a lurking suspicion that big interests were behind the scam, but there was no trace. It was one reason why we put all the evidence in the parliamentary library instead of having it destroyed, which is the usual practice. There was some resistance to this.’7

  Many of the committee members also had their doubts about the central bank Governor, Venkitaramanan. In the 1980s, as head of the Ministry of Finance, he had been openly accused in the press of belonging to a pro-Reliance clique of officials and was distrusted because of this by his then minister, V.P. Singh. His appointment as Reserve Bank Governor was generally seen in Bombay as a f
avour called by Dhirubhai during Chandrashekhar’s brief prime ministership. It emerged also that Venkitaramanan’s son was linked in a business venture in Madras with Dhirubhai’s son-in-law, Shyam Kothari.

  This sorry linkage took some years to emerge, however, and the Reliance issue of global depositary receipts was successfully put to the market in Europe from 11 to 18 May despite the financial mayhem breaking out back in Bombay. Fortunately for Reliance, the CBI did not move in to arrest Harshad Mehta and his brother Ashwin until well after the issue closed, on 4 June. By late 1993 the market bounced back as international investors discovered the ‘India story’ en masse and prices climbed to a new record .Dhirubhai’s connections with the scam had been buried and, as he might have said to his old friends in the yarn market, a first-class fountain had been built on top. Or so it seemed.

  • • •

  In December 1993 Dhirubhai announced that a duplicate of Patalganga would be added to Hazira in a second polyester–PTA complex. In September 1993 he had also entered a joint venture with ICI, Terene Fibres India, to take over ICI’s polyester fibre plant, with a capacity of 30 000 tonnes a year, at Thane, outside Bombay. The three polyester works would make Reliance the fourth biggest producer in the world (after Germany’s Hoechst, America’s Du Pont and Taiwan’s Nanya) and the only one with production integrated from napththa down to fabrics.

  The integration was to move even further back upstream. In February 1994 Narasimha Rao’s cabinet decided to award three oil and gas discoveries in the Arabian Sea to a consortium involving Reliance with the Houston-based Enron Oil and Gas Corporation and the government’s own Oil and Natural Gas Corporation, which had discovered and delineated the fields but did not have the funds to develop them. Two of the fields, Mukta and Panna, were then estimated to contain 265 million barrels of oil and the third, Mid- and South-Tapti, 67 billion cubic metres of gas, although much later it was alleged that Reliance knew the reserves were likely to be much larger. Cost of development was put at Rs 38 billion (then about $1.25 billion) of which Reliance was responsible for 30 per cent. Enron would be the operator initially but after five years would transfer the role to Reliance.