It was these second-round investment projects, conceived of as sure things, that then began to run into trouble. Not all the big names were affected: the two largest, Tata and Mukesh Ambani’s Reliance, had balance sheets that remained in reasonable shape. Instead, Gupta’s report dug into the performance of the country’s ten most heavily indebted industrial companies. The three largest from Andhra Pradesh—GMR, GVK, and Lagadapati Rajagopal’s Lanco—were all included. So was Gautam Adani’s group, and Anil Ambani’s half of Reliance. Then there were a handful of others, including Essar, a power and infrastructure business headquartered in a skyscraper just down the road from Ceejay House.
Gupta’s commentary on all this was brief and sober, but the situation it described was clearly grim. “The total debt level of these ten [companies] has jumped 5x in the past five years,” he wrote. There were plenty of other big names with huge outstanding bank loans who had not been included, from Vijay Mallya’s Kingfisher to its clapped-out state rival, Air India. But the borrowings of just these ten “House of Debt” companies were on an entirely different scale. Together they then owed $84 billion, or more than an eighth of the amount lent out by the entire banking system.
The report’s implications for India’s banking system were dire. Indian lenders, Gupta explained, were now among the most vulnerable in Asia in terms of their exposure to the debt levels of these kinds of large firms. More to the point, the closer you looked at the balance sheets of these big companies, the clearer it became that they were not just struggling to repay what they owed, but that they were probably never going to be able to repay.6 Around that time, some investors had begun to worry that the dangerously high levels of debt in China’s economy might cause some kind of economic crisis. Now it looked as if India’s situation could be even worse. “The [financial] world read the contents of that innocuously titled ‘House of Debt’ report gobsmacked,” wrote the Economic Times, India’s biggest business paper.
At first glance it might seem odd that all this came as such a surprise, but “House of Debt” attracted attention precisely because in India this kind of detailed financial information was unusually hard to dig out. The country’s industrial conglomerates were normally structured to be deliberately opaque, with holding companies that sat on top of multiple layers of subsidiaries, and money flowing back and forth between them all in ways that were fiendishly difficult for outsiders to track. Some parts of these groups were listed on the stock market, and therefore published at least some financial information for their investors. But others were held privately, and were obliged to release almost no data at all.
To make things more complicated, as globalization had accelerated, many of these same Indian companies had rushed to go global, snapping up mining assets in Africa or building industrial projects in Britain. This created an additional problem for those trying to scrutinize their finances, because it meant that some portion of their cash, as well as potentially quite a large chunk of their loans, was stored somewhere far offshore and often funneled through tax havens. All of this meant that analysts like Gupta could find out fairly easily how funds had been raised for any single new investment project, such as a steel mill or power plant. At the level of the conglomerate itself, however, no one except the “promoter”—as India’s tycoons were often known—knew the real extent of their borrowing, or from whom it had been borrowed. For Gupta and his team, finding out the true picture at each of their ten companies meant many months of painstaking research, poring over financial documents and talking quietly to sources at banks. But, bit by bit, their data began to show glimpses. “The answers which started popping out were very, very surprising,” he told me.
Part of the shock came from realizing just how large some of these companies had grown during the boom of the 2000s. “What amazed me was when I looked at the power sector,” Gupta explained. At the time, billions of dollars were being invested through public-private partnerships to build dozens of new coal-fired stations, including a new generation of especially large “ultra-mega” plants, such as those which rose up next to Gautam Adani’s Mundra Port on the coast of Gujarat. Gupta found that around three quarters of all this investment was being undertaken by just the ten companies in “House of Debt.” “It was extraordinary,” he said. “Many of them were unknown a decade ago. Now they are doing [investments worth] $10 billion or $12 billion.”
Even more extraordinary were the industrialists’ financial miscalculations. These were India’s most illustrious tycoons, admired both for their proficiency in judging risk and for navigating the country’s labyrinthine politics. In particular, they were known for “managing the environment,” as the ability to win sweetheart deals was known. Yet now, just when they needed it, the Bollygarchs’ touch deserted them: the constraints that made India such a perilous place to do business for everyone else suddenly began to apply to them as well. New Delhi stood transfixed in the aftermath of the season of scams, as once-pliant bureaucrats declined to hand over the dozens of official permissions any major industrial project needed to move forward. With their plans stuck in limbo, the tycoons’ hopes of paying back their debts began to look perilous too.
Gupta began fielding angry calls the day the “House of Debt” report was emailed out. Bankers protested that the loans they issued would come good in time, and accused Gupta and his team of spooking the market by needlessly exaggerating the scale of their problems. The ten companies were furious, claiming special circumstances and arguing that their stalled projects would soon be back on track. “There were guys who called and blasted me,” Gupta recalled. “Then there were guys who called my global CEO.”
Yet over the next year India’s bad-debt problem only worsened. A second version of “House of Debt,” released in August 2013, showed debts at the ten companies soaring to over $100 billion.7 In public, the tycoons blamed a wider economic downturn. In private, they raged at the government, claiming that political inaction was sabotaging otherwise viable investments. The phrase “policy paralysis” began to be bandied about in New Delhi, to describe the way accusations of cronyism had led government decision-making to judder to a halt.
The government saw things differently, claiming any delays were the tycoons’ fault. “These guys didn’t bother getting the clearances they needed at first, and said, ‘I’ll manage it when I come to it,’ ” I was told later by Jairam Ramesh, a combative economist turned Congress politician. Back in 2013, Ramesh had been India’s environment minister and a particular bête noire of the tycoons. He often blocked investments, including a number of major mining and power projects in forested areas. The tycoons pushed their luck, he argued, starting work without proper permission, with the aim of creating “facts on the ground” and assuming that their political connections would smooth over problems later. “You also had the prime minister, a man of great integrity, who kept talking about unleashing animal spirits,” he told me. “This just reinforced the sentiment among industrialists that they could do whatever they wanted.”
While some of these political snarl-ups were indeed outside the tycoons’ control, “House of Debt” revealed a further issue that was squarely their own fault: the tricks they used to raise debt. “Let us say a power plant costs $100, so you borrow $70 and you put in $30 worth of equity,” Gupta explained. This was the kind of sensible balance between debt and shareholders’ equity found in finance textbooks. The equity component was important, because it ensured the entrepreneur had “skin in the game,” acting as a cushion if a project went wrong. Bankers typically wanted tycoons to put in some of their own funds, not only to provide an incentive to ensure the project went well, but also because it would be used to absorb losses if things went wrong. But Gupta discovered that this equity component was often a mirage. The tycoons deployed a clever deception, telling Bank A they were putting equity into a particular project, when the money had in fact been raised as debt from Bank B, as pa
rt of the financing of an entirely different project, and then quietly transferred over. Both Banks A and B were kept in the dark, while the tycoons had to put in no money of their own.
To try and get a sense of the scale of this problem, “House of Debt” included a complex spiderweb of diagrams for each conglomerate, with arrows flowing back and forth between their various different subcompanies. When deciding whether or not to provide a loan, Gupta discovered that the banks looked only at the health of the individual companies who wanted to borrow, rather than the total debt levels of the wider conglomerate. Many of the banks simply failed to notice that the tycoons had been quietly shuffling money around, building up far larger levels of overall debt than had previously been realized.
Arundhati Bhattacharya, the head of State Bank of India, the biggest bank of all, later admitted to me that she and fellow bank chiefs had missed a trick. “We really weren’t monitoring the overall group gearing,” she told me in 2013, just a few months after the second “House of Debt” was released.8 Projects that looked properly capitalized were revealed to be funded almost entirely by debt, with little or no equity. If such projects went wrong, there was no money to soak up losses, meaning the banks were immediately on the hook. Meanwhile the total debts of each tycoon, much of it taken on by creatively shifting funds around, had reached alarming levels. “We called this the layering of debt,” Gupta said. “And that was why it was called ‘House of Debt,’ because you had these industrial houses with debt everywhere, and no equity, ready to fall down.”
The more charitable explanation was what economists Daniel Kahneman and Amos Tversky call the “planning fallacy,” a psychological bias in which those setting up projects use “forecasts that are unrealistically close to best-case scenarios.”9 In India, this meant that new steel mills were built on the assumption that steel demand would rise forever. In the same vein, power stations were planned on the basis that coal imports would always be cheaply available, hence why so many were built on India’s western coast, thousands of kilometers away from the country’s main coal supplies in the east. More generally, it was assumed that Indian growth would keep purring along, while any bureaucratic problems could be managed away. The tycoons grew giddy. “At the promoter level, there was just this sense of exuberance,” Gupta told me. “If the guy in the next bungalow to you on Altamount Road is building two new power plants, then you want to do it too.”
At its worst, the tycoons’ creative accounting could stray into outright corruption. Indian promoters were known as masters of extracting cash from projects, even those that ended up losing money. The most common ruse was “gold-plating.” Here a business approached a bank with a proposal to build a project, say a steel mill, costing $2 billion. Of this a portion—$1.5 billion, for instance—would be funded through bank loans, while the remaining $500 million would come as equity put in by the owners. The trick was that the entrepreneur knew the steel mill could actually be built for $1 billion. The difference between the amount raised from the banks and the true cost—in this case $500 million—could be pocketed as profit and used to fund investments elsewhere.
Further deception would be managed via understandings with suppliers, involving a technique called “over-invoicing.” Here, project bills—from the builders who constructed a steel mill, for example—would be inflated, with the difference shared between the supplier and the company. Bankers would be kept in the dark. Similar methods could also be used to overvalue imports, like coal or iron ore, or to rig the terms of public-private partnership contracts.10
“All of this was the worst form of crony capitalism,” as Jayant Sinha, by then a junior minister in India’s Ministry of Finance under Narendra Modi’s government, put it to me in 2015, describing the previous Congress government. “They [the banks] were taking depositor money and giving it to all of these crony capitalists in Mumbai and Hyderabad, who then went off and built all of these projects, some of which they must have known had no chance of being viable. But they were making so much money they didn’t care.” Debt problems did not affect every industrial company. Businesses in sectors like consumer goods tended to borrow more sensibly. But many projects still ended up undercapitalized. “Gold-plating of project costs was widely used by developers to take out their equity through means other than project cash flows,” Rajiv Lall, an economist and banker, wrote in 2015.11 The tycoons had grown out of control. “The atmosphere was one in which the prime minister talked about unleashing the animal spirits,” as Jairam Ramesh put it to me. “But the animals became man-eaters.”
At its most fundamental level “House of Debt” revealed that a crucial cog in India’s economy had broken. The conglomerates, the backbone of the industrial sector, found their biggest projects stuck. Hit with what economists call a debt overhang, they grew either unable or unwilling to invest again, plunging the wider infrastructure sector into recession. For all their vaunted aggression, the tycoons stumbled because they did not adapt to a significant change in India’s political economy. Many had come of age before liberalization, a time when capital was scarce but political problems were easy to negotiate. These two foundational assumptions then changed. First, capital became cheaper, as globalization extended its reach during the 2000s and long-starved tycoons helped themselves to as much funding as they could find. But then, against a backdrop of corruption scandals, the promoters found their old political tricks no longer worked. Saddled with debt, their powers to work the system suddenly vanished.
The Bad Banks
As India’s central bank head, Raghuram Rajan was the man most directly responsible for helping India’s banks to clear up the mess on their balance sheets. But to do this, he first needed the banks themselves to recognize they had a problem. “I remember one public sector banker saying to me that he had made a loan to this tycoon, who shall remain nameless,” he told me, about a year after his term as central bank chief had ended in 2016, and he had left Mumbai to return to the classroom in Chicago. “The banker found out that he [the tycoon] had been diverting cash away from one of his investment projects. And he [the banker] told me, when he found out, he said: ‘I was so angry with him, I cut his credit line by ten percent!’ And when I heard this I almost started laughing. ‘That is what you did to him? You cut his credit line by ten percent?!’ It was ridiculous.”
The timidity of the banker’s response, in which a major breach of the rules had been met merely with a slap on the wrist, drove home to Rajan the deeper imbalance at the heart of India’s financial system—between its risk-taking, plutocratic “promoters” on the one hand and its cautious, poorly paid state bankers on the other. “I don’t want to suggest the bankers were afraid. But you have to understand that they knew these guys [the tycoons] had so much more power relative to them, and more influence in the corridors of power,” he went on. “For all of their lives, they had seen these tycoons on the TV, or in the newspapers, or in the gossip columns, and so suddenly having to stand up to them was difficult.”
Rajan’s academic background was especially well suited to fixing this imbalance. Many economists who study banking prefer to stick with the neatness of theory and avoid the messy everyday realities of the financial system. Rajan was the opposite. His PhD thesis at MIT, entitled “Essays on Banking,”12 featured a trio of papers casting doubt on the idea of perfectly efficient financial markets, the last of which looked directly at the ties between corporations, lenders, and debt. In his early academic career he went on to explore a range of other unfashionable corners of the financial sector, from bond pricing and bank credit to capital structures.
Rajan had an interest in corruption, too. After the late 1990s’ Asian financial crisis, he published a paper explaining why countries with “relationship-based systems” of investment, like Malaysia and Thailand—meaning those that suffered from rampant crony capitalism—were especially prone to financial collapse.13 Then, at the International Mone
tary Fund, where he was made the youngest-ever head of the research department, there was his 2005 speech highlighting the dangers posed by risk-taking financiers and predicting much of the coming global financial crisis.14 Yet for all this, Rajan told me he still had no real sense of the scale of India’s debt crisis when he arrived at the Reserve Bank of India. It took him the best part of two years to find out.
At first he had other problems, beginning with inflation, a scourge that India had never properly managed to bring under control. Then, a few months before he took over, India was hit by a serious financial crisis, as US Federal Reserve chair Ben Bernanke hinted that he would begin to throttle back America’s quantitative easing effort, the multitrillion-dollar cash-printing machine that had helped to stave off the worst of the global crisis. Investors around the world panicked, pulling capital out of emerging markets and from India in particular, with its historically weak public finances and ominous current account deficit. India was suddenly plunged into its worst financial crisis since 1991: the rupee crashed, financial markets went haywire, and the government flailed, trying to come up with a coherent response.
Not a man given to exaggeration, Rajan walked into the RBI’s press room on a Wednesday afternoon in September 2013 to make his first speech as governor. He put the situation as calmly as he could: “These are not easy times, and the economy faces challenges.” Yet even then he gave a clear hint of the wider battle he would soon begin to fight against India’s more delinquent tycoons. “Promoters do not have a divine right to stay in charge regardless of how badly they mismanage an enterprise,” he said, towards the end of his speech. “Nor do they have the right to use the banking system to recapitalise their failed ventures.”15 Coming from an Indian central banker, these were fighting words. “I wanted to be clear that it wouldn’t just be the bankers taking the hit,” he told me later. “The industrialists taking the upside when it was good, and shoving the downside down the throats of the banks when it was bad. That had to stop.”
The Billionaire Raj Page 24