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Crony capitalism and collective laziness of operators has brought Indian telecom sector down on its knees

India has always had an extremely corrupt business environment. The government has large discretionary powers. It sets complicated rules, which it may change at will. If anybody wants to run a business, he or she has to “please” officials and ministers.

This crony capitalism, where specific businessmen are favoured by governments is not unusual. Every nation has seen some form at some stage of its economic history. More prosperous nations have moved beyond this stage.

One cynical argument is that crony capitalism eventually leads to an opening up of the economy. Examples like the US, Japan, China, Taiwan and South Korea are cited. The logic is: one crony capitalist enters a sector. The government changes rules to favour that business. Then another crony capitalist also enters. Eventually, several crony capitalists are in action; each asks its friends in government to manipulate rules. By a back-door mechanism, policy is corrected and competition develops.

One downside is that policy remains obscure and arbitrary, and national resources are looted by the nexus of corrupt governments and businesses while crony capitalists are in charge. Common citizens and consumers get a raw deal. Phases of crony capitalism can easily last decades. An example is the Indian automobile industry. For 35-odd years, there were only two major car-makers.

We’re seeing the downside of a crony capitalistic phase playing out now in telecom. This sector was hailed as a triumph for liberalisation when private players were allowed to offer telecom services. Yet it remained crony capitalistic, with multiple policy distortions. It has suffered its worst-ever year in 2012 as some attempt has been made to correct problems. Next year also promises to be bad.

Let’s run through a brief history. In 1996, private players were allowed to bid for mobile telecom licenses by the Narasimha Rao government. Himachal Futuristic, which had close links with the then-telecom minister, Sukh Ram, put in amazingly high bids. Sukh Ram was eventually nabbed with large sums of cash but the services ended up expensive. Mobile tariffs were set at ridiculous rates of Rs 16-plus/minute with both incoming and outgoing calls being charged.

In 1999, the NDA government made some smart policy changes. First, it proposed that incoming calls be free. Second, it proposed that the government take a share of revenue, rather than charging everything upfront. That helped make things economically viable. Licences were re-auctioned at more reasonable rates. Operators started a price war as telecom became highly competitive. Subscribers signed up by the millions every month. India became the second-largest market in the world, with the fastest growth rates.

However, policy issues remained. The regulator, TRAI, often clashed with the government-run Department of Telecom. Opinions differed on the treatment of licences, spectrum, technology, roaming, tax-treatment of infrastructure, investment from abroad, etc., and there was also a lot of litigation on those issues.

In 2008, the UPA’s telecom minister A Raja turned things inside-out again. First, he bid out licences on a bizarre first-come, first-served basis at the old price, which was by then ridiculously cheap. The market had grown from under 5 million to over 600 million but the licence fee remained the same. Literally 120-odd 2G licenses were handed out on a single afternoon. Second, Raja held up investments that the government-owned PSUs, MTNL and BSNL, needed and thus, crippled them. Some “lucky” licence holders happily sold stakes for massive windfall gains.

In 2010, the new generation 3G licenses were auctioned and the industry, which had saved money on 2G licenses, bid high for these. The 4G, broadband wireless access licences, were also auctioned but found fewer takers.

In February 2012, the Supreme Court cancelled the 122 “Raja 2G licences” en masse and ordered that the 2G licences be re-auctioned. This time around, spectrum allocation would be simply on the basis of auction bidding. In July, August and September, the subscriber base shrank, in part because the industry got rid of inactive pre-paid subscribers.

It was also decided that base price for 2G licenses would be higher than the 3G prices. The latter service (3G) hasn’t taken off yet – in part, because it’s expensive and also because 3G coverage is patchy. There’s also litigation going on with a dispute about 3G inter-circle roaming arrangements. The authorities also want to re-farm spectrum, which means another additional expense for operators. Refarming means releasing spectrum in one frequency and reorganising services to operate on another frequency. The next-gen 4G technology has only been rolled out in pilot projects in two or three places and there’s no uptake to speak of yet.

Every operator has massive amounts of debt on the balance-sheet; the profitable ones have seen shrinking margins for the last two years. They are also trapped in a marketing cycle where they cannot afford to exit 2G – a technology that is two generations old. Once they pay for the new licences and spectrum, the debt burdens will be even higher.

Their other capital and operating expenses will also rise. The only way to find new subscribers is to enter rural / semi-urban markets. There, the costs of back up power and setting up more towers, are higher than in urban areas. The telecom industry already consumes more diesel than the railways.

There is also a chance that other states will emulate Rajasthan, which is imposing court-mandated zoning restrictions to reduce microwave radiation from cell towers. If that happens, operating costs will rise even further because a lot of existing infrastructure will have to be junked.

There is no way that the industry can sustain competition with a dozen players in every circle and it’s likely that 2G bidding will be very selective with a big shake-out. Over the next year or two, there will be a lot of mergers and consolidation. Speculation on that front might be the only factor that keeps share prices from collapsing.

Auctions for spectrum have been delayed till January 2013, and there is still lack of clarity on policy issues. There is litigation on several technical issues. There were also events like the retrospective tax demand on Vodafone. Despite being obviously vital infrastructure, the telecom tower industry did not get “infrastructure status” until recently, thus being denied tax breaks and access to relatively low-cost funding. Merger processes are messy and so are FDI regulations.

Part of the problem was also collective laziness on the part of the telecom operators. The 2G licenses were cheap; 2G supports voice; the vast majority of subscribers only wanted voice. So operators never tried to market serious value-added services and data offerings beyond ringtones and music downloads.

As a result, India has around 700 million active mobile subscribers. But average revenue per user (ARPU) is a paltry Rs 95 for GSM services and Rs 75 for CDMA services. Most use voice, some use text messaging, very few use data services. SMS and data usage together amounts to only about 15 per cent of revenues – the global average is 30-35 per cent. The operators never tried to push higher data-usage, which is the only way to improve ARPU.

Nor did they care about quality of service – dropped calls and network errors are endemic. The only game the operators played was a price war centred on offering the cheapest voice service. SMS was basically seen by most operators as a means to offer spammers for bulk messages.

Well, the last year has turned industry economics on its head. 2G may actually end up being more expensive than 3G, and 4G could end up being cheaper than both 2G and 3G in operating expenses. Both 3G and 4G are data-efficient, which means operators will have to scramble to create data offerings and services if they want uptake. Government policy in theory should support a thrust into data since it is trying to create broadband connectivity across all panchayats with its National Optic Fibre network.

There are political dimensions too. Consumers will be angry if tariffs spike up or if usage is disrupted because the operator has shut shop and this could influence voting. There are also externalities. High telecom penetration has been an enabler for commerce in general and it helps drive GDP growth. If the industry stalls, it will be yet another factor retarding economic growth and development. We may yet see the industry recovery from this difficult situation but it will take plenty of time. This is the sort of mess crony capitalism creates.