The auction for 3G Spectrum was concluded on 19-May-2010 in India. It will fetch the Indian Government Rs.67,710 crores this fiscal. TRAI Chairman J S Sarma, a career bureaucrat, has stated that the bidding has been sensible while the premier Telecom player, Bharti Airtel, has a view that the bids have been “beyond reasonable”, primarily driven by spectrum shortage and auction format. None of the players has managed to acquire a pan-India license, however, some have managed to bid smartly than others. Now that the bidding has concluded what are it’s implications for Telecom players, consumers, future regulation and broader economy.

It was good while it lasted

Telecom sector in India (at around 4% of GDP) has seen a lot of action over the past year, with the launch of several new players and their frenzy to woo subscribers by lowering tariffs, impacting the sector’s fantastic revenue growth of the sector over the past several quarters. With two key developments this year, viz. Mobile Number Portability (MNP) and launch of 3G services, the times ahead for the players are going to be challenging rather than exciting.

  1. Inability to command tariffs
    • With voice call charges per minute at 52 paise/ min (around 1/8th of a penny), most players would be looking at 3G as the next vine of revenue to hang on to. But, a combination of subscriber-thirsty new GSM operators and subscriber-loaded old GSM operators as 3G players is a recipe for disaster for the industry. The savage tariff war for voice services has left the industry in shambles. If this tariff war extends to 3G services, which it most likely will, it will be the straw that breaks the camel’s back
    • The data services value chain in India is ill-developed. There is lack of readily available databases or content on which applications can be built to provide services to customer. As such, there will be heavy dependence on data-ridden voice services such as video-calling to provide services. These services will be competing with low-cost 2G ridden voice services substitutes – making charging economically rational tariffs difficult
  2. Huge debt burden or Dilution of ownership
    • Bharti Airtel has paid a total of Rs.12,295 crore for access to 3G spectrum in 13 circles. There operating cash flows in FY 2009 were to the tune of Rs. 12,000 crore, whereas free cash flows were around Rs. 2,500 crores (source: Annual Report FY 2009 of Bharti Airtel). With revenues stagnating due to falling tariffs, the operating cash flow will be under pressure. Inevitably, Bharti Airtel will have to raise funds through debt or equity route. Without loss of generality, it can be assumed that this will be the case for most players
    • A debt and the subsequent interest burden is likely to hit players hard, if a situation where revenues are under pressure continues to exist. Even if the debt is raised overseas, unless it attracts extremely favorable credit ratings, very unlikely, the interest burden is bound to be significant
    • Valuation of most telecom players have dropped by more than 40%, even as the market has grown by 60% over the same period. With such poor valuations, raising equity will imply significant dilution of ownership, which would lead to loss of control in some measure
  3. Launch of MNP vs Delay in allocation of 3G waves
    • Firstly, there is a delay anticipated in the allocation of spectrum to the players. The allocation hinges on the Defense department vacating the spectrum, which in turn hinges on BSNL readying an alternative fibre-optic network for them. The resultant delay will push the date of allocation of spectrum by 4 months from the stipulated September 2010
    • Secondly, MNP is slated for launch around September 2010. It will allow customers the freedom to switch operators without having to give up their number. The older and bigger players will then have to fight a uphill battle to discourage their high value customers, who would be the early adopters of 3G enabled services, to newer 3G-enabled operators. The older operators will have to go to any extent to protect their 3G revenues, even making losses on 2G services in the interim

Either way, consumers will pay

After much await, 3G services will finally be available to Indian telecom consumers. The high prices that auction has attracted, lack of a pan-India 3G services provider and a lower tariff regime will ensure that the consumer pays, one-way or the other.

  1. High tariffs
    • It is natural to assume that, as discussed above, if the voice tariff wars do not extend to 3G services, consumers will have to pay considerably high charges for availing even the most basic 3G services
  2. Lack of true data services
    • In developed markets too, 3G was primarily deployed to deliver voice content – data-ridden voice – until recently, when the apropos development in the upstream of value chain, true data services such as location-based services, social networking, music downloads, mobile books downloads, etc have started taking over
    • There is an urgency to direct effort and investment in developing the data services ecosystem in India, something which is less likely to happen, at least, in the near to medium term. If ability of operators to command high tariffs is impaired, the delay in true data services will become even longer
  3. Poor network quality
    • A tariff war will have direct implication on the quality of service of the 3G network. The quality of service on existing 2G network itself is not very laudable, even with the best operators. Consumers will thus have to pay in terms of poor experience of 3G services, as operators cut corners in a bid to sustain profitability
    • There has been no takers for the pan-India spectrum due to the high costs of the auction. This implies players will be required to ally to provide pan India services. With the existing levels of competition, apprehensions about sabotage combined with generally poor lack of enforcement of contracts in India, will imply that such alliances will be on weak support, impacting in turn service quality

The Pandora’s Box isn’t empty

The callous approach to Telecom regulation has opened this Pandora’s box for the industry (which will eventually translate into trouble for consumers). And TRAI (Telecom Regulatory Authority of India) and government isn’t done defining/ shaping the rules of the game yet.

  1. Spectrum Policy
    • Recently, TRAI has recommended an approach on Spectrum Management & Licensing. One of the key recommendations, is to make the GSM operators pay for spectrum over 6.2MHz and CDMA operators pay for spectrum over 5MHz at market prices determined by the 3G auction
    • Such mid-course abrupt change of rules can spell disaster in an industry where operators have to commit significant capital investment upfront. Considering that the outlay for 3G itself will be huge an additional stress on the operators’ balance sheet, will only do more harm than good
    • A better way to manage spectrum is through a spectrum exchange, as some have argued. It will bring in efficiency through improved specialization in spectrum management in the telecom value chain, and not bring abrupt shocks to the industry. In an industry, which has become crowded with players interested in primarily hoarding the spectrum than extend services to the Indian masses, it will spur consolidation, currently hindered due to the regulations
  2. 4G – now a distant dream
    • 4th generation technologies offer key advances over 3G technology for wireless communication. Backward compatibility with both GSM and CDMA technologies is one of the most important advances in this technology. However, if the apprehensions surrounding the inability to reap benefits of 3G in near to mid-term turn out true, then it would imply unwillingness of operators to go in for 4G spectrum auction any time soon and deprive consumers of a better technology
    • In India, where a sizable subscriber base is on CDMA platform, the prudence of not leaping to 4G from 2G and hanging on to 3G is questionable. Even as, cell phone manufacturers are yet to to catch up with 4G technology, a bit of delay over an already delayed 3G spectrum allocation would not have made a huge difference to the economy. It would however have created a level playing field between GSM and CDMA operators and fostered productive competition for subscribers/ usage rather than unproductive competition for favorable policy(s)
  3. MNP
    • As discussed above, any delay in 3G spectrum allocation vs launch of MNP will mean greater costs to the industry
    • MNP is intended to remove a key barrier to entry in the Telecom industry. However, by favoring 3G (compatible only with GSM technologies) over 4G regulation, it has ultimately disadvantaged CDMA operators vis-a-vis GSM operators and hindered competition in the country. In effect, many of the benefits which MNP was supposed to bring the consumer may only remain on paper
  4. Consolidation Norms
    • The regulatory framework on consolidation poses impenetrable barriers to consolidation in a fragmented industry. If these norms are not rationalized, the scale required by operators to foster any real innovation in 3G powered data-services beyond the phony innovation of price reduction will not be achieved

Other broad implications

The Rs. 67,710 crores that the auction will fetch the government will be around Rs. 32,000 crores more than the budgeted Rs. 35,000 crores. The government’s receipts this fiscal (FY2010-11) is budgeted at Rs. 11,08,749 crores. It implies an additional revenue of ~2.9% of budgeted to the exchequer. Ceteris paribus, it would reduce the fiscal deficit to 2.6% from budgeted 5.5%. If predictions of good monsoon stand vindicated, a further decline in fiscal deficit can be expected.

Discounting the treasury view, that fiscal effects have little impact on economy, we can anticipate a medium term softening of interest rates as government borrowing reduces and inflation lowers. This could eventually boost consumption and benefit Telecom companies indirectly.

Other possibilities are also likely:

  1. The excess amount is directed towards more social sector spending, having no effective impact on the fiscal deficit. Next year, West Bengal – a critical state from political perspective – goes to polls for State Assembly elections. The extra monies could be used to create outlays for people of West Bengal by the Government
    • Likewise, it could redirect expenditures, plan or non-plan to meet its political objectives and as a by-product to suit social ends too
  2. Government has sought to generate Rs. 25,000 crore from divestment of PSUs in the current fiscal. With the Rs.32,000 crore bonus on 3G auction (and probably more from BWA auction), it is likely that these divestments are delayed
    • It could similarly redirect any other efforts at increasing revenues – aimed at reducing subsidies, recovery of loans, etc

All this would negate the possible benefits that a reduced fiscal deficit might bring, apart from the externalities that such actions would create.

3G services offer an unbridled promise to reduce inequalities and exploitation due through reduction in information asymmetries via faster/ better information flows consequent to expansion of internet services in the hinterland of the country where traditional wireline internet services can’t reach. The high cost of the auction will actually make this very difficult as discussed above. This will be the real loss – unmeasurable but real.

Update 1:

The government made a killing with BWA auctions. Instead of the anticipated Rs. 35,000 crore from the 3G and BWA auction, the government ended up receiving Rs. 106,262 crore. This additional ~7% in receipts could wipe out the entire fiscal deficit, estimated at 5.5%, this year for the government. However, now there are even more incentives for the government to increase the social sector outlay to meet political ends. Any deficit rate lower than the budget estimates is bound to give the government a chance to give itself and to demand from others a pat on the back.

In the meantime, BSNL has threatened to strike and asked for being waived for entire Rs. 18,500 crore of charges which it is required to pay. The Telecom Ministry is advocating a refund to MTNL also. The request, if accepted by the Finance Ministry, has potential to dramatically change the post-3G market conditions by distorting competitive advantage in favor of both the ailing PSUs (more on it in a separate post).

Views expressed are personal.