Lessons to be learnt

Dismantle artificial barriers between demand-supply and strengthen oversight to nip monopolies

By Mohan Sule

India has always been a difficult place for foreign investors. For every multi-brand retailer like Walmart, who is eager to enter the country to tap the vast market, there is another disillusioned investor like Fidelity Mutual Fund, which wants to exit, frustrated by the maze of regulations that make accessing this huge pool difficult. Recent events have brought this dichotomy in foreign investors’ perception rather sharply. If the Supreme Court’s stinging rebuff to the finance ministry for levying capital gain tax on Vodafone’s acquisition of the stake of Hutchison, another overseas investor, in its telecom joint venture with Essar restored the confidence in India’s slow-moving legal system, the cancellation of all the 122 second-generation (2G) telecom licences issued on first-come-first-served basis in January 2008 has reinforced the view that India is too chaotic a place to do business, with frequent changes in the rules of the game offering no long-term stability. Two showcases of reforms with potential to power the India Growth story — telecom and aviation — have become examples of crony capitalism and the embedded bias against FDI in the political class. Sadly, India today is talked more for its corruption rather than being bracketed with China for its economic power. Nonetheless, some good may come out of the sorry events of the past days if some lessons are learnt. The first is the price of interference in the demand-supply equation can be heavy. The telecom sector is the prime example. There was cap on the number of players in each circle. Licences were issued based on technology. Foreign investors were barred. Eventually, the concept of unified services access was introduced, allowing  services providers to offer services across segments and technologies.The result was a boom in subscriber base as tariffs fell due to competition.

Yet, the awarding of the 3G spectrum shows that inferences from the earlier mistakes have not been drawn. Though the licences were auctioned, players were again restricted to circles. To get over the inability to offer pan India services, providers started inking roaming pacts with each other. This practice has been met with stern disapproval from the industry watchdog. Equally disastrous, says the second lesson, is doling out licences to equity investors masquerading as entrepreneurs rather than to those with the intention to stay and succeed. Selling part or entire stake by almost all those who bagged the 2G licences in the second round (though only Swan Telecom and Unitech Wireless have been charged by the CBI) for huge profit show that arbitrageurs benefit from lack of transparency. This should silence critics who maintain bidding raises the price of the end product or service as those acquiring the rights try to recoup their investment. This gives rise to the third lesson. There is no one-size-fits-all method to sell scarce natural resources. The expenses involved in drilling oil are fairly stable. But exploration rights are auctioned and the producers calibrate crude prices as per demand even while selling it on a first-come-first-served basis. This means even fixed pricing has a variable element. The problem arises when the cutoff is determined not by availability but to accommodate cronies as happened in the telecom space three years ago. Eventually, the corruption of the process proved self-defeating. The large number of entrants jeopardised the health of the telecom industry.

The conclusion that can be drawn is that if the price of the end product depends on demand rather than the cost of production, auctioning is the best method. Eventually, this will lead to levelling of the field, with the cost-efficient surviving the fluctuations in consumption. This leads to the fourth lesson. Imposing physical or financial barriers to limit players is harmful and so also restrictions on mergers and acquisitions, which constitute the market’s search for equilibrium. Second and third tier companies amalgamate to take on the number one player and the leader gobbles up smaller players to achieve economies of scale and stay profitable. This brings to the next lesson. There is need for a strong competition overseer who would step in to ensure that users have a choice in prices, products and services. The European Commission has nixed the proposal of the NYSE Euronext stock exchange and Deutsche Borse to merge for this reason. In India, the Competition Commission has yet to become assertive. Instead of hoping for regulatory or judicial intervention, it is time shareholders become vigilant and nip promoters’ grandiose dreams in the bud. For instance, if institutional shareholders had questioned why real estate companies need to diversify into telecom services, India would have been saved from seeing its image take a severe drubbing.

Mohan Sule