Need to untangle telecom

The setting up of a Group of Ministers to find a way out of the telecom sector's problems is ironic, in a way. Telecom has been deemed the unquestionable success of the reforms era.

Connectivity is growing at an exponential rate. People who find it hard to access water or sanitation can subscribe to phones in an instant. And yet, with all its dynamism, it appears to have run into a barrier, which can only be resolved at the policy level.

The prevailing problem in the sector is the result of three things.

First, there is the legacy of the previous regime in the form of government-owned providers, who have received differential treatment in the new regime of licensed private provision.

Second, there has been a blurring of boundaries between what were seen as two separate and distinct attributes of telephony -- 'connectivity' and 'mobility.'

Third, there is an apparent contradiction between the policy objectives of the government, which are to increase connectivity, across the country, but with particular emphasis on rural areas, and the inherent restrictiveness of any licensing regime.

Let's first look at the sector from a 'clean slate' perspective. Let's consider three stakeholders -- consumers, providers and government. The government's primary interest is defined in terms of its policy objective to increase connectivity.

Technology is secondary; to the extent that the demand for connections is price-sensitive, lowering costs and prices is really all that matters. This is a situation tailor-made for free competitive entry, except for one thing.

Uncertainty about entry will deter potential providers from making investments. It is in this context that licensing, which is entry-restricting (and therefore, competition-restricting) becomes a necessary evil. With licensing comes potential monopoly power and, therefore, regulation.

Here is where the fundamental distinction between 'connectivity' and 'mobility' becomes critical. As far as the government is concerned, its policy objective is stated in terms of expanding connectivity.

Licences will be issued, although at relatively low prices, since the regulated tariff needs to be kept as low as possible. From the provider's perspective, his licence fee is the cost of buying protection against simultaneous competitive entry.

In a dynamic setting, the value of each licence should reflect changing technology and demand conditions. It should not preclude the entry of new providers with cheaper technologies, which can take connectivity to a new level.

This logic dictates that licences and licence fees should be time-bound; that the value of an incumbent's licence, should he choose to renew it, can see its value change as the nature of technology and the intensity of competition changes.

As for the consumer, he is getting the service from a relatively large and accountable provider at a regulated price, with the knowledge that he will not be denied the benefits of new technology as and when it comes along.

But, this is as far as connectivity is concerned. What about mobility? This is really a value-added attribute to telecom services, what economists refer to as a 'superior' or 'luxury' good.

Its value, and therefore, the willingness to pay for it, is presumably quite closely related to income. In issuing licences for mobile services, the shared issue with basic connectivity is that of protection against competitive uncertainty. But there are also two additional considerations.

One, since increasing mobility (as opposed to connectivity) is not an explicit policy objective, a tax component can be built into the licence. This will be passed on to subscribers by the provider.

There is a trade-off between the government's revenue objectives and the value-for-money that the provider is able to offer, but a mutually acceptable solution can be found. Two, to the extent that the mobile provider uses the regulated spectrum, he will obviously pay a price for it.

Given that different technologies involve different spectrum usage, the mobile licence fee needs to be transparent in distinguishing between the protection-tax component and the spectrum charge.

Emerging from this is a case for a three-tier structure of licences. A basic, low-cost licence for simply providing connectivity is at the bottom. This is only for protection against uncertainty and is not driven by any revenue considerations.

The next tier is a licence for mobility, which, besides providing protection, is also a source of revenue, based on a 'luxury tax' argument, if the government so chooses. The third tier is the charge for spectrum use. This is the only basis of distinction between alternative technologies, which use the spectrum differently.

If one accepts this as a rational structure consistent with the interests of all three stakeholders, what stops the system from moving in the right direction? In a word, legacy.

From the perspective of the first generation of mobile service providers, the entry of a new generation is tantamount to competitive shock, which erodes the value of their licence.

Licence fees have to be reset, but, in addition, it is fair to argue that the difference between the old and new value of the licence provides a basis for some kind of compensation, related to the value of the protection component of the licence.

But, there is one more dimension to the legacy effect, in the form of government-owned providers, who now straddle both the basic connectivity and mobility segments, without explicit licence fee obligations.

The fee is implicit in the dividends that these companies pay the government, but it needs to be made explicit because it will become part of the pool of resources that the government would have to use to settle claims for compensation due to the changing values of licences.

Finally, to change tracks a little in the direction of universal service obligations. Providing a subsidy out of a fund is all very well, but there is one pricing change that is critical.

Usage patterns indicate that the bulk of traffic into rural networks is incoming. It is highly likely that this also originates mainly from different circles. In this situation, the only source of revenue for the rural provider is the termination charge.

This and the subsidy together still makes it a relatively unattractive proposition. There is probably an argument to be made for a 'receiving party pays' regime in rural networks.

Because it gives the rural provider some direct control over his revenues, it might induce a desirable expansion of network coverage.

The spectacular success of telecom in India has brought with it the seeds of future instability and deterrents to new investment. The government must act quickly to rationalise the regime in a way that is consistent with its own as well as the providers' and consumers' interests.

In principle, a three-tier licensing structure, which differentiates between service attributes rather than market segments or technologies, provides a sustainable way to reconcile these interests.

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