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Photo: Mint

The fuss over spectrum auctions

The annual hullabaloo over expensive spectrum rates needs to end

The recently concluded spectrum auctions have been characterized by many commentators, including Kapil Sibal and Sunil Bharti Mittal, as a windfall for the government but a loss for millions of telecom users. Their logic remains premised on the fact that telecom companies will cover for expensive spectrum by passing on costs to the consumers. The logic seems ill-founded both on theoretical as well as empirical grounds.

Sibal, a former Union telecom minister, recently sort to establish causation between high spectrum bids and final tariffs, saying, “for example, every rupee extra a chaiwala pays for his dukaan, doodh aur chai patti, will always come out of your, the grahak’s wallet". He further asserted that increased infrastructure and material costs will increase the cost of the end product. Unfortunately, Sibal’s almost tautological conclusion, even if true for a chai dukaan, is largely inapplicable to how consumer tariffs are determined in the telecom industry.

The criticism confuses the direction of causation: while ex-ante, operators take into account the estimates of future prices when determining their willingness to pay, ex-post, spectrum bids do not influence prices. This is because firms charge prices that maximize profits, that are based on forward-looking variable costs and revenues independent of sunk costs, such as auction fees.

The price of spectrum is typically a function of current supply and demand conditions and the level of competition, and is not dependent upon the historical cost at which the firms acquired their spectrum. Since, spectrum licences are granted for a 20 year period, the bid amount, a lump sum payment upfront, is amortized across the duration of licence, eliminating the chances of a hike in telecom tariff based on historical costs.

Another objection of Sibal is that large licence fees may corrode the finances of the firms. This argument assumes that the government has better information about firms’ prospects and should use its own judgement in place of commercial aspects implicit in the bids. Economic theory dictates that a firm would never knowingly bid more than the discounted value of expected profits to acquire a licence.

A competitive spectrum auction process facilitates the assigning of licences to the most efficient producers, aiding efficient aggregation of spectrum, and ensures efficient allocation of spectrum into services consumers value the most, thereby expanding the supply and reducing the prices of the wireless services most valued by consumers. Simply put, if tariffs didn’t go up in 2010 after the 3G auctions and in 2014 after the 2G auctions (which raised $14.5 billion and $10 billion, respectively) despite India having the cheapest data packages in any of the emerging economies, they should not go up now.

It is true that the exorbitant spectrum prices would leave telecom companies with distressed balance sheets; however, concerns that the rising debt-servicing costs would be passed onto customers is ill-founded. Robust price competition in the market with the imminent entry of deep-pocketed players such as Reliance Jio (with the capacity to engage in aggressive pricing strategies) and the proposed inter-circle mobile number portability (with its significant impact on retaining customer loyalty), would make it tremendously challenging for telecom firms to unilaterally lump-up tariffs.

However, payment of auction fees can create focal points that allow firms to coordinate tacitly on charging higher prices as well as make them more willing to risk collusion. These shortcomings can be precluded by a good competition policy.

For those expounding theories that the higher auction rates would deny the availability of capital to the debt-burdened telecom industry are ignoring the fact that few other sectors have had as much access to capital as telecom. For example, telecom has remained the third most attractive sector for foreign direct investment (FDI) since 1991 and in the period between 2000 and 2014, receiving more than $16,634 million in FDI inflows. In the recent past, telecom firms have taken advantage of the buoyant stock market to raise money, allowing them to deleverage. The total debt of the three listed telecom firms, Bharti Airtel Ltd, Idea Cellular Ltd and Reliance Communications Ltd, has declined from approximately 1.2 trillion as on 31 March 2014 to about 1.1 trillion as on 30 September 2014. Further, the industry’s profitability is on the rise. As per industry reports in January 2015, the sector’s adjusted gross revenue has shown a 14% increase year-on-year in the first quarter of FY15. The industry has seen the cycle of firms bidding excessively for spectrum licences in parallel with the availability of capital, rendering moot the theory that lack of capital should be another significant factor in determining the price of spectrum.

This annual hullabaloo over expensive spectrum rates needs to end. The thumb rule is spectrum pricing should be determined by scarcity and consumer tariffs by competition and if that fails, through the Telecom Regulatory Authority of India’s intervention. Having said that, the government should make efforts to reduce artificial scarcity and bring more spectrum to the market and allow for a secondary spectrum market to avoid a do-or-die situation for the incumbents.

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