Saturday, Oct 25, 2014

Because the price was right

Mistakes like not setting the right reserve prices can lead to disastrous consequences as in New Zealand, where bidders paid $6 for licences worth $100,000. Mistakes like not setting the right reserve prices can lead to disastrous consequences as in New Zealand, where bidders paid $6 for licences worth $100,000.
Written by Sandip Sukhtankar | Posted: February 18, 2014 12:34 am | Updated: February 18, 2014 10:05 am

Sandip Sukhtankar

Better auction design was key to ensuring that 2G spectrum did not remain unsold
Like a good saas-bahu saga, the story of 2G spectrum allocation in India seems to have reached its end with an exciting final episode. The 2G spectrum auction has witnessed  total bids of over Rs 60,000 crore, surpassing the Rs 30,000-40,000 crore expected by the government. The auction left telecom officials relieved, particularly after the calamitous previous auctions in November 2012 and March 2013. Why has this round of auctions been successful? What lies ahead for the telecom sector?

Before answering these questions, a synopsis of the plot is in order for those casual observers who have not kept up with all the episodes in the series. It starts in early 2008, with the farcically arbitrary allocation of 122 licences (and associated spectrum) at substantially below-market rates. In 2010, following juicy plotlines involving tapped phones and corporate lobbyists, the now-famous 2G scam breaks out, with a CAG report detailing numerous irregularities in the licensing procedure. This episode also includes the arrest of then telecom minister A. Raja in early 2011. The Supreme Court annuls all 122 licences in February 2012, which leads to auctions held in November 2012 and March 2013 to allocate the spectrum afresh. Unfortunately, with the economy having taken a turn for the worse in the interim, much of the spectrum remained unsold.

The final episode involves selling this remaining spectrum, which by all accounts Trai has managed to do successfully. The main reason why the outcome of this round of auctions was different had to do with Trai getting reserve prices right. After consultation with stakeholders and considering market conditions, reserve prices were cut sharply (up to 50 per cent) compared to those in the unsuccessful previous auctions. At the time, this decision was far from universally acclaimed: many observers expressed concern over the potential loss to the government from these cuts.

One might ask: why not just increase reserve prices, and if market players do not value spectrum above these prices, they simply won’t bid? Won’t higher reserve prices lead to higher revenue for the government? The answer here is that there is no such thing as a free lunch — an increase in reserve prices may deter entrants, and in fact make it easier for remaining bidders to collude, leading to lower actual bids. To understand these ideas better, let us examine the economics behind allocating spectrum.

Radio frequency spectrum is a valuable natural resource, perhaps nowhere more so than India, where wireless telecommunication is an especially important sector of the economy. How should the government allocate this scarce resource? The allocation mechanism has continued…

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