Dial R for regulators

There is enough evidence to suggest that large infrastructure investments have a significant impact on economic growth and poverty alleviati...

There is enough evidence to suggest that large infrastructure investments have a significant impact on economic growth and poverty alleviation. Like the previous government, the UPA Government has also committed itself to the expansion of physical infrastructure like roads, highways, ports, power, water supply and sanitation. Substantial investments are essential for the improvement of infrastructure and the Indian State is not in a position to finance and efficiently manage investments on this scale. Consequently, the role of the private sector is crucial for these tasks. The Common Minimum Programme also pledges public-private partnerships in the delivery of these infrastructure services.

However, private participation has to be preceded by sector restructuring and the creation of independent regulatory mechanisms, giving regulators clear and politically viable mandates. It has been argued that policy credibility and the existence of a sound regulatory framework are necessary for lowering the perceived risk of expropriation and thus for attracting private capital. In particular, the character of the entities entrusted with regulation determines confidence in the integrity of the system.

The task of these entities is to protect investors from opportunistic behaviour by the Government, to protect consumers from the abuse of monopoly or dominant positions by new private operators, and to ensure competition between new entrants and the dominant incumbent operators where feasible. In the absence of such credible institutions and commitment, potential investors might avoid investing in the first place or they may require additional premium to account for risk, raising the cost of capital.

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The Indian telecom story provides an interesting case of how telecom operators and potential investors include ‘‘regulatory risk’’ as a key factor in determining their investment strategies. Till TRAI was set up in 1997, DoT (Department of Telecommunication) was the regulator. The initial reluctance of the Government to break the dominance of DoT and to restructure the legal and regulatory regime led to endless litigations, which delayed the liberalisation process. Between 1997 and 1999, TRAI’s effectiveness was constrained by DoT’s successful litigation against it. Regulatory uncertainty and a lack of policy credibility were responsible for a sharp drop in FDI inflows. Several international telecom giants had by 1999 pulled out of India or frozen fresh investments. The total FDI inflow into the sector fell from $422 million to a little under $50 million over the period 1998-99.

It was only after the New Telecom Policy of 1999 (NTP-99) and the amendments to the TRAI Act of 2000 that TRAI became effective. The effectiveness manifested in many ways but most important of all was the regulator’s credible attempts in fostering competition by removing barriers to entry and through implementing competitive tariffs. Guaranteeing access to the incumbent network and reducing the incentives of the incumbent to foreclose competitive markets strengthened this endeavour.

Not that reform in the telecom sector is complete, and the gaps where they occur are due to the regulator’s inability to completely dilute the inherited strength of the state-owned incumbent. Moreover, the WLL controversy between 2001 and 2003, which eventually got resolved with TRAI’s initiative on unified licences, did not provide the correct signals.

Nevertheless, the results have been impressive. Teledensity has increased from merely 2 per cent or so in 1999 to a little over 7 per cent in 2004. Till December 2002, the capital outlay by the cellular and private basic operators for the set-up of service was $2.4 billion and $3.3 billion respectively, whereas the total foreign direct investment has been $2.4 billion. Till March of 2003 private cellular operators had made an investment of Rs 23,000 crore (almost $5.1 billion).

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The telecom sector clearly demonstrates the importance of sound regulatory regimes in providing credible commitment to safeguard investment. This institutional support is an essential pre-requisite for private investment and investor confidence. Once established, the substantial private investment flows will effectively supplement the meagre public investments that may be feasible given the dire fiscal situation of the state.

(The writer is a senior lecturer of Economics, Delhi University, and a consultant to the Centre for Infrastructure and Regulation, NCAER)