For years, the telecom industry helped successive governments line up their coffers. Now, things have come full circle, with the Prime Minister Narendra Modi-led government working on a relief package for the industry. While the exact nature of the relief package is still being worked out, reports suggest there are four options on the table: a reduction in license fees from the current level of 8% of adjusted gross revenues (AGR); a waiver of penalties and interest on past dues; a reduction in interest rates to market-linked rates; and a moratorium on dues.
Thanks to the double whammy of declining revenues and rising debt, there is a distinct possibility that Vodafone Idea Ltd may end up in bankruptcy court. The government is anxious about how this could impact competitive dynamics in the industry. That's not all. Most of the debt of the industry is held by the government and government-owned banks. So another default will have severe implications for the government's own finances, besides pulling down an already strained banking sector.
Of course, since various other industries have also asked for relief from the government, it will need to make a strong case of why the telecom sector is being singled out for help. The government's own finances aren't in the best of shape—the rating agency, Moody's Investors Service, cut India's credit ratings outlook to negative on Friday—and a relief package, depending on what form it takes, can impact the fiscal deficit in the near term.
And then the BJP government has to contend with industry leader, Reliance Jio Infocomm Ltd, which has been vociferously pointing out that taxpayer money needn't be spent on bailing out private firms which have themselves to blame for their situation.
Jio, thanks to a ₹1.75 trillion equity infusion from its parent, Reliance Industries Ltd, has the least leverage in the industry. Bharti Airtel Ltd has also managed the turmoil in the industry fairly well, thanks to regular fundraising and a recent equity infusion by its shareholders. But Vodafone Idea is precariously placed. A recent Supreme Court ruling, which confirmed a regulatory levy along with a massive penalty, has threatened the firm's existence. Its cash balance is far lower than the amount owed to the government as a result of the SC order.
"While in Bharti's case the impact will be material…for Vodafone, the impact could be nearly back-breaking," analysts at Emkay Global Financial Services Ltd said in a note to its clients.
But the big worry for the industry is that relief may come only in the form of a quick fix solution. What's really needed is a holistic policy approach that is not only pro-consumer but also encourages sustainable growth for the industry. "Telecom consumers have had it really great, with progressively declining tariffs over the past many years. But this also means that producers have had it really bad," says a former official of Telecom Regulatory Authority of India (Trai) who asked not to be identified.
Clearly, the elephant in the room is the cut-throat pricing in the industry.
The pricing factor
In the past three years, since Reliance Jio launched services, consumers have had it so good that the size of the industry has shrunk by a third. Three years ago, consumer-level spends on mobile services stood at about ₹1.8 trillion, which has now fallen to around ₹1.2 trillion, numbers collated by Kotak Institutional Equities show.
"The relief package being discussed deals primarily with the debt burden of the industry. But this wouldn't be sufficient to sustain the industry. All it would do is kick the can down the road. The heart of the matter is that current tariffs are way below optimal levels, and the government should consider regulations on pricing if it is really interested in a three-player market," says an analyst at a domestic institutional brokerage. Put simply, what would be the point of a moratorium of a couple of years on debt repayment if the companies seeking relief find themselves in the same situation when the moratorium ends?
But regulations related to pricing are a sticky affair, especially in an industry where the regulator has preferred forbearance over strictures on pricing. Besides, there is hardly any precedent for this in large telecom markets, and it won't be surprising if consumer interest groups rise up against the move. And to make the matter even more complicated, there have been turf issues between Trai and the Competition Commission of India (CCI), with even Supreme Court weighing in on the matter. On matters related to competition, the SC said CCI is the competent authority and added that this is an area Trai is not at all equipped to deal with.
In this backdrop, the government almost faces a catch-22 situation. It can claim the SC order ties its hands-on matters such as pricing, but to opt for inaction could mean that more relief is needed to be provided in the future, or that it eventually settles for a haircut on its dues.
A change in stance
Hints of the government's anxiety about a bankruptcy filing first came in mid-September. Out of the blue, Trai said it will review its decision to completely do away with interconnection usage charges (IUC) from 1 January 2020. Two years ago, it had cut IUC by about 57%, which resulted in huge savings for Jio and dealt a massive blow to the incumbents.
The cut in IUC to zero early next year was taken as a given by almost everyone concerned. "The last-minute change in stance shows that the government is keen that the current market structure with three private operators continues; it wants to avoid a monopoly or a duopoly kind of situation," said the head of research at a multinational brokerage, requesting anonymity. Vodafone Idea gets about a third of its operating profit from net IUC receipts. A review of the charge means that these receipts will continue longer than was earlier anticipated.
About a month after the decision to review IUC, the Supreme Court ruled in the government's favour on a dispute related to the calculation of AGR, and its implications for license fees and other charges levied on telcos. Along with penalties and interest on penalties, the total amount owed to the government by telcos stands at about ₹1.3 trillion, according to industry estimates.
For Vodafone Idea, the estimated outgo of about ₹40,000 crore is far in excess of its cash balance of around ₹20,000 crore. What's more, with the Supreme Court setting a three-month deadline for the payment of the dues, hardly any investors were willing to bet that the company would survive. Its shares fell to below ₹4 per share, and tellingly, stocks of banks such as State Bank of India fell sharply as well. Most of the dues owed to the government as a result of the Supreme Court order were from firms that were already bankrupt or are now facing bankruptcy. So it isn't surprising that the government has moved relatively quickly since the SC ruling. It has set up a committee of secretaries (CoS) to suggest ways to alleviate the stress being faced by the telecom sector, news reports said.
Once bitten, twice shy
Having telcos both bid for spectrum and also share a portion of their gross revenues is akin to the government having its cake and eating it too. The revenue share arrangement was part of a regime when the spectrum was administratively allocated to these firms. To continue with it in the post-auction regime amounts to a double levy of sorts. The auction process, itself, left much to be desired. Telcos were forced to get into a bidding war for the spectrum that they needed to survive. They ended up overbidding, which explains a large part of the massive debt on the books of some telcos.
With this background, some feel that a relief package will only help in undoing some of the past wrongs by the government. Besides, it's common practice for lenders to provide a moratorium on dues on the hope that a revival in the industry's fortunes will improve the chances of recovery. As such, it makes sense for the government to opt for a solution that has a more lasting impact.
Talk of a floor on pricing is typically met with criticism, especially in an industry that has been a child of the country's reforms in the 1990s. But the former Trai official says that regulation on pricing in a regulated industry isn't out of order. "Besides, if consumers have been willing to pay higher prices for nearly all goods and services as a result of inflation, what separates this industry that its tariffs only head downward," he says.
Analysts say investors are unlikely to commit more capital unless there is clarity on the relief package and the government's stance on pricing.
The counter view
While Vodafone Idea and Bharti Airtel's concerns are being highlighted by the Cellular Operators Association of India (COAI), Reliance Jio has a diametrically opposite view. Incidentally, while the incumbents have been reporting losses in their India mobile operations, Jio has been reporting profits, giving the impression that Vodafone Idea and Bharti Airtel's troubles are their own doing.
But, Jio's profits need to be seen in light of its massive investments. "Jio's return on invested capital is only around 5%, and that too after having an accounting policy that results in relatively low depreciation charges," says the analyst at the domestic institutional brokerage. Generating a 10% return on invested capital would require Jio's operating profit to exceed the peak historical annual Ebitda ever generated by the aggregate Indian telecom industry, analysts at Kotak Institutional Equities have calculated. If competitive pressures remain, achieving these targets will be an uphill task. What's more, Jio has made it clear that investors should see it as a digital platform rather than a mere connectivity business. The thing with a platform business such as Tencent of China is that it operates across different telecom networks. Needless to say, the higher Jio's subscriber market share, the more likely it will be valued as a platform business, with a monopoly structure being the ideal scenario for its investors.
From the government's perspective, however, there is much to worry about in such a situation. To start with, it would need to write off large sums owed by the incumbents to the government. It also needs to worry about the impact on the banking sector. Its future revenue streams from the sector, too, can take a hit. With no competition for the auction of spectrum, it may well have to settle for a sub-optimal price for its prized asset.
While this may appear to sound like an extreme scenario, it isn't outside the realm of possibility. Sure, the government seems keen on supporting state-run telcos such as Bharat Sanchar Nigam Ltd, but hardly anyone views them as a worthy competitor in the market.
In sum, encouraging ultra-low prices may look like a pro-consumer move now, but if this results in a monopoly situation, it can quickly turn anti-consumer. To start with, it makes sense for the government to ask CCI to weigh in on the concerns about pricing and give its recommendations.