Draft Economics Project

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TELECOM SECTOR AND ECONOMICS

India, like many other countries of the world, have adopted a gradual approach totelecom sector reform through selective privatization and managed competition indifferent segments of the telecom market. To begin with, India introduced privatecompetition in value-added services in 1992 followed by opening up of cellular

and basic services for local area to private competition. The Telecom RegulatoryAuthority of India (TRAI) was constituted in 1997 as an independent regulator inthis sector. Competition was also introduced in national long distance (NLD) andinternational long distance (ILD) telephony at the start of the current decade.

Two state-owned public sector incumbents with a large existing subscriber basedominate the fixed line service. As on December 31, 2001, the two Public SectorEnterprises (PSEs), BSNL and MTNL owned 34.73 million Direct ExchangeLines (DELs) against 0.45 million privately owned DELs. These two PSEs wereallowed belated entry into the cellular segment in the beginning of the presentdecade. Consequently, their cellular subscriber base is tiny compared to the

private operators. Out of 7.3 million cellular subscribers in the country in June2002, they had only 0.2 million subscribers.

Despite asymmetry in initial market endowments between public sectorincumbents and private operators, the act of opening up of the market unleasheddynamism that was hitherto latent in the sector. This is evident from a number ofperformance indicators. In terms of overall size of main telephone lines inoperation, India ranked 14th in the world in 1995. The rank improved to 7 th

position in 2001 (Table 1).

Table 1: Top 14 countries in the world in terms of number of main

telephone lines in operation

Country No. of linesin 1995 (000)

Ranks (1995) No. of linesin 2001 (000)

Ranks (2001)

USA 159,735.2 1 190,000.0 1Japan 62,292.0 2 76,000.0 3Germany 42,000.0 3 52,280.0 4China 40,705.7 4 179,034.0 2France 32,400 5 34,032.9 9UK 29,411.4 6 34,710.0 8Russia 25,018.9 7 35,700.0 6

Italy 24,845.0 8 27,303.0 10Korea, Rep. 18,600.0 9 22,724.7 11Canada 17,567.0 10 20,319.3 12Spain 15,095.4 11 17,427.0 14Brazil 13,263.0 12 37,430.8 5Turkey 13,215.7 13 18,900.9 13India 11,978.0 14 34,732.1 7Source: World Telecommunication Development Report 2002, ITU

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Network expansion in India was accompanied by an increase in productivity oftelecom staff measured in terms of ratio of number of main telephone lines inoperation to total number of full time telecom staff (Table 2).

One way of looking at the welfare gains to subscribers is to watch the trend inprices for telecom services, whether such prices came down in the competitiveregime. What consumer ultimately pays includes rental as well as telecom tariffs.Because of complications involved in summarizing differential rates applicable topeak and non-peak hours, a convenient proxy for the change in telecom pricescould be constructed in terms of observed trend in revenue earned fromtelephone services at constant prices expressed as a ratio of number of maintelephone lines in operation. Table 2 shows a significant decline in this ratio since1995 in Indian fixed line segment. It may be noted that the National TelecomPolicy was announced in May 1994. Steps were intensified to introduce privatecompetition in the basic and cellular services thereafter. The beginning of the

declining trend in per line revenue at constant prices coincided with the period,which witnessed emergence of competitive pressure in the sector.

Table 2: Trend in productivity and price

YearNumber of maintelephone lines inoperation per full-timetelecom staff

Telephone servicerevenue at constantprices(CPI 1995=100)per main telephone linein operation (Rs. 000)

1991 15.58 9.131992 17.65 10.251993 20.32 11.041994 23.38 10.171995 28.45 9.231996 33.90 6.121997 41.89 5.621998 50.93 4.921999 62.97 4.24Source: Computed from the data published in the Year book of Statistics:Telecommunication Services, 1991-2000, ITU

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T R E N D I N P R O D U C T IV I

0

2 04 0

6 0

8 0

1 2 3 4 5 6 7 8 9

Y E A R S ( 1 9 9

N O . O F M A I N T E

L IN E S I N O P E R A

F U L L T IM E T E L ES T A F F

T E L E P H O N E S E

R E V E N U E A T C

P R I C E S ( C P I : 1 9 9

M A I N T E L E P H O N

GRAPH 1 showing the trend in productivity and prices

Table 3 shows the long run trend in supply and demand of DELs. The number ofDELs in operation (i.e., main line in operation) has been taken as supply whereasdemand has been computed by adding the number of subscribers in the waitinglist to the number of DELs in operation

Table 3: DEL: Supply and demand (millions)

Year endingMarch 31 Direct exchangelines (DELs) Waiting List Demand

1981 2.15 0.45 2.61983 2.47 0.66 3.131985 2.90 0.84 3.741987 3.49 1.12 4.611989 4.17 1.42 5.591991 5.07 1.96 7.031993 6.80 2.85 9.651995 9.80 2.15 11.951997 14.54 2.89 17.43

1999 21.59 1.98 23.572001 32.44 2.92 35.36Source: Indian Telecommunication Statistics 2002, Ministry of Communications,Government of India.

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DEL: SUPPLY AND DEMAND

0

5

10

15

20

25

30

35

40

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

YEAR ENDING MARCH 31

W

AITINGLIST,DELANDTOTA

DEMAND(million)

Total demand

Waiting List

Del

Graph 2 showing the demand and supply of DEL

Table 4 indicates tele-density for the countries included in Table 1 as measuredin terms of number of main lines per 100 inhabitants.

Table 4: Number of main telephone lines per 100 inhabitants

Country1995 2001

USA 60.73 66.45Japan 49.61 59.69Germany 51.33 63.48China 3.30 13.81France 56.01 57.35UK 50.18 57.78Russia 16.91 24.33

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Italy 43.33 47.06Korea, Rep. 41.24 47.60Canada 59.85 65.51Spain 38.50 43.11Brazil 8.51 21.69

Turkey 21.44 28.52India 1.29 3.38Source: World Telecommunication Development Report 2002, ITU

N U M B E R O F M A IN T E L E

L IN E S P E R 1 0 0 IN H A B IT

050100150

USA

Germ

Franc

Russi

Korea,

Spain

Turke

COUNTR I

NUMBER

2001

199

Graph 3 showing the number of main telephone lines per 100 inhabitants

A comparison between Table 1 and Table 4 reveals that countries with smallernetwork sizes than India are having much higher tele-densities. However, interms of total tele-density, i.e., the sum of fixed-lines and mobile subscribers per

100 inhabitants, Indias comparative ranking in the world improved from 160 in1990 to 145 in 2000, an improvement by 15 positions

The present paper estimates that in order to attain the network size of USA in2001 India has to expand its number of operational telephone lines at acompound annual growth rate (CAGR) of 23.44 per cent between 2002 and2020. The corresponding growth rates to reach China and Japans levels are23.06 per cent and 17.63 per cent respectively. Even that is not going to mean

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much in terms of tele-densities in comparison to most of the countries cited inTable 4. Assuming no change in Indias size of population (i.e., assumingpopulation size to remain at 2001 level of 1.03 billion), Indias tele-density will be18.48 lines per 100 people even if Indias network size reaches the level of USA.Considering the fact that Indias DEL grew at a CAGR of 19.4 per cent during

1995-2000, significant effort would be needed to step up growth rate above 23per cent.

Broadly speaking, technologies of mobile telecommunications and Internet aregoing to set the contours of further technological progress in the current decadeand the next. The most recent initiative aims at convergence of voice and datareceived from multiple sources, both web based and real time video streams, inmobile handheld devices. Global satellite systems, mobile handsets and callingcards have made virtual presence possible almost everywhere and anywhereovercoming the barriers of distance, topography and remoteness.

There has been phenomenal growth in mobile subscribers in the world in thenineties, increasing from 11 million in 1990 to 941 million by the end of 2001. In1991, less than one per cent of the world population had a mobile phone. Theproportion has grown to the vicinity of one phone per every six people by the endof 2001. Similarly, one-third of the total number of countries of the world hadcellular network in 1991. The ratio rose to over 90 per cent by end-2001.Considering that the fixed telephone lines numbered just over a billion in thisyear, it is likely that mobile phones would surpass fixed line in 2002. It isinteresting to observe that China has surpassed USA to become the largestmobile market of the world. In Africa, mobile subscribers outnumber fixed linesubscribers in more than half the countries. Mobile telephony has emerged asthe major growth driver in this sector.

There are three important economic implications of mobile explosion for thedeveloping countries. First, by offering a viable techno-economic alternative it ishelping in improving telecom penetration bypassing shortages of fixed lines.Consequently, it is bringing along with it all concomitant economic benefits ofenhanced telecom accessibility. Second, it is promoting a better entrepreneurialculture and supporting employment generation through proliferation of kiosks.Third, there has been a shift in investment burden from state to private sectorand the consumers.

Cellular mobile telephones subscribers in India increased from 77 thousand in1995 to 3.6 million in 2000. By March 2002, it has grown to 6.4 million. Cellularsubscribers in proportion to total number of telephone subscribers (basic pluscellular) have increased from 0.6 percent in 1995 to 14.6 percent in 2002. This isstill lower than the average of 24.6 percent achieved by the low-income countriesin 2001. The corresponding ratio for lower middle-income countries is 41.8percent, 52.8 percent for upper middle-income countries and 50.2 percent forhigh-income countries. India is yet to experience mobile explosion of the scale

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other countries have seen. One would expect a rapid growth in mobile telephonyin coming decades. India has also achieved significant quality upgradation of itsnetwork in the 90s. Digital lines in proportion to total number of main telephonelines have increased from 87 per cent in 1995 to 99.8 percent in 1999.

The technologies currently in use are Global System for Mobile Communications(GSM) and Code Division Multiple Access (CDMA). There are primarily 10companies providing mobile services in 19 telecom circles and 4 metro cities,covering 2000 towns across the country. Presently there are 4 GSM operatorsand 2 CDMA operators in each circle. There are 100 state-of-the-art Networks(GSM + CDMA) on air with a total investment of $8 billion.

MARKET OVERVIEWThe wireless revolution will be fuelled by several factors. The affordability ofwireless for the masses will be sustained on account of low tariffs, cheap

handsets and attractive financing schemes. Wireless operators will continue tofocus on prepaid products in order to increase the adoption of wireless amongthe lower middle income and low-income groups. Wireline users will increasinglymigrate to wireless, lured by the benefits of mobility and the attractive bundledplans that are being launched by the wireless operators. Wireless data serviceswill also become a growing revenue steam. Some operators have alreadydeployed 3G technologies on their networks. With further rollout, it will accountfor a significant portion of the wireless revenue pie.

As of February 2004 the total mobile market had reached 31.67 million, of which24.65 million subscribers were GSM and 7.02 million were CDMA (excludingBharat Sanchar Nigam Limied [BSNL] and Mahanagar Telephone Nigam Limited[MTNL]). Of these totals, Reliance Infocomm had 6.822 million subscribers(6.065 CDMA and 0.757 GSM), Bharti had 6.199 million (GSM), BSNL had 4.954million, (GSM) Hutch had 4.826 million (GSM), and Idea Cellular had 2.584million (GSM). Mobile connections have reached to 56 million by the end of2004, representing a 96 per cent increase over 2003, according to Gartner. Asper the Cellular Operators Association of India, GSM mobiles phone will reach471 million by 2010. The pace of growth will accelerate with the introduction offull mobility CDMA loop services and the adoption of unified licenses.

MARKET TRENDSThe market for telecom services in 2002-03 has been estimated to be $10.7billion. The equipment market is estimated to have reached a turnover of $6.27billion in 2002-03, up from $5.71 billion in 2001-02. The telecom industrycomprising services and equipment is expected to increase to $24.29 billion by2006.

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Private players are steadily acquiring an increasing share of the telecom servicesmarket. Ten years after the sector was opened to private participation, theyaccount for more than a third of the total subscriber base in India. Privateoperators play the largest role in mobile services, where the 10 companies thatown more than 70 licenses are operating in 23 service areas (there are six

operators of mobile services in each circle). BSNLs existing market position --particularly its dominance in remote and rural areas -- has made it harder forprivate players to operate. BSNLs nationwide presence is also allowing it tocatch up with private players in the mobile market, where the state operatorprovides the most comprehensive coverage.

Graph 4 showing the increasing trends of teledensity

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COMPETITION

As noted earlier, the government initially only permitted two operators in eachcircle. But the government has now moved to unrestricted entry and unlimited

competition in all types of services. As a result, there are now multiple operatorsin each service and in each license area. The entry of additional operators(typically BSNL or MTNL) had led to drastic tariff reductions. Indeed, thecompetition was so intense that the Telecom Regulatory Authority of India (TRAI)stopped setting the price for mobile services and allowed the market to setprices.

The unified access license and the liberal takeover and foreign direct investmentnorms are expected to catalyze consolidation. In addition, in early 2004, TRAIpublished norms that would, under certain conditions, allow intra-circle mergers(i.e., at the regional level) between operators. Mergers will be allowed, for

example, if the new entity does not have a market share above 50%, or if the toptwo firms in a given circle do not together account for a market share of 75% orhigher. If these conditions are not met, TRAI has asked the DOT to conduct adetailed impact study on the proposed merger before granting its approval.

The competitive nature of the Indian market leads analysts to predict that therewill be a spate of takeovers at the national level in 2004 and 2005, and that onlythe large operators - BSNL/MTNL, Reliance Infocomm, Tata, Hutchison-Essar,Idea and Bharti - will survive. The consolidation has already begun. Aircel,which operates GSM mobile services in the southern state of Tamil Nadu (exceptChennai), has in 4Q03 taken 100% stake in RPG Cellular in the city of Chennai.Aircel will now be able to offer services in the capital city also. Aircel had475,705 customers in Tamil Nadu while RPG Cellular has 212,823 customers inChennai.

Idea Cellular, the three-way joint venture between the Tata group, the AdityaBirla group and AT&T, has signed a purchase agreement to buy 100% stake inEscotel, which operates in the six states of Kerala, Haryana and UP (west), UttarPradesh (east), Rajasthan and Himachal Pradesh. The subscriber base in thesestates exceeds 800,000. The 100% buyout comprises the 51% stake held byEscotel and the 49% stake held by First Pacific. Hutchison is consolidating all its11 operating circle licenses into a single holding company, Hutchison- Essar.Post consolidation, Essar is likely to have a 35% stake in the company. TheTata- owned and recently privatized VSNL has purchased Dishnet Internet andDSL business for $65.7 million while Tata Teleservices may buy HFCL InfotelsPunjab circle operations. Reliance Infocomm has acquired Flag Telecom for$112 million. With this, Reliance Infocomm will become a leading supplier ofbandwidth to over 100 telecom players round the globe.

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There are three types of players in telecom services:

1. State owned companies (BSNL and MTNL)

2. -Private Indian owned companies (Reliance Infocomm, TataTeleservices)

3. -Foreign invested companies (Hutchison-Essar, Bharti Tele-Ventures,Escotel, Idea Cellular, BPL Mobile, Spice Communications)

Graph5 showing the comparison between the growth of fixed and mobilesubscribers

BSNL

On October 1, 2000 the Department of Telecom Operations, Government of Indiabecame a corporation and was renamed Bharat Sanchar Nigam Limited (BSNL).BSNL is now Indias leading Telecommunications Company and the largest

public sector undertaking. It has a network of over 45 million lines covering 5000towns with over 35 million telephone connections.

The state-controlled BSNL operates basic, cellular (GSM and CDMA) mobile,Internet and long distance services throughout India (except Delhi and Mumbai).BSNL will be expanding the network in line with the Tenth Five-Year Plan (1992-97). The aim is to provide a telephone density of 9.9 per hundred by March2007. BSNL, which became the third operator of GSM mobile services in most

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circles, is now planning to overtake Bharti to become the largest GSM operator inthe country. BSNL is also the largest operator in the Internet market, with ashare of 21 per cent of the entire subscriber base.

BSNL plans to add 21.8 million GSM phone and 6.76 million CDMA phone

between 2002-2007. BSNL will buy GSM and CDMA switches and transmissionequipment and SIM cards.

BHARTI

Established in 1985, Bharti has been a pioneering force in the telecom sectorwith many firsts and innovations to its credit, such as being the first mobileservice in Delhi, the first private basic telephone service provider in the country,the first Indian company to provide comprehensive telecom services outsideIndia in the Seychelles, and the first private sector service provider to launchNational Long Distance Services in India. Bharti Tele-Ventures Limited was

incorporated on July 7, 1995 for promoting investments in telecommunicationsservices. Its subsidiaries operate telecom services across India.

Bhartis operations are broadly handled by two companies: the Mobility group,which handles mobile services in 16 circles out of a total 23 circles across thecountry, and the Infotel group, which handles the NLD, ILD, fixed line,broadband, data, and satellite-based services. Together they have so fardeployed around 23,000 km of optical fiber cables across the country, coupledwith approximately 1,500 nodes, and have presence in around 200 locations.The group has a total customer base of 6.45 million, of which 5.86 million aremobile and 588,000 fixed line customers, as of January 31, 2004. In mobile,Bhartis footprint extends across 15 circles. The company plans to invest $444billion in the current financial year. It plans to install 29 mobile switching centers,buy transmission equipment and also roll out new networks in five new circleswith an additional investment of $155 million.

MTNL

Mahanagar Telephone Nigam Limited (MTNL) was set up on 1st April 1986 bythe Government of India to upgrade the quality of telecom services, expand thetelecom network, introduce new services and to raise revenue for telecomdevelopment needs of Indias key metros in Delhi, the political capital, andMumbai, the business capital. In the past 17 years, the company has taken rapidstrides to emerge as Indias leading and one of Asias largest telecom operatingcompanies.

MTNL operates basic, cellular and internet services in the metro cities of Delhiand Mumbai. These two cities already have a high telephone density comparedto the rest of India. MTNL has over 5 million subscribers and 330,000 mobilesubscribers.

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MTNL plans to add 1.6 million landline/CDMA phones and 1.15 million GSMmobile phones between 2002-2007. The company plans to invest $500 millionduring 2004-2005 to expand GSM and CDMA services.

RELIANCE INFOCOMMReliance is a $16 billion conglomerate involved in businesses ranging from oilexploration and refinery to power and textiles. It is also an integrated telecomservice provider with licenses for mobile, fixed, domestic long distance andinternational services. Reliance Infocomm offers a complete range of telecomservices, covering mobile and fixed line telephony including broadband, nationaland international long distance services, data services and a wide range of valueadded services and applications. Reliance IndiaMobile, the first of Infocomm'sinitiatives was launched on December 28, 2002. Reliance Infocomm plans toextend its efforts beyond the traditional value chain to develop and deploytelecom solutions for India's farmers, businesses, hospitals, government and

public sector organizations.

Until recently, Reliance was permitted to provide only limited mobility servicesthrough its basic services license. However, it has now acquired a unifiedaccess license for 18 circles that permits it to provide the full range of mobileservices. It has rolled out its CDMA mobile network and enrolled more than 6million subscribers in one year to become the countrys largest mobile operator.It now wants to increase its market share and has recently launched pre-paidservices.

TATA TELESERVICES

Tata Teleservices is a part of the $12 billion Tata Group, which has 93companies, over 200,000 employees and more than 2.3 million shareholders.Tata Teleservices provides basic (fixed line services), using CDMA technology insix circles: Maharashtra (including Mumbai), New Delhi, Andhra Pradesh, TamilNadu, Gujarat, and Karnataka. It has over 800,000 subscribers. It has nowmigrated to unified access licenses, by paying a $120 million fee, which enablesit to provide fully mobile services as well.

The company is also expanding its footprint, and has paid $90 million to DoT for11 new licenses under the IUC (interconnect usage charges) regime. The newlicenses, coupled with the six circles in which it already operates, virtually givesthe CDMA mobile operator a national footprint that is almost on par with BSNLand Reliance Infocomm. The company hopes to start off services in these 11new circles by August 2004. These circles include Bihar, Haryana, HimachalPradesh, Kerala, Kolkata, Orissa, Punjab, Rajasthan, Uttar Pradesh (East) &West and West Bengal.

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Table5 showing the basic comparison between the top four mobile serviceproviders in India

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Graph 6 showing the increase in private sector licenses

Table 6 showing the market share of GSM mobile service operators as on31march2007

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Table 7 showing the market share of CDMA mobile service operators as on31march2007

Graph7 showing the cellular tariff decrease over the years

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Mergers & acquisitions (M&A) in Indian telecom industry:

India has become a hotbed of telecom mergers and acquisitions in the last

decade. Foreign investors and telecom majors look at India as one of thefastest growing telecom markets in the world. Sweeping reformsintroduced by successive Governments over the last decade havedramatically changed the face of the telecommunication industry. Themobile sector has achieved a teledensity of 14% by July 2006 which hasbeen aided by a bouquet of factors like aggressive foreign investment,regulatory support, lower tariffs and falling network cost and handsetprices. M&A have also been driven by the development of newtelecommunicationtechnologies. The deregulation of the industry tempts telecom firms(telcos) to provide bundled products and services, especially with theongoing convergence of the telecom and cable industries. The acquisition

of additional products and services has thus become a profitable move fortelecom providers.

REGULATORY FRAMEWORKM&A in telecom Industry are subject to various statutory guidelines and Industryspecific provisions e.g. Companies Act, 1956; Income Tax Act, 1961;Competition Act, 2002; MRTP Act; Indian Telegraph Act; FEMA Act; FEMAregulations; SEBI Takeover regulation; etc.

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Table 8 showing the various M&A deals in Indian telecom Sector

Revenue Generation and Efficient market structureDisinvestment plays an important role in revenue generation. Disinvestmentreceipts can help the government reduce fiscal deficit not only by way of equitysale in PSUs (public sector units) but also by the subsequent cap in government

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transfers to bleeding PSUs. But has the government been successful in itsdisinvestment endeavor? Trends in the past few years present an abysmalpicture. There are wide differences in disinvestment targets and actual receipts .

Table 9 showing the targeted receipts and actual receipts over the years

Political hurdles in disinvestment, intervention of stakeholders and poor financialstate of sold PSUs have all contributed to this performance.

Apart from revenue generation, creating an Efficient Market Structure is also oneof the important goals of the disinvestment/privatization process. Thegovernment seeks to establish a competitive market that would result in drivingdown consumer prices (e.g.Privatization and Deregulation in the Telecom Sectorin India has reduced prices andincreased consumer base dramatically)On the other hand the government would try to maximize revenue by divesting inapseudo monopoly environment and using regulation to control rent seekingbehavior (e.g. When Reliance acquired IPCL a pseudo monopoly was formed inthe petrochemical market. But government control on crude prices as well as itscontrol on petrol prices led to some form of price regulation) The government

cannot try to maximize both, revenue and market structure. The followingexample will explain the contradiction in the two objectives.

Consider the case of the Domestic Airline industry in India, an oligopolydominated by three players: Jet, Sahara and Indian Airlines. Consider ahypothetical case of privatization of Indian Airlines, the government owned airlinecompany. How should the government privatize Indian Airlines? Should thegovernment encourage more players by offering investment incentives andsubsequently divest in a competitive market or should the government sell IndianAirlines to a third new entrant say Tata Airlines or should it permit a currentplayer to buy Indian Airlines and increase the possibility of monopoly creation.

Table 10 depicts the given situation objectively.

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Table 10

Graph 8 explains the inverse relation between objectives of competitive marketStructure and revenue maximization. Competitive structure is plotted on Y axisand Disinvestment receipts on X axis

As the number of players in the market increase the value of the governmententity to be divested decreases. In this situation how should the governmentbalance its objectives?The government can look at three components to arrive at the solution.

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1) Different privatization strategies on the basis of the nature of goods i.e.commercial, social, public utilities etc

2) Establishing a regulatory framework to lay down the rules of the market.3) Withholding the sale, until the required market structure is created with thehelp of entry incentives.

Diagram 1 explains about the promoting entry level-models.

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Diagram 2 shows the phases of policy reforms in India

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