2G Reform for Indian Telecom

Indian telecom was once an example of the economic dynamism that could be unleashed by a reform-minded government. Today, it has become a national embarrassment. A scandal over the sale of mobile phone spectrum has landed businessmen and politicians in prison and thrown the country into a frenzy over corruption.

Telecom in India took off in the early 2000s because regulation pointed the right way. In 1999 the state took away the government's stranglehold on the market and gave private players the chance to compete on an equal footing. It also decreased costs for firms. Innovations and low-cost services followed, allowing the number of mobile subscribers to reach an astonishing 850 million today from fewer than six million in 2001.
But as soon as telecom became lucrative, politicians and regulators were tempted to intervene again. In 2008, then-Telecom Minister Andimuthu Raja decided to sell second-generation or 2G mobile spectrum on a first-come, first-served basis at below-market rates, instead of the open auction many in government favored. Prosecutors allege that Mr. Raja rigged the sale to favor a few firms in exchange for bribes, a charge he denies.

The case became a national scandal last year when the government auditor reported that the Telecom Ministry's methods cost the exchequer $39 billion in revenue, making it the largest scam in India's history. Mr. Raja has since resigned and is under arrest, along with his political associates, awaiting trial.

Now New Delhi is trying to come to grips with the problem with a new draft telecom policy, unveiled last week. On the plus side, the policy would boost the market's price discovery of spectrum in a number of ways, including by allowing private players to share and trade frequencies among each other. The government also plans to increase available spectrum for next-generation technologies.

But these benefits are undercut by existing rules that manage competition, which prevent new operators from selling their licenses or merging with others in the first three years of getting a license. Last week's plan does little to remove this regulatory impediment.

The new policy also fails to address the regulatory and tax uncertainty faced by foreign investors. This year, U.S.-based Qualcomm saw its application for a license to provide Internet services rejected, after having already paid for the spectrum. The government says the application wasn't filed in time, though the company contends it followed guidelines; yesterday, regulators finally granted the license. The government is also battling U.K. telecom operator Vodafone over $2.5 billion in capital gains taxes that didn't accrue within India, the first case of its kind.

It's progress when a government understands that if a scarce natural resource—spectrum, in this case—isn't priced transparently, the economy will see gross inefficiencies and more instances of corruption. But New Delhi isn't helping matters by trying to stand in the way of market consolidation at a time when profit margins are being squeezed and investment in telecoms has plummeted.

The government can resolve these problems by setting clear, simple rules while selling spectrum at market prices. The last time it took this route, in the late 1990s, it created a telecom revolution. It can do it again.