India's 2G Telecom Scandal Spans the Spectrum of AbusePublished: December 02, 2010 in India Knowledge@Wharton
India has been reeling under a series of corruption scandals, and one involving the licensing of telecom spectrum for 2G (second generation) services in 2008 has come to a head and may beat the rest in shock value, brazenness, arbitrariness and size. India's telecommunications ministry caused nearly US$40 billion in losses to the exchequer by selling the licenses at 2001 prices and by conducting the sale on a so-called first-come, first-served basis (as opposed to auctions) to benefit a few select bidders, according to an audit by India's Comptroller and Auditor General (CAG).
A. Raja, who headed the telecom ministry before being forced to resign on November 14, disregarded repeated warnings to use the auction mechanism and conduct the licensing with transparency and more equity, the report says. The whole exercise collected Rs. 12,386 crore (US$2.8 billion) from applicants. The CAG has revalued that spectrum according to several benchmarks, with its peak valuation at Rs. 176,645 crore (US$40 billion), using rates secured in the auctions of 3G spectrum in June 2010. "Even for a country that has a history of new scandals that pop up every time one thinks that things could not possibly get worse, they do," says Wharton management professor Jitendra Singh.
The 2G telecom controversy may well have ended like many others before it -- death by silence -- but for a confluence of events that included rising public anger over other corruption scandals. For more than a year since the spectrum allocations in early 2008, media reports had highlighted its flaws. Little came of those reports, but the CAG's November audit report emboldened Opposition parties to step up their drumbeat against Raja. Even after Raja quit, India's Supreme Court asked the prime minister's office to explain why it took 11 months to respond to a petition filed in November 2008 by Subramanian Swamy, president of the Janata Party, seeking permission to prosecute Raja. (The government later said it was "premature" to sue Raja, and asked Swamy to wait for the outcome of an ongoing investigation.) Swamy now plans to file a criminal suit against Raja. "The sheer scale of [the flawed spectrum allocations] and the sheer audacity of Mr. Raja permeated down to the whole society and a feeling of hopelessness also came that it won't be possible for society to survive if this goes unpunished," he notes. "The judiciary also became more cognizant that this is eating into our system."
The controversy grew murkier after Outlook magazine in November published secret phone recordings, claiming they exposed the role of Niira Radia, a high-profile corporate lobbyist, in using top journalists to help secure Raja's job as telecom minister. Radia's firm Vaishnavi Corp., which represents the Tata Group and Mukesh Ambani's Reliance Industries among others, issued a statement saying the tapes were unverified and denied any wrongdoing. Tata Group chairman Ratan Tata told television channel NDTV that his group has never used Radia to influence public policy, seek favors or make payments. He has also sought a court restraint on the publication of the transcripts of conversations between him and Radia. India's Enforcement Directorate has recently interrogated Radia on unspecified charges.
Tweaking Procedures to Benefit a Few
The CAG's report details how the telecom ministry under Raja went about allotting the spectrum licenses on the cheap, defying market logic, government directives and rules, and calls for transparency. For starters, the ministry's actions frustrated a policy decision of the Telecom Regulatory Authority of India (TRAI) to replace fixed license fees with a pricing mechanism that would more accurately capture market prices -- a combination of a nominal license fee and a market-determined "spectrum fee" through competitive bidding. The transition to the market-based regime was planned over two phases from 1999, but that was abandoned midway to retain the fixed-price mechanism. The prices in 2001 reflected "a totally nascent market", the CAG says. Raja's ministry also ignored efforts to bring in transparency through auctions and updated spectrum valuations by the prime minister, the ministries of finance and law & justice, TRAI, the telecom commission and a ministerial group, among others.
Although the telecom ministry professed a first-come, first-served policy in allocating 2G spectrum, it actually favored a few bidders who seemed to have been privy to advance information. On September 24, 2007, the ministry's department of telecommunications (DoT) issued a press release saying it would stop accepting spectrum applications from October 1 (a week later) -- effectively an artificial cap on the number of licenses. But it later advanced the cut-off date to September 25, or 24 hours after the press release. The DoT has cited a huge rush of applications for the change in the cut-off date.
On January 10, 2008, the telecom ministry issued 121 licenses -- a far cry from earlier practices of taking several months to decide on applications. It had received 575 applications, 408 of which were filed after the September 24 press release -- an indicator of the huge unsatisfied demand for scarce spectrum. A notice through another press release gave applicants less than an hour to collect the licenses, for which they had to submit bank guarantees. Some licensees "who could proactively anticipate such procedural changes were ready with the demand drafts and could avail of the benefit of first right to allocation of spectrum, having jumped the queue," the CAG report says. "The entire process lacked transparency and objectivity and has eroded the credibility of the DoT." To boot, 85 licensees did not meet basic eligibility conditions; some had provided incomplete information and submitted fictitious documents, the report adds. Kapil Sibal, the new telecom minister after Raja's exit, has said he will issue show-cause notices to the 85 licensees for violation of eligibility criteria, and also to 69 licensees that have failed to meet spectrum rollout obligations.
Raja defended his actions in the Supreme Court through his counsel, arguing that fixing 2001 prices for the spectrum sale in 2008 was consistent with the telecom regulatory body's recommendations. He also described the CAG's math as a "presumptive valuation of mind-boggling loss," and lamented that he stands "condemned, charge-sheeted, tried and convicted by the media." The court is hearing petition filed by the Center for Public Interest Litigation on the 2G scandal.
Finding the Best Spectrum Pathway
Valuations of telecom spectrum are of course prone to huge margins of error, and depend on a variety of factors including the general economic climate, the extent to which markets for telecom services develop and the ability of individual companies to maximize opportunities. The telecom spectrum auctions in the U.S. have also fallen far short of market valuations, according to Alok Gupta, professor of information and decision sciences at the University of Minnesota's Carlson School of Management and an expert on bidding strategies. The three U.S. spectrum auctions raised a combined US$55 billion, while "even the most conservative estimates put the valuation at US$500 billion, he says. At the same time, governments "have to leave something on the table for buyers and not extract all the value" in spectrum auctions, he adds. "Nobody actually broke the law [in the U.S. auctions, but] they may have done things that are not considered ethical." Gupta, however, considers it "egregious" that India avoided an auction for the 2G allocations.
In fact, the TRAI issued guidelines that it would auction 3G spectrum even before the 2G bidding round, notes Ravi Bapna, professor of information systems at the Carlson School and executive director of the Centre for Information Technology and the Networked Economy at the Hyderabad-based Indian School of Business. He recalls making presentations to TRAI members advocating auctions as the best method. "Everybody in the room bought it," he says. The proof of the superiority of the auction method is that the government made more than Rs. 100,000 crore (US$22.5 billion) in the 3G auctions, or a third more than its initial target, he adds. The right lessons have to be learned from the 2G debacle, he cautions. "I am less worried about the telecom space now than about distribution of other scarce natural resources," he says, listing electricity, infrastructure, oil and gas and water and mineral rights as examples.
Since 2008, more than 15 countries have distributed spectrum through the auction route, including Austria, Columbia and Mexico, according to K. Raman, who heads infocomm, media & education at Tata Strategic Management Group, a consulting firm. In shaping the best practices for allocation of telecom spectrum, India's policy makers need to look no further than the department of telecommunications itself, he says. "The auction process adopted for 3G spectrum has proven to be one of the most successful of processes for all involved," he points out. "It was transparent, ensured maximum value for the resource and entities that value the resource obtained it."
Transparency in spectrum allocation processes is useful, but it has its downsides, according to Gupta. He says in the past three sets of auctions of telecom spectrum in the U.S. over the past decade, bidders knew who the others in the fray were and what each player bid in previous rounds (in multiple-round auctions), and that transparency could actually hurt competition. "If you as a small bidder see that all the big players are bidding on a particular spectrum, you are unlikely to participate," he notes. Taking advantage of that sentiment, the bigger companies tend to bid on "lots of frequencies where they really had no interest because they didn't want the smaller players [to get involved]," he adds.
Several bidders in the U.S. auctions have also resorted to questionable practices like creating dummy small companies when the regulator provided incentives for small bidders including price discounts, according to Gupta. A five-year lock-in on spectrum allocations ensured that smaller players stayed in the business, but many eventually turned over their bandwidth to the larger companies. Gupta recommends "careful design" of bidding processes to prevent abuse or other downsides. "Design shouldn't be just off the shelf; they should involve people who know the industry."
India in the World's Eyes
Wharton's Singh feels foreign investors may view corruption in India "as the cost of doing business." But the country would attract more foreign investments and business interest if it had a stronger reputation for being non-corrupt, he says. Investors are attracted to India because "there are not too many other options that are particularly attractive ... but this can change rather quickly," he cautions, calling for prompt action against the guilty to rebuild confidence in India as a destination for foreign capital.
The 2G scandal is unlikely to hurt India's investment appeal globally, according to Alok Shende, principal analyst and founder director of Ascentius Consulting. "Foreign investors may actually perceive the role of courts and rule of law, the role and independence of the CAG and the will of the government to unearth this scam as a positive attempt to spring-clean all that was wrong," he notes. It is also likely, he adds, "that a new system that will evolve will contain greater checks and balances for a repeat of such instances."
Singh says corruption is "heterogeneous and multifaceted," ranging from a simple bribe to systemic corruption, "where retrograde cultural norms get well-established in specific settings, such that a non-corrupt newcomer may well find it impossible to survive." Inferior cultural norms are the toughest to tackle, and those values could prove very difficult to unhinge, according to Singh. "In its abstract form, the gains in a transaction get disproportionately appropriated by actors in relation to their role in the creation of this value," he says. "This distorts incentives and, ultimately, values in a society and leads to inequitable distribution of income and wealth, and inefficient allocation of capital." He warns of "collective consequences such as the institutionalization of inferior cultural norms [for example, 'in order to succeed, you have to be dishonest, because everyone else is dishonest'] that may take generations, even centuries, to sort out meaningfully."
Just who will play a constructive role in making this happen? Singh doesn't feel politicians, the civil service or even the judiciary in select cases have earned the necessary credibility for the job. "There is no silver bullet, but the citizenry have the right to vote out of power forever all corrupt leaders and elect better replacements," he says.
A trained economist, Swamy has a theory on why scandals like that of the 2G spectrum allocations actually occur. He refers to a theory of probability in his recent book, Corruption and Corporate Governance, that he also teaches at Harvard Summer School each year. "Suppose the chances of getting caught is number P, the bribe is number X and if you get caught, the damage done is number D," he says. The expected value in a corruption-laden deal is a tradeoff between the quantum of punishment and the probability of being caught, he adds. "If the quantum of punishment is very large, even if the probability of getting caught is small, the expected value for everybody would be negative, and you would not be corrupt anyway."
For example, even after confessing to inflating profits, Satyam Technologies' former CEO Ramalinga Raju moves "from one air conditioned hospital to another," while another self-confessed fraudster in the U.S. -- Bernard Madoff -- is serving a 150-year jail sentence, Swamy points out. "The message I learn from the U.S. practice is that if you catch somebody, however big -- the bigger the better -- then you throw the book at him." Swamy would like politicians and other high-profile people in corruption scandals in India to go to jail. "Once that happens, the expected-value calculation will make everybody honest on their own; you don't need too many powers or [enforcement] agencies."
Such powers could be a quick-fix. "In China, corruption cases are typically settled through extra-judicial means such as physical punishment [including execution] and life imprisonment," according to Dev Kar, lead economist at Global Financial Integrity, a Washington, D.C.-based organization that works to curb the flow of illicit funds and promote transparency. But he doesn't see that as an option for India. "[China's] legal system should not, rather cannot, be emulated in a democracy even if such a system would lead to lower corruption. It would be akin to inviting the devil to dinner in order to get rid of the local tough."
But Ascentius' Shende believes that India's governance systems have not kept pace with the "demands and complexity" as the country transitioned to a market economy over the past two decades. The telecom spectrum scandal "is likely to trigger a regime and mechanisms that will be based on discovery of market prices based on market forces," he says. But he urges caution on that path. "While there is no doubt that this is a great opportunity to clean the closet, the risk that such endeavors might translate into a case-by-case approach remains high," he notes, calling for transparent policies and quick punishment of the guilty.
Live telecasts of bid openings and avoidance of "in-camera secret decision-making" will make for a fresh start in transparency, according to N. Balasubramanian, professor at the Indian Institute of Management (IIM) in Bangalore and Ahmedabad. Balasubramanian, who formerly chaired IIM-Bangalore's Centre for Corporate Governance and Citizenship and has written and edited books on corporate governance, feels senior bureaucrats must be held accountable for deviations from established policies and processes. "A second violation should lead to termination of service, not just a reprimand or transfer from one job to another," he says. Similarly, politicians violating rules should forfeit their parliamentary or legislative status and be debarred from public office, he adds. The underlying theme Balasubramanian recommends is Louis Brandeis' dictum that "sunlight is the best disinfectant."