A Tale of Two Sectors: What Can Indian Telecom Firms Teach the Power Industry about Reforms?

The casual visitor to India might find it hard to believe that it houses one of the world’s hottest economies — one increasingly mentioned in the same breath as China’s. In India, shabby airports, potholed roads and clogged ports remain the norm, and major cities suffer regular brownouts, especially during the summer when demand for electricity surges. The government estimates that India will need to spend $150 billion over the next seven to eight years to bring its infrastructure up to par.

According to experts at the Boston Consulting Group (BCG), better roads, ports, power and airports could easily nudge India’s annual GDP growth rate up from 7-8% in recent years to a sustainable 8-10%. (The growth rate in 2005-06 and 2006-07 to date has been more than 8%, despite all the infrastructural constraints.) “I think it’s an extremely important issue,” says Harsh Vardhan, a director with the Mumbai office of BCG. “The Indian economy has taken off. Better infrastructure will not only sustain this growth but accelerate it further.” (See additional sidebar: What’s Next on India’s Infrastructure Agenda?

The road to better infrastructure has been a bumpy one so far: While sectors like telecom have boomed and transformed the business landscape seemingly overnight, others, such as energy, have been highly visible failures. According to BCG experts and faculty at Wharton, the failure of power sector reforms and the success of the telecom industry underscore the importance of foreign investment and competition in India’s infrastructure upgrade.

Brownouts and Theft

Nowhere is India’s weak infrastructure more obvious than in power. In cities and towns across the country, richer homes hum with the sounds of diesel generators during frequent brownouts. Poorer ones sit in darkness and silence. According to India’s ministry of power, in the previous financial year up to March 31, peak demand exceeded supply by about 10,500 megawatts, or 11.6%. In China, electricity demand in the first six months of the current year exceeded supply by 700 million kilowatt hours, according to the China Electricity Council.

Ravi Aron, senior fellow at Wharton’s Mack Center for Technological Innovation, says overpriced and unreliable supply forces many Indian businesses to invest in their own power generation plants. About three-fifths of Indian manufacturing is supplied by such power, compared to less than a fourth in China. “This is an additional capital investment which shows up on the balance sheet,” says Aron. “Insulating yourself from India in India is an expensive business.”

India’s failure to modernize its power sector has not been for lack of trying. Indeed, it was meant to be one of the cornerstones of economic reforms begun in 1991. Strapped for cash, the government invited private companies — both foreign and domestic — to invest in eight so-called “fast track” projects. The most well-known of these was Enron’s massive $2.8 billion plant in Dabhol, in the western state of Maharashtra.

By the late 1990s, the fast track model had little to show for it. Most of the projects were unable to reach financial closure. Dabhol became bogged down in allegations of corruption and overpricing, and a new government in Maharashtra refused to honor the contract entered into by its predecessor.

The failure of Dabhol was a huge setback for India’s attempts to attract foreign investors to its power sector, creating the impression that India was an unstable and unreliable place to invest. Perhaps more damagingly, it politicized the domestic issue of private participation in power and tarred the reform process with the brush of corruption.

“The ghost of Dabhol still looms large,” says Vardhan of BCG. “The government is incapable of making the needed investments, so you need private players. But they will invest only if they are assured returns and protection. You need to adhere to consistent policies, and you need clarity in implementation.”

“Enron told foreign players that India’s democratically elected policy makers are unreliable,” Aron adds. However, Arindam Bhattacharya, a director at BCG, notes that the regulatory regime in both power generation and distribution has become more stabilized in recent years, attracting more private investments.

The timing was also bad. The California power crisis of 2000 and 2001 altered the global landscape. Power shortages changed the assumption that the only growth opportunities lay in the developing world rather than in the mature markets of the United States and Europe. With alternatives to choose from, India suddenly ceased to look as appealing.

At the heart of India’s power problem lie the government-owned State Electricity Boards or SEBs. Afraid of angering powerful farmer lobbies, state governments tend to heavily subsidize agriculture at the expense of industry. In states such as Punjab and Andhra Pradesh, the promise of free power to farmers has been an electoral campaign staple. Thanks to political patronage, most boards are also chronically overstaffed.

Theft has played a major role, too: It’s not uncommon for consumers to simply hook their homes and businesses illegally to the transmission grid, or to bribe corrupt board employees to look the other way. Between 1992 and 2002, 40% of the power generated in India was stolen. Analysts estimate that SEB losses in the financial year ending March 31, 2004, the most recent figures available, came to $4.7 billion, or nearly 1% of GDP.

Sunila Kale, a research specialist at the University of Pennsylvania’s Center for the Advanced Study of India (CASI), says politics and federalism have gotten in the way. Ironically, the very importance of electricity for day to day life makes progress more difficult. “Power reform has become such a politically contentious issue,” says Kale. “It’s required as much for agriculture as for industry. It’s required for every kind of activity.” Furthermore, says Kale, in India, unlike in China, political power is not centralized. “In China, fewer people have veto powers.”

Since 1997, India has attempted to solve the problem of SEBs by following a World Bank-inspired strategy that relies on “unbundling” the generation, transmission and distribution of power. The underlying assumption: The market will deliver a dose of discipline. Private distribution companies have an incentive to stop theft and corruption. At the same time, an independent regulator, insulated from political pressure, would be in a better position to set tariffs to ensure that consumers were protected while companies profit.

Progress has been sluggish. State governments — loath to anger powerful farm lobbies or dismantle carefully nurtured patronage networks — have dragged their feet. In 2003, New Delhi was forced to introduce a new law that gave the federal government a greater say in the process. Kale of CASI estimates that since then, 24 out of 28 state governments have established independent regulators and 20 states have either broken up their boards or are in the process of doing so. The stabilizing policy framework is reflected in the Indian Government’s recent auction of Ultra Mega Power Projects (UMPP), which has drawn a strong response from private players. Two projects have already been awarded, and the winning bidders promise highly competitive rates of power generation.

Telecom Revolution

India’s telecom sector started out with many of the same drawbacks as power. Rahul Mukherji, a visiting research fellow at the Institute of South Asian Studies at the National University of Singapore, points out that when reforms began, the telecom sector was also the exclusive domain of inefficient, government-owned monopolies. It, too, needed competition and a massive infusion of private and foreign capital to improve efficiency. When reforms began in 1991, telephones were a luxury in India — the waitlist for one could stretch for years. As late as 1995, four years into liberalization, only one in a hundred Indians had a telephone, compared to two out of a hundred in Indonesia, four in China and eight in Thailand.

Yet, though telecom reform started later than power, it has been far more successful. Between 2000 and 2005, India added about 18 million fixed phone lines and nearly 73 million mobile connections. Teledensity grew more than three-fold to 11.5%; in urban areas to 34.7%. Foreign companies such as Singapore Telecommunications and Vodafone have poured billions into Indian telecom, as have large Indian companies such as Reliance and the Tata Group. In 2005 alone FDI announcements for the telecom sector amounted to $2.5 billion. The telecom boom has shaken up the business landscape. Sunil Mittal of Bharti Telecom, with an estimated net worth of $6.9 billion, is now one of the richest Indians on the planet.

What, then, made telecom so much easier to fix? Paradoxically, it benefited because phones were seen as a luxury whereas power was seen as a necessity. This meant that there was never any political pressure to set artificially low prices for phone calls. “People in India, by and large, did not think of telecommunications as a right,” says Mukherji.

Moreover, there were fewer vested interests to fight off in telecom. The large state-owned companies tried to fight reform, but they had nowhere near the political clout of state electricity boards. The government was able to set up a relatively competent and efficient regulator to balance the interests of state-owned companies, foreign and domestic private investors and consumers. While there were the usual allegations of favoritism and ad hoc policy decisions, on the whole the regulator was able to adhere to basic principles — private participation and competition.

Third, telecom policy is the exclusive domain of the federal government in New Delhi, whereas many crucial policy decisions in the power sector are made by the country’s 28 states. Once the federal government was on board, there was little that state-level politicians could do to derail telecom reform. “Telecom did not affect any vote banks,” says Vardhan. “Political will was required to a limited extent, compared to power. Also, typically anything completely in the purview of the central government tends to proceed faster.”

The late 1990s also coincided with the boom of India’s software industry and the first signs of the potential of outsourcing. The tremendous prestige attached to these industries gave them disproportionate clout. Prodded by industry groups such as the National Association of Software and Service Companies (Nasscom), bureaucrats and politicians in New Delhi quickly realized the potentially catastrophic consequences of unreliable and overpriced telecom on both these export-driven industries and moved to correct them.

On a somewhat less tangible level, the reform process in telecom was seen as driven from within by a confluence of domestic factors, whereas with power the process was seen as an agenda of the World Bank, which made implementing it that much harder.

Looking Ahead

In telecom the future looks bright. The Telecom Regulatory Authority of India estimates that in 2005, India added on average 338,000 fixed lines and 2.3 million mobile phones each month. Waiting lines for phone connections have evaporated. According to BCG analysts, urban teledensity is expected to soar to 60% by 2010.

“A lot more needs to be done,” says Wharton’s Aron. “But compared to power, ports and roads, this is an extraordinary fairy tale with a happy ending.”

Power has some way to go to achieve the telecom success. Captive power plants allow Indian industry to overcome these problems, albeit at a cost. However, the recent successes of UMPP policy show that finally the policy structure may be falling into place. Vardhan of BCG remains cautiously optimistic. “A lot of companies are interested in investing in India,” he says. “It’s a growth market with a huge demand and supply gap.”

Sidebar: What’s Next on India’s Infrastructure Agenda?

Telecom and power represent the two sides of Indian infrastructure, one rapidly growing and world-class in pockets, with some of the lowest costs in the world, and the other struggling to bridge the growing supply-and-demand gap with attendant quality issues. The rest of Indian infrastructure — roads, ports and airports — reveals more of a mixed picture. For the most part, it remains far below par. In Shanghai, for example, an ultramodern magnetic levitation train whisks travelers across the 19 miles from the airport to downtown in eight minutes. In India’s business capital, Mumbai, the 12-mile ride in from the airport can easily take 90 minutes along traffic-congested roads with shanties along parts of its stretches.

“It goes beyond the real impact on the economy,” says Harsh Vardhan of BCG. “The impact on perceptions is also very important.”

India is in the midst of the most ambitious infrastructure upgrade in its history. Workers are laying thousands of miles of asphalt; new ports and airports are springing up, often despite opposition. Joydeep Mukherji, a credit analyst with Standard and Poor’s in New York, says there has been a tangible shift in attitudes. Ten years ago, he says, infrastructure reforms were being discussed, but people weren’t really sure how to go about them. Now, game plans are in place, and all that remains is execution. As with telecom, privatization along with foreign capital and expertise are key elements of the process.

“Changes are happening for two reasons,” says Mukherji. “The people using the infrastructure are becoming more demanding. And the people running these institutions no longer defend stupid policies with any conviction.”

Wharton’s Ravi Aron notes that pressures on the government’s finances also act as a spur. “[India is] broke. It doesn’t have money to do it,” he says. “So politically unpalatable decisions have to be made, like privatization and allowing more foreign investment.”

India’s growth in GDP has led to record-high tax collections, which could make government financing of infrastructure projects more viable. But Aron points out that India’s budget deficit, including oil and power subsidies (which are off budget items), is about 8%. “This reflects the true magnitude of the challenge of funding infrastructure,” he says, adding that divestments of up to 49% of state-owned companies — called Navaratnas — would help. “Indeed a more reasonable policy would be privatization, which would be politically very difficult given the stranglehold on power that unions have in India.”

Roads: Onto the Fast Track

India’s efforts to modernize its infrastructure are most visible in an ambitious road-building project called the golden quadrilateral. The quadrilateral, a 3,635-mile four-and-six lane highway, links four of India’s largest cities — Delhi, Mumbai, Calcutta and Chennai. The $6.25 billion highway is the core of an ambitious 15-year plan to pave and widen 40,000 miles of highway. Estimated cost: $60 billion.

The project, kick-started by the previous National Democratic Alliance government under the no-nonsense management of a former army engineer with a reputation for honesty, has done things differently from the start. Much of the construction has been subcontracted to firms from Malaysia and Korea, countries with recent road-building experience whose companies aren’t squeamish about working in India with its wafer-thin margins and red tape. In several cases, they have had to overcome arcane land-acquisition procedures, politician-backed gangsters running protection rackets and irate villagers defending local shrines that fall in the highway’s path. But the work has progressed, and the results are beginning to show.

“There’s optimism,” says Mukherji of Standard & Poor’s. “This is starting from ground zero, but it is happening.”

Ports: A New Culture

Investment has been concentrated in a few economically dynamic parts of the country. India’s first private port, Gujarat Pipavav in the western state of Gujarat, has now been in operation for a decade. Kandla, in the same state, is also home to a modern and efficient port. Andhra Pradesh in the south has handed over the management of two ports to the private sector. One of them, a deepwater port in Kakinada built with assistance from the Asian Development Bank, is run by Singapore’s International Sea Ports. The massive government-run Jawaharlal Nehru Port Trust in Mumbai, estimated to handle nearly 65% of India’s container cargo, has partially opened up to foreign investors.

“This is one instance where competition between states has worked,” says Mukherji. “There’s no vote bank opposing it. If you build a better port, industry will come.”

Vardhan of BCG agrees that private ports such as Pipavav are helping set a higher benchmark for the country. But he points to the long, sluggish lines of trucks outside the main port in Mumbai as evidence that much more needs to be done.

Airports: Foreigners Welcome

In February of this year, thousands of airport workers nationwide went on strike in an attempt to foil plans to privatize India’s two busiest airports: Mumbai and Delhi. In a few cases, police manned desks vacated by striking workers and passengers deplaned using step ladders.

The government has refused to back down on the privatization contracts, together worth approximately $1.5 billion. Mumbai’s airport will be upgraded and managed by a consortium that includes the Indian company GVK Industries and the Airports Company South Africa. Indian construction firm GMR Infrastructure in alliance with Fraport, which operates Frankfurt airport, captured Delhi. The first phase of their work is expected to be completed by 2010.

Facelifts for Delhi and Mumbai airports are part of a larger plan that includes new international airports for Bangalore and Hyderabad, centers of India’s booming software and call-center industries. The modernization of 30 smaller airports is also in the cards. BCG estimates that Indian airports require $5-6 billion worth of investment over the next five years, and that total passenger traffic will rise from approximately 19 million in 2005 to 140 million in 2015.

Indeed, a broader renaissance in Indian aviation is under way. In recent years, a rash of private airlines with names like Kingfisher, SpiceJet and Deccan Air have begun to compete with state-owned airlines and relatively established private players such as Jet Airways. The government has raised the cap on foreign investment in aviation from 26% to 49%. State-owned Air India recently inked a deal with Boeing for 68 planes with a list price of $11 billion.

Mukherji of Standard & Poor’s says the sound and fury surrounding protests tends to obscure the fact that a political consensus has emerged in India that something needs to be done. “Even the Marxists say we need to modernize the airports. Earlier they would have said, ‘Why do we need to fly?'”

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