07 Aug 2017 19:39 IST

The conundrum of the telecom bailout

Government has to choose between worsening banks’ NPA position and exceeding its fiscal deficit target

The government has acknowledged that the telecom sector is under stress. An industry that was a ‘mover and shaker’ of the Indian economy for the last two decades, it has grown over 20 times in size, going from 3.5 crore subscribers in 2001 to around 90 crore subscribers in 2011.

As of 2017, India’s telecom network is the second largest in the world in terms of the number of users — there are more than 100 crore fixed-line and mobile phone users. However, this sector is now under enormous financial stress and needs a serious bailout.

Three-way dynamics

What makes this case interesting is the underlying dynamics between three key stakeholders — the telecom companies, the banks and the economy (fiscal deficit).

The stressed telecom companies want the Centre to bail them out following the adverse industry developments of the recent past, triggered largely by the entry of Reliance Jio, the price cuts, and the resultant impact on players in the sector.

The banks that lent money to the telecom companies will support this initiative. In the event that the government does not agree to the bailout request, the non performing assets (NPAs) of the banks, which are already at a tipping point, will be further aggravated.

However, if the government does provide the concessions demanded and bails out the telecom companies, the fiscal deficit for the year 2017-18 will fall below the target. This could be a bigger problem, especially the deviation from fiscal discipline and its consequences in terms of investor confidence, not to mention the potential drop in credit ratings by international agencies.

The telecom angle

For the first time since 2009, Indian telecom companies (telcos) have reported a drop in revenue. The price of the voice calls dipped sharply as Vodafone and Bharti Airtel responded to Jio’s entry pricing.

A drop in revenue and profits is only one side of the story. The accumulated debt, interest and principal repayment due to the banks, and the license fees payable to the government are the other major stress areas for the telecom companies. Further, the Jio effect has strained the incumbent players with respect to interconnection charges (inter-connecting Jio’s calls to its subscribers), impacting their margins further.

Over the last ten years, the telcos have been bidding aggressively in the spectrum sale auctions conducted by the Centre, spending huge sums to acquire the spectrum assets, predominantly financed by bank loans. The total debt of the telecom sector is close to ₹485,000 crore. With competitive rivalry growing multi-fold, profits have dwindled and there is enormous pressure due to the liabilities these companies carry.

To add fuel to the fire, the GST rate applicable to the sector has been pegged at 18 per cent, which, the operators feel, is quite high. There is a demand to drop this to 5 per cent, given the stress the sector is going through.

In addition to the loan interest of around ₹50,000 crore, around ₹30,000 crore of spectrum licence fees and other fees need to be paid. However, the telecom industry’s cumulative earnings before interest, tax, depreciation and amortisation (EBITDA) could be pegged at around ₹50,000 crore. Such is the stress.

The bailout

The telecom companies are looking to the government to improve the situation by easing the license fee term beyond the current contracted period — the current contracts have a 10-year payment period, which the companies are demanding be extended to 20 years.

More importantly, given the profit accruals, banking experts feel the level of debt beyond ₹4 lakh crore is totally unsustainable. The government and a group of ministers are currently looking into the demands of the telecom firms.

A number of issues that are pending with the government will also need to be speedily addressed — Jio has complained that the competitors (Bharti Airtel, Vodafone and Idea) are indulging in cartelisation by not offering points of interconnection (PoI) for Jio to scale up.

The incumbent telecom players have alleged that Jio’s free voice calls are a clear case of ‘predatory’ pricing that has adversely impacted the telecom sector. These are hard issues and the government, regulations or courts need to take a firm call. And these cannot be ignored when the bailout proposal is being discussed.

The banking angle

Indian banks are the most at risk because of the telecom companies’ financial stress. The RBI recently cautioned banks to avoid additional exposure to the sector and to ensure that adequate provisions are made towards NPAs, given the companies’ weak financial position.

Worried about the banking sector’s risk due to the exposure to the telecom industry, and the possibility of non-payments of interest and principle, State Bank of India (SBI) has requested the Department of Telecom to conclude a bailout package at the earliest.

Many of the telecom companies are currently being listed as Special Mention Accounts (SMA). These refer to companies that are on the verge of becoming an NPAs. For example, Reliance Telecom, the Anil Dhirubhai Ambani Group company, has defaulted on its debt obligations to more than 10 banks and is a classic case of a non-performing asset in the making.

The banks are offering complete support for the telecom companies demanding a bailout package, as this will also safeguard their NPA position.

Economic angle: fiscal deficit

The fiscal deficit angle, however, is more worrying. According to the budget estimates for the fiscal year 2017-18, the Finance Ministry target from the telecom companies towards licence usage and spectrum fees is set at around ₹48,000 crore.

In the current state of affairs, this may not be achievable. Experts say that companies are already paying more than 30 per cent of their revenues to the government and, with the current stress, this could worsen.

Rating agencies have warned that the fiscal deficit target for 2017-18, pegged at 3.2 per cent, may overshoot to 3.35 per cent because of the shortfall in telecom industry revenues.

Inevitable solution

In effect, it will come to the point where the government will go ahead with the bailout package, just as it has done in the past. This can be seen as a quick-fix, as it doesn’t allow the banks’ NPA positions to deteriorate and muddy the waters further.

Eventually, the economy will have to bear the brunt, putting a big dent in the fiscal deficit targets. Unfortunately, this will give out a wrong signal — that one can get away with aggressive bidding and poor execution.