Insight into Regulation – Indian Institute of Management

Thanks for inviting me to speak today. Prof Rajeev Gowda has given me Regulation and the Indian Economy as the broad areas to touch on.

I will broaden the context and talk about Public policy making in India – more relevant to describe regulatory institutions in that context.

Let me first establish my credibility and credentials before I start. I am more than a little equipped to be a commentator on the current Indian economy and the performance of its institutions, because my career as an entrepreneur is aligned completely to this new India – starting as I did in the mid 90s when the phenomenon of entrepreneurship and new opportunities was being thrown open and being an observer, participant, victim and eventually beneficiary at different stages of evolution of the reform process and development of public policy and institutions.

Today, there is a growing sense of destiny about India and Indians becoming an economic superpower soon. This treatise and hypothesis has been bandied about so much in recent times - on the back of a deadly combination of rhetoric and euphoria that we have really begun to believe that this is our automatic destiny – and that we are going to get there regardless. This is both right and very wrong.

The right is simple – yes, we can, on the back of our growing middle class and economic growth, become a strong economic power. But the bad news is that this is not some slam dunk automatic given. The biggest roadblock or hurdle is the one about governance and our institutional performance. The truth is that over the last several years – just as the non-government India has grown, thrived and reached new levels of performance and capability – the government and Institutional side of India has not kept pace in either scale or quality of performance and has shown remarkable decline, politicization, corruption and plain ineptitude.

This deteriorating state and institutional capacity - my friends – represents the clear and present danger to our future as a nation. This is the single biggest hurdle to our future progress. And surprisingly it’s the aspect that’s hardly every talked about or written about or debated apart from a high brow intellectual group that writes and speaks preachingly or contemptuously about India’s political corruption and then moves on quickly to the next high brow discussion on Urban Infrastructure, Art exhibitions or Drama or whatever is the flavor of that month – depressingly there is very little debate and spotlight on this critical area of public policy making, governance and regulation.

Let’s start with governance – Public spending (a big consequence of public policy) is inefficient and institutionalizes corruption. Government programmes are big black holes into which tax payer money gets shoveled in – in a brutal force way to eradicate poverty – with an emphasis on spends rather than outcomes. Despite several years of reforms as a public policy objective – significant parts of the economy are still not competitive with obvious cartels and market manipulation at play in various areas.

Despite liberalization, many parts of the economy are still held hostage by monopolies. We are one of the least competitive nations in terms of transaction costs due to the volumes of transactions, red tape and litigation.

These are the real structural issues that need to be addressed, for us to get to the next level as an economy and nation. This is, therefore, the set of objectives for public policy and regulation. I set up this background – to define what ought to be public policy and regulatory objectives – That of creating intense competition, creating a more efficient economy and consumer benefit through this competition and where competition is not possible to make sure tariffs and costs are regulated in a way to ensure that there is efficiency and consumer benefit.

Now that we are clear about what the deliverables for regulatory institutions should be, let’s focus on the institutions themselves.

Our democracy and constitution has decided on a system of governance which consists of three pillars – the Legislature (The elected representatives), the Executive (Government) and the Judiciary. These three pillars are supposed to provide a system of checks and balances in our democracy – which, each one of these pillars, are supposed to provide oversight to the other.

In theory – the system is to work quite simply – For a certain issue the Executive proposes legislation and law, Parliament/Legislature oversees/modifies the law and enacts it, the Executive enforces it and the Judiciary adjudicates disputes arising out of such enforcement.

The creation of Independent regulators was a natural consequence of liberalization and increased participation of private capital in our economy and the growing financial value of each of the many components and sectors of the economy.

The regulator or independent regulator is an institution whose idea comes from the need to have a credible, empowered institution that is insulated from the bureaucracy and politicians pressures and therefore is capable of taking independent and correct/un-compromised decisions in the interest of the country/consumers/investors etc . I remember during a fund raising road show in 1996 when I was trying to raise equity for my company – the question I was asked then, the most, was a simple one – You have a license today. What prevents the next minister or politician to do something to adversely affect the terms of your 15 year concession? I failed in my efforts to raise capital primarily because of what was perceived as high regulatory risk and came back to become the strongest advocate for an Independent Regulator for Telecom – resulting in the first TRAI.

The role of Regulators in mitigating this regulatory risk - has become even more important as the economic impact of public policy and regulation on the economics of the private investor has become direct and significant. Some of the regulators well known are the more obvious ones – The RBI, SEBI etc, the more recent sector specific regulators are those like IRDA – The insurance regulator, TRAI – The Telecom regulator, TAMP – The Port Regulator, Company Law Regulator etc. Today, while the idea of the independent regulator and the need for it remain compelling – the country’s experience has been very mixed and in many cases scandalous and indefensible.

Let’s take one example to demonstrate the commercial effect that a regulator’s decision can have. Let’s take the instance of the Port Regulator –A private company wins the bid for operating a container terminal. Bid criterion is Percentage of Revenues and the tariffs chargeable are determined by the Regulator on a cost plus basis. The regulator, then, in a series of steps, defines and redefines what is considered cost and allows the treatment of the royalties to be paid to government as costs and calculates tariffs accordingly. In addition, the TAMP calculates Tariffs based on costs and projected traffic and utilization – with no correction or claw back if utilization exceeds projections. Total estimated benefit to the Port operator - $1.5 Billion. Of course the pioneers in this cost based approach to tariffing were the early power projects – the towering pioneers of this kind of rip-off being a certain Enron Corporation from Houston. Another example closer home is BIAL Airport.

Mercifully, the cost based approach to tariffing is being increasingly given a go-by by many Regulators. But the important point is that there was hardly any debate or discussion about these decisions by the regulator and the windfall gains accruing to the Private Company operating as a concessionaire to the Government.

While it’s easy to explain away the performance of the legislature and Executive as being caused by years of neglect and politicization, the performance of Regulators – a more recent and modern phenomenon requires deeper scrutiny.

Let’s take the example of the Telecom Regulator - an institution with which I have more than a little experience. In 2001 The Telecom Regulator or TRAI did something that would be hysterically funny if it wasn’t so disruptive and blatantly wrong. In the name of common man and get this mobile for the poor – the regulator developed a case for companies to bypass the entire existing system of licensing and spectrum allocation. This caused a series of litigation and chaos that lasted for over two and half years – Many investors bailed out of the sector and ran. In the middle of all this, the Regulator recommends an auction for cellular licenses. Very few people bid – almost no new bidder bids – Natural result is that the bid amounts for an All India license is around Rs 1300 Crores – A low number that is currently still used as a benchmark for Licensing for all these years. The same regulator in another decision, justified again in the name of the poor man, came up with a policy of Access Deficit Charges (ADC) which created loopholes for private companies to exploit and created a whole new black market or grey market for international calls.

Impact of these decisions on exchequer and taxpayer ? The regulatory decisions and chaos caused a depression in the values of the Telecom sector by keeping potential investors away – That depressed value is used to sell licenses then and even today. What is the estimated value of a Telecom license today – Take a wild guess – Given that market caps of listed Telecom companies like Bharti Airtel Market Cap ($40 Bln), Vodafone Essar ($25 Bln), you can assume that licenses should be worth billions of dollars. Therefore the dysfunctionality and losses arising out of the famous WLL Regulatory decision lives well beyond the 2001 or even 2003 timeframe and even today. The grey market International call losses were estimated to be about a Billion dollars a year conservatively - Loss to Country – Billions of Dollars!

The regulator in this case – despite being presented evidence on this – did not act – caused huge losses to the taxpayers – it was finally addressed when his term ended and mercifully no extension was possible because the minister had changed. Any other civilized country and the person would be facing charges for causing such losses to the nation, but he’s out and even better, consulting to private companies – no doubt advising them of new loopholes to exploit. So what’s the point I am making? – Regulatory decisions cause real loss to the country and end up creating far reaching dysfunctionalities in that sector – dysfunctionalities in real competition, affordability and often ends up contradicting public policy objectives for the sector.

I will give you another instance of Regulatory misconduct in recent times – A group of Telecom operators all raise tariffs to the customer almost simultaneously -a conduct that smacks of blatant cartel behavior, to even the most untrained observer. After being coerced into action by my intervention in Parliament and committee and Media reports, the regulator investigates this and then does nothing - calling it ‘co-operative pricing’. Co-operative pricing? What is that – isn’t that another way of describing cartels?

As with the earlier example of Ports, there was very little effort to question the Regulatory decisions that created the WLL fiasco in 2001 or the Regulatory order that regularized it in 2003 or the co-operative pricing joke. It is clear from this example and the example of the Port that orders and actions of the Regulators are having the effect of creating windfalls for licensees/concessionaires of the Government and consequently serious losses to taxpayers and consumers. No one has been held accountable for such huge losses and windfalls to the concessionaire. There are 100s of stories that I can repeat to you about blatant regulatory misconduct but that would take a few days and worse get most of you very depressed about our system.

This less than satisfactory performance of regulators is causing a phenomenon called Regulatory Arbitrage to be practiced by many savvy Corporates – where tremendous value is created for a corporate by either manipulating the Regulatory process or by influencing it and consequently loss to the country and/or to its consumers.

So why is regulatory performance so dismal ? There are two answers – lack of oversight and poor regulatory capacity. Let me tackle the issue of regulator capacity first.

Just like Judicial bodies are expected to have trained jurist, lawyers and judges having a certain quality and level of judicial Capacity, a good regulatory body needs adequate Regulatory capacity. Regulatory capacity here refers to a good knowledge of the key regulatory issues – like economics, law, competition, anti-competitive behavior. Regulation is sophisticated work and its important work, especially when it involves private concessionaries who will, as is their right to do – engage the brightest minds in the game to outwit/outflank/out convince the Regulator and outwit a sleeping/ignorant media and civil society.

In almost all cases we have retired secretaries to government of India or retired judges manning these bodies. One of the main issues of Regulatory bodies has been this over dependence on retired bureaucrats and judges. The argument that’s put forward for that is that no one else will come for the paltry salaries. Given the current context there may be some merit in that argument. However with the pay commission report having recommended some upward compensation for our bureaucracy and government servants – this is one issue that we should revisit. I, for one, am in favour of the principle of revising Government compensation to be in line with trends. For example , How can we expect our beat policeman to be honest and be public service oriented when he sees the world he is policing living a standard of living so out of his league. How can one expect a bureaucrat to be honest if you pay him nothing compared to the industries and spends he oversees. In the same vein, how can we get a regulator with the Intellect and Integrity to regulate multibillion dollar industries if we don’t pay him adequately? Why is it difficult for us to bring better talent from outside the system into our bureaucratic and regulatory system? Economic regulation of the type we require – needs us to have resources which are specialized and capable. Recognizing the importance and role of Regulators, The Pay Commission also recommends a higher scale for Regulators. This is an idea in the right direction but doesn’t go far enough.

It’s not like there haven’t been good regulators who stood up to and could take on the vested interests and still do the job of regulating.

Ramakrishna and Damodaran at Sebi, Justice Sodhi and Zutshi at TRAI are examples I can think of that meet the twin requirements laid out above. Messrs Justice Sodhi and Zutshi who were the Chairman and Vice Chairman of TRAI in those crucial formative years of the telecom sector did what no Telecom regulator has done since. They covered themselves with glory and credit by introducing a high quality and well thought through regime of Regulation and Competition. This was a regulator that had the unenviable task of creating competition and space for Private capital – in an area where there was an entrenched Monopoly and with its usual cast of characters of bureaucrats and insecure officials, who saw ghosts and other paranormal beings when the words competition and consumer benefit were mentioned. But this small group is the exception rather than the norm and the challenge is to make this the norm. Like with a lot of Government servants they have neither been recognized and feted – This is the mistake we make – of not recognizing excellence when it’s there and hence incentivizing similar conduct from others. There is also very little we do to incentivize the government to perform better – Eg have you ever wondered why the Padma awards list doesn’t contain even one serving Government officer or regulator or bureaucrat? Is it because there’s no one good in government or we don’t care to recognize them? I asked this question of the Home Minister in Parliament and he gave me a usually obfuscating reply which didn’t answer the simple question.

Coming to the critical issue of oversight – Regulators must have strong parliamentary oversight. As I explained in the beginning, Parliament has, as its role – both legislation and oversight of the Executive and Regulator. While Parliament is very effective in its role of legislation, its role of executive and regulatory oversight isn’t developed enough. Towards this I have suggested to all the political parties that parliamentary committee proceedings where Regulators depose – be made public and not be held in camera. My initiative was supported by Media and indeed Speaker of Lok Sabha, Shri Somnath Chatterjee, but not by any major political party. This is what we must insist on.

One of the most tragic scenes being played out during this recent inflation debate in Parliament was the sight of the Finance Minister and senior members of the government alternating between some helpless wringing of hands and sabre rattling and threats – against Industry, in particular steel and cement to try and get some control back into their soaring prices. This whole scene would have been funny if it wasn’t such a tragic indictment of our regulators/institutions failure to manage true competition and thereby a free market. I had made the point in an earlier that market players were getting far smarter than market regulators – and here was a real life example of it playing out.

I don’t have any evidence on this, but the conduct of some of the industrial components of the IIP clearly point to cartel like behavior. In a regime of shortages and in the total absence of any institutional intervention to prevent this behavior – the conduct of some of these companies becomes even more blasé. Any government would expect investors and business to behave this way and maximize their profits – regardless of the moral or other consequences on this. I find this whole approach of using moral appeals to industry very funny if not tragic, because it only signals the government’s helplessness. So even inflation can be linked to poor regulation coming home to roost, I’ve already told you about the instance of a regulator refusing to intervene in a blatant case of price fixing - terming it co-operative pricing and choosing to ignore it. This kind of laissez faire regulation is dangerous and clearly anti consumer. It is a clear abrogation of the duty of a regulator or executive and has become evident and ends up costing the common man as in the case of inflation.

Some moons ago, our Prime Minister at an Industry seminar said that Oligopolies are as dangerous to the nation as monopolies and that true competition is at heart of creating a competitive and efficient economy. I am guessing that he meant competitive and efficient for the Indian citizen and consumer.

But very little happened to translate that vision of his into a reality. Competition levels in our economy remain the same. Arguably with increasing evidence of cartels in Steel, Cement, Hotels, Airlines, Telecom – one can even argue that things are far less competitive today than they were before. There is almost no government intervention when Telecom companies raise prices on the same day, Hotels increase room rates almost simultaneously, Airlines increase ticket charges in a concerted manner. There is very little protest when every public policy debate becomes a debate about two industry groups and not the public – which it would seem obvious that public policy should be targeting. Thus public policy debate on Mineral depletion becomes a discussion/debate of Iron Ore Industry vs Steel Industry – The debate on telecom Policy is reduced to a CDMA group and a GSM group and the cleverer group walks away with public policy in his favour. The BIAL airport is another example of terrible public policy making of creating a monopoly and that too a substandard one and making a mockery of the whole idea of Private Public partnership? This important question needs to be asked and asked again? Why is public policy and regulation balancing away from the public to the investor? This tilt away needs to be corrected if you and I are to benefit from public policy.

So in summary – we need clear public policy objectives, we need better regulatory institutions who are manned by more talented and honest people and last and most importantly all these institutions have tighter oversight by Parliament and their decisions are scrutinized and subjected to debate by civil society.

Let me end my talk with my take on the economy and the direction we are taking as a country. I referred to India as a work in progress in a recent talk. We have to believe that we are still only half complete. While there is clearly an India of confident, young professionals and entrepreneurs – there is still a large part of India that lives in abject poverty and destitution of sub-saharan proportions. This is not a sustainable situation and a lot of the social unrest is translating into and will continue to translate into political movements and sometimes violent movements into opposing the reforms and liberalization path that our nation has set on.

This is causing a clear division of the political space into smaller and more regional political players causing the fragmentation of political power into these coalitions which we see today – coalitions which have no ideological underpinning. These coalitions are creating resistance to any reform and improvement in governance and functioning of institutions.

There is no doubt in my mind that there is inherent momentum and horsepower in our economy to take us to a clear decade of sustained growth – This kind of a decade long uninterrupted growth is the only way we can addresses the problems of destitution in India. But the inability of the larger mainstream parties of Cong and BJP in creating a consensus and an ability to work together on a minimum set of objectives is key and so far disappointing. The current Nuclear Deal fiasco is a classic case of how consensus should have been shaped around it instead of how it was handled.