Revisiting FDI Caps In Telecom

THE recent case in Delhi High Court has brought into the open what has been always public knowledge – that Telecom companies have been flouting the FDI limits set by the law. During Vodaphone’s taking over of Hutchison Telecom’s shares, it has emerged that the Hong Kong based Hutchison Telecom effectively held more than 89 per cent shares in Hutch Essar, in complete violation of the 74 per cent FDI limit. Not only has the limit on foreign holdings been violated, there has also been violations of the Foreign Exchange Management Act (FEMA) and Benami Transaction (Prohibition) Act. While Hutch is not the only company in the telecom sector in this boat, it is certainly the biggest and the most obvious violator.

While we will go into the shenanigans of Hutch, what concerns us more is the role that finance ministry has played in all this. When the government had mooted the idea that FDI cap should be raised from 49 per cent to 74 per cent, one of the arguments it had advanced is since these caps are in any case being flouted, let us give legal recognition to what is being done through backdoor means. The Left parties, in their note had stated that if backdoor means is being availed of by the telecom companies and this is known to the finance ministry, then the right course is bringing these companies to book and not rewarding them by legalising their illegal actions. It is precisely because the government preferred to wink at such violations that the same telecom companies who had violated their earlier cap of 49 per cent felt no qualms of violating the 74 per cent cap also. If the finance ministry gives the signal that if you violate the law, instead of punishing you we will change the law, it should not surprise anybody that this will only embolden lawbreakers further.

METHODS OF LAW BREAKING

First, the facts of the Hutch case. Hutchison Telecommunications International Limited, a Hong Kong based company (officially registered in Cayman Islands), acquired 52 per cent stakes in Hutchison Essar Limited, which in turn holds as 100 per cent subsidiaries, a number of other telecom operating companies in India. Hutch Essar already had 22 per cent foreign holdings through Mauritius based companies. So, according to Hutchison Telecom, the foreign holdings in Hutch Essar did not go beyond 74 per cent, the official FDI limit. What Hutch did not disclose is that it had already secured another approximately 15 per cent through separate transactions, bringing the foreign stake in Hutch to 89 per cent.

The methods that Hutch has employed are well known and are used to hide the real stakes of a company. In this case, it reached an agreement with Ashim Ghosh, the current Managing Director of Hutch Essar and Analjit Singh, one of the founders of the company (Max India, which had originally 51 per cent stakes in the Mumbai operations), that they would hold shares in Hutch Essar on behalf of Hutch Telecom’s. The money for the shares was also bankrolled by Hutch, through a number of indirect transactions. The route chosen was that Hutch Telecom would give the security for Ashim Ghosh and Analjit Sing, while the financial institutions would lend them the capital required for acquiring these shares (Ashim Ghosh – 4.68 per cent and Analjit Sing – 7.58 per cent respectively). Similarly, a portion (2.77 per cent) of Hinduja’s stake of 5.11 per cent was shown as IDFC (Infrastructure Development & Finance Company Ltd), though originally it was bought by Hutch Telecom. All this put together, meant that an additional 15 per cent shares shown as domestic equity was in fact Hutch Telecom’s equity.

Indian agencies were happy to be blissfully unaware of all these transactions. Unfortunately for them, Vodaphone’s acquisition of Hutch Telecom’s stakes brought all this out in the open. Both companies – Vodaphone and Hutch Telecom – acknowledged that the total equity changing hands was 66.99 per cent and not 52 per cent as Hutch Telecom had claimed before Indian agencies. The fiction of 74 per cent FDI cap being maintained was no longer tenable. However, neither the finance ministry nor the Department of Telecom, nor indeed the telecom regulator – TRAI – moved on this issue. It was only when a PIL was filed in Delhi High Court by Telecom Watchdog and the court directed the FIPB to examine this case, did the matters come to a head.

ISSUES INVOLVED

There are two issues that are involved here. One is that the government, while accepting the need for FDI caps in select areas, has no interest in implementing them. If they cannot get their way in lifting such caps, the government is willing to point out the various backdoor methods the companies can use. This was the meaning that the telecom companies read into the finance ministry’s response to Left party’s opposition to raising of FDI caps in 2005. Interestingly enough, the government had argued when lifting the caps that this will lead to “the availability of foreign investment in an open and transparent manner.” It is now clear that if FDI caps for 49 per cent are violated, there is no reason they would not be violated again by just increasing this to 74 per cent. The only way laws can be enforced is by proceeding against offenders and not rewarding them by changing the “offending” laws. The reason that the government does not follow this route is because it perceives such laws as forced on them by the Left and is therefore willing to connive with the lawbreakers. It also brings under question the larger assumption that liberalisation of capital flows and norms will bring in a greater transparency and better governance. All that it ensures is that the scale of the violations becomes even larger with liberalisation.

The second issue is India missing the Telecom Bus while seeing one of the highest growths in the telecom sector in the world. If we take the case of China and India, the way we have dealt with this vital sector will become clear. Both have seen dizzying growth in telecom, particularly in the mobile segments. In both countries, the mobile sector has overtaken the fixed line segment and has been the main driver of increased teledensity. Today, China is the largest telecom network in the world, with India in the third place. However, the resemblance ends here.

The key difference between China and India has been how China has protected both the service sector as well as the manufacturing sector, building up domestic capability. The Chinese mobile companies today have 461 million subscribers with an annual increase of 60 million additional subscribers per year. The Chinese mobile companies are State-owned enterprises with more than 70 per cent of the shares held ultimately by the finance ministry. It has sold some of the equity in the stock exchange and has been able to raise huge amounts by sale of small amounts of equity, while retaining control. China Mobile and China Unicom, the two major mobile operators are the largest and third largest mobile operators respectively in the world today. Vodafone holds only 3.27 per cent stock in China Mobile, valued at $3.25 billion. It is the cash transfusions of this kind that has helped China Mobile and China Unicom to leverage their expansion.

Contrast this with India. If BSNL is taken out of reckoning, Indian telecom sector is coming increasingly under foreign dominance. The problem here is that Indian companies tend to sell out early – they take their money and run before their equity is really worth something. Hutch today has sold its 67 per cent share of Hutch Essar for $11.1 billion to Vodafone, a gain for Hong Kong billionaire Li Ka-Shing of reportedly $9.6 billion! The Indian companies who sold out early, sold their shares in Hutch for less than a billion. If the cap had remained in place as the Left parties had asked, if nothing else the capital gains tax on a part of this transaction would have come to finance ministry’s coffers. Though the IT Department is chasing Hutch Telecom for $1.9 billion in capital gains tax, knowing the finance ministry’s soft corner for Mauritius (Hutch Telecom’s equity investment was routed through Mauritius), this may not last the distance.

TELECOM MANUFACTURING 

The other part of the Telecom story that is so different for India and China is the telecom manufacturing. Using the clout that the Chinese government has on purchasing equipment – all the operators are public sector entities – Chinese government could force technology transfers from the MNCs to local domestic companies. They also forced the major players who manufacture handsets and switches to set up local subsidiaries and move manufacturing to China. Today, China dominates the telecom manufacturing sector –– it not only is flooding the global market with its cheap handsets, but is also competing in more sophisticated network equipment. Companies such as Bird (collaboration with Siemens), TCL (collaboration with Alcatel) have emerged as major players in the telecom market. ZTE and Huawei are Chinese companies that are not only raking up major international sales, they are offering prices that very few international telecom majors can beat. In India, it was the Motorola-ZTE bid, which had to be disqualified under dubious circumstances for others to get an opportunity.

Not only has Chinese domestic industry kept the investments in telecom expansion within the domestic economy, but it has also resulted in dramatic fall in prices, driving the telecom expansion even further.
Contrast this with India. The benefits of lower prices were not on passed on to the consumer for a long time. The government’s belief that 100 per cent FDI in telecom manufacturing would automatically bring in telecom manufacturers has proved to be a chimera. Even the duty structure is such that it penalises those who manufacture as against those that import or assemble the final equipment. All in all, a dismal picture compared to the rapid strides that China has made in telecom manufacturing.

An obvious strategy for any country that wants to promote its industry is to use its market, particularly if it also happens to be one of the fastest growing and largest markets in the world. The Chinese could do this as they controlled the domestic market for telecom through the control of the telecom operators. This could then be leveraged to force telecom manufacturers to move shop to China and also part with technology. This combined with a philosophy that the next steps would be taken by Chinese themselves – upgrading their technology by tying in R&D institutions to these technology transfers – has today resulted in China emerging as not only the biggest manufacturing base for telecom by virtue of its domestic market but also a major global player in all markets!

The question now is what should be done in the telecom sector? The smaller issue should be quite clear. The law on 74 per cent equity caps needs to be implemented and all the parties that have been flagrantly violating the law need to be brought to book. The entire ill-gotten gains of the benami transactions have to be disgorged by the parties concerned. However, this is only the tip of the iceberg. The government needs to take the issue of implementing its own laws more seriously, instead of the nudge and wink policy it has been pursuing with the offenders.

The question of building up a viable telecom manufacturing sector still remains. It might be noted that hidden in the license terms and conditions, is not only the forgotten clause of rural telephony but also promoting domestic manufacture. It is time that the Department of Telecom puts in place a plan for the domestic industry. Otherwise, it is only the Nokias and ZTEs that will benefit from the Indian telecom expansion.