Taking the lid off FDI caps

By virtually legalising the illegalities of those companies that first busted the 49 per cent and then the 74 per cent telecom FDI limit, the government has rewarded the lawbreaker. If this is how things go, India can never hope to catch up with China, which tightly regulates the international telecom players who hope to play within.

By Prabir Purkayastha

The recent case in the Delhi High Court has brought into the open what has been always public knowledge—that telecom companies have been flouting the foreign direct investment (FDI) limits set by law. During Vodaphone’s take over of Hutchison Telecom’s shares, it has emerged that the Hong Kong-based Hutchison 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 the 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 looking at Hutch’s shenanigans, what is of more concern is the role that the finance ministry has played in all this. When the government had mooted the idea that the FDI cap should be raised from 49 per cent to 74 per cent, one of the arguments it had advanced is that since these caps are in any case being flouted, it might as well give legal recognition to it. The Left parties had stated in their note that if backdoor means were being used by the telecom companies, and the finance ministry knew of this, then the right course was to bring these companies to book and not reward them by legalising their illegal actions. It is precisely because the government winked at such violations that the same telecom companies who had violated their earlier cap of 49 per cent felt no qualms about violating the 74 per cent cap.

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, its foreign holdings in Hutch Essar did not go beyond 74 per cent, the official FDI limit. What Hutch did not disclose was that it had already secured another approximately 15 per cent holdings 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 camouflage 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. 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 Singh, while the financial institutions would lend them the capital required to acquire these shares (Ashim Ghosh 4.68 per cent and Analjit Singh 7.58 per cent). 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), although originally it had been bought by Hutch Telecom. Totalled up, it 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 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 the Indian agencies. The fiction of a 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 Regulatory Authority of India, moved on this issue. It was only when a public interest litigation was filed in the Delhi High Court by Telecom Watchdog, a non-governmental body, and the court directed the Foreign Investment Promotion Board to examine this case, did matters come to a head.

There are two issues involved here: One is that the government, while accepting the need for FDI caps in select areas, has no interest in implementing them. If the companies 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 the Left party’s opposition in 2005 to the raising of FDI caps. Interestingly enough, the government had argued when lifting the caps that this would 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 even the cap were increased 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 believes that such laws are forced on it by the Left, and is, therefore, willing to connive with the lawbreakers. It also brings under question the larger assumption that the liberalisation of capital flows and norms will bring in greater transparency and better governance, when all that it ensures is that the scale of the violations becomes even larger.

The second issue is India missing the telecom bus while seeing one of the highest growths in the telecom sector in the world. Both China and India have witnessed dizzying growth in telecom, particularly in the mobile segments. In both nations, the mobile sector has overtaken the fixed-line segment and has been the main driver of increased teledensity. Today, China has the largest telecom network in the world, with India in third place. The resemblance, however, 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. Chinese mobile companies today have 461 million subscribers, with an annual increase of 60 million additional subscribers per year. China’s mobile companies are state-owned, with more than 70 per cent of shares held ultimately by the country’s finance ministry. The state has sold some of its equity in the stock exchange and has been able to raise huge amounts through the sale of small amounts of equity, while yet retaining control. China Mobile and China Unicom, the two major mobile operators, are the world’s largest and third largest mobile operators respectively. Vodafone holds only 3.27 per cent stock, valued at US$ 3.25 billion, in China Mobile. Cash transfusions of this kind have helped China Mobile and China Unicom leverage their expansion.

Contrast this with India. If Bharat Sanchar Nigam Limited is taken out of the reckoning, the Indian telecom sector is increasingly coming under foreign dominance. 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 US$ 11.1 billion to Vodafone, a gain for Hong Kong billionaire Li Ka-Shing of reportedly US$ 9.6 billion. The Indian companies who bailed out early sold their shares in Hutch for less than US$ 1 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 the finance ministry’s coffers. Although the Income Tax Department is chasing Hutch Telecom for US$ 1.9 billion in capital gains tax, knowing the finance ministry’s soft corner for Mauritius (from where Hutch Telecom’s equity investment was routed), this may not last the distance.

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

Not only has China’s domestic industry kept the investments in telecom expansion within the domestic economy, but it has also resulted in dramatic fall in prices, driving telecom expansion even further.

In India, the benefits of lower prices were not 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 equipment. It is 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 because they controlled the domestic market for telecom by controlling the telecom operators, control that could then be leveraged to force telecom manufacturers to move shop to China and also part with technology. Combined with a philosophy that the next steps would be taken by the Chinese themselves—upgrading their technology by tying in R&D institutions to these technology transfers—this 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 in India? 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. All the ill-gotten gains of benami transactions have to be disgorged by the parties concerned. However, this being 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 that it has been pursuing with the offenders.

The question of building up a viable telecom manufacturing sector still remains moot. Hidden in the licensing terms and conditions is not only the forgotten clause of rural telephony, but also the promoting of domestic manufacture. It is time that the Department of Telecom draw up a plan for the domestic industry. Otherwise, it is only the Nokias and the ZTEs that will benefit from the India’s telecom expansion.