1 Telecom 200503 Icra

ICRA

Telecom

ICRA Sector Analysis

TELECOM March 2005

Industry Comment

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Telecom

Contacts: Vineet Nigam Rajeev Thakur Amul Gogna

Asst. General Manager Research Head Executive Director

Date

March 2005

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Telecom

TABLE OF CONTENTS EXECUTIVE SUMMARY.....................................................................................................5 OVERVIEW..........................................................................................................................7 MARKET S IZE AND S EGMENTATION ................................................................................ 7 INDUSTRY STRUCTURE.................................................................................................... 7 UNIFIED L ICENSING ...................................................................................................... 14 MARKET CHARACTERISTICS—DEMAND ....................................................................18 OVERALL TELEPHONE PENETRATION .......................................................................... 18 SLOW GROWTH IN F IXED NETWORK S ERVICES IN RECENT YEARS ............................. 19 SHIFT IN D EMAND TOWARDS CELLULAR WIRELESS .................................................... 21 PLAYERS...........................................................................................................................27 PLAYER TYPES AND OUTLINES OF PLAYERS ................................................................ 27 MARKET SHARE AND COMPETITION ............................................................................. 28 NLD MARKET ................................................................................................................ 40 KEY SUCCESS FACTORS................................................................................................45 CELLULAR SERVICES ..................................................................................................... 45 FIXED SERVICES ............................................................................................................ 46 REGULATIONS.................................................................................................................48 TARIFFS—BASIC SERVICES ........................................................................................... 48 TARIFFS—CELLULAR SERVICES ................................................................................... 49 APPLICABILITY OF TARIFFS........................................................................................... 49 INTERCONNECT CHARGES ............................................................................................. 49 CARRIAGE CHARGES ...................................................................................................... 50 ACCESS DEFICIT CHARGES ........................................................................................... 50 LICENSING FEES ............................................................................................................ 51 SPECTRUM CHARGES..................................................................................................... 51 CRITICAL ISSUES THAT NEED TO BE ADDRESSED..................................................52 SPECTRUM AVAILABILITY FOR EXPANSION .................................................................. 52 H IGH LICENSING F EES .................................................................................................. 52 EXISTENCE OF CROSS-SUBSIDIES AND TARIFF BALANCING ......................................... 53 POLICY FRAMEWORK...................................................................................................54 EXCISE DUTIES /SERVICE TAX ....................................................................................... 54 CUSTOMS DUTIES .......................................................................................................... 54 FOREIGN DIRECT INVESTMENT (FDI)/FOREIGN TECHNOLOGY COLLABORATION AGREEMENT ................................................................................................................... 54 FINANCIAL PERFORMANCE..........................................................................................56 SUMMARY....................................................................................................................... 56 OPERATING INCOME...................................................................................................... 56 Report by ICRA Information, Grading and Research Service

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Telecom PROFITS AND MARGINS ................................................................................................. 58 FINANCIAL PERFORMANCE DURING 9MFY2005 .......................................................... 61 OUTLOOK.........................................................................................................................64 UNION BUDGET FOR 2005-06.........................................................................................65 MAJOR INITIATIVES ....................................................................................................... 65 IMPACT........................................................................................................................... 66

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Telecom

EXECUTIVE SUMMARY The telecom sector for the purpose of this report includes voice (local and long distance) and data services on fixed and wireless cellular networks. For the purpose of this report, the two segments are fixed and wireless cellular networks. The Indian fixed services access network (also usually called basic services) had an estimated 42.84 million subscribers at end-March 2004 (end -FY2004), which increased to 44.76 million at end-December 2004. In terms of revenues, the fixed access services revenues were estimated at around Rs. 300 billion during FY2004. The Indian cellular wireless mobile services segment comprises cellular mobile services based on second-generation (2G) digital standards—global system of mobile communications (GSM) and code division multiple access (CDMA). Subscriber base of cellular services aggregated 33.69 million at end -FY2004, comprising 26.15 million on the GSM standard, and 7.54 million on the CDMA standard. Since then, cellular subscriber base has increased to an estimated 48.45 million at end December 2004 (comprising 37.38 million on GSM and 11.08 million on CDMA). Total market size in terms of revenues was estimated at around Rs. 145 billion during FY2004. While the Indian national long distance (NLD) market was estimated at around Rs. 50 billion during FY2004, the international long distance (ILD) market was estimated at around Rs. 43 billion during FY2004. Since most subscribers who subscribe to fixed and/or cellular services can make/receive NLD and ILD calls, subscription base for NLD and ILD market is not relevant and available. Total fixed line connections increased 3.3% during FY2004 to 42.84 million at end FY2004, as compared with a growth of 7.6% during FY2003, and 17.9% during FY2002. By comparison, cellular wireless connections increased 159.4% during FY2004 to 33.69 million at end -FY2004, as compared with a growth of 102% during FY2003, and 79.8% during FY2002. In India, overall teledensity (telephones per 100 inhabitants) increased from 5.11 at end-FY2003 to 7.02 at end -FY2004, and to 8.47 at end -December 2004. There has been an increased substitution of demand towards wireless cellular networks, which is reflected in higher growth rates for cellular services vis-à-vis fixed services, and rapidly increasing cellular teledensity. Fixed line teledensity was 3.94 at end -FY 2004, as compared with 3.88 at end -FY 2003, and 3.68 at end -FY 2002. However, cellular services teledensity is rising at a fast rate—from 0.2 at end-FY 2000 to 1.22 at end -FY2003, and to 3.10 at end-FY2004. The existing record of competition in fixed telecom services in India demonstrates that competition in the provision of local services to residential customers has proceeded more slowly and tentatively than competition to serve business customers. Further, effective competition seems likely in NLD and ILD services. Local access competition is likely to be witnessed more in the cellular services sector than in basic telephony. Cellular networks have made significant contribution to the telecom sector by demonstrating the benefits of competition and innovation and by extending connectivity. They not only add the feature of mobility, but also complement and compete with the fixed line network for voice Report by ICRA Information, Grading and Research Service

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Telecom communications. Significantly, cellular mobile telecommunications are likely to play an increasingly important role in providing universal service, at a lower cost, than fixed line service. In areas of low subscriber density, cellular mobile systems can have lower costs. In fixed line services, the rate of growth in service revenues is likely to be lower in comparison with the pace of increase in the number of fixed lines. This expectation is based on the likely increase in competition from cellular networks and the expected sharp decline in the prices of NLD and ILD services. However, in a competitive environment, slower revenue growth for incumbent operators from voice services could be offset by increased revenues from increasingly higher-speed data related services, and network access services. In cellular services, although subscription growth is expected to be high during the next few years, the rate of growth in revenues is likely to lag the growth in subscriptions because of declining prices, and reduced average revenues per user (ARPU). The deployment of alternative access networks—including fixed, wireless or cable—has been recognised as a means towards greater service competition to the incumbent operators. Cellular services have the maximum potential in diluting the incumbent’s traditional monopoly control over telecommunications services. Since their launch in 1995, the potential of cellular services has become evident from the rapid growth of cellular telephone systems, which attracted nearly 48.5 million subscribers by end -December 2004. Cellular wireless subscriptions accounted for 52% of total telephone connections at end -December 2004, as compared with 44% at end -FY2004, 23.8% at end-FY2003, and 14.3% at end-FY2002. Cellular wireless connections have surpassed fixed line connections during October 2004. The increased preference for wireless telephones in general is attested by the fact that cellular wireless telephone connections accounted for 89% of new telephone connections during April-December 2004, as compared with 94% during FY2004, 69% during FY2003, and 33% during FY2002. For users, cellular mobile telecommunication offers the obvious benefits of mobility and better service quality. By contrast, for the operators, the already high risks are increasing. Greater competition would lead to lower prices for consumers, which in turn will stimulate market demand, thus exerting a downward pressure on costs because of the economies of scale involved. Mobile service price premium are likely to decline, thereby fuelling further market expansion and increased fixed to mobile substitution. However, falling prices and lower ARPUs could endanger the survival of some of the weaker players. The weaker operators would then be forced to enter into strategic alliances or divest equity in favour of stronger players.

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Telecom

OVERVIEW The telecom sector for the purpose of this report includes voice (local and long distance) and data services on fixed and wireless cellular networks. For the purpose of this report, the two segments are fixed and wireless cellular networks.

M a r k e t S i z e a n d S egmentation The Indian fixed services access network (also usually called basic services) had an estimated 42.84 million subscribers at end-March 2004 (end -FY2004), which increased to 44.76 million at end-December 2004. In terms of revenues, the fixed access services revenues were estimated at around Rs. 300 billion during FY2004. The Indian cellular wireless mobile services segment comprises cellular mobile services based on second-generation (2G) digital standards—global system of mobile communications (GSM) and code division multiple access (CDMA). Subscriber base of cellular services aggregated 33.69 million at end -FY2004, comprising 26.15 million on the GSM standard, and 7.54 million on the CDMA standard. Since then, cellular subscriber base has increased to 48.45 million at end-December 2004 (comprising 37.38 million on GSM and 11.08 million on CDMA). Total market size in terms of revenues was estimated at around Rs. 145 billion during FY2004. While the Indian national long distance (NLD) market was estimated at around Rs. 50 billion during FY2004, the international long distance (ILD) market was estimated at around Rs. 43 billion during FY2004. Since most subscribers who subscribe to fixed and/or cellular services can make/receive NLD and ILD calls, subscription base for NLD and ILD market is not relevant and available.

Industry Structure Basic Services Prior to telecom services market liberalisation during the mid-1990s, the provision of fixed network voice services (and most telecom services) in India was the monopoly of the State-owned/controlled operators1—the Department of Telecommunications2 (DoT; now Bharat Sanchar Nigam Limited, or BSNL)3, the Mahanagar Telephone Nigam Limited (MTNL)4 and Videsh Sanchar Nigam Limited (VSNL)5. Following market liberalisation since the 1990s, the Indian fixed services market participants include the erstwhile State-owned and controlled operators—BSNL and MTNL, previously state-controlled VSNL, and private At present, the Government of India (GoI) holds a 100% equity stake in BSNL, 56.25% stake in MTNL and 26.1% stake in VSNL. 2 In October 1999, the DoT was split into licensing (DoT) and operating (Department of Telecom Services or DTS) bodies. The DTS was corporatised on October 1, 2000 and renamed BSNL. BSNL has an authorised capital of Rs. 100 billion and a paid-up capital of Rs. 50 billion. 3 Provides telecom services across the country, except in the MTNL licensed areas of Delhi and Mumbai. 4 Primarily provides fixed and cellular telecom services in Delhi and Mumbai. 5 Primarily provides ILD and NLD services. 1

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Telecom operators licensed during the first round of licensing in 1995 and second round in 2001. Historically, voice telecommunications services in India have been categorised into three distinct market segments: local, long distance national, and long distance international. Broadly speaking, `local telecommunications services' is a phrase used to describe the provision of customer access networks and telecommunications services over relatively short distances. If the calling parties are both within a local area, the boundaries of which are defined by the public telecom operator (PTO) for billing network use, the service is deemed to be `local telecommunications'. On the other hand, national and international telecommunications mean the provision of facilities that link local networks and allow services to be provided across the country and around the world. At present, a fixed network call travelling for less than 50 km radial distance between two any exchanges or between any two charging centres is treated as a `local call'. By contrast, any call travelling over 50 km is treated as a NLD call if it is terminated within the territorial jurisdiction of India, and as a ILD call, if it is terminated outside India. Each customer of a PTO has at least one telecommunications mainline connected to an exchange (the "local loop" or more broadly, the "local access network"), which is used to switch local, long distance national and international calls on the network. It is important to note that the local access network is primarily the infrastructure, allowing the delivery of telecommunications services. Here, two main categories of retail services markets are involved: q Traditional voice telephony (local, long distance national and international) services offered to residential and business users; and q The new emerging market consisting of data services which can be delivered on the local loop in the form of dial-up services, integrated services digital network (ISDN) and digital subscriber line (xDSL) services. Significantly, the local access is also a commodity that can be priced and rented to competitors. This is because the local subscriber link is necessary to provide new services elsewhere in the network. An Internet Service Provider (ISP) has to provide Internet access on the local access lines of BSNL/MTNL/new entrants; similarly, a long distance national and international operator has to interconnect with the local access network for call origination and termination. All this means that as soon as access is given to a part of the network, a new access market develops which is also a relevant market for an operator with control of the access network. Such `bottleneck' characteristics of the fixed local access network give it strategic importance: q there are high fixed and sunk costs associated with investment in the local loop; q there is a high degree of economies of scale and scope in the local loop; q duplication of the fixed local loop is not possible or economically justifiable; q control of the local loop leads to control of information about customers; and q access to the local loop is important to competition across a broad range of services, as described above. Report by ICRA Information, Grading and Research Service

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Telecom In the context of competition in basic services, the ubiquity of the local access infrastructure controlled by an operator is not in all circumstances economically feasible to duplicate, and alternative fixed local access infrastructure cannot usually be constructed with the same ubiquity and competitive conditions within a reasonable time. In basic services, India first introduced competition in local and intra-circle long distance markets. The GoI’s attempt to break the monopoly of the DoT/BSNL and MTNL in the local market began in January 1995 when it invited private participation for the provision of fixed network local and intra-circle long distance services for 21 circles6. Each circle is roughly coterminus with the State boundary, except in a few cases. A duopoly structure was envisaged, whereby only one private operator was to be allowed to operate in each circle (apart from the already existing incumbent operator—BSNL/MTNL). However, only six operators signed licence and interconnect agreements for the circles: Bharti Telenet Limited (BTL) (now Bharti Infotel Ltd. or BIL) for Madhya Pradesh (MP), Tata Teleservices Limited (TTL) for Andhra Pradesh (AP), Hughes Ispat (now Tata Teleservices (Maharashtra) Limited or TTM) for Maharashtra, Shyam Telelink Limited (STL) for Rajasthan, Essar Commvision (now HFCL Infotel or HFCIL)) for Punjab, and Reliance Telecom Limited (RTL) for Gujarat. In the second round of licensing during 2001, the GoI issued twenty-five licences as follows: Reliance Infocomm Limited (RIL) for 17 service areas, BIL for 4 service areas, and TTL for 4 service areas. Till the announcement of Unified Licensing Regime in November 2003, these basic services operators (BSOs) in India provided fixed network telephone services through traditional copper (wireline), fixed wireless (WLL-F), or limited mobility wireless in local loop (WLL-LM). They were allowed to provide voice local and intra-circle long distance services, and various data and enterprise services. Following their migration to the unified licensing regime during November 2003, the erstwhile BSOs are also called unified access service providers (UASP). Such UASPs can now provide both fixed and cellular local and intra-circle long distance services, on any standard/technology, on a unified access licence.

Circles are categorised as Category A—Andhra Pradesh, Delhi, Gujarat, Karnataka, Maharashtra (including Mumbai), Tamil Nadu (including Chennai); Category B—Haryana, Kerala, Madhya Pradesh (including Chattisgarh), Punjab, Rajasthan, Uttar Pradesh-West (including Uttaranchal), Uttar Pradesh-East, West Bengal (including Kolkata) and; Category C—Assam, Bihar (including Jharkhand), Himachal Pradesh, Jammu & Kashmir, North East, Orissa, Andaman & Nicobar Island. 6

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Telecom

Service Area Category A AP Delhi Gujarat Karnataka Maharashtra Tamil Nadu (TN) Category B Haryana Kerala MP Punjab Rajasthan Uttar Pradesh-West (UP-W) Uttar Pradesh-East (UP-E) West Bengal (WB) Category C Andaman & Nicobar (A&N Islands) Assam Bihar Himachal Pradesh (HP) Jammu & Kashmir (J&K) North -East Orissa Compiled by INGRES

BSOs Market Structure Incumbent Operator

1st round (1994-95)

2nd round (2001)

BSNL

TTL

Reliance Infocomm Ltd. (RIL) BIL, RIL, TTL TTL BIL, RIL, TTL RIL

MTNL BSNL BSNL MTNL (Mumbai), BSNL (rest of Maharashtra circle) BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL BSNL

RTL TTM

BIL, RIL, TTL

BIL HFCLI STL

BIL, RIL RIL RIL RIL RIL RIL RIL RIL RIL RIL RIL RIL

National Long Distance (NLD) Markets In 1997, India made commitments under the World Trade Organisation (WTO) negotiations on basic telecommunications services, to review the liberalisation of the NLD market in 1999. The New Telecom Policy, 1999 (NTP, 1999) envisaged the end of the DoT's monopoly in the provision of NLD services with effect from January 1, 2000. Subsequently, on the basis of the recommendations of the telecom regulator—Telecom Regulatory Authority of India (TRAI)—the GoI announced the final entry guidelines during August 2000. The salient features of the entry terms and conditions include: • The NLD licensee has the right to carry inter-circle traffic, excluding intracircle traffic, except where such carriage is with mutual agreement with the BSOs in accordance with their mutually agreed terms. • The licence will be issued on non-exclusive basis, for a period of 20 years, extendable by 10 years at one time. • Licences will be issued without any restriction on the number of entrants. • The applicant company must have a minimum paid-up equity capital of Rs. 2.5 billion. The promoters of the applicant company must have a combined net worth of Rs. 25 billion. Net worth shall be the total of paid-up equity capital and free reserves. The net worth of only those promoters will be counted who have at least 10% equity stake in the total equity of the company. • One-time non-refundable entry fee has been fixed at Rs. 1 billion. In addition, four Bank Guarantees (BGs) of Rs. 1 billion each must be given, which will be Report by ICRA Information, Grading and Research Service

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Telecom

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released on completion of each of the four phases subject to fulfilling the network roll-out obligations by establishing PoPs in LDCAs. In addition to the entry fee described above, licence fee in the form of revenue share @ 10% plus prescribed contributions towards the universal service obligation (USO) Fund with a total cap of 15% is payable. Only facilities-based competition is recommended in the initial phase. The NLD service provider may, however, build its own infrastructure, or buy and/or lease infrastructure/ bandwidth from infrastructure providers. Infrastructure providers can become NLD providers if they do so through a structurally separate licensed legal entity.

The entry norms have provided for competition in inter-circle long distance markets only, except where new entrants make mutual arrangements with existing access providers for carriage of intra-circle traffic. As can be seen from the table below, licenses have been issued to four companies—BSNL, BIL, RIL, and VSNL. While BIL commenced services during January 2002, RIL and VSNL commenced services during FY2003. NLD licencees in India Name of Operator BSNL RIL BIL VSNL Compiled by INGRES

Status Incumbent Service started in May 2003 Service started in January 2002 Service started in September 2002

International Long Distance (ILD) Markets In India, the provision of ILD services was the mo nopoly of the State-controlled carrier, VSNL. According to India's commitments at the WTO and the policy framework envisaged in NTP, 1999, the monopoly of VSNL in the provision of ILD services was to be reviewed only in 2004. But in September 2000, the GoI announced that VSNL's monopoly on ILD services would end on March 31, 2002. The salient features of the entry guidelines for new players are listed here: • There will be no ceiling on the number of operators. Licences shall be issued to all operators who meet the pre-qualification criteria. • The licenses should be for a period of 20 years, with extension of 5 years at a time. The net worth of a prospective ILD operator (ILDO) must be at least Rs. 250 million. q Facility-based competition has been stipulated, i.e., prospective ILDOs must build their own ‘Gateway Facilities’ • Network roll-out conditions ensure that within 3 years from the date of the license agreement ILDOs must: (a) ensure receipt and delivery of traffic from/to all the exchanges in the country; and (b) ensure delivery of traffic to all countries through one or more Gateway Switches having appropriate interconnection with National Long Distance Operator (NLDO). A minimum of four Points of Presence (PoP) will need to be established, one in each region of India. Delivery of traffic to all the countries of the world must be ensured through at least four Direct Routes, i.e., one each to North America, Gulf Region, Europe and any one location in South East Asia, Far East and Oceania. Report by ICRA Information, Grading and Research Service

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The License Fee shall consist of: (a) entry fees of Rs. 250 million; and (b) unconditional bank guarantee for Rs. 250 million favouring the licensor guaranteeing due fulfillment of the stipulated roll-out conditions. The guarantee will be released as soon as the roll-out obligations are met. Nonfulfilment of the roll-out conditions will result in encashment of the bank guarantee by the licensor. In addition to the one -time Entry Fee, ILDOs are required to pay an annual license fee @ 15% (including USO Levy) of the Adjusted Gross Revenue (AGR). ILDOs are permitted to deploy circuit switched or managed packet switched networks. They are also permitted to engineer a lower than toll quality network for customers who do not mind some degradation in the voice quality. The quality of service parameters shall be Mean Opinion Score (MOS) of 4 or above on a scale of 1-5. The subscriber should be made fully aware of the lower quality and lower tariff of such service, which should be made available through a separate dialing code. ILD licencees in India Name of Operator VSNL RIL BIL Data Access (India) Ltd. (DAIL) BSNL MTNL Compiled by INGRES

Status Incumbent Service started in March 2003 Service started in July 2002 Service started in July 2002 Services started Services not started

The GoI has also permitted Internet Service Providers (ISPs) to process and carry voice signals, with effect from April 1, 2002. Internet Telephony has been defined as an Application Service, which the customers of ISPs can avail from their PCs, capable of processing voice signals or other IP-based Customer Premises Equipment (CPE) as follows: (a) PC to PC (within as well as outside India); (b) PC to Telephone (PC in India to telephone outside India); (c) IP-based H.323/SIP Terminals in India to similar terminals both in India and abroad, employing IP addressing scheme of Internet Assigned Numbers Authority (IANA). GSM Cellular Services Cellular mobile communications services can be considered a new product. Although ideas and products based on mobility in telecommunications have been around since the late 19th century, the breakthrough that enabled mass-market cellular communications occurred only in the early 1990s, with the arrival of digital technology. Radio frequency (RF) spectrum is necessary for the transmission of signals between the users’ mobile handsets and the base stations of the cellular operator, but spectrum is scarce and constitutes a bottleneck for cellular mobile services. Digital technology, which was introduced in the early 1990s, makes more efficient use of the radio spectrum than the early analog technology of the 1980s and can, therefore, accommodate more subscribers. The enabling factors have been technological progress both for user terminals and transmission technology. Advances in microelectronics make the design of small, hand-held phone sets possible with ever-increasing functionality and ever-

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Telecom declining prices. Moreover, service quality has improved and a wider range of services can now be offered. In May 1991, the Government of India (GoI) announced its intention of awarding licences to private operators for providing cellular services based on the GSM standard in the four metro cities of Delhi, Mumbai, Kolkata, and Chennai. In July 1992, the GoI invited private participation in providing cellular mobile services in the country. Initially, a duopoly model of competition was adopted for each service area. The award of GSM cellular service licences was planned in two phases through a competitive bidding process. In the first phase, GSM cellular licences were issued to eight operators for the four metros in 1994. The licence for the four metros became effective from November 1994. In the second phase, GSM cellular service licences were to be issued for 20 Circles. The telecom Circles were categorised as A, B and C, in accordance with their status of telephony and potential. GSM Cellular Mobile Service Areas Metros Delhi, Mumbai, Kolkata, Chennai

Category A Circles AP, Gujarat, Karnataka, Maharashtra, TN

Category B Circles Category C Circles Haryana, Kerala, MP, A&N Islands, Assam, Bihar, Punjab, Rajasthan, UPHP, J&K, North -East, Orissa E, UP-W, WB Mumbai includes local areas served by the Mumbai, New Mumbai and Kalyan Telephone Exchanges; Delhi includes local areas served by the Delhi, Ghaziabad, Faridabad, Noida and Gurgaon Telephone Exchanges; NorthEast includes Arunachal Pradesh, Manipur, Assam, Meghalaya, Mizoram, Tripura and Nagaland; UP-W now includes Uttaranchal; MP includes Chattisgarh; Bihar includes Jharkhand. A&N Islands is now part of WB for cellular services.

After a competitive bidding process, 34 additional licences (besides the eight in the first round awarded for metros) were issued in 18 State Circles (A&N Islands and J&K did not receive any bids; WB and Assam received only one bid each). The licence for most of the Circle Operators came into force from December 19957. Cellular mobile services8 based on the GSM standard were introduced in India on a commercial basis in the four metros during 1995. On August 23, 1995, Modi Telstra (now Spice Communications) launched the first cellular services in the country in Kolkata. The launch of services by operators in the metros was followed by the launch of services in Circles during 1996-1998. The licenses provided for the payment of fixed amounts as license fees and were valid for an initial period of 10 years (subsequently increased to 20 years). In response to industry conditions, the GoI approved the New Telecom Policy, 1999 (NTP, 1999) in 1999. Further announcements under NTP, 1999 in July 1999 allowed existing cellular mobile service providers (CMSPs) to switch from the previous licence fee regime to a new revenue sharing arrangement, subject to the fulfillment of certain conditions: • The cut-off date for moving to the new regime was August 1, 1999.

7 8

The licences for GSM cellular services are for a period of 20 years, further extendable by 10 years at one time. Cellular network local and intra-Circle (within a Circle) long distance services.

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Licence fee dues payable by the operator till July 31, 1999 was treated as entry fee. All arrears of licence fee had to be payable by January 31, 2000. The percentage of revenue share and entry fee was to be recommended by the TRAI. In the interim, operators were required to pay 15% of gross revenue as licence fee; gross revenue excluded public switched telephone network (PSTN)related call charges payable to the DoT/MTNL and service tax payable by the subscribers. Licence period was to be extended from 10 years to 20 years. Both the operators in cellular Circles had to agree to migrate, otherwise they would remain under the previous licence fee regime. A five -year lock-in period of present shareholders from the date of licence agreement was mandated.

In addition to the existing two operators, the State-owned/controlled operators— BSNL9 and MTNL reserve the right to be the third operator in each of the licensed service areas10. MTNL holds the licence to provide cellular services in Delhi and Mumbai, and commenced its GSM cellular services during February 2001. BSNL is the third-operator in 20 service areas (including the metros of Kolkata and Chennai, five Category A circles, eight Category B circles, and five Category C circles). BSNL launched its GSM cellular services from Kolkata and Bihar during January 2002. Services in other service areas were launched during 2002-03. During 2001, the GoI also invited bids for the award of licences (for a duration of 20 years, further extendable by 10 years at one time) to the fourth operator for cellular services in the four metros and telecom circles, besides filling up of the existing slots of A&N Islands and WB. In August 2001, after a `multi-stage ascending bid’ process, the GoI issued licences to the successful bidding companies, following their payment of the entry fees of Rs. 16.34 billion. Nearly all licenced fourth-operators commenced services during 2002. During February 2003, the GoI also invited fresh tenders for grant of 14 licences for providing cellular services for the vacant slots in 8 circles (A&N & WB, Assam, Bihar, J & K, North-East, Orissa, UP-E, and UP-W). Although 7 companies purchased the tender document, none of the companies submitted their bid.

Unified Licensing Unified Access Services License (UASL) In November 2003, the GoI also allowed basic and cellular services to be unified within the service area (called the unified access services license or UASL). In In October 1999, the Department of Telecommunications (DoT) was split into licensing (DoT) and operating (Department of Telecom Services or DTS) functions. The DTS was corporatised on October 1, 2000 and renamed BSNL. Against an authorised equity share capital of Rs. 100 billion and preference share capital of Rs. 75 billion, the paid-up equity share capital and preference share capital of BSNL as on March 31, 2003 were Rs. 50 billion and Rs. 75 billion respectively. BSNL is the largest telecom services operator in India. During FY2003, it earned a net profit of Rs. 14.44 billion on revenues of Rs. 252.93 billion. 10 The licences for cellular services by BSNL/MTNL are for a period of 20 years, further extendable by 10 years at one time. 9

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Telecom pursuance of this decision, the salient features of the guidelines for the UASL are detailed below: 1. The existing operators shall have an option to continue under the present licensing regime (with present terms & conditions) or migrate to new UASL in the existing service ar eas, with the existing allocated/ contracted spectrum. 2. The license fee, service area, rollout obligations and performance bank guarantee under the UASL will be the same as for fourth CMSPs. 3. The service providers migrating to UASL will continue to provide wireless services in already allocated/contracted spectrum and no additional spectrum will be allotted under the migration process for UASL. 4. In addition to services permissible under current licences, CMSPs may also offer limited mobility facility existing within Short Distance Charging Area (SDCA) as permitted to BSOs at appropriate tariffs through concepts such as home-zone operations, etc. 5. The UASL service providers are free to use any technology without any restriction. 6. No additional entry fee shall be charged from CMSPs for migration to UASL. For BSOs, the entry fee for migration to the UASL for a Service Area shall be equal to the entry fee paid by the Fourth CMSP for that Service Area, or the entry fee paid by the BSO itself, whichever is higher. While applying for migration to UASL, the BSO will pay the difference between the said entry fee for UASL and the entry fee already paid by it. 7. Notwithstanding anything stated in para 6 above, no additional entry fee will be paid by the existing BSOs where no Fourth CMSP had bid despite repeated attempts. 8. Those BSOs who do not wish to migrate to the full mobility regime, would only be required to pay the additional fee for WLL-LM, with mobility confined strictly within SDCA, as prescribed separately. 9. The Service Areas for UASL will be as per the existing Cellular Mobile Telephone Service Licences. BSO wishing to migrate to UASL will be permitted to operate in the service area in which it is already operating. It is, however, clarified that BSOs in Delhi, Haryana and UP (West) service areas, on migration to UASL, will have service area as that of CMSP in Delhi, Haryana and UP-W service areas respectively. Since the service area for the UASL will be as per existing CMSPs, existing BSOs in Maharashtra, TN and WB service areas will be required to hold two UASLs (one for Mumbai Metro city and the other for the rest of Maharashtra and so on). 10. The existing BSOs after migration to UASL may offer full mobility; however, they will be required to offer limited mobility service also for such customers who so desire. 11. The Licence Fee is 10%, 8% & 6% of Adjusted Gross Revenue (AGR) for Metros and Category A, Category B, and Category C Service Areas respectively with effect from April 1, 2004. 12. Consequent upon migration, the Licence will be termed as UASL. The relevant applicable conditions of the existing licence agreements will get modified to the extent of the conditions stated above. The amended Licence shall be set out in detail separately. Report by ICRA Information, Grading and Research Service

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Telecom All the erstwhile BSOs have migrated their existing Service-Specific Access License to a UASL. Many CMSPs have also migrated some Service-Specific Access License to a UASL. Upon obtaining a UASL, the erstwhile BSOs have the option of providing fully mobile wireless services based on any technology. However, given the substantial investment of many BSOs in CDMA technology (through which they provide WLL-F and WLL-LM services), they are unlikely to switch to the GSM technology, even though there are no regulatory restrictions on such a switch-over. Presently, UASPs largely provide the following types of telephone connections—basic copper, WLL-F, WLL-LM, and fully mobile (presently based on CDMA). Conversely, given their substantial investments in GSM networks, GSM cellular services operators are unlikely to adopt the CDMA standard. Thus, presently the Indian cellular mobile services market is served by both GSM and CDMA operators. Unified Licensing In its Unified Licensing recommendations of October 2003, the TRAI had envisaged a two-stage process to introduce a Unified Licensing Regime in the country. The first phase that entailed a UASL at circle level has already been implemented. In January 2005, the TRAI forwarded its recommendations of Unified Licensing Regime (ULR) in India. The recommendations are yet to be accepted by the GoI. The salient features of TRAI’s recommendations are as follows: q There shall be four categories of licenses: (a) Unified License—all public networks including switched networks irrespective of media and technology capable of offering voice and/or non-voice (data services) including Internet Telephony, Cable Television, Direct To Home (DTH), TV & Radio Broadcasting shall be covered under this category. Unified License implies that a customer can get all types of telecom services, from a Unified License Operator. The operator can use wireline or wireless media. (b) Class License—all services including satellite services, which do not have both way connectivity with Public Network, shall be covered under Class license. This category excludes Radio Paging and Public Mobile Radio Trunking Systems (PMRTS) Services and includes niche operators. (c) Licensing through Authorisation—this category will cover the services for provision of passive infrastructure and bandwidth services to service providers, Radio Paging, PMRTS, Voice Mail, Audiotex, Video Conferencing, Videotex, E-mail service, Unified Messaging Services, Tele-banking, Tele-medicine, Tele-education, Tele-trading, Ecommerce, Other Service Providers, as mentioned in NTP’99 and Internet Services including existing restricted Internet Telephony (Personal Computers (PC) to PC; within or outside India, PC in India to Telephone outside India, IP based H.323/SIP Terminals connected directly to ISP nodes to similar Terminals; within or outside India), but not Internet Telephony in general. (d) Standalone Broadcasting and Cable TV licence—this category shall cover those service providers who wish to offer only broadcasting and/or cable services. q This licensing framework except stand-alone Broadcasting & cable TV services shall be hierarchical in nature with Unified Licence being at the highest hierarchical level. Such a licensing regime would enable a licensee to provide any or all telecom services by acquiring a single license. Report by ICRA Information, Grading and Research Service

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Telecom q There shall be no restriction on usage of Internet Telephony or other IP

q

q q

q

q

q

q

enabled services provided they are offered by operators with Unified License who have duly paid the prescribed registration charges and who will be subjected to license fees. Niche Operators—To increase penetration of telecom services in rural/remote/backward areas, the TRAI has recommended that SDCAs where fixed rural teledensity is below 1% shall be area of operation for Niche Operators. Niche Operators shall be permitted to offer fixed telecom services including multimedia, Internet telephony and other IP enabled services only in these SDCAs. These operators shall however, be permitted to use wireline/fixed wireless networks. This definition of niche operators shall be reviewed depending upon market conditions and development of various technologies and various applications. Service Area—Depending upon the choice of service provider it could be national level or circle level. For niche operators it would be at SDCA level. Bank Guarantees—Performance Bank Guarantee (PBG) for Unified License will be as per UASL. There shall be no PBG for Class License and `Licensing through Authorisation’. For NLD/ILD operators and UASLs who do not migrate to Unified Licensing Regime, the existing PBG shall continue. License Fee—For Unified License, Class License and Niche operators the License fee shall be 6% of Adjusted Gross Revenue (AGR), comprising contribution to universal service fund (USF) of 5%, administrative cost of 1%. Services licensed through Authorisations shall not be required to pay any License fee. Reselling—The TRAI has recommended that reselling should not be permitted at this stage. However, franchise and sharing of infrastructure among service providers should continue to be implemented. Migration—The TRAI has recommended that migration of the existing service providers to the ULR may be optional. However, after a period of 5 years it shall be mandatory for all telecom operators to migrate to ULR. Till the ULR comes into effect, the operator is free to take UASL in any circle and this situation should continue till two year of implementation of ULR. This period of two years would also be available for all other existing services. After this period of two years no new service specific license including UASL, as in the existing licensing regime, shall be issued and all new Service Providers shall be licensed under new ULR.

The key objective of the ULR appears to be to encourage free growth of new applications and services leveraging on the technological developments in the Information and Communication Technology (ICT) area. Other main objectives of the ULR are to simplify the procedure of licensing in the telecom sector, encourage efficient small operators to cover niche areas in particular rural and remote areas, and to ensure easy entry, level playing field.

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Telecom

MARKET CHARACTERISTIC S—DEMAND Overall Telephone Penetration In India, overall teledensity (telephones per 100 inhabitants) increased from 5.10 at end-FY2003 to 7.02 at end-FY2004. As the table below, overall teledensity has increased from 1.9 at end-FY1998. As at end-FY Total Urban Rural Compiled by INGRES

1998

Overall Teledensity in India

1.94 5.78 0.43

1999

2000

2001

2002

2003

2004

2.33 6.87 0.52

2.86 8.23 0.68

3.58 10.37 0.93

4.29 12.20 1.21

5.11 14.32 1.49

7.02 20.74 1.57

The teledensity data indicates that while rural areas had a teledensity of 1.57 at end-FY2003, urban areas had a teledensity of 20.74. Overall Teledensity in India at end-March 2004

Fixed and cellular connections per 100 inhabitants Total Urban Rural

METROS

Kolkata Chennai Delhi Mumbai

18.92 38.81 41.79 36.08

18.92 38.81 44.48 36.08

AP Gujarat Karnataka Maharashtra TN CATEGORY B Haryana Kerala MP Chattisgarh (MP) Punjab Rajasthan UP Uttaranchal (UPW) WB CATEGORY C A & N Islands Assam Bihar Jharkhand (Bihar) J&K HP North East-I North East-II Orissa TOTAL-INDIA Compiled by INGRES

7.85 10.14 9.46 8.00 8.54

22.70 22.46 22.58 19.99 17.21

2.03 2.52 2.41 2.31 2.35

8.38 14.87 3.99 1.63 17.33 4.50 2.96 5.10

22.01 32.82 12.91 6.02 38.25 14.83 12.24 15.17

2.42 8.60 0.68 0.47 4.81 1.32 0.47 1.48

11.56 17.50 2.13 12.47 1.67 11.64 2.00 7.34 3.01 10.12 10.14 51.12 3.35 10.89 2.71 9.07 2.95 13.86 7.02 20.74

8.40 0.56 0.50 0.45 0.61 5.51 1.08 1.01 0.95 1.57

CATEGORY A

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Telecom As shall be discussed below, there has been an increased substitution of demand towards wireless cellular networks, which is reflected in higher growth rates for cellular services vis-à-vis fixed services, and rapidly increasing cellular teledensity. As at end-FY

Overall Teledensity in India by types of telephone

Fixed CDMA WLL-LM/fully mobile GSM Cellular Total Compiled by INGRES

2000

2001

2002

2003

2004

2.66 0.00 0.19 2.85

3.20 0.00 0.37 3.58

3.68 0.00 0.61 4.29

3.88 0.03 1.19 5.11

3.94 0.69 2.40 7.02

December 2004 4.07 1.01 3.40 8.47

Slow Growth in Fixed Network Services in Recent Years Till FY2000, the fixed line network in India primarily consisted of the networks of the state-owned/controlled incumbent operators—BSNL/MTNL. However, private operators now have an increasing presence in the provision of fixed networks and basic services. However, more than 50% of the subscriber connections of private operators are based on WLL-F, rather than the traditional copper network. For example, of the 4.30 million fixed connections provided by BSOs at end-December 2004, an estimated 2.86 million (accounting for 66.4% of total connections) were for WLL-F services. The most obvious measure of the size of a telecom operator is the number of telephones installed. The number of fixed telephones installed by BSNL and MTNL has increased at a compounded annual growth rate (CAGR) of 13.4% over the last five years, from 26.51 million as of end-FY2000 to 40.58 million as of end FY2004. However, growth has slowed down since FY2003 primarily because of increased competition from cellular services, and some surrender of fixed line connections and installation of cellular connections by subscribers of BSNL and MTNL. Including basic and WLL-F connections of private operators, the total fixed line connections in India increased 3.3% during FY2004 to 42.84 million at end FY2004, as compared with a growth of 7.6% during FY2003, and 17.9% during FY2002. Overall per month incremental fixed telephone additions have declined from 0.487 million in FY2002 to 0.245 million in FY2003, and to 0.112 million during FY2004. Despite the increasing reach of BSNL and MTNL's telephone network, there remains a high level of unmet basic telephone demand in the country till recently. There is a large element of latent demand for telephones, despite a sustained high growth in network expansion and provision of new connections. Thus, in an economy which has high potential for growth, telecommunication shows up as an area due for robust demand growth requiring huge investments. This overall scenario of growth orientation is typical of a supply-constrained environment where telephone demand increases with accelerated supply. However, in recent years, with increased coverage of cellular services, the wait list for fixed basic telephone connections has declined, indicating a shift in demand towards cellular services.

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Telecom Fixed Network Subscriber Connections in India As of end-FY BSNL MTNL BIL HFCLI RTL RIL STL TTL TTM Total Growth-% Compiled by INGRES

1999

2000

2001

2002

17,940 3,654

22,480 4,032 92

28,109 4,327 115 13 0

33,416 4,543 181 73 0

9 70 59 32,702 22.7

27 150 161 38,552 17.9

21,594 21.3

27 22 26,652 23.4

Thousands, includes basic, WLL-F 2003 2004 Sep. 2004 35,908 36,112 36,147 4,634 4,367 4,124 371 637 765 80 125 162 0 44 81 459 841 49 92 108 217 670 1,104 233 334 535 41,491 42,841 43,868 7.6 3.3

Despite the impressive network size and growth achieved during the latter half of the 1990s, fixed line installation in India is not spread evenly across all regions. For example, the four metropolitan cities accounted for 16.9% of the fixed lines installed by BSNL/MTNL as of end-FY2004. For private operators, the four metros accounted for 35.2% of their fixed line connections at end-FY2004. Despite wide differences in call rates, consumer demand and expenditure patterns on telephone services are remarkably similar across countries. In general, highincome consumers spend two to three times as much on telephone service as lowincome consumers. Lower disposable income is thought to be the main reason why rural areas and backward States with the least income per capita have lower telephone penetration rates and lower average revenues. Thus, for areas with relatively low-income levels, there is insufficient demand at remunerative prices to warrant the same penetration rates as exist in wealthier regions. However, given their potential, custome rs in lower income regions might not want a telephone network as extensive as that existing in wealthier regions. Nearly 70% of India’s population lives in villages. However, rural areas accounted for only 30% of total fixed line connections of BSNL/MTNL at end-March 2004. Rural operations have a much more difficult time generating revenues than urban ones. Lower disposable income is thought to be the main reason why rural areas and backward States with the least income per capita have lower telephone connections. For FY1998, the TRAI estimated BSNL’s average annual revenues from rural DELs at Rs. 4,725 per annum compared with Rs. 8,778 for urban lines. In May 2000, the BSNL had indicated to the TRAI that, based on the information available for 15 Telecom Circles, the cumulative average revenue for a rural mainline was an estimated Rs. 2,232 per annum. Fixed Network Penetration Fixed line teledensity is exceedingly low in India. Although it was rising at a fast rate till FY2003, the growth in fixed line teledensity has slowed down during FY2004.

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Telecom Fixed Line Teledensity in India 3.9

3.7

3.9

4.1

3.2

Dec-04

Mar-04

Mar-03

Mar-02

Mar-01

2.7

Mar-00

2.2

Mar-99

1.8

Mar-98

4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

Compiled by INGRES

As of end -2002, there were an estimated 22.4 worldwide mobile subscribers per 100 inhabitants, as compared with 18.5 worldwide fixed line subscribers.

Shift in D e m a n d t o w a r d s C e l l u l a r W i r e l e s s The demand for telephone connections has shown a rising trend in favour of cellular wireless connections. For example, fixed line connections accounted for 48.1% of total telephone connections in India at end -December 2004, as compared with 56% at end -FY2004, 76.2% at end -FY2003, and 85.7% at end-FY2002. However, the share of cellular wireless (GSM/CDMA) in total telephone connections has increased from 14.3% at end-FY2002 to 23.8% at end -FY2003, to 44% at end -FY2004, and 52% at end -December 2004. Status of Total Telephone Connections in India At end-FY

1999

2000

2001

2002

2003

2004

Thousands December 2004

Subscriptions ('000) Fixed Cellular CDMA Cellular GSM

21,594 0 1,200

26,652 0 1,884

32,702 0 3,577

38,552 0 6,431

41,491 303 12,688

42,841 7,540 26,154

44,760 11,075 37,379

Total

22,793

28,536

36,279

44,983

54,482

76,535

93,214

94.74 0.00 5.26

93.40 0.00 6.60

90.14 0.00 9.86

85.70 0.00 14.30

76.16 0.56 23.29

55.98 9.85 34.17

48.02 11.88 40.10

100

100

100

100

100

100

100

Percent of total Fixed Cellular CDMA Cellular GSM Total Compiled by INGRES

Looking forward, it seems highly that the share of basic fixed line connections is likely to decline. The increased preference for wireless telephones in general is attested by the fact that cellular wireless telephone connections (GSM and CDMA) accounted for 93.9% of new telephone connections during FY2004, as compared with 69.1% during FY2003, and 33% during FY2002.

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Telecom India: Percent of Total Telephone Additions

9MFY2005

FY2004

FY2003

Cellular GSM

FY2002

CDMA

FY2001

FY2000

Fixed

FY1999

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Compiled by INGRES

For most of the 127 years of telecommunications, wireless cellular has played a secondary role to fixed/wireline in the provision of telecommunications services. That changed during the last few years and the trend is likely to accelerate during the present decade. It would not be farfetched to say that, within the present decade, what we think of ‘telephone service’ namely voice telephone calls—will be increasingly carried by cellular wireless networks. Fixed line access would, then, evolve towards extremely low cost, extremely high speed links for applications that need bandwidth but not mobility—that is, wireless will serve the voice applications, while fixed line will serve the specialised data applications. Further, new gene ration digital cellular technologies, such as 3G technologies, will begin to remove the present data performance barrier for wireless, further improve the performance capabilities of wireless, and drive down the cost of both wireless voice and data. Howeve r, it is highly unlikely that consumers with a mobile subscription will relinquish their fixed lines connections. There are a number of reasons for this, ranging from human requirements, the technical capabilities of mobile technology, the pricing of mobile services, expected improvements in fixed network data capabilities through xDSL, in the short term, and the ubiquitous deployment of extremely high bandwidth fibre in the long term. High Growth in GSM Cellular Services Subscriptions Since their launch in 1995, the exciting potential of wireless cellular technologies in India is evident from the rapid growth of GSM cellular telephone systems, which had attracted 37.38 million subscribers by end-December 2004. On a calendar year basis, the GSM cellular mobile subscriber base increased at a 5-year CAGR of 88.2% to 37.38 million subscribers at end -2004. On a fiscal year (FY) basis, subscriptions increased at a 5-year CAGR of 85.2% to 26.15 million at end FY2004. Subscriber base increased 106.1% during FY2004, as compared with 97.3% during FY2003, and 79.8% during FY2002. On a calendar year basis, subscriptions increased 65.4% during 2004, as compared with a growth of 109.3% during 2003, and 91.3% during 2002.

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Telecom GSM Cellular Subscriptions in India As at end-FY Subscriptions Metros Category A Category B Category C

1999

2000

2001

2002

2003

1,199.58 519.54 354.80 288.32 36.92

1,884.31 795.93 585.65 460.09 42.63

3,577.10 1,362.59 1,165.78 932.69 116.04

6,430.81 2,567.76 2,134.33 1,501.15 227.57

12,687.64 4,439.52 4,364.94 3,374.54 508.63

Figures in thousands 2004 December 2004 26,154.41 7,941.77 9,698.30 7,402.07 1,112.27

Avge. Monthly 26.44 57.06 141.07 237.81 521.40 1,122.23 Additions Metros -2.68 23.03 47.22 100.43 155.98 291.85 Category A 14.82 19.24 48.34 80.71 185.88 444.45 Category B 12.50 14.31 39.38 47.37 156.12 335.63 Category C 1.80 0.48 6.12 9.29 23.42 50.30 Source: Compiled by INGRES based on Cellular Operators Association of India (COAI) Data

37,378.81 10,259.71 13,505.38 11,581.29 2,032.43 1,247.16 257.55 423.01 464.36 102.24

Average monthly subscribers (net of churn) increased 115.2% during FY2004 to 1.12 million, as compared with increases of 119.3% during FY2003, and 68.6% during FY2002. The recent surge in the growth of mobile telecommunications has eclipsed what had been achieved previously. For example, between 1995 and end FY2003, subscriptions increased to 12.69 million by end -FY2003. However, subscriptions then more than doubled to 21.99 million at end -2003. Such subscriber growth rates are comparable or somewhat higher than the rates achieved in developing country markets over an extended period. The subscriber growth rates in India also lag the growth rates achieved in many developing economy markets. Between 1995 and 2002, in countries with GDP per capita of less than US$2,000, subscriber base increased at a CAGR of 75.7%. GSM Cellular services penetration in India is rising at a fast rate—from 0.2 at end-FY2000 to 2.4 at end-FY2004, and to 3.4 at end -December 2004. GSM Cellular Teledensity in India 3.5

3.4

3.0 2.5

2.4

2.0 1.5

1.2

Dec-04

Mar-04

Mar-03

0.6 Mar-02

0.3 Mar-01

0.1

0.2 Mar-00

0.0

0.1 Mar-99

0.5

Mar-98

1.0

Compiled by INGRES

In India, cellular (GSM and CDMA) teledensity is higher in metros than in circles. Although there exists a high correlation between Gross Domestic Product (GDP) per inhabitant and cellular penetration, there are other factors that might explain the level of variations in cellular penetration for regions. These include Report by ICRA Information, Grading and Research Service

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Telecom distribution of income, start up date of launch of cellular services, market structure (fragmented or concentrated), level of competition within the region, and cost of service. An alternative method of analysing GSM cellular penetration is to compare cellular subscribers with fixed line connections. Over the last few years, the increased competition in cellular vis-à-vis fixed networks, declining price premium for cellular services over fixed services, the ease of getting a cellular connection, and improved availability has resulted in cellular services being increasingly perceived as a substitute for fixed lines, at least for some subscribers. GSM Cellular subscriptions made up 34.2% of the total telephone connections in India at end-FY2004, as compared with 23.3% at end -FY2003, and 14.3% at end-FY2002. Including CDMA subscriptions, cellular wireless subscriptions accounted for 44% of total telephone connections at end-FY2004, as compared with 23.8% at end FY2003, and 14.3% at end -FY 2002. While cellular subscriptions have increased at a uniformly high rate in all the service areas during the past few years, a majority of the subscriber additions during the last two years have taken place in the Circles. GSM Circle subscriber additions of 1.13 million during FY2001 accounted for 66.5% of the national subscriber additions. However, GSM circle subscriber additions accounted for only 57.8% of national subscriber additions during FY2002, mainly because of slower growth in Category A circles and higher growth in metros (following the launch of service by MTNL). During FY2003, GSM subscriber additions in circles represented 70.1% of the total national subscriber additions, mainly because of the launch of services by BSNL and other newly licensed operators. The proportion of GSM cellular services additions in circles increased to 74% during FY2004. The GSM cellular subscriber base in the Circles represented 68.9% of the national subscriber base at end-FY2004, as compared with 65% at end -FY2003, and 60.1% at end-FY2002. Share of National GSM Cellular Subscriber Base 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Mar-99

Mar-00

Mar-01 Metros

Mar-02 Cat. A

Cat. B

Mar-03

Mar-04

Dec-04

Cat. C

Source: Compiled by INGRES based on COAI Data

The share of circles has increased not because of a significant slowdown in subscriptions in the metros, but rather because of network expansions which has Report by ICRA Information, Grading and Research Service

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Telecom resulted in wider coverage. Subscription growth in the metros remains high at 72.9% during FY2003, and 78.9% during FY2004. Subscriptions in circles also continue to increase at a high rate, mainly because of lower penetration and increasing availability of services. India: Service Area Wise Growth in GSM Cellular Subscriptions FY METROS

1998

1999

69.3 -5.8 44.3 -15.5 44.2 0.2 34.7 -22.3 122.1 -6.1 CATEGORY A 1724.6 100.5 AP 572.6 96.5 Gujarat 865.9 105.8 Karnataka 0.0 76.9 Maharashtra 0.0 116.7 TN 0.0 122.1 CATEGORY B 4510.3 108.5 Haryana 365.8 31.7 Kerala 0.0 113.4 MP 0.0 70.1 Punjab 0.0 226.5 Rajasthan 0.0 23.9 UP-West 0.0 105.9 UP-East 0.0 135.4 WB 0.0 110.0 CATEGORY C 4079.2 141.3 Assam 0.0 71.3 Bihar 0.0 160.2 HP 468.3 61.5 J& K 0.0 0.0 North -East 0.0 0.0 Orissa 0.0 177.6 TOTAL SUBSCRIBERS 160.2 36.0 Source: Compiled by INGRES based on COAI Data Chennai Delhi Kolkata Mumbai

2000

2001

2002

2003

Percent per annum 2004 2005 (9M)

53.2 51.4 54.1 126.4 39.9 65.1 42.5 79.4 66.2 18.4 262.1 59.6 36.0 133.6 94.8 70.3 24.2 -25.1 109.3 35.0 15.5 50.5 14.1 50.2 0.0 29.9 -8.0 57.1

71.2 131.0 67.5 80.0 62.4 99.1 94.6 70.2 70.9 132.7 147.7 102.7 140.7 168.9 115.9 69.5 230.4 97.6 28.2 298.3 172.2 156.5 179.2 185.2 0.0 172.0 158.1 89.8

88.4 107.6 91.8 64.0 87.9 83.1 141.6 87.9 83.0 77.6 31.1 60.9 66.2 28.4 141.8 118.1 79.0 81.6 -24.0 167.8 96.1 92.2 101.3 52.9 0.0 129.7 108.7 79.8

72.9 73.0 69.2 85.9 73.4 104.5 78.1 123.6 105.3 110.3 108.3 124.8 144.2 79.5 107.7 163.0 108.1 126.5 138.2 246.2 123.5 64.9 111.6 175.7 0.0 92.6 166.9 97.3

78.9 118.9 79.4 79.3 67.6 122.2 115.3 98.3 114.4 133.5 164.7 119.4 122.5 91.8 84.0 124.2 148.0 123.8 206.7 94.7 118.7 82.6 97.9 178.3 0.0 252.4 106.0 106.1

38.9 65.2 24.6 70.8 36.1 52.3 46.9 38.1 64.7 39.1 82.4 75.3 65.4 68.6 53.0 54.5 103.9 64.6 135.4 143.0 110.3 226.5 57.6 104.4 568.4 268.6 91.5 57.2

Rapid Growth in WLL -LM/CDMA Subscriptions The CDMA mobile services offered by UASPs is fairly similar to the GSM cellular services business model. Earlier, the provision of WLL-LM by BSOs had led to an anomalous situation with respect to licence fees and spectrum availability. WLL was subsumed under the provision of basic services though it used the spectrum, as do the cellular services. Thus while entry into cellular services was limited with licences being auctioned, entry into WLL-LM was no t limited and the associated licence were not auctioned. The Telecommunications Dispute Settlement and Appellate Tribunal (TDSAT) had upheld that WLL-LM would go a long way in increasing the teledensity and will render services cheaper and affordable. In August 2003, it passed a split verdict, allowing basic operators to offer WLL-LM even as it directed TRAI to take steps to ensure a level playing ground for cellular operators. For instance, it had ordained that basic operators should pay an entry fee for offering WLL services and had asked TRAI to calculate the amount. It had also asked the regulator to levy charges for additional spectrum requirements on WLL operators. Further, WLL Report by ICRA Information, Grading and Research Service

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Telecom operators had been prohibited from offering roaming facilities and mobility had been restricted to a SDCA. Lastly, the use of mobile switching centres by WLL operators had not been allowed. However, with the announcement of Unified Access Service Guidelines in November 2003, and the migration of erstwhile BSOs to UASLs, the WLL-LM issue has now been resolved with UASPs allowed to offer the same cellular services with complete mobility as was being offered by GSM cellular operators. Since the launch of CDMA WLL-LM services during 2003, and the upgradation of services to CDMA fully mobile from November 2003, subscriber growth for CDMA mobile services has been significant. Subscription base aggregated 11.02 million at end-December 2004, as compared with 7.54 million at end-FY2004, and 0.30 million at end-FY2003. CDMA Cellular Subscriptions in India As at end-

June 2003

September 2003

Subscriptions-thousands 2,081.28 4,616.98 Category A 1,535.65 3,192.83 Category B 531.82 1,338.25 Category C 13.80 85.90 Compiled by INGRES; does not include BSNL/MTNL

December 2003 6,189.94 4,279.75 1,756.07 154.12

March 2004 7,157.16 4,897.43 2,069.47 190.26

December 2004 9,996.00 6,587.63 3,108.08 300.29

CDMA cellular services teledensity has increased from 0.03 at end-FY2003 to 0.69 at end-FY2004, and to 1.01 at end-December 2004. Pricing Declines and Cellular Services Growth Mobile cellular communication services have a sustained but declining price premium over fixed voice services. However, higher prices seem to have done little to detract users from the value of a mobile service. Users value the defining feature of a cellular mobile service—the ability to make and receive calls `anywhere’. In addition, cellular services also provide more value -added functions, which are typically not available on the fixed network. Examples include caller identification, short messaging service (SMS), Internet access on terminal, high functionality voice mail and a wide range of supplementary services. SMS adds value to a GSM network by offering services such as voice-mailbox notifications, two-way-paging and message storage. There has been a sharp decline in prices of cellular services in India over the last few years. This has been reflected in a significant decline in revenues per minute (RPM) for GSM cellular services. RPM for GSM Cellular services has declined from Rs. 6.70 during FY2000 to Rs. 1.55 during FY2004. RPM for postpaid service alone has declined from Rs. 6.55 during FY2000 to Rs. 1.79 thereby showing a decline of 73%. For prepaid service, the decline has been 81% (from Rs. 7.32 to Rs. 1.39).

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Telecom

Trends in earned Revenues per Minute for GSM Cellular Services in India Postpaid FY2000 FY2001 FY2002 FY2003 FY2004 Source: TRAI Data

RPM 6.55 4.82 3.67 2.55 1.79

% change -27% -24% -30% -30%

Prepaid RPM 7.32 5.65 5.43 3.49 1.39

Rs.

Blended

% change

RPM 6.70 4.98 4.05 2.82 1.55

-23% -4% -36% -60%

% change -26% -19% -30% -45%

As the cost of cellular services has declined, it has become a mass-market product. As subscription levels have increased, operators have been able to distribute the fixed costs of a cellular network over greater numbers of users, thereby optimizing network usage. Additionally, competition has resulted in further price declines, thereby making services affordable to even greater number of potential users. The experience of cellular operators in India and most of the other countries indicates that the number of subscribers and penetration accelerates as usage becomes more ubiquitous. In addition, in spite of the continuing decline in prices, average revenues per user (ARPUs), and MoUs, many operators experience growth in operating profit at a higher rate than subscriber growth.

PLAYERS Player Types and Outlines of Players The Indian telecom industry consists of incumbent players such as BSNL, MTNL, and VSNL; and private operators licensed for various services since the mid-1990s. The major players in the various sub-segments are detailed below: Basic Services BSNL MTNL BIL HFCLI RTL RIL STL TTL TTM Compiled by INGRES

Major Players in the Indian Telecom Industry

Cellular GSM Bharti Televentures BSNL Hutchison Essar IDEA Cellular/Escotel BPL Group Spice Reliance MTNL Aircel

Cellular CDMA BSNL MTNL BIL HFCLI RTL RIL STL TTL TTM

BSNL RIL BIL VSNL

NLD

VSNL RIL BIL DAIL BSNL

ILD

According to TRAI, the overall revenue for the telecom sector for all the operators for FY2003 was estimated at Rs. 456,722 million or Rs. 456.72 billion. With revenues of Rs. 311 billion, BSNL and MTNL together accounted for almost 68% of the total revenues. Among the private operators, Bharti group had a turnover of Rs. 31.72 billion, accounting for around 7% of total sector revenue. VSNL had a turnover of Rs. 45.38 billion, representing 10% of total sector revenues.

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Telecom

Operational Revenues of Major Players in the Indian Telecom Industry—FY2003 Name

Major Services Provided

BSNL MTNL VSNL Bharti Cellular Ltd. Bharti Infotel Ltd. Idea Cellular Hutchison Max Telecom Bharti Mobile Ltd. Data Access (I) Ltd. Hutchison Essar Telecom BPL Mobile Communications BPL Mobile Cellular Fascel Ltd. Tata Teleservices (Maharashtra) Reliance Telecom Escotel Mobile Tata Teleservices Aircel Ltd. Hutchison Telecom East Source: TRAI

Basic, Cellular, NLD Basic, Cellular, NLD NLD, ILD Cellular Basic, NLD, ILD Cellular Cellular Cellular ILD Cellular Cellular Cellular Cellular Basic Cellular Cellular Basic Cellular Cellular

Revenues greater than Rs. 2,000 million Revenues Market Share (Rs. Million) (%) 252,932 55.4% 58,065 12.7% 45,386 9.9% 13,982 3.1% 11,025 2.4% 8,515 1.9% 7,669 1.7% 6,718 1.5% 6,014 1.3% 5,334 1.2% 4,426 1.0% 4,125 0.9% 3,635 0.8% 3,596 0.8% 3,564 0.8% 3,219 0.7% 2,619 0.6% 2,224 0.5% 2,043 0.5%

Market Share and Competition Fixed/Basic Network Services Although nearly a decade has elapsed since India laid out a regulatory framework for the liberalisation of basic telecom services, competition in fixed local loop telephone services, so far, extends to only a fraction of the total population. Competitive entry has focused principally on services for urban customers in relatively affluent areas. Even the pattern of switching capacity (which indicates the capacity in a circle) indicates that around 57% of the switching capacity of the private operators at end-September 2003 was in metros and Category A circles. Further, an estimated 68% of the fixed network telephone connections of private operators at end-March 2004 were in metros and Category A circles. Fixed Network Switching Capacity and Telephone Connections at end-March 2004 Switching Capacity ('000) 47,070 7,059 729 223 7,317

BSNL MTNL BIL HFCLI RTL RIL STL 140 TTL 1,400 TTM 574 Total 64,511 Compiled by INGRES

Share

73.0% 10.9% 1.1% 0.3% 11.3% 0.0% 0.2% 2.2% 0.9% 100%

Telephone Connections ('000) 36,112 4,367 637 125 44 459 92 670 334 42,841

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Basic, WLL-F, Share

84.3% 10.2% 1.5% 0.3% 0.1% 1.1% 0.2% 1.6% 0.8% 100%

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Telecom In terms of subscriber connections, private operators had a market share of around 5.5% at end -FY2004, as compared with 2.3% at end -FY2003, and 1.5% at end FY2002. While private operators accounted for 25% of subscriptions in urban areas at end -March 2004 (17% at end -September 2003), their market share in rural areas was negligible at 0.2% (0.2% at end-September 2003). Because subscriber density and income (and ability to pay) are low, providing access in rural areas is unprofitable because of the higher costs and lower revenues. The cost of providing telephone service in rural areas is much higher than in urban or suburban areas. The demand for profitable long distance services and value -added fax and Internet services is insignificant in rural areas. Above -cost long distance services are often bundled with cheaper local services in urban areas. These discounted telephone service prices are often the cause of stagnation in network growth as operators find it unattractive to invest in new subscriptions, especially in rural areas. The upshot is that the overwhelming majority of basic telephone users must acquire access from BSNL and MTNL. During FY2000-04, private operators installed only 11.2% of the total fixed lines installed during the period. Thus, at end-FY2004, an estimated 94.5% of all fixed lines were still provided by the incumbent operators (BSNL & MTNL). However, because of WLL-F, the prospect of increased competition from the private sector has improved. WLL, which has appeared as the quickest way to build an alternative local loop, seems most suitable to address the needs of individual end-users with specific needs. Private operators installed 105% of the additional fixed network conne ctions during FY2004, as compared with 12.2% during FY2003, and 5.6% during FY2002. Thus, during FY2004, while fixed network connections of BSNL/MTNL declined for the first time, the private operators witnessed a significant increase in subscriber base. However, the fact remains that the incumbent operators still retain a dominant position in the provision of basic telecom services. The financial burden and risk of deploying competitive networks outside urban areas districts is so great that the number of new entrants willing to expose themselves to the risk of constructing nationwide access networks remains limited. The total gross block of the BSNL and MTNL telecom network exceeded Rs. 1,109 billion at end-March 2003 (BSNL: Rs. 913 billion, MTNL: Rs. 196 billion). The new entrants are likely to find it difficult to build fixed network facilities that duplicate the facilities of BSNL and MTNL, which were built over the past decade or more. Replicating even a portion of the existing local telephone network is expensive, and the business risk is high. Even if operators are keen to finance fresh investments, construction time runs into years, and incumbents enjoy advantages of economy of density, which make it very difficult initially for even the most efficient of new entrants to compete. There exist major economies of scale, scope and density in the provision of access networks and these economies form a major barrier for entry into the access network market. These economies primarily arise from the relatively ubiquitous nature of the incumbent's networks. The problem is one of market share. A new entrant with a 5% market share has a much higher unit cost than an incumbent with a 95% market share. The incumbent enjoys the advantage of a relatively

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Telecom more ubiquitous network that provides them economies of scale11, scope and the ability to reach nearly all existing and potential subscribers in their service areas. New entrants must reach significant market shares before the economies of the incumbents disappear. Reaching such market share is a lengthy, expensive and risky process and might never be achieved. The extent and nature of competitive entry also depends on the fact that there are substantial asymmetrical cost impacts between incumbent and new entrants that characterise fixed network deployment. •

Fixed Costs include those incurred on switches, multiplexers, feeders and distribution plants, fibre optic transport ring, etc.; these costs must be incurred even before service is launched. Fixed costs are frequently associated with economies of scale, i.e., a new entrant faces both a substantial upfront fixed cost and a constant or declining variable cost. Its average unit cost will fall as output increases, and the firm's cost structure is said to exhibit economies of scale. The costs a new entrant incurs to construct its own OFC transmission infrastructure would constitute a fixed cost, because, at least in the short run, this cost would not vary as the new entrant's subscribers (output) changed. In its early stages of development, the new entrant would have a significantly higher average unit cost than the incumbent, which has a significantly larger output and customer base over which to spread the fixed costs. At the same time, uniform pricing structure for both incumbents and new entrants and subsidised local access prices imply that new entrants will have to offer local services to many of their customers (particularly residences in small towns and rural areas) at rates that are substantially below their own costs. By comparison, the business subscribers are often the source of higher profit margins. A new entrant, incurring substantial upfront fixed costs of entry will, therefore, recoup its investment more quickly by focusing on the business sector. Moreover, selling and administrative costs per line are probably lower for business customers, which often have multiple lines, than for residential customers who, typically, have one line.

•

The distorted tariffs are also a particular problem for the established incumbents as they prepare to meet competition. They are more vulnerable to entry than they would be if prices better reflect costs. Entrants will obviously target customers who are geographically concentrated and whose rates have been kept far above cost, particularly business customers, heavy long-distance users, or urban residences. New entrants will generally not target the rest of the `unprofitable’ market where the rates are generally below cost and customers are geographically dispersed, particularly the residential markets in small cities and the rural areas. This trend is reflected in the lower monthly ARPU for BSNL than for private operators. According to the TRAI, while the monthly ARPU for private basic operators was Rs. 1,254 during March 2003, the monthly ARPU for BSNL was Rs. 514. For example, in Karnataka, while

As a result of the higher subscriber penetration on per-subscriber costs, the provider with the highest penetration rate may have a substantial cost advantage over its competitors if per-passing costs are significant. 11

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Telecom BSNL realised a monthly ARPU of Rs. 619, BIL achieved an ARPU of Rs. 1,754. •

Sunk costs include the costs of deploying a copper loop, fees paid for rights of way (RoW), repairing dug up roads and highways, etc. These costs once incurred cannot be recouped if the new entrant ceases service. Unlike switches and multiplexers that can be scaled to need, relocated if the business fails to develop, or sold if a new entrant exits the market, much of the sunk costs is dedicated to a particular location, and may not be recovered if a new entrant exits the market. The need to incur substantial upfront sunk costs constitutes a significant barrier to entry. When an incumbent has already deployed sunk facilities to serve all customers, a new entrant may be unwilling to sink the costs of duplicative facilities, either because it may be unable to lure customers away from the incumbent and generate enough revenue to cover those substantial sunk costs quickly, or because resulting competition between itself and the incumbent would drive prices so low that, even if the new entrant achieved a significant market share, it would still be unable to recover its sunk costs.

•

Other costs: New entrants are also likely to incur higher costs than the incumbent to attract subscribers, because unlike the incumbent, they must establish a brand name before they can overcome the incumbent's long standing relationship with customers. New entrants must also incur the initial costs of setting up their operations and developing their systems. They also face a substantial risk when they enter the local market, because they enter without the incumbent's knowledge of local operating costs and consumer demand.

The existing record demonstrates that competition in the provision of local telecom services to residential customers has proceeded more slowly and tentatively than competition to serve business customers. Generally, the urban business market is more profitable than residential and rural markets. High subscriber density in business districts enables economies of density, shorter loop lengths (and lower cost), fibre build-out to provide advanced information services, and intensive utilisation of infrastructure. New entrants have initially built their network in the central business district of large cities and towns (where the economies of scale from having low market share are smaller) and/or on large corporate sites (where the number of lines per site reduces the economies of scale advantage of the incumbent and the high traffic volumes make subsidy of the access network worthwhile). The concentration of subscribers in business districts reduces the costs of serving them. Business users are less costly to serve, generate more volumes and revenue and buy a greater variety of services12. For these subscribers, the new entrants can also use economies of scope with other emerging markets for high bandwidth services. In India, where penetration is low and service quality poor, new entrants can build a network that is especially attractive to the best A new entrant, incurring substantial upfront fixed costs of entry, will recoup its investment more quickly by focusing on the business sector. Moreover, selling and administrative costs per line are probably lower for business customers, who often have multiple lines, than for residential customers who, typically, have one line. 12

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Telecom customers. In conclusion, it can be economical to deploy new infrastructure around business districts; but elsewhere, constructing facilities for many residential and rural consumers is often uneconomical, because these customers do not generate enough revenues to recover costs13. The upshot is that the great majority of fixed network residential and rural subscribers still depend on BSNL and MTNL. Percentage distribution of WLL lines and rural lines in total Fixed Lines provided by Fixed Operators—end-September 2004 BSNL MTNL BIL HFCLI RTL/RIL STL TTL/TTM Total Source: TRAI

% of Fixed WLL 2.6 1.1 3.5 24.5 97.3 18.5 77.39 7.7

% of Rural lines 35.2 0.0 0.08 0.45 0.66 3.4 0.2 28.9

For broad, mass-market entry, the facilities-based avenue has limitations that can be solved only over time, and at considerable expense, as competing networks are physically extended to individual households. Although facilities-based competition encourages more investment in alternative fixed networks, price distortions encourage new facilities that target only the business segment. The TRAI has worked on restructuring the present system of prices for local telephone service in a way that both preserves unive rsal service and makes serving residential and rural customers more attractive for competitors. But until prices are made competitively neutral, entry incentives will continue to remain skewed. Another fundamental problem in promoting competition in telecommunications is overcoming the economic and technical advantages of an incumbent that arise from the `network’ aspect of the industry: telecommunications services derive their value from connecting the originator to the recipient. The local access network of BSNL/MTNL is a bottleneck: new entrants need this facility to connect to the incumbent's customers, are unable to construct the facility at reasonable cost, and denial of access to this facility would harm the new entrants. Because a new entrant cannot immediately enter at a scale that gives it a large market share, in the early stages of local network competition, the new entrant must acquire access from the incumbent monopoly provider. For their networks to have any value and attract any subscribers, new entrants must purchase interconnect from the monopolist or they cannot complete calls from their customers to the customers of the incumbent network. Without interconnect to BSNL/MTNL's network, the calling opportunities of new entrants’ subscribers to other fixed telephone subscribers would be less than 10% of the total calling opportunities that arise with interconnect to BSNL/MTNL network. By comparison, because there are so The entry of private operators into the business market, and their construction of facilities for both voice and data, are likely to have benefits for residential customers over time. For instance, new entrants have been constructing fibre networks that pass not only businesses, but also homes on the way as well. Once the infrastructure is in place, serving residential customers along the way and particularly in "apartments" and other multiple dwellings becomes easier and may entail only an incremental cost. As the most profitable customers provide the new entrants with the initial revenues, new entrants hope to expand service offerings to customers from which they earn less return. 13

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Telecom few subscribers on the entrant's network, neither the incumbent nor its subscribers would reasonably attach any value to being interconnected to the entrant's network. Because the incumbent currently serves a vast majority of subscribers in its local serving area, it has little economic incentive to assist new entrants in their efforts to secure a greater share of that market. As a result, interconnection is unlikely to occur in the absence of regulation. Even with interconnect, the erstwhile incumbent monopolist can discriminate in providing interconnect in various ways: by providing poor interconnections; slowly and/or ineffectively repairing and maintaining leased network facilities; delaying or denying the use of local network innovations to competitors; charging high prices for interconnect; and in general imposing other onerous conditions for terminating calls from the new entrant's customers to the incumbent's subscribers. High interconnection prices can force the entrant to suffer financial losses, and inadequate and poor interconnect prevents the entrant from competing effectively for customers who care about service quality. It is natural for an incumbent to have strong incentives to behave this way, leading customers to reject alternative providers and so preserve local monopolies. On balance and in the light of available evidence, it is likely that at least for the foreseeable future, BSNL/MTNL are likely to retain their dominance of the basic fixed telephone network. It is, however, apparent that there are some relatively affluent and geographically defined markets that will favour competition. New entrants may compete across certain segments in certain areas. History indicates that roll-out takes time and generally starts, for sound economic reasons, with higher-revenue customers. The residential and rural market remain areas in which competition needs to develop further. In these markets, the higher costs or business risks may delay the creation of a competitive market. Thus, it is highly improbable that in the short term alternative basic fixed access networks that are able to match BSNL/MTNL's nationwide network and address the entire customer population will be put together. It appears that control of the nationwide local loop gives BSNL and MTNL considerable leverage in maintaining their dominant positions on existing fixed voice telephony markets, or for establishing similar positions on new emerging markets for high bandwidth services. Their basic local access network will still be the key infrastructure for providing both fixed access voice telephony retail services and the emerging high bandwidth services to all customer segments. Cellular GSM & CDMA Services For cellular GSM and CDMA services, there presently exists significant extent of competition in nearly all service areas. In GSM services, during January 2005, of the 23 service areas (reduced from 24 after the merger of A&N Islands into the WB circle), fourteen service areas had 4 operators, seven service areas had 3 operators, and two service areas had 2 operators, and one had only one licensed operator. However, the intensity of competition is higher in Metros and Category A circles, which have higher potential and penetration. For example, all the four metros and five Category A service areas had four licensed operators. By comparison, six out of 8 Category B circles, and none of Category C circles had four operators. Report by ICRA Information, Grading and Research Service

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Telecom Competition in GSM Cellular Services—December 2004 Number of Operators 4 3 2

Service Areas Metros: Chennai, Delhi, Mumbai; Category A: AP, Gujarat, Karnataka, Maharashtra, TN; Category B: Haryana, Kerala, MP, Punjab, UP-West, West Bengal Metros: Kolkata; Category B: Rajasthan, UP-East; Category C: Assam, Bihar, HP, Orissa Category C: J & K, North -East

Further, after the migration of BSOs to UASL, cellular operators operating on the second-generation digital GSM standard also face increased competition from digital CDMA based wireless services offered by UASPs. GSM and CDMA Services Market Structure

Number of operators as of January 2005

Metros Chennai Delhi Kolkata Mumbai Category A AP Gujarat Karnataka Maharashtra TN Category B Haryana Kerala MP Punjab Rajasthan UP-W UP-E WB Category C Assam Bihar HP J&K North -East Orissa Compiled by INGRES

GSM

CDMA

4 4 3 4

3 4 3 4

4 4 4 4 4

3 3 3 4 3

4 4 4 4 3 4 3 4

3 2 2 4 4 3 3 3

3 3 3 2 2 3

1 3 3 1 1 3

With the acquisition of UASL by erstwhile BSOs, and their upgradation of CDMAbased limited mobility WLL (WLL-LM) services to fully mobile CDMA services since November 2003, there has been increased competition to cellular services based on the GSM standard. Unlike GSM, which offers seamless national and international roaming, WLL-LM services did not offer roaming. However, with the acquisition of UASL, CDMA mobile services are, currently, competitive on product offerings and prices as compared with cellular GSM services. At end-2004, there were an estimated 11.08 million CDMA mobile connections, as compared with 37.38 million cellular subscriptions. Thus, CDMA subscriptions accounted for 22.9% of the total wireless mobile connections in India at end-December 2004. Thus, the digital GSM mobile services offered by cellular operators in India faces

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Telecom the possibility of increased mobile services competition from CDMA mobile services offered by UASP operators. The extent of competition between GSM and CDMA services in India can only be analysed from FY2004 onwards. At end -FY2003, there were only 0.3 million subscribers on CDMA, as compared with 12.69 million on GSM. However, CDMA services subscription have increased significantly since the launch of nationwide services by RIL in May 2003. The two Reliance Group companies—RIL and RTL— had achieved a combined CDMA subscriber base of 9.49 million at end-December 2004, accounting for 85.7% of total CDMA subscriptions in India. The other major CDMA operator is the Tata Group, which through its group companies—TTL and TTM—had achieved CDMA subscriptions of 0.93 million at end-December 2004. The Reliance Group is also the largest wireless mobile services operator in India with a combined CDMA/GSM subscriber base of 10.52 million at end-December 2004. The largest GSM operator is BTV with 9.83 million subscribers at end December 2004. Although BTV continues to be the market leader, both BTV and various incumbent cellular services operators' face increased competition from well-funded competitors such as BSNL. Because of its already dominant position in the provision of fixed network services, and strong financial strength, BSNL has gained market share rapidly and had a national market share of 22.4% in GSM services at end -December 2004. As of end -December 2004, BTV was the market leader in 5 out of 20 service areas in which it provided services. However, in only one of the service areas, its market share exceeded 50%, with the highest of 58.6% in HP. At end -December 2004, BSNL had gained market leadership position in 8 out of 21 service areas in which it provided cellular services. Subscriber Base and Market Share of GSM and CDMA in India at end-December 2004 GSM Reliance BTV BSNL Hutchison Essar IDEA Cellular/Escotel BPL Group Aircel Spice Tata Group MTNL Others Total Compiled by INGRES

CDMA

Subscriptions 1,031 9,826 8,438 7,180 4,696 2,468 1,647 1,498

Share 2.8% 26.3% 22.6% 19.2% 12.6% 6.6% 4.4% 4.0%

595 37,379

Total

Subscriptions 9,490

Share 85.7%

8.4% 1.3% 0.7%

Subscriptions 10,521 9,826 8,880 7,180 4,696 2,468 1,647 1,498 927 735 75

Share 21.7% 20.3% 18.3% 14.8% 9.7% 5.1% 3.4% 3.1% 1.9% 1.5% 0.2%

442

4.0%

1.6%

927 140 75

100%

11,075

100%

48,454

100%

However, even with the launch of CDMA mobile services by UASP operators during late-2003, growth in GSM subscriber base continues to be strong. Because of their launch during 2002-03, CDMA services are presently not comparable with GSM's coverage and availability. Further, comparable price offerings have enabled strong growth for both services. GSM works by dividing a single radio frequency into multiple time slots so it can support multiple calls. GSM allows for up to eight calls per frequency. CDMA Report by ICRA Information, Grading and Research Service

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Telecom technology works by encoding individual conversations into a series of digits and then spreading the transmission of the sequence over available spectrum. GSM and CDMA technologies are not currently compatible or interchangeable with each other and require separate types of wireless phones and network infrastructure. GSM and CDMA are the predominant digital technologies, accounting for around 86% of the global digital cellular subscriber base at end -2003. However, GSM dominates with a world market share of 71.7%, followed by CDMA at 13.9%. Both are widely supported by equipment vendors, and are dynamic and evolutionary technologies in that a variety of technical enhancements are constantly being developed and implemented to extend the capacity and performance capabilities of each. Because the operation and performance of wireless communications networks and handsets is functionally identical on all digital technologies, customers are generally unaware of or unconcerned with the particular technology of their chosen mobile operator. The disadvantages of GSM (and its evolution to 2.5G through GPRS/Enhanced Data Rates for GSM Evolution or EDGE) versus CDMA primarily arises from the fact that current CDMA systems offer greater voice capacities than GSM. Both GSM and CDMA will have technology evolution paths that will offer comparable higher speed throughputs and capacities in the future. However, the advantage of GSM arises from the fact that GSM is the dominant 2G digital standard. A unified GSM standard implemented in Europe and many other parts of the world has led to various equipment makers and service providers investing heavily in the development of GSM network infrastructure and terminals. For equipment manufacturers, increased volumes for GSM equipment has resulted in enhanced development efforts, larger production runs, declining manufacturing costs, achievement of economies of scale, thereby driving down prices of equipment. Larger economies of scale in the production of both terminals/handsets and network infrastructure equipment reduce costs and increase availability, i.e., the higher the sales of chipsets, terminal, and network equipment, the lower the unit cost. Additionally, the variety of handsets tends to be greater. A wide manufacturing base thus has also reduced the fears of many developing countries that they might select a wrong standard, or get locked into with a single equipment supplier. GSM handsets are also technically simpler compared to CDMA (less processing is required). Unlike GSM, royalties payable to Qualcomm for the use of CDMA technology equate to a slight inherent cost advantage of GSM over CDMA technology. Because Qualcomm led the development of CDMA technology, it owns significant intellectual property, including patents, patent applications and trade secrets that it licenses to other companies. Qualcomm generates revenues through licensing fees and royalties on CDMA-based products (such as wireless handsets and the hardware required to establish and operate a CDMA wireless network) sold by its licensees. CDMA services are also perceived to have limitations in international roaming, because of the lack of CDMA networks in many countries. Another important issue when assessing the handset market is the second-hand market for the handsets. This market is often significant in size and reduces the initial entry barrier. For example, in India, the grey market for cellular handsets has been Report by ICRA Information, Grading and Research Service

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Telecom estimated at around 40-50% of total handsets sold. There is a major difference between GSM cellular and CDMA cellular second-hand markets. In GSM, the subscriber’s number is embedded in the subscriber identification module (SIM) card, and not in the handset as in CDMA. This makes it possible for the users to switch phones whenever needed because they only have to insert their SIM card into the new handset. A CDMA handset may be taken to an operator, who could offer to re-program it but may refuse, stating that handsets are not compliant with their network. Although both GSM and CDMA standards are likely to exist in India and exhibit strong subscription growth, GSM is now a proven technology and market and technological risks from CDMA is significant, but not a critical threat to the GSM standard. Both services are wireless-based rather than wireline, and the rate of growth is likely to be high for both services, in view of the increasing utility of voice services on mobile wireless networks. The extent of competition between GSM and CDMA services is likely to depend on availability, price and scope of services offered by the competing networks. Comparable licence fee structures for the two services and implementation of CPP on cellular networks has created a level playing field for competition between the two services, which is likely to result in intense competition, lower prices, and increased penetration for both services. A key factor in analysing the degree of competition in the Indian cellular services market has been the trend of increased concentration in the Indian GSM cellular services market. The top five operators/operator groupings accounted for 87.2% of total cellular subscriptions at end -December 2004, as compared with 79.5% at end FY2003, and 76.6% at end-FY2002. Unlike in many countries (where licenses were awarded on a national or regional basis), the cellular services industry structure in India was fragmented at the outset. The direct consequence of the GoI’s policy14 in the first round of bidding in 1995 was that licence ownership was fragmented and most of the operators could offer no more than contiguous regional coverage; national coverage could only be provided through a multitude of roaming agreements. Seamless national coverage is an obvious objective for an industry whose goal is to provide mobility, but delivering such a service has been fraught with difficulties. However, since the award of licences, the ongoing consolidation represents the industry’s attempts to redress the situation by creating large regional or near national coverage. Operators have been accumulating licences in multiple markets and contiguous service areas to expand their footprints into new regions in the hope of capitalising on the various efficiencies associated with economies of scale and the marketing possibilities of multiple product offerings. The need for this increased size has been exacerbated by the increased competition from BSNL and other recently licensed operators.

The upper limit on the number of Category A and B Circles to be awarded to any one bidder was placed at three. However, the guidelines for the entry of the fourth operator did not place any restrictions on the number of licences that could be awarded to a bidder company. 14

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Telecom The GoI has also permitted the transfer of licences in respect to telecom services, which may take place by way of merger or demerger of companies, subject to certain conditions. These include: • The new entity to which the licence gets transferred should be eligible for grant of a fresh licence of that particular service. • All the terms and conditions of the licence including the complete rollout obligation will apply to the transferee company irrespective of the time at which such transfer takes place and there will be no dilution with regard to the same. • All the past dues till the date of transfer will have to be cleared before transfer of licence is allowed. • Provisions of Section 391 to 394 of the Companies Act, 1956 will be complied with for demerger of a company. Previously, intra-circle mergers were not permitted. However, in February 2004, the GoI also announced the guidelines for merger of Basic, Cellular and USL licences in a given service area. The salient features of the guidelines are as follows: • Merger of licences shall be restricted to the same service area. • Merger of licence consequent to mergers/acquisitions or restruc turing of the operations shall be permitted for (a) Cellular Licence with Cellular Licence; (b) Basic Service Licence with Basic Service Licence; (c) USL with USL; (d) Basic Service Licence with USL; and (e) Cellular Service Licence with USL. • In case of a merger of a basic service license with USL, the basic service licensee shall pay, at the time of application for merger, the difference of amount of the entry fee, if any, as per the Guidelines for migration to USL. • Merger of licences will be permitted subject to the condition that there are at least three operators in that service area for that service, consequent upon such merger. It is clarified that USL will be counted for Basic as well as Cellular service separately while deciding the number of operators in a given service area. • Prior approval of the DoT will be necessary for merger of the licence. • Any merger, acquisition or restructuring, leading to a monopoly market situation in the given Service Area, shall not be permitted. Monopoly market situation is defined as market share of 67% or above within a given Service Area, as on the last day of previous month. Subscriber base shall be criteria for computing the market share. For this purpose, the market will be classified as fixed and mobile separately. In case of merger of two USL , the total subscriber base of each will be taken into account. • Consequent upon the Merger of licences, the merged entity shall be entitled to the total amount of spectrum held by the merging entities, subject to the condition that after merger, the amount of spectrum shall not exceed 15 MHz per operator per service area for metros and category A service areas, and 12.4 MHz per operator per service area in category B and category C service Areas. Currently, the major cellular operators and their alliances—Reliance, BTV, BSNL, Hutchison/Essar, and IDEA Cellular control around 85% of the industry subscriber base. Report by ICRA Information, Grading and Research Service

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Telecom A compelling reason for the ongoing consolidation is network externalities. Network externalities arise when the value that a consumer derives from a product or service increases as a function of the number of other consumers of the same or compatible products or services15. An additional connection to the system increases the benefit of the network to all users. Another possible source of externalities is call externality. When one person calls another, the second person may call a third person, and so on, thereby generating more revenues for the network operator who has all three persons as subscribers. The calling opportunities in a 1 million subscriber network are four times the size of calling opportunities in a 0.5 million subscriber network. The value of a network to a telecom firm increases faster than its size because the marginal cost of adding additional subscribers and services is a fraction of the fixed cost of building the backbone of the network. Importantly, the value of the service provided by the network to the customer also increases exponentially with the size of the network. For this reason, telecom firms inter-connect their networks, so that a customer of one network can reach customers on other networks. Thus, for instance, both email and traditional voice telephony are of great value to the user because both can be used to reach thousands of other users. If the number of persons connected to the network were small, the value of being connected would also be small16. These benefits are externalities, because users, when deciding to join a network, only take into account the private benefits accruing to them, and will not normally consider the fact that their joining the network increases the benefits to other users. From the trend emerging, it is clear that consolidation in the Indian cellular telecommunications industry will be driven by the need to vertically integrate products over a fixed cost structure as well as by the benefits of gaining scale economies through a broader geographic reach. A larger footprint helps the operator by spreading marketing and operating costs over a bigger subscriber base. Operators also have more flexibility with regional pricing plans since they are not subject to the typically higher roaming charges charged by other operators. From an ease of use standpoint, a contiguous regional coverage could make an offering more marketable to business consumers who may have heavy roaming patterns. Roaming revenues now account for around 10-11% of total services revenues of a cellular operator. By owning the networks, operators have more flexibility in pricing plans. Such pricing plans and bundled, state-of-the-art cellular service increase the value of a subscription to a consumer. The more value added a service, the less likely a customer will defect to a competitor. Increased customer loyalty is likely to translate into lower subscriber acquisition and retention costs, which can support further bundle-discount strategies. Further, to the extent that a subscriber in one service area roams across the operator’s footprint in other regions, the operator can keep the roaming traffic within the network. Larger operators can also exert negotiating leverage on Metcalfe’s Law, which states that the value of a network grows in proportion to the square of the number of users of the network, is a specific expression of network externalities. 16 For this reason, telecom firms interconnect their networks, so a customer of one network can reach customers on other networks. 15

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Telecom handset and equipment manufactures, as well as on long distance providers, and on roaming charges where they do not own networks. The opening up of NLD services increases the urgency towards consolidation and acquisition of cellular operators with either a strategic location along a highdensity route (such as Delhi-Mumbai, South-South) or with a substantial network buildup. The major cellular networks have invested a considerable amount of money in building up their long distance transmission infrastructure. As existing cellular operators continue to build up valuable assets (radio spectrum, network equipment and backbone, etc), well funded, aggressive players such as BSNL, BTV, Hutchison Group, IDEA Cellular, and the Reliance Group, with stateof-the-art networks should emerge as strong competitors, particularly since they have all invested substantially in facilities and in scaleable and upgradable networks. Increased concentration and the high barrier to exit make things worse for existing unprofitable operators and single licensees. Low-coverage operators may not secure enough market share and volume to survive against well-funded national operators even if their investment costs are low. For weaker operators with neither a significant subscriber base nor well-funded promoters, their financial performance has deteriorated under low subscriber revenues, high losses, and high debts. These operators face the possibility of being swamped by well-funded new entrants, who will reduce tariffs and, thus, negate the benefits of revenue sharing, calling party pays (CPP) and increased subscriber penetration. For the weaker operators, merger with an existing well-funded operator remains the only way to survive and recoup investments.

NLD Market The Indian NLD market was estimated at around Rs. 50 billion during FY2004. Because of the significant decline in prices of NLD services caused by regulatory interventions and market competition, the NLD market has declined from around Rs. 59 billion during FY2003. Though the number of minutes of NLD traffic has increased, the market has shrunk because of intense competition between the various operators—BSNL, BIL, RIL, and VSNL.

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Telecom Market Shares in the Indian NLD Market

BIL 6.7%

RIL 3.5%

F

F BIL 7.2%

VSNL 0.9%

VSNL 0.3%

BSNL 88.8%

BSNL 92.4%

Compiled by INGRES

Inspite of significant competition in the market, the incumbent—BSNL—still dominates the NLD market. Although the entry guidelines for NLD service provision were announced in August 2000, competition in NLD services did not commence before end -2001. At the same time, the major impact of the tariff rebalancing over the last five years has been to increase the size of the local telecommunications market relative to NLD and ILD markets. In other words, the market for local telecommunications is increasing its share of the total market. Non-inclusion of mandated access to intra-Circle traffic further reduces the competitive long distance market size to 54% of the total long distance market size. Further, the pre qualification conditions are stringent and have ensured that only a few national level operators have entered to serve the market. Competition is steadily leading to a decline in NLD prices as they more accurately reflect true costs. However, long-distance service hinges on access to local networks, which for now is controlled by BSNL, MTNL, and private operators such as BTV, and Reliance. Share of Total Telephone Connections in India at end-December 2004 Basic, WLL-F, Cellular

Hutchison/Es sar 7.7%

BTV 11.4%

Tata Group 3.1% Spice 1.6%

Idea Cellular 5.0% Others 0.4%

Reliance Aircel 1.8% 12.6%

BPL Group 2.6%

BSNL 48.6% MTNL 5.2%

Compiled by INGRES

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Telecom Long-distance service hinges on access to local networks. Thus, new entrants without a significant fixed/cellular local access customer base will have to use the customer access networks of the existing local access network operators (fixed and cellular) to originate and terminate their traffic. The countries which have liberalised their telecommunications markets allow an interesting comparison to be made between how much market share has been obtained by new entrants under different market structures. In countries (e.g., Finland, Canada, the UK, etc.) where new entrants in long distance services have faced incumbents with control over bulk of the consumer access networks, the new entrants have not been able to capture significant market share (in long distance) from the incumbent, which also provided long distance services. By contrast, in countries (notably the US) where there was a vertical separation between local access and long distance service provision , there has been increased entry, a rapid expansion in market revenues, and a corresponding decline in the incumbent’s long distance market share revenues. What the experience of other countries shows is the tremendous strategic importance of owning and managing access to customers. When there has been a separ ation of local and long distance services that the incumbent can provide or when new entrants have existing consumer local access, they have quickly wrenched market share from the incumbent that did not control a dominant portion of the local access network. However, operators owning and managing local access networks are much better able to defend national and international market share against new rivals. The efficiencies from providing all telecommunications services involve the cost savings from joint provision of services and the value that customers place on one stop shopping and billing. A clear cost advantage arises because BSNL can provide long-distance service at lower cost than could other entrants deploying new facilities and not providing all services. The technological cost savings seem more modest, since long distance network costs constitute a lesser proportion (18%-25%) of the total costs. However, the retailing economies can be significant. Offering all services to existing customers entails lower incremental costs of marketing, billing, and customer service. Competitors do not enjoy cost benefits from joint provision, and consumers might prefer dealing with a provider of integrated services. Customers may place significant value on one-stop shopping, e.g., because of a single bill and a single service contact point. New entrants can also enjoy the same efficiencies, if they could provide the same services. However, new long distance operators lacking a local network cannot effectively provide a single point of contact right to the home/office, and cannot `bundle' local services (which everyone needs) with other optional services. Bundling of local services with long-distance and other services increases the customer base (a `pull-through' effect) by providing `one -stop' services and reduces churn—a key cost driver in service provision. Such ability to provide integrated services is widely regarded as important. By relying on other parties for the local interface, new entrants also have no direct control over service delays and quality for network elements closest to the end -customer. New entrants may also face difficulties in tracking customer Report by ICRA Information, Grading and Research Service

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Telecom behaviour. They may lack direct access to customer calling patterns and carrier identification codes. Operators with control over the access network can also fully/partially recover any revenue loss from price declines in long distance services through interconnect receipts from new entrants. New NLD entrants, without significant control of the local network, must rely on the local access network to terminate or originate long distance calls. Thus increased competition boosts demand for access to local access network, provides the local access operators with increased interconnect revenues and allows them the flexibility to reduce prices for competitive long distance services. Thus, operators with control over the local access can appropriate a significant proportion of new entrants’ revenues, as interconnect payments. The additional sources of revenues will increase their leverage to reduce long distance prices, which may eventually force down new entrants’ prices towards their costs of interconnection. In conclusion, new NLD operators, without control over the local access network, could see low market share and low profit margins. ILD Market The Indian ILD market was estimated at around Rs. 43 billion during FY2004. Because of the significant decline in prices of ILD services caused by regulatory interventions and market competition, the ILD market has declined from around Rs. 50 billion during FY2003. Market Shares (Value) in the Indian ILD Market FY2004

FY2003

BIL 11.6%

RIL DAIL

6.6%

11.7%

BIL 6.0%

DAIL 19.2%

VSNL 62.5% VSNL 82.4%

Compiled by INGRES

Though the number of minutes of ILD traffic has increased from 3.7 billion during FY2003 to 5.2 billion during FY2004, the market has declined in value terms because of intense competition between the various operators—VSNL, DAIL, BIL, and RIL. Report by ICRA Information, Grading and Research Service

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Telecom ILD Call Traffic—India FY Outgoing Incoming Total Incoming/Outgoing Compiled by INGRES

2000 473 1,769

2001 527 2,167

2002 575 2,546

2003 764 3,110

2004 1,176 4,043

2,242 3.74

2,694 4.11

3,120 4.43

3,875 4.07

5,219 3.44

Million minutes 2005 1,720 4,843 6,564 2.82

The outgoing call minutes reported by the four licensed ILD operators for FY2004 were estimated at 1,176 minutes. By comparison, ISPs reported 70 million outgoing ILD minutes (for internet telephony), i.e. about 6 % of the outgoing minutes of ILD operators. This level of traffic was being carried by ISPs when their tariff rates for internet telephony calls were around Rs. 5 per minute. Although the incumbent (VSNL) still dominates the ILD market, its market share in value terms is estimated to have declined significantly from 100% during FY2002 to 62.5% during FY2004. Even though ILD services have been liberalised with effect from April 1, 2002, it is likely, given the time taken to set up alternative facilities, that VSNL may not face a drastic erosion in market share. At present, VSNL uses its Gateway Switches for the carriage of ILD service. Most of the transmission capacity (satellite and OFC) is leased from wholesale international bandwidth providers. New entrants are also likely to build their own gateways and lease transmission capacity. The deployment of international gateway switches by new entrants would be based upon projections on traffic volume, concentration, and prices. A new entrant is expected to commence operations on a limited scale initially. Installation of multiple gateways without any certainty about their utilisation will only increase their costs and losses. The number of new entrants is likely to be restricted to only 3-4, apart from VSNL. Favouring entry are lower investment costs compared with basic or cellular services. However, the number of operators would be restricted by the shrinking market size, price declines, roll-out obligations, and the possible forfeiture of bank guarantees for not fulfilling roll-out obligations. Continuing decline in ILD charges is likely to stimulate outgoing traffic and is expected to result in lower growth in incoming traffic. Although, India is expected to be a net importer of international traffic, the incoming to outgoing multiple is expected to decline. With settlement rates (paid to terminating carriers in a foreign country) expected to decline sharply, revenues from incoming traffic are expected to be decline significantly in both absolute terms and on a per minute basis. Although outgoing traffic is expected to increase, the significant decline in outgoing call charges is expected to result in decline in outgoing call revenues. Thus, ILD revenues are likely to decline because of decline in outgoing collection charges and decline in settlement rates. Competition is expected to be intense, and such competition is expected to put pressure on prices, revenues and mar gins of VSNL. Although, for the foreseeable future, VSNL is expected to be the leading provider of ILD services in India, its market share is expected to decline. Report by ICRA Information, Grading and Research Service

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Telecom

KEY SUCCESS FACTORS Some key success factors in the Indian Telecom Industry are identified below:

Cellular Services •

• •

• •

Subscription base and resultant economies of scale: Cellular Operators with larger subscription base and wider footprints can achieve economies of scale and increased efficiencies compared with operators with smaller footprints. There is also a need to vertically integrate products over a fixed cost structure as well as by the benefits of gaining scale economies through a broader geographic reach. A larger footprint helps the operator by spreading marketing and operating costs over a bigger subscriber base. Operators also have more flexibility with regional pricing plans since they are not subject to the typically higher roaming charges charged by other operators. From an ease of use standpoint, a contiguous regional coverage could make an offering more marketable to business consumers who may have heavy roaming patterns. Roaming revenues now account for around 10-11% of total services revenues of a cellular operator. By owning the networks, operators have more flexibility in pricing plans. Such pricing plans and bundled, state-of-the-art cellular service increase the value of a subscription to a consumer. The more value -added a service, the less likely a customer will defect to a competitor. Increased customer loyalty is likely to translate into lower subscriber acquisition and retention costs, which can support further bundle-discount strategies. National Coverage: Seamless national coverage is an obvious objective for an industry whose goal is to provide mobility. Financial and Management Strength: In a growing market, operators need to incur significant capital expenditures on an ongoing basis for network expansion and introduction of new services. The telecommunications services industry is highly capital intensive, and stronger operators with wider coverage and larger market position are in a better position to raise resources at a lower cost. Bargaining Power with Equipment Vendors: Because of the ongoing need for capital expenditures, operators need to exhibit higher negotiating leverage on handset and equipment manufactures, as well as on long distance providers. Customer Retention Strategies: In view of the extremely low penetration in India, growth in subscriptions will continue to be important. But operators will have to balance growth with the profitability of the segments they serve. Traffic volume —from voice and data services—is likely to emerge as more important than the number of net additions to each network. Although targeting the high end of the customer range is important, cellular networks require volume as well. Certain customer segments with lower levels of income but also with lower levels of churn and bad debts can also be economically attractive for operators. Of course, segments that are less profitable should be avoided. Subscriber growth may be lower, but so will the risk of churning and nonpayment.

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Telecom

Fixed Services •

•

Control of Access Network: The control of local access network is highly important in a network industry such as telecommunications. Apart from provision of basic telecom services, the local access is also a commodity that can be priced and rented to competitors. This is because the local subscriber link is necessary to provide new services elsewhere in the network. An ISP has to provide Internet access on the local access lines of BSNL/MTNL/new entrants; similarly, NLD and ILD operators have to interconnect with the local access network for call origination and termination. All this means that as soon as access is given to a part of the network, a ne w access market develops which is also a relevant market for an operator with control of the access network. Such `bottleneck' characteristics of the fixed local access network give it strategic importance: there are high fixed and sunk costs associated with investment in the local loop; there is a high degree of economies of scale and scope in the local loop; duplication of the fixed local loop is not possible or economically justifiable; control of the local loop leads to control of information about customers; and access to the local loop is important to competition across a broad range of services, as described above. In the context of competition in basic services, the ubiquity of the local access infrastructure controlled by an operator is not in all circumstances economically feasible to duplicate, and alternative fixed local access infrastructure cannot usually be constructed with the same ubiquity and competitive conditions within a reasonable time. In a monopoly environment that has persisted till recently, the local access networks have been viewed, in the main, as the cost of doing business. In a competitive environment, local access networks and control of the local customer will be increasingly seen as a tremendous strategic asset, and quite possibly, the most secure route towards revenue growth in the dynamic information and communication industry. New market players with new services (long distance and international voice services, and Internet services) will increasingly recognise the strategic importance of owning and controlling access to customers and the potential of new access technologies to bring down costs and provide new revenue streams. Tariff Rebalancing: Currently, the price per call unit is different for different ranges of consumption and for different social and economic levels. An inverted block is used where consumers with higher usage pay a higher price per call. Further, a rural low user pays a lower price per call than an urban low user. In addition, a rural non-commercial user is entitled to more free calls per month. A rural user is also likely to pay lower monthly access charges (rentals) than an urban user. Since the costs of rural access networks are higher, the present rural rentals are in the wrong direction of economic efficiency, i.e., monthly line rentals are the lowest in the highest cost areas. Unless such price distortions are reduced or eliminated, they are likely to be the prime factor for stagnation in network growth as operators find it unremunerative to invest in new subscriptions, especially in unprofitable residential or rural areas. Thus, price subsidies are likely to seriously distort investment signals (in favour of urban business areas) and competition. As competition becomes more vigorous, the pressure will build on operators to increase rural access charges. In spite of tariff re-balancing, the absence of competition has resulted in the level of long

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Telecom

•

•

distance prices in India being high compared with other countries. As competition intensifies, technology evolves and costs decline, distance-based pricing are likely to be increasingly replaced by distance-insensitive prices, i.e., the prices for local, long distance and international calls are expected to converge, reflecting the actual cost of providing the service. In addition, as a result of increased competition, tariffs in competitive markets are expected to decline precipitously, particularly in the areas of NLD and ILD services. Increased Presence in Higher-Speed Internet (or Broadband) Services: Looking forward, fixed line voice revenue growth is likely to be adversely impacted by the slow growth in telephone subscriptions, and sharp decline in prices of profitable NLD and ILD calling. The major factors that are likely behind the decline in prices inc lude deregulation of services markets; entry of new competitors and investment of substantial capital in the existing and new services, resulting in significant price competition; and technological advances resulting in a proliferation of new services and products coupled with rapid increases in network capacity. With regard to competition, while the NLD and ILD markets are characterized by increasing competition, the local basic services voice market is still dominated by the incumbent local exchange carriers such as BSNL/MTNL. Incumbent local exchange operators still largely own the only universal telephone connection to the home, have very substantial capital and other resources, long-standing customer relationships and extensive existing facilities and network rights-of-way. One factor that could have a positive impact on the basic services operators is the development of data services. Use of the Internet, including intranets and extranets, has grown significantly in recent years, with a subscriber base of 4.55 million at end-FY2004. The growth in user base has been driven by a growing installed base of PCs, improvements in network architectures, increasing numbers of network-enabled applications, emergence of compelling content and commerce-enabling technologies, and easier, faster and cheaper Internet access. Consequently, the Internet has become an important new communications and commerce medium. The Internet represents an opportunity for enterprises to interact in new and different ways with both existing and prospective customers, employees, suppliers and partners. Enterprises are responding to this opportunity by substantially increasing their investment in Internet connectivity and services to enhance internal voice and data networks. As a result, future revenue growth in basic services is likely to be driven by growth in ISDN services and other increasingly higher-speed data related services, largely the result of the increased demand for Internet data communications. Although strong demand portends healthy growth for volumes from data and Internet services, revenue growth is expected to be lower because of price cuts. Revenue growth is also likely to be driven by network access services, revenues earned from competing fixed & cellular services operators and providers of high-capacity broadband services who use the local exchange facilities of fixed network operators to provide usage services to their customers. Technologically Advanced Networks and Niche Entry: Although new entrants face many disadvantages in the provision of basic telecom services, technological progress has somewhat reduced the economic significance of scale economies in comparison with technical capabilities, managerial efficiency, and service

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Telecom quality. Technological progress has also favoured niche entry (advanced voice and data services to businesses) by new entrants. In India, where penetration is low and service quality poor, new entrants are building fibre networks that are especially attractive to businesses. Once the infrastructure is in place, serving residential customers along the way becomes easier and may entail only an incremental cost. As the most profitable customers provide the new entrants with the revenue necessary for effective entry into the local market, competitors are likely to be able to expand service offerings to residential customers from whom they earn lesser returns. On balance and in the light of available evidence, it is likely that for the foreseeable future, new entrants will compete effectively only across certain segments (long distance national and international services) in certain areas. Basic services network rollout is likely to take time and the residential market remains an area in which competition will develop at a slower pace. Thus, it is highly improbable that in the short term alternative basic fixed access networks that are able to match BSNL/MTNL's nationwide network and address the entire customer population will be put together. In the medium term, the basic fixed network of BSNL/MTNL is likely to be the key infrastructure for providing both access voice telephony retail services and the emerging high bandwidth services to all customer segments.

REGULATIONS The various regulations including regulations on tariffs, interconnect, etc are discussed below:

Tariffs —Basic Services • • • •

Registration Charges—Forbearance (operators free to fix charges) Installation Charges—Forbearance Initial Deposits—Forbearance Monthly Rentals Urban Subscribers—Forbearance Rural Subscribers—refer table below (applicable for basic and WLL-F) Capacity of local exchange system (number of lines) Upto 999 1,000-29,999 30,000-99,999 Over 100,000

• •

Senior Citizens (Rs.)

Others (Rs.)

70 120 180 250

70 120 200 280

Free Calls Urban Subscribers—Forbearance Rural Subscribers—50 metered calls per month of billing cycle. Tariff per Metered Outgoing Call (Pulse Rate of 120 seconds) Urban Subscribers—Forbearance Rural Subscribers—refer table below (applicable for basic and WLL-F)

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Telecom First 300 calls per month of the billing cycle (except for free calls) 0.80

• • • • •

Metered Calls in Excess of the first 300 calls per month of the billing cycle (except for free calls)Others (Rs.) 1.20

Tariffs for Incoming Calls—Nil Domestic Long Distance Tariffs for Intra-Circle and Inter-Circle Calls— Forbearance International Long Distance Calls—Forbearance Calls to Cellular Mobile—Forbearance Dial-up Access Charges for Internet—Forbearance

Tariffs —C e l l u l a r S e r v i c e s • •

• •

• • • • •

Rentals—Forbearance Airtime Charges for Outgoing Calls—Forbearance provided that every service provider shall specify a monthly rental and airtime charge per minute with a pulse duration of 30 seconds, as a `Reference Tariff Package of the Service Provider'. Airtime Charges for Incoming Calls—Nil Installation Charges—One time installation charge may be levied by a service provider only when a customer initially gets connected to the network of the service provider. No installation charge shall be levied when a subscriber moves from one package to another offered by a service provider. Roaming Monthly Access Charge for Regional and/or National Roaming— Ceiling of Rs. 100 Roaming Airtime Charge for Regional and/or National Roaming—Ceiling of Rs. 3 per minute Domestic Long Distance Tariffs for Intra-Circle and Inter-Circle Calls— Forbearance PSTN Charge—As applicable from time to time (discussed below under Interconnect) All services which do not affect `talk time value' including incoming voice calls / SMS shall continue to be available to the Pre-paid subscribers during the entire validity period even after the talk time value is exhausted.

Applicability of Tariffs A tariff plan once offered by an Access Provider shall be available to a subscriber for a minimum period of 6 months from the date of enrolment of the subscriber to that tariff plan.

Interconnect Charges •

Termination Charges—Termination charge for calls to Basic (Fixed, WLL-F, WLL-LM) and Cellular (GSM and CDMA) networks are uniform @ Rs. 0.30 per minute. The same termination charge are applicable for all types of calls viz. Local, NLD, and ILD.

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Telecom •

Origination Charges—Forbearance. The Originating Service Provider shall retain origination charges from the residual after payment of the charges for carriage, termination and access deficit.

Carriage Charges •

•

•

Long Distance Calls within India (Rs. per minute)—Rs. 0.20 (below 50 kms); Rs. 0.65 (50-200 kms); Rs. 0.90 (200-500 kms); Rs. 1.10 (above 500 kms). The service providers are allowed to negotiate a spot value within +/- 10% of the long distance calls carriage charge beyond 50 kms. Forbearance for carriage charge for long distance calls is likely to be introduced once carrier selection by customers is implemented. Transit Charges for intra-SDCA calls—forbearance, subject to the condition that direct interconnection between Access Providers is mandatory. For exceptional cases of Intra-SDCA transit, operators may decide the charges through mutual negotiation. However this should be lower than Rs. 0.20 per minute. Carriage charges for ILD calls including international termination charge (i.e. International settlement)—forbearance

Access Deficit Charges •

Access Deficit Charge shall be applicable for the specified category of calls mentioned in Table below. The rates are shown in Rs. per minute on a bulk settlement basis. Local

Intra-Circle Inter-Circle ILD 0-50 >50 0-50 50-200 >200 Outgoing/ kms kms kms kms kms Incoming Fixed-Fixed 0.00 0.00 0.30 0.30 0.30 0.30 2.50/3.25 Fixed-WLL-LM 0.30 0.30 0.30 0.30 0.30 0.30 2.50/3.25 Fixed-Cellular 0.30 0.30 0.30 0.30 0.30 0.30 2.50/3.25 WLL-LM-Fixed 0.30 0.30 0.30 0.30 0.30 0.30 2.50/3.25 WLL-LM-WLL-LM 0.00 0.00 0.00 0.30 0.30 0.30 2.50/3.25 WLL-LM-Cellular 0.00 0.00 0.00 0.30 0.30 0.30 2.50/3.25 Cellular-Fixed 0.30 0.30 0.30 0.30 0.30 0.30 2.50/3.25 Cellular-WLL-LM 0.00 0.00 0.00 0.30 0.30 0.30 2.50/3.25 Cellular-Cellular 0.00 0.00 0.00 0.30 0.30 0.30 2.50/3.25 `Cellular' means fully mobile service provided by CMSPs and UASPs through GSM, CDMA or any other technology.

•

Collection and distribution of ADC: The amount given above is to be collected/paid as follows: For all intra-circle calls from cellular mobile/WLL-LM to fixed line, BSNL to be paid the access deficit amount. For all intra-circle calls from fixed to cellular mobile/WLL-LM, the originating service provider to retain the access deficit amount. For intra-circle calls from fixed line to fixed line, the originating service provider to retain the access deficit amount (local calls and calls within `0 to 50 kms' do not have any access deficit charge). No access deficit charge is payable to the terminating fixed network.

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Telecom For all outgoing Inter-Circle and ILD calls from fixed line, the originating service provider to keep the access deficit amount. No access deficit charge is payable to the terminating fixed network. For all ILD calls to fixed line, BSNL to be paid the access deficit amount by the ILDO (directly or through NLDO, wherever applicable), and the termination charge should be paid to the terminating network. For all Inter-Circle calls from Cellular Mobile/WLL-LM to fixed line, the access deficit charge and termination amount is to be collected by the NLDO from the originating service provider and the access deficit charges should be paid to BSNL and the termination charge should be paid to the terminating service provider. For all Inter-Circle calls from Cellular Mobile and WLL-LM to Cellular Mobile/ WLL-LM, the access deficit amount is to be collected by the NLDO from the originating service provider and paid to BSNL. For all ILD outgoing and incoming calls from/to Cellular Mobile and WLL-LM, the access deficit amount is to be collected by the ILDO and paid to BSNL.

Licensing Fees The present levels of licensing fees payable (including universal service obligations or USO) is detailed in the table below: Licensing Fees payable by Telecom Service Providers in India

Percent of adjusted gross revenues (AGR) Type of Licence Licence Fees Basic, Cellular, Unified Access Category A: 10%; Category B: 8%; Category C: 6%/5% NLD & ILD 15% An additional benefit of 2 percentage points reduction in revenue share has been granted to first and second circle (and not metro) cellular licensees for a period of four years with effect from April 1, 2004. The minimum license fee, however, has been specified at 5%.

Spectrum Charges In India, Cellular Mobile Services started with a duopoly in 1994-95. The technology at that point of time was specified as GSM and the licenses had a spectrum commitment of 4.5 MHz+4.5 MHz (later amended to 4.4 MHz+4.4 MHz) with a possibility of increase to 6.2 MHz+6.2 MH z. Keeping in view the development of technology, all the licenses were made technology neutral in 1999. Also, the third cellular mobile license was granted to the incumbent in 1999. In 2001, the Government auctioned the fourth cellular license in 1800 MHz band. For the 4th cellular license, the committed spectrum was 4.4 MHz+4.4 MHz and a possibility of increasing it to 6.2 MHz+6.2 MHz was mentioned. The spectrum charges were earlier based on number of mobile terminals and allocated spectrum. Since August 1999, the spectrum charges have been converted to percentage of AGR. This varies from 2% to 6% based on the amount of spectrum allocated. Most of the operators today have 6.2 MHz, while some have been allocated upto 10 MHz based on criteria of subscriber base. The amount of revenue share payable (as percent of AGR) by GSM and CDMA cellular operators increases with the increased allocation, i.e. 3% upto 6.2 + 6.2 MHz, 4% upto 10 + 10 MHz, 5% upto 12.5 + 12.5 MHz and 6% upto 15 + 15 MHz. Report by ICRA Information, Grading and Research Service

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Telecom

CRITICAL ISSUES THAT NEED TO BE ADDRESSE D Spectrum Availability for Expansion The rapid growth in cellular mobile has exerted pressure on spectrum allocated to various service providers. In cities like Delhi and Mumbai, where operators have been allocated upto 10 MHz, there is already demand for more than 10 MHz. Though spectrum bands for mobile services has been earmarked in National Frequency Allocation Plan (NFAP), 2002 in 800 MHz, 900 MHz and 1800 MHz band, the present amount of spectrum available or likely to be available in near future is 20 MHz in 800 MHz band, 23.4 MHz in 900 MHz band and 10~25 MHz in 1800 MHz band. It is evident that at the present juncture and particularly in metros, GSM is expected to get spectrum to the tune of total 15 MHz when additional spectrum gets released in the 1800 MHz band. So far as CDMA is concerned, there is no path available for provisioning more than the currently allocated/committed amount of 2x5 MHz to four service providers. With the 900 MHz GSM band completely occupied, the allocations beyond 8 MHz to each operator is possible only in 1800 MHz band. In 800 MHz CDMA band, some licensees have been allotted upto 3 carriers, out of a total of 4. With the growth of data, there is likely to be demand for more here too. Internationally, the next band for expansion of GSM and CDMA systems is 1800 MHz/1900 MHz. Other Government users are presently occupying a large part of these bands and refarming of this spectrum is a continuous but long drawn process. It, thereby, increases the pressure on the existing spectrum and necessitates efficient utilisation by all. In areas, where the amount of available spectrum at the time of demand exceeds supply, some criteria would need to be applied for allocation. These could be technical, economic or techno-economic. In parallel, efforts would have to be made by the Government to accelerate the process of refarming. Spectrum Allocations in India

Band 800 MHz 900 MHz 1800 MHz

Spectrum Allocation 824-849 MHz paired with 869-894 MHz 890-915 MHz paired with 935-960 MHz 1710-1785 MHz paired with 1805-1808 MHz

1900 MHz

1880-1900 MHz

Used by WLL (M) and CDMA operators 1st , 2nd, 3rd GSM operators 4th GSM operator; and additional allocation to 1st , 2nd, 3rd GSM operator. Earmarked for Micro cellular technologies based on TDD

Compiled by INGRES

High Licensing Fees Although the migration to revenue sharing and the significant reductions in revenue sharing percentage has resulted in lower costs (and prices) of mobile services, the revenue sharing percentage in India is still high as comparable with other countries. The high revenue sharing costs crowd out the funds available for investment in network infrastructure and expansion. The high fees also reduce the flexibility of operators to reduce prices, and slow down the development of new & innovative services. Further, as compared with private operators, the state owned operator—BSNL—has been granted a significant competitive advantage arising out of reimbursement of any licence fee paid by it by the GoI. This has proven Report by ICRA Information, Grading and Research Service

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Telecom disadvantageous for the private operators. With a vastly lower cost structure, BSNL can price its services at rates significantly lower than its rivals.

E x i s t e n c e o f C r o s s -s u b s i d i e s a n d t a r i f f b a l a n c i n g Prior to the establishment of the TRAI in 1997, the DoT had the sole mandate of setting telecommunications tariffs in the country. After the TRAI was set up in 1997, the mandate of fixing telecommunications tariffs shifted to it. At present, all telecom tariffs are set, and can be altered, only by the TRAI. In India, the call duration and distance are combined to define a unit call and the usage is priced per unit call. For each distance band, a pulse or duration, which constitutes a unit call, is specified. The price per minute of a call is calculated by multiplying the calls in one minute with the unit call charge. The `standard’ pulse rate for a local call from fixed networks is 120 seconds at present , i.e. a local call of up to 120 seconds duration is measured as one local call. Currently, the price per call unit is different for different ranges of consumption and for different social and economic levels. An inverted block is used where consumers with higher usage pay a higher price per call. Further, a rural low user pays a lower price per cal l than an urban low user. A rural user is also likely to pay lower monthly access charges (rentals) than an urban user. Since the costs of rural access networks are higher, the present rural rentals are in the wrong direction of economic efficiency, i.e., monthly line rentals are the lowest in the highest cost areas. Such price ceilings are cited as the prime factor for stagnation in network growth as operators find it unremunerative to invest in new subscriptions, especially in unprofitable residential o r rural areas. Large subsidies, which are financed from within the telecommunications industry will, therefore, seriously distort investment signals (in favour of urban business areas) and competition. As competition becomes more vigorous, the pressure will build on operators to increase rural access charges. In India, the cheapest technology for rural areas is WLL technology which costs somewhere between Rs. 10,000 to Rs. 15,000 per line whereas the copper cable costs around Rs. 25,000 per line. But even then WLL technology is not a viable proposition in rural areas because of the rentals and tariff structure. The current tariff structure provides for significant cross-subsidisation, i.e., one group subsidises the other. To promote `universal service’, i.e., widespread access to telephone service at affordable prices, the prices for local services have been historically kept below cost, while the prices for NLD and ILD services were higher than the cost of supply. Further, the pattern of cross-subsidies has generally been from business (who make more NLD and ILD calls and are less costly to serve) to residential, and from urban to rural consumers. In the way that telecommunications services have been priced, `tariff re-balancing’ generally involves raising the monthly access charges and prices of local services and reducing the prices of NLD and ILD. In India, significant tariff rebalancing and increased competition over the past five years has resulted in a significant decline in NLD and ILD charges. However, these price declines have been only Report by ICRA Information, Grading and Research Service

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Telecom partially compensated by an increase in local charges. Further, in spite of tariff rebalancing, the absence of competition has resulted in the level of long distance prices in India being high compared with other countries. Worldwide, long distance national and international call prices have declined significantly during the past few years, because of technological advancements, capacity additions, and competition. As competition intensifies, technology evolves and costs decline, distance-based pricing are likely to be increasingly replaced by distance-insensitive prices, i.e., the prices for local, long distance and international calls are expected to converge, reflecting the actual cost of providing the service. In addition, as a result of increased competition, tariffs in competitive markets are expected to decline precipitously, particularly in the areas of NLD and ILD services.

POLICY FRAMEWORK Excise Duties/Service Tax There is no excise duties on telecom services. However, telecom services charged a service tax of 10% plus education cess of 2%. Thus, the effective service tax is 10.2%.

Customs Duties There is no customs duties chargeable on telecom services.

Foreign Direct Investment collaboration agreement •

• •

•

(FDI)/Foreign

t e c h n o logy

In basic, Cellular Mobile, paging and Value Added service, and Global Mobile Personal Communications by Satellite, FDI is limited to 74% (under automatic route) subject to grant of license from DoT and adherence by the companies (who are investing and the companies in which investment is being made) to the license conditions for foreign equity cap and lock in period for transfer and addition of equity and other license provision. Foreign direct investment upto 74% permitted, subject to licensing and security requirements for the following (a) Internet Service (with gateways); (b) Infrastructure Providers (category-II); Radio Paging Service. FDI upto 100% permitted in respect of the following telecom services (a) ISPs not providing gateways (both for satellite and submarine cables); (b) Infrastructure Providers providing dark fibre (IP Category I); (c) Electronic Mail; and Voice Mail. FDI upto 100% is allowed subject to the conditions that such companies would divest 26% of their equity in favour of Indian public in 5 years, if these companies are listed in other parts of the world. The above services would be subject to licensing and security requirements, wherever required. In manufacturing sector, 100% FDI is permitted under automatic route.

Report by ICRA Information, Grading and Research Service

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Telecom Year-wise FDI Inflow Year

FDI Inflow (Rs. million) 21 140 2,067 7,648 12,452 17,756 2,127 2,886 39,709 3,014 874

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2004 (upto March 2004) Compiled by INGRES

Sector-wise FDI Inflow (August 1991-March 2004) Year Basic Telephone Cellular Mobile Radio Paging E-Mail VSAT Manufacturing & Consultancy Holding Companies Others Total Compiled by INGRES

FDI Inflow (Rs. million) 3,937 26,646 910 688 281 15,784 48,420 2,843 99,509

% of total 4.0% 26.8% 0.9% 0.7% 0.3% 15.9% 48.7% 2.9% 100%

Country-wise FDI Inflow (August 1991-March 2004) Year Mauritius UK US Netherlands Thailand Sweden France Hong Kong NRIs Israel Japan Others Total Compiled by INGRES

FDI Inflow (Rs. million) 71,998 8,876 4,905 3,158 2,212 1,532 1,009 901 889 800 540 2,689 99,509

Report by ICRA Information, Grading and Research Service

% of total 72.4% 8.9% 4.9% 3.2% 2.2% 1.5% 1.0% 0.9% 0.9% 0.8% 0.5% 2.7% 100%

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Telecom

FINANCIAL PERFORMANC E Summary During FY2004, the operating income (OI) of the four listed companies in the Indian Telecommunications Services Industry—BTV, MTNL, TTM, and VSNL— aggregated Rs. 151,339 million, representing an increase of 10% over FY2003. The growth in income was caused by significant increase in cellular subscriptions. However, prices of telecom services continued on their downward trend caused by increased competition, and cost reductions (because of reduction in costs of equipment and achievement of higher economies of scale). A higher increase in the cost of sales and a moderate increase in depreciation charges resulted in an improvement in profits. While the combined operating profit (Operating Profit before Depreciation, Interest and Taxation or OPBDIT) of the four companies increased 7.4% during FY2004 to Rs. 41,328 million, the net profit (profit after tax, or PAT) increased 47.7% to Rs. 18,421 million. While the operating margins declined from 28% during FY2003 to 27.3% during FY2004, the net margins increased from 9.1% to 12.2% over the same period. However, the improvement in overall performance was accompanied by an improvement in profitability of BTV and MTNL, which offset a significant deterioration in the profitability of VSNL and TTM.

Operating Income During FY2004, the OI of the four listed telecom service providers increased 10% to Rs. 151,339 million. By comparison, their OI had declined 4.4% during FY2003. The increase in OI during FY2004 was primarily because of a significant increase in OI for BTV and TTM (accompanied by a modest improvement for MTNL), which offset the significant decline in OI for VSNL. The trends for the last three years reflect a slow growth in the fixed network subscriber base and revenues, a significant decline in prices and revenues from NLD and ILD services, and a substantial increase in the cellular services subscriber base and revenues. Segment Trends in OI for Listed Telecom Services Companies 45,000

Fixed Telephone

40,000

Cellular Telephone

Rs. million

NLD/ILD/others

35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Q1

Q2

Q3

Q4

Q1

FY2003

Q2

Q3

Q4

FY2004

Segment trends for FY2002 not available Compiled by INGRES

Report by ICRA Information, Grading and Research Service

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Telecom During FY2004, MTNL’s OI increased 9.7% to Rs. 63,704 million, mainly because of higher revenues from interconnect services and cellular services, which offset decline in fixed network subscriptions and revenues. MTNL began receiving interconnect payments in respect of incoming ILD calls since April 1, 2002, when several interconnect agreements, including an agreement with VSNL, took effect. As a result, revenues from basic fixed services increased 5.1% during FY2004 to Rs. 59,323 million. However, MTNL's call revenues from basic services are estimated to have declined because of a 5.7% decline in fixed line connections to 4.37 million at end -FY2004. MTNL's revenues from cellular services increased 21.3% during FY2004 to Rs. 1,898 million. Cellular services revenues accounted for 2.9% of MTNL’s OI during FY2004, as compared with 2.8% during FY2003. MTNL’s cellular services subscriber base in the metros of Delhi and Mumbai increased 23.5% during FY2004 to 360,550 at end-FY2004. However, its monthly average revenue per user (ARPU) from cellular services is estimated to have declined from Rs. 573 during FY2003 to Rs. 485 during FY2004. However, its market share in cellular services also declined from 8.4% at end -FY2003 to 5.9% at end-FY2004. VSNL’s OI declined 30.3% during FY2004 (OI declined 30.3% during FY2003) to Rs. 31,635 million, mainly because of a 34% decline in telephone service revenues to Rs. 27,177 million. Telephone services revenues, which accounted for 86% of the company’s total revenues during FY2004, declined because of a significant drop in settlement rates (which operators originating international calls pay to operators terminating international calls). As the following figure illustrates, because of the April 2002 opening up of the ILD sector to competition and reduction in call charges, VSNL’s OI has declined significantly. Quarterly OI Trends—Q1FY2002 to Q4FY2004 20,000

BTV TTML

18,000

Rs. million

MTNL VSNL

16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Q1

Q2 Q3 FY2002

Q4

Q1

Q2 Q3 FY2003

Q4

Q1

Q2 Q3 FY2004

Q4

Compiled by INGRES

BTV’s OI increased 64% during FY2004 to Rs. 50,025 million, mainly because of significant increase in cellular and fixed wireless telephone subscriptions, and increased revenues from NLD and ILD services. BTV's cellular services revenues, Report by ICRA Information, Grading and Research Service

Page 57 of 67

Telecom accounting for 65.2% of OI during FY2004, increased 56.5% during FY2004 to Rs. 32,608 million, caused by a significant increase in subscriptions. Cellular subscriptions based on GSM standard increased 111.8% during FY2004 to 6,504,314 subscribers at end-FY2004. During mid-2004, with coverage in 15 service areas and receipt of licences/letter of intent for 6 more service areas, BTV had a near nation-wide presence in GSM cellular services. BTV has the GSM largest cellular service subscriber base in India. Its national market share in GSM cellular subscribers increased from 24.2% at end -FY2003 to 24.9% at end-FY2004. However, inspite of an increase in average MoUs per user, GSM cellular service revenues increased at a lower rate than subscriptions because of a decline in the monthly ARPU from an estimated Rs. 775 in FY2003 to Rs. 528 in FY2004. The ARPU declined because of increased competition, declining prices, and increased percentage of prepaid subscribers (who generate lower usage revenues than contractual or post-paid subscribers). Indicators of BTV's GSM Cellular Services Prepaid Subscriptions, MoUs and ARPUs Prepaid (% of total subscriptions) MoU per month ARPU per month -Rs.

Q1 64%

Q2 66%

Q3 70%

Q4 76%

FY2003 FY2003 76%

Q1 81%

Q2 83%

Q3 82%

Q3 79%

FY2004 FY2004 79%

194 880

208 807

224 762

249 687

227 775

249 582

300 546

296 519

295 493

296 528

Compiled by INGRES

BTV's fixed access services revenues, accounting for 15.5% of OI, increased 117.1% during FY2004 to Rs. 7,758 million, mainly because of a significant increase in subscriptions. In fixed services, BTV offered fixed access services in six circles at end-FY2004. Its fixed network subscriber base increased 71.6% during FY2004 to 636,714 at end-FY2004. BTV's revenues from long distance and data services also increased 71.3% during FY2004 to Rs. 14,715 million. Revenues from this segment accounted for 29.4% of OI during FY2004. BTV's long distance operations have experienced a substantial growth in traffic carried by it due to increased captive subscriber base. It has also experienced significant increase in the data revenues on sale of lease line in its NLD network. TTM’s income from telephone services increased 66.2% during FY2004 to Rs. 5,975 million, mainly because of a 43.1% increase in its fixed network subscription base to 334,033 at end-FY2004. TTM also launched cellular digital mobile services based on CDMA standard during mid-2003, and had achieved a subscriber base of 150,850 at end-FY2004. The Company has migrated to the UASL with effect from November 14, 2003. The licence fee, service area, roll-out obligations and performance bank guarantee requirements of the Company under the UASL is the same as for the Fourth Cellular Mobile Service Provider. The Company did not have to pay any additional Entry Fee for migration to USL. It now holds two UASLs for Mumbai, and rest of Maharashtra (including Goa).

Profits and Margins As compared with a 10% increase in OI during FY2004, the operating costs of the four listed telecom service providers increased 11% during FY2004 to Rs. 110,011 Report by ICRA Information, Grading and Research Service

Page 58 of 67

Telecom million. While network costs declined (aggregate figures are not available for all the four service providers), employee costs increased 14.1% during FY2004 to Rs. 21,694 million. Employee costs accounted for 14.3% of the OI during FY2004, as compared with 13.8% during FY2003. The increase in employee costs was because of increase in employee costs for BTV and MTNL. BTV's employee costs increased 35.2% during FY2004, because of network expansion and an increase in the level of operations. Employee costs, as a percentage of OI during FY2004, were 25.4% for MTNL (24.7% during FY2003), 7.4% (9% ) for BTV, 6.6% (10.8%) for TTM, and 4.4% (3.4%) for VSNL. During FY2005, the telecom services operators are expected to benefit significantly because of a reduction in revenue sharing percentage with effect from April 1, 2004. In December 2003, the GoI announced concessions for the telecom industry with a focus on compensating operators for high license fee. The license fee has been reduced by two percentage points, from 12%, 10% and 8%, across the board for all service providers (excluding NLD and ILD operators) and an additional benefit of 2 percentage points reduction in revenue share has been granted to first and second circle (and not metro) cellular licensees for a period of four years. The minimum license fee, however, has been specified at 5%. The package comes into effect from April 1, 2004. Because of a higher increase in operating costs, the combined operating profits of the four companies increased 7.4% during FY2004 to Rs. 41,328 million. By comparison, their operating profits declined 11.5% during FY2003. The improvement in operating profits was accompanied by a decline in operating margins—from 28% during FY2003 to 27.3% during FY2004. Trends in Operating Profit and Margins FY 2000 BTV 856 MTNL 19,430 TTM -1,057 VSNL 17,830 Total 37,059 Compiled by INGRES

Operating Profit (Rs. million) 2001 2002 2003 1,827 3,114 7,195 21,827 23,993 19,366 -572 135 514 19,174 16,250 11,403 42,256 43,492 38,479

Operating Margin (%) 2004 16,670 19,508 -4 5,154 41,328

2000 19.1 37.5 -165.6 25.6 29.3

2001 21.5 37.7 -41.1 26.3 30.0

2002 21.0 39.1 5.4 25.0 30.2

2003 23.6 33.3 14.3 25.1 28.0

2004 33.3 30.6 -0.1 16.3 27.3

The combined operating margins declined marginally during FY2004, mainly because of the lower operating margins for MTNL, TTM, and VSNL, which offset substantially higher operating profits and margins for BTV. While MTNL’s operating profit increased 0.7% during FY2004 to Rs. 19,508 million, its operating margins declined from 33.3% during FY2003 to 30.6% during FY2004. Higher subscriber connections and the resulting economies of scale enabled BTV to report significantly higher operating profits. While BTV’s operating profits increased 131.7% during FY2004, operating margins improved from 23.6% during FY2003 to 33.3% during FY2004. BTV's operating margins had been impacted during FY2003 because of a substantial increase in promotional expenses on launching of services in additional service areas. According to BTV's calculations, while segment operating margin in cellular services business increased from 26.8% during FY2003 to 32.1% during FY2004, segment operating margin in access services increased from 9.3% to 21.4%; segment operating margin in long distance, data and enterprise services also increased from 22.4% to 31.3%. As the following figure Report by ICRA Information, Grading and Research Service

Page 59 of 67

Telecom illustrates, higher subscriber connections (from an initially low base) have resulted in new telecom service providers with large upfront sunk and fixed costs to reap higher benefits of economies of scale, which were hitherto available only to the existing operators. Trends in Quarterly Operating Profit—Q1FY2002 to Q4FY2004 8,000

BTV TTML

(Rs. million)

MTNL VSNL

6,000 4,000 2,000 0 Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

-2,000 FY2002

FY 2003

FY2004

Compiled by INGRES

In comparison to the significant increase in operating profits for BTV, operating profits declined for VSNL and TTM. While VSNL’s operating profit declined 54.8% during FY2004, its operating margins declined from 25.1% during FY2003 to 16.3% during FY2004. Operating margins declined inspite of a significant decline in network and transmission costs caused by lower settlement rates, mainly because of an increase in other operating costs. TTM reported an operating loss of Rs. 4 million during FY2004, mainly because of a substantial increase in marketing and business promotion costs associated with the launch of CDMA services. Administration and other expenses also increased significantly during FY2004 because of an amount of Rs. 440 million on account of provision for claims made by the DoT but disputed by TTM. Excluding such provision, TTM's operating profits declined 15.2% during FY2004. The combined pre-tax and net profitability of four companies increased significantly during FY2004. Their combined operating profit before tax (OPBT) increased 18.7% during FY2004 to Rs. 18,532 million mainly because of higher operating profits, and lower depreciation charges. However, interest expenses increased 17.5% to Rs. 4,822 million during FY2004, mainly because of capital costs on network expansion. Unlike MTNL and VSNL, which have significant cash flows from operations, BTV and TTM rely to a greater extent on external funding. The combined depreciation charges of the four companies however declined 4.2% during FY2004 to Rs. 17,975 million, mainly because of a 37.3% decline in MTNL's depreciation charges. The decline was because of change in the useful life of plans & apparatus, cables, lines & wires with effect from April 1, 2003 based on technical evaluation. The combined non-operating income/adjustments increased 10.3% —from Rs. 5,203 million during FY2003 to Rs. 5,737 million during FY2004. However, inspite of a profit of Rs. 941 million from sale of stake in INMARSAT, VSNL's other Report by ICRA Information, Grading and Research Service

Page 60 of 67

Telecom income/adjustments declined during FY2004 because of an expense of Rs. 1,030 million on VRS. TTM also reported a significant increase in other income. Its other income for FY2004 includes an amount of Rs. 498 million credited by DoT out of excess interest which was recovered by DoT pursuant to the migration package in FY2000. Overall lower provisioning for taxes because of lower profits of VSNL resulted in the combined net profits of the four companies increasing 47.7%—from Rs. 12,468 million during FY2003 to Rs. 18,421 million during FY2004. By comparison, the combined net profits had declined 48.5% during FY2003. Trends in Net Profit and Margins Net Profit (Rs. million) FY 2000 2001 2002 2003 BTV -550 -1,208 -1,362 -2,051 MTNL 10,878 15,402 13,007 8,772 TTM -2,701 -2,088 -1,485 -2,050 VSNL 8,403 17,788 14,074 7,798 Total 16,029 29,894 24,234 12,468 Compiled by INGRES

Net Margin (%) 2004 5,837 11,505 -2,697 3,777 18,421

2000 -12.3 21.0 -423.3 12.1 12.7

2001 -14.2 26.6 -150.0 24.4 21.2

2002 -9.2 21.2 -58.8 21.6 16.8

2003 -6.7 15.1 -57.0 17.2 9.1

2004 11.7 18.1 -45.1 11.9 12.2

The combined net margins of the four telecom services companies increased from 9.1% during FY2003 to 12.2% during FY2004. While the net margins of MTNL improved from 15.1% in FY2003 to 18.1% in FY2004 because of lower depreciation charges, the net margins of VSNL declined from 17.2% to 11.9% over the same period. In spite of higher income, TTM reported higher net losses during FY2004. Because of substantially higher operating profits, BTV reported a net profit of Rs. 5,837 million during FY2004, as compared with net losses of Rs. 2,051 million during FY2003. Trends in Quarterly Net Profit—Q1FY2002 to Q4FY2004 5,000

BTV TTML

(Rs. million)

MTNL VSNL

4,000 3,000 2,000 1,000 0 -1,000

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

-2,000 FY2002

FY2003

FY2004

Compiled by INGRES

Financial Performance during 9MFY2005 During 9MFY2005 (April-December 2004), the operating income of four listed fixed service providers aggregated Rs. 127.34 billion, representing a growth of 17.2% over 9MFY2004 (April-December 2003). The growth was mainly because of Report by ICRA Information, Grading and Research Service

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Telecom significant increase in income for BTV and TTM, which was accompanied by a decline in income for MTNL. During 9MFY2005, MTNL’s operating income declined 12.6% (year on year or yoy) to Rs. 40.26 billion, mainly because of decline in revenues from fixed services—from Rs. 44.79 billion during 9MFY2004 to Rs. 38.41 billion during 9MFY2005. The decline in income from fixed services has been because of decline in prices of long distance calling and a decline in fixed network connections. By contrast, over the same period, MTNL’s revenues from cellular services increased from Rs. 1.30 billion to Rs. 1.85 billion because of growth in cellular subscriber base, which was somewhat offset by a decline in per-subscriber revenues. MTNL’s cellular services subscriber base in the metros of Delhi and Mumbai increased from 324,933 at end-December 2003 to 594,742 at endDecember 2004. Its market share in cellular services in its service areas increased from 6% at end -December 2003 to 8% at end -December 2004. VSNL’s operating income increased only 0.6% (yoy) during 9MFY2005 to Rs. 24 billion, mainly because of a 13.5% (yoy) decline in telephone service revenues to Rs. 17.97 billion. Telephone services revenues declined because of a significant decline in settlement rates, increased competition from new entrants, and a decline in call tariffs. BTV’s income from telephone services increased 65.8% (yoy) to Rs. 57.17 billion during 9MFY2005, mainly because of increased revenues from all operating segments. While its access services revenues increased 47.8% (yoy) to Rs. 8.16 billion during 9MFY2005, revenues from cellular services increased 68.2% (yoy) to Rs. 38.21 billion. BTV’s cellular services subscriber base on the global system of mobile communications (GSM) standard increased 72.3% (yoy)—from 5.70 million at end December 2003 to 9.83 million at end-December 2004. Its fixed access services subscriber base also increased from 0.57 million at end -December 2003 to 0.80 million at end -December 2004. BTV's revenues from long distance services also increased from Rs. 8.10 billion during 9MFY2004 to Rs.13.59 billion during 9MFY2005. TTM’s income increased 38.9% (yoy) to Rs. 5.91 billion during 9MFY2005 because of an increase in subscriber base. TTM’s total telephone (fixed and cellular) subscriber base increased from 0.415 million at end-November 2003 to 0.772 million at end-November 2004. Financial Results of MTNL,VSNL, BTV and TTM—9MFY2005 BTV 9 Months ended December 31 Operating Income Cost of Sales Operating Profit Interest Depreciation OPBT Other Income/Adjustments PBT Tax Net Profit Compiled by INGRES

MTNL

TTM

Rs. million

VSNL

Total

2004

2003

2004

2003

2004

2003

2004

2003

2004

2003

57,174 36,559 20,615 1,389 7,821 11,405 125 11,529 1,505 10,025

34,492 23,110 11,382 2,067 6,322 2,982 395 3,377 220 3,157

40,259 30,397 9,863 276 4,334 5,253 3,148 8,401 2,068 6,334

46,084 29,468 16,616 243 3,833 12,540 2,037 14,577 4,871 9,706

5,911 6,608 -697 1,238 2,077 -4,013 514 -3,499 0 -3,499

4,257 3,758 499 834 1,493 -1,828 34 -1,793 0 -1,793

24,000 18,447 5,553 0 1,698 3,855 1,447 5,302 1,730 3,572

23,854 20,501 3,353 0 1,221 2,132 1,836 3,968 1,014 2,954

127,344 92,011 35,333 2,903 15,930 16,500 5,233 21,734 5,302 16,431

108,687 76,837 31,850 3,144 12,879 15,826 4,302 20,129 6,105 14,024

The combined operating profit of the four companies increased 10.9% (yoy) to Rs. 35.33 billion during 9MFY2005. The increase was lower than the increase in Report by ICRA Information, Grading and Research Service

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Telecom income and was mainly because of a lower 19.7% (yoy) increase in cost of sales to Rs. 92.01 billion. Cost of sales increased at a higher proportion mainly because of a significant increase in employee expenses. Combined operating margins declined from 29.3% during 9MFY2004 to 27.7% during 9MFY2005, mainly because of significantly reduced margins for MTNL. While MTNL’s operating profit declined 40.6% (yoy) during 9MFY2005 because of significantly higher employee expenses, its operating margins decline d from 36.1% during 9MFY2004 to 24.5% during 9MFY2005. While VSNL’s operating profit increased 65.6% (yoy), its operating margins increased significantly from 14.1% in 9MFY2004 to 23.1% in 9MFY2005 because of a significant decline in network and transmission costs, and employee expenses. Higher subscriber connections and the resulting economies of scale enabled BTV to report higher operating profits. BTV’s operating profits increased 81.1% (yoy) to Rs. 20.62 billion during 9MFY2005. Its operating margins improved from 33% during 9MFY2004 to 36.1% during 9MFY2005. According to BTV's calculations, while its segment operating profit margin from cellular services improved from 32.1% during 9MFY2004 to 33.6% during 9MFY2005, segment operating profit margin from access services improved from 20.8% to 28.8%. TTM reported an operating loss of Rs. 0.70 billion during 9MFY2005, mainly because of higher network and marketing expenses. The combined profitability of the four companies improved significantly during 9MFY2005. Combined profit before tax increased 17.2% (yoy) to Rs. 16.43 billion mainly because of higher operating profit, higher non-operating income, and lower interest charges. While combined non-operating income increased 21.6% (yoy) to Rs. 5.23 billion during 9MFY2005, interest expenses declined 7.7% (yoy) during 9MFY2005 to Rs. 2.90 billion. However, depreciation and amortisation charges increased 23.7% (yoy) to Rs. 15.93 billion. While BTV's depreciation charges increased mainly because of capital costs on network expansion, MTNL's depreciation charges declined because of change in the useful life of Apparatus & Plants, Cables, Lines & wires from April 1, 2003 based on technical evaluation. Because of a 13.1% (yoy) decline in taxation, combined net profits increased 17.2% (yoy)—from Rs. 14.02 billion during 9MFY2004 to Rs. 16.43 billion during 9MFY2005. Combined net margins remained stable at 12.9%. While the net margins of MTNL declined from 21.1% during 9MFY2004 to 15.7% during 9MFY2005, mainly because of higher employee costs, its net profits declined 34.7% (yoy) to Rs. 6.33 billion during 9MFY2005. BTV reported a 218% (yoy) increase in net profits to Rs. 10.03 billion during 9MFY2005. Its net margins improved from 9.2% during 9MFY2004 to 17.5% during 9M2004-05. After reporting a declining trend in profitability, VSNL's net profit increased 20.9% (yoy) to Rs. 3.57 billion during 9MFY2005. However, TTM’s net losses increased from Rs. 1.79 billion during 9MFY2004 to Rs. 3.50 billion during 9MFY2005, because of operating losses, lower operating margins, and higher interest and depreciation costs.

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Telecom

OUTLOOK During FY2004, fixed network subscriptions increased at a slow rate of 3.3% to 42.84 million at end-FY2004. By comparison, subscriptions increased 7.6% during FY2003, and 17.9% during FY2002. The increased competition from cellular wireless services is attested by the fact that cellular subscriptions (based on GSM and CDMA standards) increased from 13 million at end -FY2003 to 33.69 million at end-FY2004. The existing record of competition in fixed telecom services in India demonstrates that competition in the provision of local services to residential customers has proceeded more slowly and tentatively than competition to serve business customers. Further, effective competition seems likely in NLD and ILD services. Local access competition is likely to be witnessed more in the cellular services sector than in basic telephony. Cellular networks have made significant contribution to the telecom sector by demonstrating the benefits of competition and innovation and by extending connectivity. They not only add the feature of mobility, but also complement and compete with the fixed line network for voice communications. Significantly, cellular mobile telecommunications are likely to play an increasingly important role in providing universal service, at a lower cost, than fixed line service. In areas of low subscriber density, cellular mobile systems can have lower costs. Fixed line teledensity was 3.94 at end-FY 2004, as compared with 3.88 at end -FY 2003, and 3.68 at end-FY 2002. However, cellular services teledensity is rising at a fast rate—from 0.2 at end-FY 2000 to 1.2 at end -FY2003, and to 3.1 at end-FY2004 (including CDMA and GSM services). The current low leve l of telephone penetration in the country, the large unmet demand for telephone connections, and the emerging demand for data services, is expected to result in the expansion of the Indian fixed line network to expand from 42.8 million lines at end -FY2004 to around 45 million by end -FY2005. The rate of growth in service revenues is likely to be lower in comparison with the pace of increase in the number of fixed lines. This expectation is based on the likely increase in competition from cellular networks and the expected sharp decline in the prices of NLD and ILD services. However, in a competitive environment, slower revenue growth for incumbent operators from voice services could be offset by increased revenues from increasingly higher-speed data related services, and network access services. In cellular services, although subscription growth is expected to be high during the next few years, the rate of growth in revenues is likely to lag the growth in subscriptions because of declining prices, and reduced average revenues per user. The deployment of alternative access networks—including fixed, wireless or cable—has been recognised as a means towards greater service competition to the incumbent operators. Cellular services have the maximum potential in diluting the incumbent’s traditional monopoly control over telecommunications services. Since their launch in 1995, the potential of cellular services has become evident from the rapid growth of cellular telephone systems, which attracted nearly 33.6 million subscribers by end -FY2004. Cellular wireless subscriptions accounted for 44% of Report by ICRA Information, Grading and Research Service

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Telecom total telephone connections at end -FY 2004, as compared with 23.8% at end -FY 2003, and 14.3% at end-FY 2002. Cellular wireless connections are expected to exceed fixed line connections during October-December 2004. The increased preference for wireless telephones in general is attested by the fact that cellular wireless telephone connections (GSM and CDMA) accounted for 94% of new telephone connections during FY2004, as compared with 69% during FY2003, and 33% during FY2002. For users, cellular mobile telecommunication offers the obvious benefits of mobility and better service quality. By contrast, for the operators, the already high risks are increasing. Technology and market risks for GSM operators are expected to increase with the launch of CDMA services. CDMA services had already attracted 7.54 million subscribers by end -FY2004. The implementation of unified licensing for basic and cellular services is also expected to result in increased competition for existing GSM-based cellular operators from CDMA services. Greater competition would lead to lower prices for consumers, which in turn will stimulate market demand, thus exerting a downward pressure on costs because of the econo mies of scale involved. Mobile service price premium are likely to decline, thereby fuelling further market expansion and increased fixed to mobile substitution. However, falling prices and lower ARPUs could endanger the survival of some of the weaker players. The weaker operators would then be forced to enter into strategic alliances or divest equity in favour of stronger players. In spite of continued high subscriber growth, the possibility of lower revenue growth, lower profitability and continuing accumulated losses could inhibit the flow of large long-term financial investments into the industry. A slower growth in revenues and increased network investments to meet the increased demand would imply that most of the operators would not be able to wipe out their accumulated losses soon.

UNION BUDGET FOR 2005 -06 Major Initiatives • Customs duty exemption presently available to specified telecom network equipment and parts thereof upto March 31, 2005, when imported by telecom service providers, has been continued without any time limit. • Customs duty reduced from 20% to 10% on optical fibres/bundles and optical fibre cables (OFC) of heading 9001(optical fibres and optical fibre bundles, OFC other than those of heading 8544, which include OFC made up of individually sheathed fibres). • Customs duty has been exempted on specified items covered under the Information Technology Agreement (ITA). With this, all 217 ITA bound items are now fully exempt from customs duty. • Enabling power is being taken to levy an additional duty of customs of 4%, on all items imported into India. To begin with, this additional duty will be charged only on ITA bound items and on specified inputs/raw materials for manufacture of electronics/information technology items, which have been exempted from customs duty. Manufacturers will be able to take credit of this additional duty for payment of excise duty on their finished products. Report by ICRA Information, Grading and Research Service

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Telecom • Under Section 80IA of the Income Tax Act, an undertaking which has started or starts providing telecommunications services, before March 31, 2005 is allowed a deduction for any 10 consecutive years beginning from the year in which it starts providing services. The amount of deduction is 100% of profits for first 5 years, and 25% of profits (30% for companies) for the next 5 years. The terminal date for setting up new undertakings and commencement of services has not been extended beyond March 31, 2005. • Reduction in corporate income tax rate from 35% to 30%. • So far, Government has released Rs. 17 billion to the Universal Service Obligation (USO) Fund, which has been fully utilized. A provision of Rs.12 billion has been made for 2005-06. As a result, 1,687 subdivisions will get support under the USO Fund for rural household telephones. BSNL has undertaken to provide village public telephones (VPTs) in the next three years to the remaining 66,822 villages uncovered. • The one-in-six criteria for filing income tax returns has been amended, with the removal of subscription to a cellular mobile telephone. Instead, payment for electricity of more than Rs. 50,000 per year will be included as a criterion for filing a return of income.

Impact Some major items pertaining to telecommunications in the ITA, which have been exempted from customs duty include line telephone handsets, telephonic switching apparatus, optic fibre cables, cellular handsets, and fixed wireless terminals. However, the reduction has been moderated by the levy of additional duty of 4%. In view of the low telephone penetration in India (8.8 telephone connections per 100 inhabitants at end -January 2005), overall decline in effective customs duty on many items of telecom equipment is likely to reduce per-line capital costs, make telecom services more affordable, and improve telephone penetration. The provision of Rs. 12 billion towards USO is expected to bring the country closer to universal access to telephone services across the country. The overall effective customs duty on cellular and fixed wireless handsets is expected to decline marginally. Since these products are largely imported, the expected price declines could reduce entry costs for subscribing to cellular services, increase sales of handsets imported through official channels, and bring down purchases of handsets from the grey market. Most private sector service providers are unlikely to be impacted by the reduction in corporate income taxes since most of them continue to incur losses. However, the reduction is likely to have a positive impact on profitable service providers such as Bharti Televentures Ltd. (BTV), Mahanagar Telephone Nigam Ltd. (MTNL) and Videsh Sanchar Nigam Ltd. (VSNL). The Budget has not extended the tax benefits for setting up telecom projects, from the previous cut-off date of March 31, 2005. Thus, the tax holiday has been withdrawn for projects set up after March 31, 2005. The removal of cellular mobile services from the one -by-six criterion for filing income tax returns is unlikely to have a significant impact on demand for new connections.

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Telecom

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