Spectrum auction in danger, time to act

Current auction design is self-defeating in attracting new entrants and can alienate handful of existing operators.

The spectrum auction for the introduction of mobile broadband in Pakistan is in danger. As a central piece of Finance Minister Ishaq Dar’s budget strategy for FY2013-14 and the first test of foreign investors’ appetite to invest in Pakistan under the administration of Prime Minister Nawaz Sharif, this should be worrisome. The good news though is that the central issues that are concerning existing mobile operators and potential new investors can be resolved before the auction takes place.

Pakistan has just one per cent broadband penetration. This dismal number lets down a population that will be approaching 200 million inhabitants soon. In the 21^st century, broadband is as important as water and electricity for the well-being of citizens and for dynamic development. While water and electricity require strong government intervention, broadband deployment is driven worldwide by private investment and light regulation that provides guidance on the general policy objectives without micromanaging outcomes.

The information memorandum (IM) and the draft licence offered by the Pakistan Telecom Authority (PTA) under close watch of the Ministry of Information and Telecommunications goes in the wrong direction of strong government intervention in the telecom industry. This is a big disappointment for the telecom sector and should be fixed. Otherwise, spectrum auctions that are important for the sector and the whole economy, could fail.

Let’s start with technology neutrality.  This means that telecom operators can use the spectrum they acquire from the government in auctions to deploy any technology they find suitable for delivering services to consumers. This has been a corollary of Pakistan’s telecom policy since the 2004 Mobile Policy that is still in effect. The current IM for the auctions and the draft licence both, break with this principle and restrict the use of new spectrum “only for the Next Generation Mobile Services for which it is permitted”. This would tie the hands of operators unnecessarily and break with a key principal of the telecom policy: governments should not impose technology; the private sector chooses technology.

As with many such big mistakes, the break from technology neutrality comes with good intentions.  Pakistan waited too long to deploy third-generation wireless networks — 3G or HSPA — for its mainstream voice and data technology. 4G or Long-Term Evolution came after that. The government’s intention is to accelerate the roll-out of new networks. But tying the hands of operators is not the best way to achieve this objective. Leaving operators free to efficiently deploy technologies based on each operator’s unique strategy is better and would keep a key principle of policy enshrined in the existing policies and best practices.

Another fundamental issue is the auction design itself. It is designed to create an artificial spectrum scarcity. The country has five operators but only three slots of spectrum in the 2.1GHz band (a key slice of spectrum for 3G) is being offered. This could create fierce competition and hike up prices in this band, but it could also lead operators not to engage in the auctions. The government is also offering two slots of 1,800MHz (useful for both 2G and 4G) and one in 850MHz (good for both 3G and 4G). However, it is not allowing all operators to bid for it — only winners of the 2.1GHz or a potential new entrant could bid. A better auction design would allow all operators, existing and new, to bid for all bands simultaneously. Which new entrant would want to enter a cutthroat auction for 2.1GHz? The current auction design is self-defeating in attracting a new entrant and can alienate the handful of existing operators; if the auction design is improved, the government will fetch better financial results with the auctions than under the current design.

To give operators flexibility to deploy 3G and 4G, spectrum associated with both should have flexible rollout obligations. Operators most likely will deploy 3G first to develop a mass data market for the common person, which currently does not exist in Pakistan. 3G devices are cheaper and more suitable for the mass market. Then, they will start deploying pockets of 4G and will expand. The current obligations for a rollout of 3G (2.1GHz) and 4G (1,800MHz) are too ambitious and discourage bidders. More time (a factor of two times more for 2.1GHz and a factor of five for 1,800MHz) would allow operators to bid for both spectrum bands confidently. The current obligations will cause no bidders for 1,800MHz, destroying value for the auctions.

There are additional financial burdens in the draft licence that also act to discourage bidders. Future revenues resulting from services provided with this spectrum will be in rupees but the cost of the spectrum is in US dollars. A mismatch between this big expense (spectrum cost in USD) and revenues (in rupees) is not financially sound. Pakistan needs to go beyond the practice of charging for spectrum in USD. Moreover, if bidders decide to parcel 50 per cent of the payment in installments, libor plus three per cent is due. In USD, the financial hedge is there, no interest should be added to it; in rupees, the interest would make sense due to inflation. A number of unnecessary guarantees for payment of regulatory fees also add to the costs of the auction and should be eliminated, as other punishments for non-payment of fees are already in place, including cancelation of licence.

The biggest flaw is perhaps, in the proposed scheme for the auction. The proposed draft licence is unacceptable to existing operators, which already have an operating licence. The new draft licence contradicts the existing one in several aspects, forcing operators to create ‘two accounting operations’ — one to serve the existing licence and one to serve the new one. It is time to separate the operating licence from spectrum assignment in order to resolve this problem. This is a big job for the PTA but it can be and should be done now while there are in-house consultants supporting the auction. For starters, issuing a simple spectrum assignment with terms of payment, duration and obligations could address these concerns, while the PTA would move to a definitive separation between operating licences and spectrum assignments in the next few months.

Finally, an important element in the environment for the auctions is taxation. In defining how much they are willing to pay for spectrum, operators run an Excel spreadsheet with the potential returns over the period of the licence (currently 15 years, better if 20 years). Taxation is a major factor affecting returns.  The finance ministry would go a long way in enhancing the likelihood of auction success if it eliminates the activation tax of Rs250 and brings the GST to the 17 per cent that is normal for most sectors (telecom currently is paying 19.5 per cent). This should be done ahead of the auction to create certainty, instead of only promises that can be withdrawn once the auction is done.

The finance minister, IT Minister Anusha Rehman and PTA Chairman Dr Ismail Shah form a dream team that any government would like to have running the affairs under their responsibilities. It is now in their hands to ensure that spectrum auctions will be successful. Much work is still to be done, but it must be done for the sake of the common person in Pakistan.

Published in The Express Tribune, March 7^th, 2014.

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