Telecom: FDI hike a major boost

The cellular telephony segment has emerged as the fastest growing segment in the Indian telecom industry. In fact, the segment achieved a landmark in FY03 when for the first time, more cellular subscribers were added than fixed line subscribers. A slew of tariff reduction in the past 18 months has helped the segment to gain in popularity. The cellular segment is playing an important role in the industry by making itself available in the rural and semi urban areas where teledensities are the lowest and where the fixed line services will take some time to come because of high capital investments required to build a network.

Budget Measures

	FDI limit in the sector increased to 74% from 49%.
	Customs duty exemption on mobile switching centers imported by telecom service providers now extended to universal access service providers.
	Service tax increased to 10% from 8%.
	2% education cess on direct and indirect tax.

Budget Impact

	A hike in the FDI limit has increased the attractiveness of the sector for foreign telecom majors and consequently, there could be a large flow of capital into the sector. This will go a long way in improving the growth prospects of this sector. Specifically, players like Bharti Televentures, Idea Cellular and Hutchison-Essar Telecom, which have foreign partners, are likely to benefit. Other companies that have till now not explored the possibility of raising capital in this manner can have a fresh look at this source of capital. Consolidation is also likely to speed up.
	An exemption in the customs duty will lower the infrastructure cost.
	A hike in service tax is likely to be passed on to the consumers, which could hurt demand in this sector in the short-term.

Sector Outlook

Strong competition that has brought down tariffs as well as simplification of policy environment has promoted healthy competition among various players. Due to this reason telecom density in the country has risen to 7.5% in FY04 compared to 3.64% in FY01. Post the hike in FDI limits we are very optimistic about the prospects of the telecom sector. Higher FDI will bring in the capital required to help telecom companies to expand their operations in the country. The mobile sector is likely to benefit form the hike in FDI limit as is likely to meet the target of reaching a size of nearly 75m by FY06. However, telecom still continues to be one of the highly taxed sectors in the country and until there is rationalisation on this front, we may not be able to see telecom companies exploiting the full potential of the Indian telecom sector. In the long-term we continue to remain optimistic about the prospects of the sector.

Industry Wish List

	Zero import duty on the mobile equipment used to build out networks.
	Reduction in custom duties on mobile phones and fixed wireless terminals.
	Proposal for an increase in the service tax from existing eight per cent.
	Other levies including revenue share and contribution towards Universal Service Obligation (USO) fund need to be lowered.
	Increased service tax should go towards funding all USO, while the total license fee in the form of revenue share should not exceed one per cent of adjusted gross revenue.
	Exemption from all types of taxes including service tax for the broadband services to prop up the nascent industry
	Allow higher FDI, or, at least, keep the FII investment out of the FDI ceiling.

Budget over the years

Budget 2001-02	Budget 2002-03	Budget 2003-04

No significant developments	Increase in basic customs duty and removal of the 16% counter veiling duty on cellular handsets.	Foreign direct investment limit on telecom companies raised to 74% from 49% earlier. Reduction in customs duty on capital goods for the telecom sector from 25% to 15%. Continuation in tax holiday for infrastructure related sectors. Customs duty on optical fibre cable reduced from 25% to 20%

Key Positives

	Emerging Sector - The telecom sector has been one of the fastest growing sectors in the Indian economy in the last 2 years. This has been witnessed due to string competition that has brought down tariffs as well as simplification of policy environment that has promoted healthy competition among various players. Due to this reason telecom density in the country has risen to 7.5% in FY04 compared to 3.64% in FY01.
	Mobile telephony growth driver - The mobile sector alone has been growing rapidly and has emerged as the fastest growing market in the whole worlds. This sector is expected to reach a size of nearly 75m by FY06.
	Long distance telephony potential - The de-regulation of the domestic/international long distance telephony segment and tariff rationalisation has increased telecom usage. Due to the entry of competition in these segments the tariffs have reduced significantly and this has led to higher usage of these services. Going forwards due to the low penetration of these services among the populace, the growth of these services is likely to be robust. Just the international long distance telephony segment is likely to witness growth of between 15%-18% in volumes in the next 3-4 years.
	Consolidation picking up - The government has eased the rules regarding inter circle and intra circle mergers. This has led to a slew of mergers and acquisitions in the recent past. Also as the sector is moving closer to maturity, further consolidation is a reality and this will lead to the survival of more profitable players in this segment. Smaller players are slowly realising the need for adequate management skill (given the dynamics of the industry) and capital to sustain growth. Bigger players continue to expand operations.
	Broadband push - In order to further promote the use of Internet in the country the government is taking proactive steps to develop this sector with the help of the various players in this segment. Hence for this purpose the use of broadband technology is being mooted and this will go a long way in improving the productivity of the Indian economy as well as turn out to be the next big opportunity for telecom companies after the mobile communications segment.

Key Negatives

	Regulatory environment still evolving - The regulatory environment, though has improved, is still perplexing. The tariffs in this sector are still regulated to an extent by the Telecom Regulatory Authority of India (TRAI). This impedes free market forces form deciding on tariffs.
	Favoritism prevalent - Competition has increased multifold and certain government policies seem to be favoring telecom PSUs. Penetration level in rural areas has more or less remained stagnant. For instance cellular operators have to pay an Access Deficit Charge (ADC) to a fixed line carrier. Since over 90% of the fixed line infrastructure is owned by the incumbent BSNL, cellular firms have to pay a heavy toll to BSNL, which in turn is passed on to the consumers. This in turn keeps the tariffs high.
	Highly taxed sector - The COAI (Cellular Operators Association of India) has indicated that the telecom sector, especially the cellular services segment, continues to pay very high duties and levies. The association has also indicated that due to the high rates of duties and levies and falling ARPUs, cellular service providers are not in a position to fund expansion and enter in to the relatively lesser-serviced rural areas. Currently, the sector is paying duties and levies under various heads including annual license fees, spectrum charges and access deficit charge. In addition to the above, significant levies are also imposed on the industry on account of sales tax, service tax and import duties on handsets and other telecom hardware. As a matter of fact, the report states that the burden on the sector on account of access deficit charge, spectrum charges and license fees is to the tune of 25%

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