India's regulators and their magnificent obsession with floor prices

The mechanism hasn't just been the subject of heated discussion in telecom but has also pervaded other sectors such farming, water supply, renewable power and even in natural gas

Why don't floor prices work? Remember there was a service called SMS on mobiles till WhatsApp came in and nearly killed it? The former charged a minimum price—a floor price and the upstart internet whizkids undercut it using better technology. 

It is worth considering this when the Supreme Court has stuck to its stand on Wednesday that all pending adjusted gross revenues payable by telecom service providers must be recovered at one go. The combined dues of Vodafone Idea, Airtel and erstwhile Tata Teleservices are about Rs 1.19 trillion. The non-oil companies, including  Gail and Oil India, need to pay about Rs 1.83 trillion. Can the telecom department (DoT) step in to offer these companies any financial space to mitigate the impact? One of these is for the government to lower its future license fees or spectrum base prices, both of which eminently possible. Instead, there are reports that an anti-competitive plan -- that of a floor price for future telecom services -- could be in the works. Is there a possibility of an SMS-to-WhatsApp game happening here too. if the floor prices are allowed?

Incidentally the Internet and Mobile Association of India has given fairly similar reasons to oppose a floor price for telecom service operators. 

Regulatory crosswires

If a floor has to come in, it will be through the Telecom Regulatory Authority of India (Trai), which will have to do the weightlifing. Also, most likely it will certainly be shot down by the Competition Commission of India. One of the quirks of the Indian regulatory space is that regulators fight among themselves about their scope, bitterly dragging their fights to courts. CCI and the Trai have fought over who will decide whether the telecom companies have offered adequate facilities to each other for subscribers to call across different networks. The experts commenting on the fight noted that it was a proxy war among the three private sector companies Vodafone Idea, Airtel or RJio to get an advantage over the other. 

If Trai chooses to offer a floor price or some variation on it, one can be sure CCI will be at loggerheads with it. Though to be fair, the telecom regulator has already made public why it does not think a floor price is a great idea. A consultation paper released by the regulator in December weighs the evidences to note, “Fixing of a floor price is, thus, fundamentally against the consumer interest. Not only this, price controls cause a net Dead Weight Loss… A floor price is, therefore, considered inefficient for the economy”.

There are no significant telecom markets in the world which offer a floor price and for the same reasons. Telecom analyst Mahesh Uppal says a floor price “is a retrograde idea and no mature markets offers to set floor price”. 

The Trai argument endorses Uppal and should, in principle, find support from the CCI too. Think of a floor price as a minimum support price (MSP) that the government offers farmers for cultivation of 24 types of crops. To understand why it is a failure ask any farmer. The price support should not be necessary if there is a shortage, as farmers will be able to sell prices which are higher than MSP. It should work whenever there is a glut of production. Yet farmers are annoyed because the state agencies do not manage to buy more during the glut. The farmers then sell at a price lower than the MSP and make a loss. The experiment shows instead that making the markets efficient would help the farmers more than this administrative fiat.

Floor price: other sectors

Curiously though India has continued to experiment with floor prices in several sectors. We saw its impact on farming. There are other sectors too like water supply, renewable power and even in natural gas. The experiments in water supply and gas date back to the early nineties while that for renewable power are fairly recent. These experiments informs us why there is an environment of pundits which support floor price in a sector. 

“An effective price floor hurts the very people who it is supposed to benefit i.e. the consumers. Their welfare worsens because of loss in consumer surplus. Plus, the overall society is worse-off because of the deadweight loss” argues Bornali Bhandari, senior fellow at NCAER. She says the only way part of the deadweight loss can be transferred to government but consumers will still be overall worse off.

This is what happened in other sectors. In the case of renewable power, the Central Electricity Regulatory Commission has set a floor and forbearance for trading through exchanges. This should not have been necessary since a power exchange by definition should set prices. In its order dated December 30, 2014 for the period between April, 2012 to March, 2017 the power regulator had set the prices. The reason are the same, as that which Trai has received from the telecom sector. The floor will stop distress sale of renewable power by the producers. Remember the government has brought in a renewable power purchase obligation for the electricity distribution companies, i.e. they have to mandatorily buy a percentage of their power from the renewable sector. Since there is no rule which decides what will be the price at which those purchases will happen, the CERC waded in to set a floor price. Significantly while renewable energy has a share of 23.39 per cent in the total installed generation capacity in the country i.e. 368.98 Gw (up to February 29, 2020), most of the growth has happened after 2017 when the floor price ceased to operate  

The other example is natural gas. The production sharing contracts for the first set of gas fields—Panna-Mukta & Tapti had elements of floor price. Those contracts were written in December 1994. The price formula for the gas was linked to an internationally traded fuel oil basket, with a specified floor and ceiling price of $ 2.11 and $ 3.11 per million metric british thermal units, respectively. 25 years later these fields have exhausted their production capacity but the bad habits have persisted. The government still works on a price fixation formula to set domestic gas prices every six months. It has announced in 2018 plans to migrate to a spot exchange for gas but those are still in the works with the first step hiving of Gail to separate its role as a carrier from the business of providing gas in cities, still pending. Meanwhile China has already set up a spot exchange for gas in Shanghai. It is not the only one, there are 21 more countries with a spot exchange for the fuel. The underlying rationale is the same, better price discovery for the consumers. 

The domestic exploration sector is basically assured there shall be a floor price for its discovery and the costs are consequently gravitating there. It has not helped. The more the price setting mechanism has been fine tuned, the differential with global prices have come down. It is expected to fall by close to 51 per cent in just one year a Bloomberg report notes, eating into the profits of state run ONGC. A move to erase the floor would have made the company far better. 

The case of water is somewhat different. Many countries impose a minimum price on water consumption, irrespective of whether it is consumed or not. Latin America does it and so does many South Asian countries. The rationale for the floor is again to ensure there is a minimum cost recovery by government run water suppliers. About the Latin American experience Prof OP Mathur of Indian Institute of Public Administration had written, “The water company’s discretionary estimates of each user’s water consumption are crucial to tariff setting. This discretion is often used with the intention of trimming the bill to what the company thinks each part of the market will bear”. The floors encourage a certain level of consumption that affords little incentive to improve efficiency of the system. As a result the variety of rates for water connections remain high. Delhi for instance which offers a 20 kilolitre free water has three rates for domestic consumers and seven for commercial enterprises. A CAG report notes Delhi Jal Board has loans outstanding of Rs 26,268.89 crore, as on 31 March 2018, close to half of the total revenue of the Delhi state. 

Then there is gold. The world’s largest consumer of the metal still has prices set by the  Indian Bullion Jewellers Association, which uses a smorgasbord of price to benchmark not only the spot markets but also to fix the price of sovereign gold bonds. A full year after Budget 2018-19 floated the idea the government has to still set up a regulator and then allow exchanges like the Bombay Stock Exchange or the Multi Commodity Exchange to start spot and forward trading in gold. Again China has the up and running Shanghai Gold Spot Exchange to offer competition.