Making of India’s regulators

Business Standard, September 13, 2011

Many new regulators have emerged in the last 20 years. Some have done well, others have struggled to deliver.

As India began opening up its economy and markets in the early 1990s, there was a need to put in place rules and regulations in sectors that were being deregulated. To attract foreign investment and provide a level playing field to the new players and the incumbent, the government set up regulatory bodies in many sectors.

For instance, mobile telephony came into India in 1995-96 but interconnection with the public sector operator, BSNL, was not easy. Following multiple disputes, the High Court asked the government to set up a Telecom Regulatory Authority of India (Trai) in 1997. Justice S S Sodhi became the first chairman of Trai, and built a foundation which subsequent regulators used to bring in radical changes.

Or take the Tariff Authority for Major Ports (TAMP), constituted in April 1997 to regulate all tariffs at major ports. But ports under the state governments (non-major ports) are free to decide on their charges. There is now a move to do away with tariff regulations and create a common regulator for all ports, which will monitor service and performance standards.

A tale of two sectors

Orissa in 1995 became the first state to set up a state regulatory commission and privatise distribution of power in 1995. The Central Electricity Regulatory Commission (CERC) was set up in 1998 to set tariffs for central PSUs and regulate inter-state movement of power, among other things. While the CERC had done good work in enforcing grid discipline and in creating a market for electricity, the problem lies in the states, where regulators in many cases have failed to determine what should be the price for electricity.

The problem lies in the selection of regulators, who are mostly retired IAS officers, with little understanding of the science of regulation, which requires a sound understanding of law and economics. “They lack the rigour and vigour needed to do such demanding jobs but claim domain knowledge after having worked in the particular sector ministry,” says an expert. What’s worse, they are closely connected to the existing power structure.

“Politicians want to keep tariffs low. The cost of putting up a power plant is Rs 4-5 crore per Mw. If the money is not recovered, the distribution company goes bust,” says S L Rao, a former CERC chairman. State utilities have accumulated losses of Rs 75,000 crore; this is likely touch Rs 125,000 crore by 2013. “State regulators are pandering to the needs of the politician, and in the process have destroyed the private sector,” he says.

If the power sector suffered despite a good law and regulators, the telecom sector made the best of some aggressive regulatory changes. As a result, tele-density in India rose from 1.92 per cent in 2002 to 70 per cent in 2010, while tariffs have came down from Rs 4-8 a minute in 2002 to Rs 0.25-0.50 a minute. India adds nearly 20 million mobiles a month, three times what China ever added, taking India’s mobile base on a par with China.

Telecom and information technology — which was enabled by seamless connectivity at very low costs — are two sectors where India outperforms China. Unlike power, where capacity additions fell short of targets by 50 per in the last 20 years, telecom exceeded Plan targets by 300-400 per cent in 2010 and rural connectivity by 400-500 per cent. “A lot of credit for setting the tone goes to the first regulator, who did not compromise on principles of level playing field regulation,” said a former telecom regulator.

The Insurance Regulatory and Development Authority (Irda) was set up in 1999 when the insurance sector was opened up. “The Irda has done a good job of making sure only serious and financially-strong players (the likes of Prudential, Standard Life, among others) got in and has played a key role in the development of product range and channels of distribution,” said Rajesh Sud, CEO and managing director of Max New York Life.

The Controller of Capital Issues was abolished, and the Securities and Exchange Board of India (Sebi), set up in 1988, was made a statutory body in 1992. Over time, Sebi’s tasks and powers expanded. After the 2001 Ketan Parekh scam, G N Bajpai took over as the new regulator and tried to improve transparency and corporate governance. Structural changes were introduced to shorten the settlement cycle, and improve margining and surveillance systems as advised by a Parliamentary panel.

In 2002, foreign institutional investors (FIIs) were allowed to hedge their entire exposure in Indian equities. By 2003, the number of FIIs exceeded 500, with 1,500 sub-accounts. Thanks to FII interest, the Rs 10,000-crore ONGC IPO in March 2004 was subscribed in 10 minutes. Sebi allowed companies to determine the par value of shares issued by them, and allowed IPOs to go in for “book-building” to get bids in a price band to help discover the market price.

Measures continued to improve transparency in markets. In 2003, the National Stock Exchange prohibited cash transactions. In 2004, Sebi asked brokers to reveal details of transactions involving more than 0.5 per cent of the listed shares of a company, and banned them from trading with each other on the same exchange.

Says former Sebi Chairman G N Bajpai: “Fast paced reforms over the years by Sebi have made our capital markets modern, efficient and safer for investors. The quality of the equity segment — cash and futures — of the Indian capital market compares favourably with the best in the world.”

Yet, the regulatory environment which has developed over a period of time is not coherent across sectors, says Pradeep Mehta, secretary general, CUTS International, a Jaipur-based think tank and trade advocacy body. “A careful analysis of the existing legal, policy and institutional framework in India reveals a somewhat haphazard and uneven approach to the evolution of regulation across and within different sectors of the economy, resulting in inadequate and expensive reform,” he says.

Political constraints and government preferences have often dominated the regulatory reform agenda in India. To develop a common institutional regulatory framework, the Planning Commission is drafting the Regulatory Reform Bill, which will lay down the legislative action needed for reforming the regulation of key infrastructure services. “But it has met with stiff resistance from many because of a) status quoism and b) turf issues, because many of the ministries will lose control over the regulators,” says Mehta.

Conflicts and frictions

An offshoot of the regulatory evolution has been the occasional friction and conflicts between regulators. In the turf war between Irda and Sebi on who will regulate Ulips, they were first advised to approach a court of law to resolve the dispute of jurisdiction. However, even before they could do that, the finance ministry stepped in and formed a new body headed by the finance minister — which was not the best solution.

Similarly, there is a pending dispute on futures trading in electricity between the CERC and the Forward Markets Commission, which went to the Bombay High Court. It held that futures contracts in electricity cannot be exclusively dealt with by any one of these regulators. The mixed nature of this subject falls in the domain of both the regulators, unless one of them is given the mandate. The matter is pending in the Supreme Court.

In this context, it is important to identify the specific and delineable roles for regulatory commissions and the Competition Commission of India (CCI). “The interface between regulators and the CCI needs to be formalised in legal terms and cannot be left to an ad-hoc process. It is best to leave the determination of behavioural/ conduct issues to the CCI and structural issues to sector-regulators,” says Mehta. A good approach could be to ensure mandatory consultation between regulators and the CCI.

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