India might be the world's hottest mobile market, but it also suffers from limited supply of the most critical resource - spectrum.
Indian operators are managing one of the world's greatest ever rampups in mobile demand with typically less than half the spectrum normally available.
Last month's much-delayed 3G auction finally gave them a chance to grab more precious radio real estate.
But midway through the auction the Telecommunications Regulatory Authority of India (TRAI) dropped its bombshell: under its 2G spectrum blueprint it expects cellcos to pay for frequencies they already owned.
The issue - involving billions of dollars of investment and some of the country's biggest enterprises - is almost certain to end up in court, or before the cabinet, or both.
For more than a year, the industry had been waiting on TRAI's 2G licensing roadmap. When it was finally unveiled on May 11, they learnt the regulator planned to slug them for allocations of more than 6.2 MHz that they had previously been given for free.
Officially, the Department of Telecommunications (DoT) has limited GSM spectrum in a single service area or "circle" to a maximum of 6.2 MHz. To begin with, an operator gets 4.4 MHz of spectrum for free in a circle with an operating license. When the operator reaches certain subscriber targets in a given circle, it can apply to increase its allocation to 6.2 MHz.
But on an ad hoc basis, between 2003 and 2006 the DoT allocated up to 12.4 MHz - twice the license quota - to GSM900 incumbents, including Bharti Airtel, BSNL/MTNL, Vodafone, Idea Cellular and Aircel.
Even 8-10 MHz of spectrum (only MTNL has 12.4 MHz of spectrum in both Mumbai and Delhi) is substantially lower than global norms of 15-20 MHz per operator for 2G.
Idea Cellular - the fifth largest pan-Indian operator, with 4.4-8 MHz per circle for 60+ million subscribers - says the small spectrum lots have increased operators' financial burden.
"With spectrum at a minimum level of 4.4 MHz or 6.2 MHz, we need a really large dose of capex to get a network that is capable of operating seamlessly," Rajat Mukarji, chief corporate affairs officer for Axiata-backed Idea, told Telecom Asia.
"If there had been spectrum allocated in larger chunks to a smaller number of operators, there would be more efficient networks, benefits of scale, far fewer towers and more realistic coverage for customers."
TRAI has suggested that a one-time fee for allocations of more than 6.2 MHz be benchmarked against 3G auction prices, which surpassed even the most conservative of estimates.
TRAI estimates that India's leading cellco Bharti will have to find 34.98 billion rupee ($776.5 million) for spectrum it has been given above 6.2 MHz.
All up, operators will have to find a cool $3 billion to compensate the government previously handing out spectrum on a makeshift basis a few years ago.
However, that's not all.
Under its refarming proposition, TRAI proposes that operators swap their 900-MHz spectrum for an equal amount of spectrum at 1800-MHz when their licenses come up for renewal (the bulk of Bharti and Vodafone's licenses are due for renewal in 2016). After an operator moves to 1800-MHz, the DoT will take the vacated 900-MHz spectrum and auction it for either 2G or 3G purposes.
So for Bharti, if it has 10 MHz at 900-MHz, it can swap this for 10 MHz at 1800-MHz.
But it will first have to pay for excess spectrum above 6.2 MHz, and it will have to find additional capex if it wants to maintain its existing service levels (since it will need to deploy more base stations at 1800 MHz than it had at 900 MHz).
Then, at a new auction, it can opt to bid for the 10 MHz of spectrum that was vacated at 900 MHz.
Market leader Bharti has said the new rules "overturn all existing policies of Department of Telecommunications for the last 15 years, recommendations made by various government committees and even TRAI's own earlier recommendations."
"Besides, these are against all existing global norms for spectrum allocation and efficiency."
Shiv Putcha, principal analyst with Ovum's emerging markets unit, believes GSM900 operators will legally challenge TRAI's refarming plan should it become policy.
"The 900-MHz operators got the first mover advantage and have sunk in a lot of investment," he says.
"I expect operators will want to keep their 900-MHz spectrum and push for re-farming in the true sense of the word [i.e., roll out 3G at 900 MHz]. I expect this to be the counter proposal."
There is 5-10 MHz of 900-MHz spectrum and 30 MHz of 1800-MHz spectrum not yet allocated to cellcos. However, both spectrum lots are occupied by various government agencies, including the defence forces.
For the time being, the operators' fate is in the hands of the DoT.
"If the DoT adopts the TRAI recommendations as policy, I expect that action to lead to legal challenges and then eventually [issues will] be decided by committees and possibly cabinet level intervention," says Putcha.
"This course of action will take a long time, probably over a year."
Yet even if the DoT does not accept TRAI's blueprint, a compromise formula is going to take months to be worked out and that means more delays.
"If they [new operators] do not get more start-up spectrum any time soon, there will clearly be a loss of earnings for them," says Putcha. "Time to market and return on investment will also be much longer."
For established operators, a lack of new spectrum will crimp growth and quality of service.
"For existing operators, there will be pressure to attract more subscribers in a circle," adds Putcha. "The only way to do that is more price competition, so there will be more pressure on pricing and margins."
Maxis-backed Aircel, which carries more than 35 million customers in blocks of mostly 4.4 MHz, says India's small spectrum lots are not enough.
"If we have more spectrum, then we can add more frequency rather than cell splitting and so on which is more expensive," says the firm's boss for strategy and emerging business, Bharat Bhargava.
But the capacity crunch is getting worse as Indian operators continue to add 17 million customers or more every month.
India's spectrum shortage is not only restricted to populous centers, says Luca Ferro, managing partner of management consultancy Value Partners, in Mumbai.
"There is definitely a spectrum crunch not just in metros (Delhi and Mumbai) but also in top cities of other circles; for example, Pune in Maharashtra," says Ferro.
"Operators have invested significantly in the network; not just in increasing base stations but also in deploying new technologies like synchronized frequency hopping to increase capacity on their networks.
"However, we have to remember that India is a low ARPU market and investments in network are limited by financial viability and whether there is a business case for additional investment."
The lack of 2G frequencies is of course one of the reasons why 3G bids beat all expectations last month, topping out at a whopping $14.6 billion.
Leading operators abandoned plans to bid in all 22 circles, as aggressive bidding pushed the price tag for pan-Indian spectrum to $3.6 billion, almost three times higher than analysts' expectations.
"It was a winner's curse," says Idea's Mukarji of the 3G auction. "You couldn't stop bidding because you needed the spectrum."
"First, we need to provide capacity in certain areas where there is high voice demand because of the extreme shortage of spectrum. In the second phase, I think we will see a migration of heavy data users onto the 2100-MHz spectrum band.
"In a crowded market, if a customer has a 3G phone, they will automatically go to one of three 3G network providers," adds a source from Reliance Communications, India's second-biggest cellco.
"As an incumbent operator, you don't want to miss out on that."
Since there was no possibility of gaining new 2G airwaves to ease capacity constraints, Ovum's Putcha says "3G was the only outlook to spectrum life."
But he says, given the small 3G allotments, success will be limited if a particular service kicks off.
"Operators run the risk of rapidly using up their lifeline which they've paid a lot of money for."
Putcha believes operators will find it difficult to make a return on 3G, since margins for all operators are falling amid the country's tariff war.
"If your existing business is under threat and you struggle to fund your 3G buildout, an operator is going to struggle on a return for 3G," he says.
It could take eight years or more for an operator to reach a profit on 3G, says Value Partner's Ferro.
"The PBT [profit before tax] varies a lot by operator and circle as well," Ferro told Telecom Asia. Had a tier 1 operator won pan Indian spectrum, it would have taken 12-14 years to return a pre-tax profit, he added.
"There are circles with a lower PBT such as Kolkata (eight years), others with a higher one such as Andhra Pradesh, but again it varies a lot depending on the competitive positioning (market share, ARPU) of the operator in that specific circle."
Aircel's Bhargava believes that breakeven on its 3G networks won't be "very difficult as the 2G network is already there."
But he says recovering Aircel's $1.4 billion 3G license fee will take a "period of time. We don't see a problem," he added.
So much for 3G. Could LTE help ease the burden?
In a pre-consultation paper, TRAI has identified at least 108 MHz in spectrum at 700 MHz for LTE. Unlike in Europe, this 108 MHz of spectrum is vacant.
TRAI will issue a consultation paper on 700-MHz allocation in the next two to three months, with a goal of publishing its 700-MHz spectrum plan by year-end.
"There is also 114 MHz of spectrum, currently used for broadcasting, at 548-798 MHz, some of which could be used for LTE," noted an operator source. "One option would be to free up say 60 MHz of this spectrum for LTE by moving the broadcasters to other spectrum."
But the country's LTE auctions could be a couple of years away, or more, as the whole licensing process between TRAI, the DoT and eventually the government is only just getting started.
And just how much 700-MHz spectrum per operator is eventually put up for grabs, might well depend on market consolidation (see story to the left) .
Bharti, Reliance Com, Vodafone, Idea, Tata and Aircel are also in the mix for 2.3-GHz broadband wireless spectrum. In a BWA auction underway as Telecom Asia goes to press, they are competing with Qualcomm, which is planning to roll out TD-LTE, rather than Wimax.
The DoT says it has no schedule for the next 3G auction round, saying only that should a "further round of auction for 3G... spectrum take place within 12 months from the current round, the reserve price in such a round will be the same as the winning price in the current round."
"The ability to offer fresh [2100-MHz] spectrum depends on rehabilitating defense into other bands, which typically takes longer than expected," adds Putcha.
SIDE BAR: Curbs to consolidation