Competition in Infrastructure-Complex Issues for Regulators: & Place of Competition Commission S L RAO INTERNATIONAL CONFERENCE CUTS, DELHI JANUARY 31/FEBRUARY 1 2005

Overview • Conflict between Ind. Reg. & CCI • Options in Reforming infrastructure towards competition: • Continuing State Ownership • Private entry into state markets • Public-Private participation • Privatization Alternatives • Privatization-Issues • Regulation-Policy Decisions in Design & Effective Functioning 2

COMPETITION-Usual Preconditions

• Many suppliers • Choice for consumers • Freedom of entry and Exit • Full Information available to all on Supplies, Prices, Quality • Freedom to transport/transmit • MANY CONDITIONS NOT TODAY IN SOME INFRASTRUCTURE SERVICES 3

Effects of Competition

• Improved Availability of Supply • Greater Efficiency/productivity • Lower Costs • Improved Quality • Lower Prices • Markets consist of different segments • At boundary alternative services/products can substitute • EFFECTS CAN BE SIMULATED THROUGH REGULATION 4

Infr. Issues-specialization

• What to do about the poor and marginalized?

• Protection of SOEs • The problem with cross-subsidies • Competition in generation, transmission distribution • Frequency variation,ABT&Trading • Competition in refining, pipelines, retail • The relevance of open access • Separating functions • Telecom today a result of Regulation; problem of protection to BSNL/MTNL • Simulating competition in Power, airports, ports, roads, railways. 5

Infr. Ownership Possibilities • • State-wide Monopolies OR Smaller Monopolies; Vertical Integration or Unbundling; • Natural monopolies and Competition in rest • Private Entry Options • Concession Contracts • Public-Private Partnership Models • Privatization Methods & issues • Regulator can simulate effects of competition and markets 6

State Ownership:Problems that Regulator must regulate • State ownership usually of monopolies • Long intimacies bet. SOEs & bureaucracy • Lack of enterprise and commercial cultures • Tolerant of inefficiencies • Overstaffing & lack of Discipline • Inadequate investment in levels of Renovation and Maintenance • Low Modernization • Populist tariffs, many times uncapped & charged to SOE • No scrutiny of decisions • More conscious of social obligations • Can independent regulation help?

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Private entry into State Monopoly Markets • Regulator (Government Department or Independent) must ensure transparency in allocating investments no cherry-picking by SOE • When SOE is sole carrier, open access must be legislated-rail lines & privatized trains; roads; power transmission lines; oil & gas pipelines; airports • Should production, trading, transportation, supply, exchange and Line management be separated?

• To build private investor confidence distance government from SOEs (Has never worked:MOUs, Navratnas, etc) • Regulation must be transparent, neutral, independent 8

Public-Private Partnerships can help • Enables extending government funds • Brings in enterprise vs. administrative culture into SOE & Sector • Need for careful & thorough contracts design to cover all eventualities • Don’t change Rules midway • Lay down time frame for major milestones with penalties on each violator of contract conditions • Could vary from BOO to BOT to BOOT • Essential to detail responsibilities and commitments of each partner • Vital role for Independent Regulator in achieving or simulating competition 9

Concession Contracts: another transition solution

• Concession:Private Operator operates for a ‘set’ period-Used extensively for Water & Sewerage • Awarded on lowest price of service • Period: Does contractor make investments or Government?

• Lease or Full Concession Contract • Innumerable Variations including BOT . 10

Privatization Alternatives (Role for Competition Commission) • Essential to have transparent unalterable methods

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laid out in advance • Sell Private equity shares in SOEs with or w/o golden share control holding

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• Sell to single buyer who can exercise management • Or to many small holders; management & control by independent Board and managers • And with or without sunset clause for government • Involve independent Regulator in Planning and implementation 11

Privatization-Some Conditions • Transition period to full privatization might see decline of SOE-Need to ensure no neglect in management or investment • Essential to ensure USO, fairness and equity between stakeholders • Government must underwrite social obligations • Obviously job of Independent Regulator 12

Privatization-Issues: Who decides?

• ESTIMATE IN ADVANCE: • 1) All Risks 2) Types of State support 3)Financial commitments for interim period by government • Identify & Estimate Uncontrollable risks (e.g. currency fluctuation, natural disasters, economic cycles) & cover them in contract • Discuss & establish liability for Partially controllable risks (e.g. taxes, environmental/safety rules, fuel prices, new obligations or rules) • GOVERNMENT TO DECIDE 13

Privatization Issues (2) • Controllable risks (e.g. operations, construction, technology) must be borne entirely by investor • With Regulated Tariffs it is essential to give certainty for 3-5 years; Concept of Multi Year Tariffs • Avoid favourable treatment of early investors since it will lead to subsequent pressure to equalize playing field • Risk treatment and mitigation to be publicized • SOME OF THESE ARE INDEPENDENT REGULATOR

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S DECISIONS 14

Privatization-Issues (3) • All risk cannot be entirely with State • Nor entirely with Private Investor • Impact of earlier poor management by State cannot be dumped on private investor: Need to establish & quantify interim financial support from government • Private entry may actually increase tariffs in nominal if not in real terms • But private entry must improve supply and quality • Essential to identify, quantify & allocate Risks between parties to diminish market perception of risk & thus, the cost of capital • Reaction of world capital markets to Risk perception must be evaluated 15

Regulation: Policy decisions in Design (IRC best placed to decide most; OR Government) • • a) b) • Economic efficiency & social considerations & costs not compatible; Regulator has to get clear guidelines on limits to each from govt.

• • Who and How to bear social costs must be decided & announced • b) TWO REGULATORY METHODS FOR TARIFFS: a) Based on rules Based on Contracts that regulator enforces Should Regulator decide Rate of return? Should it be on Equity or Equity +Debt? TARIFF ALTERNATIVES: Based on cost plus with stipulated Return OR on price caps 16

Regulation: Policy Decisions (2) • If monopolies exist Regulator can prevent cartelization & exploitation • OR encourage competition and market formation if he has powers to do so • Define what are effects of competition for the Sector and its Results • Determine stages through which sector will go before it arrives at full competition and markets • Economic efficiency must lead to lower tariffs for customers with lower real costs to serve; and for bulk buyers 17

Regulation: Policy Decisions (3)

• Quantify Social considerations: USO, Lower tariffs to special groups(rural, especially farmers, & poor) • Decide extent of compromise on efficiency over social considerations (Examples: environment-e.g. Using

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green

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energy; economic development of special zones or products; resource preferences (e.g. domestic coal vs. imported gas) • Who pays for social considerations and how soon?

• Methods: Reimbursements, Cross-subsidies, cess by operator, tax 18

Regulation: Policy decisions • Rule Based – Rules announced after wide consultation – Regulator can change rules with similar procedure – Procedural safeguards built into rules re Decision Time; Freedom of Information, etc. – There must be clarity and predictability for investor to cover all circumstances – There will be Short-term uncertainty till rule is in vogue and interpreted – Safeguards against changes due Political instability • Contract Based – Written in contract, so No unilateral changes – Contractual safeguards against misbehaviour by any party – Pressure is on both parties to anticipate eventualities correctly from start – Political stability:Contracts less likely to be revoked than Rules which can be changed – Can provide for multi year tariffs to ensure certainty for financial closure 19

Policy Choices in Tariff Regulation till advent of Competition & Markets RATE OF RETURN – Rate of return formula: (capital investment

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DEPRECIATION)x ROR + expenses: – Regulator determines ROR, on equity or capital, – depreciation rates, treatment of tax & foreign exchange fluctuations, – accepts all or part of capital investment, can question capital costs, rate of interest, etc) – Fixes operational Norms PRICE CAP – Price cap formula: Base Tariff x RPI (-x?) where x is efficiency factor not allowed, I.e. shared with consumer – Cap is fixed and operator free to improve efficiency and earn more – Adjustment for inflation not fully given since it assumes improvement in efficiency and partly shared with consumer – HOW WILL CCI DECIDE ON THESE?

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Pros & cons of ROR & Price Cap DELETE

Rate of Return

Data intensive (Poor or nil data) Regulator is practically reviewing quality and actions of management Regulator is deciding on profits Based on uniform operating norms (cost, efficiencies, etc) Rates of Return vary with time and efficiency but here they are constant for that Project

Price Cap

Very theoretical(assumptions about inflation numbers,& efficiency) But Regulator does not interfere in management Regulator only indirectly reviews profits by deciding Base Tariff Operator determines operating factors, not regulator More depends on performance 21

What does the Independent Regulator Do?

• Simulate effects of Competition 1) Adjudication of Disputes 2) Policymaking concurrent with Regulation 3) Enforcement of Orders and Ensuring compliance : 4) Advocacy of Regulatory functions and reform Vision 5) When all or some end product prices are capped, how can you leave prices to competition? The Dilemma of ‘abolition’ of APM.

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Enforcement Powers with regulator • Can impose Only Civil penalties • Decides Standards-e.g. operating norms, quality of service • Can Order performance-quality of service, accounting, etc.

• Can Escrow (earmark future) funds • Can allow/disallow Rate adjustments • Can Adjust productivity indices and incentives • Give Public censure and embarrassment to obstreperous party 23

Enforcement Powers (2) • Revoke or suspend license • Authority to impose standards (e.g. quality of service, accounting) • Give Specific order to perform • Order Consumer refunds • Disallow capital cost/claimed current costs • Criminal sanctions 24

Institutional Issues • Single national or multiple local Regulators • Multi sector or single sector jurisdiction • Multi-member Commission or single Member • Appellate process (superior courts or government or arbitration or special appellate authority ) • Applicability of foreign laws or courts • Consumer protection (e.g. price, safety, service quality, fraudulent practices) • Clarity on jurisdiction with CCI • MOU with Other Regulatory bodies • Fulfillment of social objectives 25

CONCLUSION • Competition and Market development in Infrastructure related to effective and Independent Regulation • An articulated statement of what is competition, what are markets, what are the stages to get there in each Sector is essential • Clarity on Roles, Authorities, Accountability, Relationships, Responsibilities of Regulator and Government essential • Regulator must state his approach to issues • Expectations must be quantified 26

COMPETITION COMMISSION

• COMPETITION COMMISSION CAN LOOK AT ISSUES IN PRIVATIZATION, MERGERS, ACQUISITIONS, BUT NOT ISSUES & INSTRUMENTS IN SIMUILATING/ACHIEVING COMPETITION • “Restrictive Practices” must be left to IRCs • IRCs may be trying to simulate effects of Competition because conditions for competition will take time to be created 27

THANK YOU