Max Gutbrod Issue: Europe I 2002
Article no.: 14
Topic: The Challenges to Growth in Russian Telecommunications
Author: Max Gutbrod
Title: Managing Partner
Organisation: CIS, Moscow
PDF size: 24KB

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Article abstract

The infrastructure of Russia’s incumbent operating companies needs modernization. Cross-subsidized calls, lack of transparency in interconnection pricing and licensing and government reluctance to open the market according to WTO standards inhibit investment and growth. Mobile service growth has been strong, but investment to the upgrade fixed services has been hindered by these problems. The government stimulates investment in new areas, but resists changes that challenge traditional operators. This harms consumers as new, cheaper, efficient, services that endanger incumbents are repressed.

 

Full Article

As in other emerging markets, the infrastructure of Russia’s incumbent operating companies is deficient. Local calls are cross-subsidized by international and inter-urban calls. There is a perceived lack of transparency in interconnection pricing and licensing and the Russian government is reluctant to commit to opening the market in the context of Russia’s WTO accession. Foreign investment in fixed lines generally tends to be low. On the other hand, mobile operators have used foreign capital to invest heavily and have, with a certain time lag, enjoyed success similar to Western newcomers. In a scenario different from most other countries privatisation of Russia’s former state monopoly led to the creation of many, separately owned telecommunications companies. This forced the newly formed companies to negotiate interconnection prices between one another. Decentralization has also made it virtually impossible for strategic decisions to be taken on a national level. Another peculiarity of the Russian market is that historically, there were a number of fixed – line networks which operated independently of the telecom authorities. These networks, some of which belong to ministries, continue to operate separately. “It would appear then even if interconnection prices were only based on objective criteria in Russia – more so than other countries – the prices would ultimately be determined by political factors.” There are also differences between Russia, some of the other CIS countries and other emerging markets, which are less evident and have consequences, which are difficult to assess. For instance, although the telecommunications infrastructure is clearly outdated, its geographical coverage is generally adequate, despite the region’s vastness and the fluctuations in population density. Further, unlike in the former GDR, it is easy to make connections even at peak hours. Finally, CIS do not phone companies do not print directories, nor do they make them available online. While this last point may make little difference for future development, it underscores a major difference between the former Soviet and Western telephone systems; namely, that one of the functions of Western telephone systems is to keep track of phone numbers to assist in finding people and organizations. Indeed, the development of directories in the CIS seems in many ways characteristic not only of the change in mentality which has accompanied the system’s transformation, but also of the development of the telecommunications sector. The few directories that do exist in Russia are generally commercial, focusing only on listing government bodies and commercial organizations – in other words, phone numbers and addresses, which could generate sales revenues for the users. “Discussions about whether or not a state monopoly should remain, and how much foreigners should be allowed to invest in the telecommunications sector when Russia accedes to the WTO, divert attention from the real issue.” Similarly, authorities seem to allow infrastructure investment whenever this is likely to be profitable and attract new clients. Using this model, mobile operators have attracted substantial investment from international telecommunications operators and, through multi-million debt and equity offerings, the international investment community. Dissatisfaction within the industry over interconnection pricings has not played a substantial role in assessing the viability of this investment. Most likely, investors have not worried about incumbent pricing practices since the incumbents have been unable to raise the funds necessary to enter mobile communications themselves and consequently, had no interest in discriminatory pricing in other jurisdictions. In addition to investments in mobile phone services, there has also been some investment into fixed-line infrastructure. This has been aimed at providing additional services to businesses willing to pay higher charges for extra benefits. As with mobile phone services, most of this investment comes not from Russian phone companies but rather from newcomers, some of which have attracted substantial foreign investment. Although the government has allowed investment in new areas, it seems reluctant to make changes, which might affect the traditional telecom sector to any significant degree. This resistance is partly due to the legal system’s lack of sophistication with regard to the telecommunications industry. For instance, although several projects to place international fibre optic cables alongside pipelines have been announced, they have never been successfully completed. This is due, primarily, to problems in determining whether the owner of the telecommunications lines can be other than the owner of the relevant real estate. A more substantial obstacle to development can be attributed to concern that new technologies might draw users away from the current system and lead, ultimately, to its financial collapse. If, for instance, new digital inter-urban and international lines became accessible, dependable and easy to use, this might jeopardize the owners of existing, somewhat undependable, obsolete analogue lines. Eventually, these lines might be forced out of use. Disruptions of this sort could lead not only to financial problems for the companies concerned, but also to political problems for the powers-that-be, if service to large numbers of citizens is disrupted or becomes markedly more expensive. Similarly, resistance to complying with GATS tele-communications sector obligations seems to be prompted by the fear of losing control by allowing developments that could eventually endanger the whole sector and cause political problems. There are some more-or-less obvious downsides to what may seem to be a realistic, although cautious, approach. First, this approach harms consumers. New technologies providing cheaper, more efficient services are kept from the market whenever they endanger the incumbents. To some extent, this has been the case with satellite-based personal mobile telecommunications services. By requiring a Russian gateway, the government has probably prevented satellite mobile service operators from offering inexpensive international connectivity. Voice telephony using the Internet also seems to have been subject to rather arbitrary restrictions. Cable TV though, the first stage of multifunctional broadband access, which could eventually also provide voice IT-telephony services, Internet access and other services, currently seems to be completely free. Indeed, the political powers that be seem to encourage this segment of the market. “A pricing model based on the cost of building required infrastructure would be more logical and seems to be what the Russian Anti-monopoly Ministry (the regulatory body in charge of pricing) is currently contemplating.” Secondly, and even more importantly, this approach leads to lack of transparency and predictability; it prejudices investment conditions and allows insider transactions. This lack of transparency is most notable in current licensing practices and interconnection pricing. Current licensing practice includes restrictions on interconnection, which are very clearly designed to protect the providers of inter-urban and international services. This practice has no basis in existing legislation, which gives the impression that licences for telecommunication services can be granted provided the operator is qualified and has the facilities to provide telecommunication services. Thus the current practice, which deviates from the legally regulated licensing regime, sets a problematic precedent. “New technologies providing cheaper, more efficient services are kept from the market whenever they endanger the incumbents.” Interconnection pricing, as in many countries, is the most important single issue for the long-term future of the telecommunications industry. In the absence of market prices, interconnection prices should logically be based on the costs of interconnection. There is however, no reliable basis for determining the costs of using an infrastructure that was constructed in socialist countries. Arguably, a justifiable price for this type of cost should be close to zero since the equipment, measured by world standards, is worthless. This approach, though, is not workable: such low pricing would not generate enough revenue for investment and would endanger the financial viability of the existing infrastructure. “There are some more-or-less obvious downsides to what may seem to be a realistic, although cautious, appraoch.” A pricing model based on the cost of building required infrastructure would be more logical and seems to be what the Russian Anti-Monopoly Ministry (the regulatory body in charge of pricing) is currently contemplating. Indeed, even if investment is generated in some locations, it is questionable whether this will benefit many of the regions of the huge Russian Federation. Furthermore, distortions in interconnection pricing are inevitable considering the many entities into which the former monopoly has been split. Although it was previously possible to cross – subsidize inter-urban and international calls (using local call revenues from diverse jurisdictions within the original, monopolistic structure of the incumbent), cross-subsidization in Russia today would have to take place, company by company, between the many operators created by privatisation. A local operator, then, would need to get his share of the overcharge for inter-urban and international calls by overcharging on interconnection prices. “In a scenario different from most other countries privatisation of Russia’s former state monopoly led to the creation of many, separately owned telecommunications companies. This forced the newly formed companies to negotiate interconnection prices between one another.” It would appear then, that even if interconnection prices were only based on objective criteria, in Russia – more so than in other countries – the prices would ultimately be determined by political factors. This clearly gives ample opportunity to determine interconnection prices for all operators in an arbitrary manner. Given the overall tendency to encourage investment, that is not presently a danger to the existing system. Interconnection prices are not prohibitive for new entrants, although there is reason to believe that some operators obtain better prices than others. Discrimination does not seem to have reached a level that forces profitable companies to give up their business. However, once prices for local interconnection generally increase, it may well be that strategic – or seemingly strategic – decisions are made which force some currently successful operators with substantial investments to sell. Conclusion Discussions about whether or not a state monopoly should remain, and how much foreigners should be allowed to invest in the telecommunications sector when Russia accedes to the WTO, divert attention from the real issue. The issue is not whether foreign investment on the basis of goodwill should be allowed but rather, if a clear, transparent and predictable legal basis for sector activities should be established. This may well include enhanced personal and corporate liability for operators, which charge discriminatory interconnection prices and a complete overhaul of the licensing system. The revenues already generated, and the investments already attracted by the new entrants all over the CIS, demonstrate the potential of this market. By establishing legal stability, Russia could stimulate a building boom and create the telecommunication infrastructure and system growth needed to provide the advanced services necessary for international competitiveness.