'Bank mergers lead to too-big-to-fail entities'

We have to ensure that mergers do not substantially reduce competition and consumer choice, says Indian Finance Minister P Chidambaram.

There are massive gains, both private and societal, from mergers and integration in industries: economies of scale, ease of information transmission, reduction of uncertainties, and synchronisation of demand and supply are just some of the benefits of integration. At the same time, we have to ensure that mergers do not substantially reduce competition and consumer choice.

A good example is the telecom sector. Given the high costs and rapid pace of technological development, telecom is a market where there are obvious gains from integration. However, as has been shown by developments in the US and Europe, consumer experience is extremely sensitive to the prevailing market structures.

What is important is not just to ensure current competition between existing players, but also potential competition between existing players and new entrants, and between current technologies and emerging technologies.

At the same time, regulators need to keep in mind the feature this sector has of a natural monopoly, with large up-front fixed costs and low variable costs. Such industries can succumb to ruinous competition, where no player makes enough money to be financially healthy.

The Indian telecom market has thrived with competition. Indian call rates are among the cheapest in the world, as Indian firms have evolved a uniquely Indian business model. Large volumes have, of course, helped, but those large volumes and the broad reach of communications - a cell phone in almost every hand - would not have been possible if it were not for the low price emerging from the business model.

However, there are downsides. Quality has suffered. The sector is laden with debt. New players are loathe to enter and some existing ones are threatening to quit. Auction of spectrum has found no bidders in several circles. Going forward, though, one can foresee the continuing need for regulation to ensure competition, innovation, and low rates and better service for the consumers.

There are other sectors that may well need restructuring, and each sector has its own issues. For example, some banks, including some public sector banks, among the 26 PSBs that we have, may be better off merging. The need for two or three world-size banks in an economy that is poised to become one among the five largest in the world is rather obvious.

At the same time, mergers may reduce competition in certain segments or geographies substantially, and may alter competition between banks and non-banks. Are our regulators well positioned to evaluate the consequences to competition in different sub-markets and across regulatory jurisdictions? Is there a role for the Competition Commission of India here?

Finally, we have seen bank mergers lead to too-big-to-fail entities. What constitutes a merger too far? How do the relative merits of prudential regulation and competition regulation weigh?

Monopolies

Let me turn now to pure natural

monopolies. They arise when there are gains from concentration of ownership, for instance, because of large upfront investments. Fortunately, there are fewer and fewer situations where pure natural monopolies exist. For instance, power distribution used to be thought of as a natural monopoly, but given the advances in technology, we can allow multiple producers to distribute via the same grid - indeed, much of India is moving this way.

Nevertheless, there are still a number of areas, many of them involving services to the public such as water distribution, which are natural monopolies. Given that we are increasingly turning to private firms in these areas, we do need regulation. We need separate regulators for such sectors, whose role will be to keep the private producer working for the public interest while ensuring the producer makes reasonable profits and that the public sector does not transfer undue risk on to the private sector.

Public sector enterprises

In theory, public sector undertakings are not influenced by pure profits, and are an arm of the government. As such, concerns about excessive prices and anti-competitive practices may seem unwarranted. Yet, this assumes an idealistic view of PSUs that is not borne out by reality. As an institution, a PSU may well care about its profits and market share as much as any private sector entity.

Moreover, the deadening effect of lack of competition or the lack of incentives to innovate or produce quality goods and services is as likely to affect PSUs, where survival is assured, as it does private sector enterprises. But perhaps the most important reason to bring PSUs under scrutiny for anti-competitive practices is that we increasingly have an open economy, where the private sector has to compete with the public sector.

A level playing field is in the best interests of the public - the consumers whose interests the CCI is mandated to protect.

PSUs often are handicapped by government regulations on recruitment, pay, procurement and pricing that limit their business independence and flexibility. They are also open to government directives. While these directives are rare and usually in the larger public interest, they can detract from firm efficiency and profitability.

Sometimes, to presumably compensate for these handicaps, PSUs are given special privileges - they are favoured in government contracts, for instance.

Favouring PSUs by the government can be anti-competitive, and create an un-level playing field. In the medium term, we have to remove the constraints on PSUs that limit their ability to compete, even as we take away special privileges and make the playing field as level as possible. There are difficulties in doing that.

For instance, the public may believe, or even expect, that PSBs have the implicit protection of the government, and are thus safer. An important role of the CCI in the years to come will be to guide us on how the interaction between the government and PSUs should play out to create the most competitive environment that we can.

Finance Minister P Chidambaram’s inaugural address on the Competition Commission of India’s annual day, in New Delhi on May 20.