COMMENT: A harsh regime but BT is big enough to take it

`BT's campaign for early full-scale deregulation was never a runner. But a more relaxed approach certainly seemed a possibility'

British Telecom surely never seriously expected Oftel to run up the white flag and abandon price regulation altogether when the present controls run out in July 1997. But it might realistically have hoped for a more enlightened approach than the one meted out by the industry watchdog yesterday. Even if competition in telecommunications were already sufficiently developed to make price regulation unnecessary, which it is not, the public is plainly not yet ready to see the bobby entirely removed from the beat. BT's campaign for early full-scale deregulation was never a runner. But a more relaxed approach, with a progressive phasing out of most forms of price control by the turn of the century? Certainly that seemed a possibility.

As it is, rigid price controls are to remain until 2001, and on the face of it, they are harsh ones too. The more BT studied the detail of Don Cruickshank's proposals yesterday, the more depressed it became about them. While the overall price cap of the rate of inflation minus 5 to 9 per cent does not seem significantly different from the one presently in force - RPI minus 7.5 - it is plainly not possible for BT to carry on cutting costs at the present rate indefinitely. During the period of the present price controls the BT workforce has shrunk by over 100,000 to 134,000. There's more to go but not much.

Furthermore, in setting the new price cap the regulator is making some heroic assumptions about growth. Phone usage is obviously going to grow dramatically over the next five years but there are big differences about how much. BT's own forecast is that the average of call minutes per line will rise by only 2 minutes to 13 minutes. The regulator, by contrast, is assuming usage will rise by more than half to 17 minutes.

And there is worse. As foreshadowed in an earlier discussion document, in calculating the price cap, Mr Cruickshank has slashed the allowed rate of return on capital to a range of just 9.2 per cent to 13.4 per cent, a level which BT, and indeed many of its competitors, regards as wholly inadequate. What this means in layman's terms is that in order to raise the rate of return to a more acceptable level, BT is going to have to outperform the regulator's already optimistic assumptions on both volume and the scope for efficiency gains. If it underperforms on only one of these yardsticks, its rate of return will fall below even the regulator's prescribed level and there will be nothing BT can do about it.

Enough special pleading for BT, however. BT is always crying wolf and it is undoubtedly exaggerating the true position in the hope of winning concessions. Furthermore, BT is large and financially robust enough to take the pain if the regulator does prove to have been over-zealous. The real question is: are the others? If the price ceiling is too low, competitors will be discouraged from coming into the market. Even now, BT's competitors are not exactly in rude health. Since all competitors have to undercut BT to make inroads, too onerous a price control regime for BT is going to be doubly so for them. Paradoxically, therefore, the effect of the regulator's proposals might be to make BT even more dominant than it is now, by driving the competition out of the market place.

Efficiency gain and investment are also linked issues. You do not get efficiency gain without investment and if the return allowed on new investment is too low, then you don't get any new investment. The further the regulator drives down the allowed rate of return, therefore, the less likely he is get the efficiencies from which lower prices are derived.

These are difficult issues to call, as Mr Cruickshank readily concedes in what on the whole is a well thought out and thoroughly researched consultation document. Telecommunications is a fast changing industry. Such are the wonders of new technology that there are virtually no capacity constraints. The network's ability to absorb ever higher volumes is almost limitless. In theory then, there is scope for prices to fall very substantially regardless of what the regulator does. The 10p transatlantic telephone call, already a reality on the Internet, is possibly only years away. Mr Cruickshank may actually find his new price controls rendered wholly irrelevant by the force of the market alone. To happen under its own steam, this would admittedly require a really quite breathtaking increase in volume, but it is more than a possibility.

In this scenario, the business of providing carriage for telephone traffic becomes a wholly commoditised and very low margin one. For the telecommunications company of the future, the chief source of revenue is not the traditional one of shunting voices around the globe, but in add-on, high-value services. To survive, BT is going to have to become much more of a service provider than a network operator.

Broad money and flares back in fashion

Just as the catwalks have been displaying late Seventies touches such as flares and hipsters, so the latest trend in economic analysis harks back to those days of early monetarism. Broad money is back in fashion. The reason is that M4 has been the only one of the monthly indicators signalling against Mr Clarke's interest rate cuts. Its annual growth has been steadily increasing, even as actual inflation and manufacturing activity have slowed. No wonder it has caught the eye of City commentators.

One well known monetarist, Professor Tim Congdon of Lombard Street Research, has concluded that the surge in M4 growth since the start of 1994 looks rather like earlier episodes of monetary expansion in 1977 and 1986. With banks eager to carry on expanding their balance sheets, it will continue, he reckons. The result of several years of rapid money growth will be inflation above 5 per cent by 1999 and perhaps as high as 10 per cent.

The Clarke case against this monetarist revival has several strands. The new gilts repo market clearly distorted M4 upwards in January and will make the monthly figures more erratic. In addition, there has been rapid growth in the deposits and borrowings of companies and financial institutions, which is likely to be related to higher takeover activity. This does not have any immediate or direct implications for the pace of economic activity and inflation, although it might eventually. Finally, the Chancellor thinks there is no evidence yet that growth in personal sector deposits prefigures faster consumer spending.

This combination of special factors and not looking too far ahead allowed Mr Clarke to conclude in his February meeting with the Governor of the Bank of England that "it was not clear that M4 growth posed an inflationary risk at the moment".

The danger is that by the time it is clear, it will be too late to do anything about it. But Mr Clarke does not have to join the fashion groupies in the City to admit that with M4 racing away and signs of consumer spending turning positive, there is little case for the further reduction in base rates many analysts expect after the May local elections. The chances of him doing so are none the less remote.