A court ruling to cancel cell-phone licenses held by several telecom companies in India amid allegations of fraud in their allocation will penalize foreign companies not involved in any wrongdoing, and will likely further hit foreign investor sentiment toward India, say telecom experts.

“This is very bad for India’s reputation,” says Kunal Bajaj, a director in the Indian offices of Analysys Mason Ltd., a London-based telecom-consulting firm.
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On Thursday, India’s Supreme Court ordered the government to cancel all 122 mobile 2G cell-phone telecom licenses allotted since January 2008. An Indian advocacy group had petitioned the court to scrap the licenses due to allegations of fraud in their allocation.

Several government officials, including former Telecom Minister A. Raja, and telecom industry executives have been arrested in the so-called 2G scandal in the past year. A special Central Bureau of Investigation court is continuing to probe the matter.

The Supreme Court said the current 2G license holders — including local joint ventures of Norway’s Telenor and Etisalat of the United Arab Emirates — could continue to operate for four months.

The court said the government must then put up the licenses for re-bidding. It wasn’t immediately clear how those auctions would be conducted and what would happen to existing subscribers if current license holders decide to pull out of India. These license holders collectively account for a small market share of India’s cell phone industry.

The cancellation of all licenses came as a surprise to the telecom industry, which was hoping the Supreme Court would take a less drastic action, like ordering the setting up of an independent panel to look into cases of malfeasance on a case-by-case basis.

Major infractions could have led to termination of licenses, while less grave issues, such as technical mistakes during the bidding process, could have been dealt with by fines, while allowing companies to continue operating.

But the Supreme Court ruled that the government had erred by issuing the licenses on a first-come-first-served basis and should instead have carried out a public, transparent auction, which would have netted the state more money and stopped fraud. On this basis, it canceled all the 2G licenses.

Uninor, Telenor’s India joint venture, said in a statement it was being “unfairly treated as we simply followed the government process we were asked to. We are shocked to see that Uninor is being penalized for faults the court has found in the government process.” The company currently has 36 million customers and 17,500 employees in India.

Foreign partners like Telenor did not directly buy licenses from the Indian government, but later partnered in joint ventures with Indian companies that had earlier won the right to operate 2G services. Telenor set up Uninor in 2009 in a joint venture with Unitech Group, an Indian real estate company that had no experience in operating cell phones but won one of the 2G licenses. A senior Unitech managing director was arrested in 2011 and is now on bail on allegations of fraud in the winning of that license.

At the time of their investment, foreign companies, following procedures laid down by the Indian government, had no reason to believe there were any irregularities in the granting of the licenses, say experts. Over the years, these companies have invested major sums of money into India in an effort to gain a pie of India’s growing telecom market.

“These are the companies who have really instigated massive amounts of competition and generated huge amounts of end-consumer benefit,” says Mr. Bajaj. He says turning a blind eye to these investments is “fairly short-sighted.”

The biggest beneficiaries of the verdict are larger phone service providers like Vodafone India, Bharti Airtel Ltd. and Idea Cellular Ltd., whose licenses date to before 2008 and could expand their business. Bharti’s stock was up nearly 8% on Thursday afternoon to trade at 389.65 rupees ($8), while Idea shares gained 4% to trade at 97 rupees ($2).

The revoking of licenses comes on the heels of a flip-flop by the Indian government last year on whether to allow foreign supermarkets to set up in India. First the government gave the go-ahead, but later rolled back the decision amid pressure from opposition politicians.

“There’s no consistency in terms of regulation,” says Ashish Basil, partner in the telecom practice at consulting firm Ernst & Young India. Against this backdrop, he says foreign investors would hesitate to invest in India, particularly in sectors heavily regulated by the government.